Current Exchange Market and Challenges

Exchange Markets

Global Credit Markets

Assess the importance of LIBOR to the world's financial/credit markets.

The London Inter-Bank Offered Rate (LIBOR) is one of the single most important determinants of interest rates in the world. As such, it commands an unparalleled effect on the world financial and credit markets. According to the text by Kennon (2012), the vast majority of the credit-worthy banks in the world look to the interest rates set daily by the LIBOR in order to author their own interest rates. In this regard, the LIBOR sets the climate for interest rates in a way that is more immediate, dynamic and impacting that the occasional and reactionary terms offered by organizations such as the United States Federal Reserve.

As Kennon notes, the interest rates offered by the LIBOR are produced every day at 11AM London time and, from there, may shift numerous times during the course of a trading day. The fact of that LIBOR is the primary determinant in shaping interest rates means that it can have a profound impact on the long-term economic prospects of whole nations. Indeed, its setting of interest rates will have a direct bearing on the interest rates on the highest scale loans such as those engaged between national governments in the interests of providing economic aid. As the text by Kennon notes, "LIBOR is important because it is often used as the base for variable-rate government and corporate loans and derivative-based products such as credit swaps. A small, impoverished nation, for example, may have to pay a spread of a percentage point or two above and beyond the established LIBOR rate; thus, an increase or decrease in LIBOR will result in a corresponding rise or fall in its cost of borrowing." (Kennon p. 1)

This means that the LIBOR is a determinant entity in establishing or relieving the economic burden placed on nations both in the developed sphere. Another aspect of importance in understanding the profound impact of the LIBOR on the world's financial and credit markets is the fact that its terms are based on the Eurodollar. This means that for much of the world, interest rates are tied to the availability and performance of the Euro on currency trade markets.

2. In your own words, relate the importance of a CDS to the Credit Crisis of 2007-2009.

In the latter part of the 2000s, the global community was afflicted with a sudden and disastrous downturn of the world's credit markets. The culprit was identified as subprime lending, in which individuals who were not otherwise suited for the terms of their repayment conditions were awarded with large scale loans such as mortgages. When a sudden downturn in the stock market produced evidence that numerous major banks were not in a position to repay withdrawing investors, collections and foreclosure became threat to subprime borrowers.

A major culprit that was less readily identified, however, would be the Credit Swap, a transactional strategy which became exceedingly popular in the financial trading markets in the years just before the credit crisis took hold. According to the text by Microchnik (2010), "CDS are meant to simply shift economic risk to those parties most willing and able to bear it without adding systemic risk to the economy, during the recent financial crisis the unregulated and pervasive CDS market actually contributed to systemic risk." (p. 1)