Interest Rates

LIBOR

bbalibor maintains a list of interbank rates. You can see current quoted rates for a given period. LIBOR stands of London inter-bank offered rates, and represents an estimate of the interest paid by banks when they borrow money between each other.

Some bonds and paid in relation to interbank rates.

Central Bank Rates

There are central bank rates that set via monetary policy.

The latest benchmark interest rates can be found at the respective reserve bank sites. You can lookup rates for EUR (Fixed rate), USD (Fed funds effective), AUD (Cash rate target)

Net, Gross and AER rates

Gross rate is the interest rate before tax is applied. It is typically calculated daily.

AER rate is the Annual Equivalent Rate. It is the rate you would receive if it is was calculated yearly. If you are paid interest more than once per year (e.g. monthly), then the AER will be higher than the Gross rate as it is calculated using compound interest.

Net rate is gross rate with tax deducted. In UK this is 20% for a typically tax payer. Any difference is paid or reclaimed as part of your tax return.

USD rates

Federal funds effective rate

The weighted average of the Federal funds rate is known as the federal funds effective rate.

Federal funds rate

If a bank falls short of their reserve requirement, it can temporarily borrow the shortfall from another bank.

The rate of this loan is negotiated between the banks themselves, and is known as the federal funds rate.

Federal funds target rate

The Federal Open Market Committee determines the target USD rate for the federal funds effective rate.

Open Market Operations

To lower the fed funds target rate, the Fed will print money, and buy short term treasures from commercial banks in the open market.

Commercial bank balance sheets have: assets = loans + reserves, liabilities = deposits.

If a commercial bank sells $100M worth of bonds to the Fed, then their cash reserves will go up by $100M. Total assets stay the same (-$100M bond asset, but +$100M cash reserves).

This improves their reserve ratio and will more easily meet the reserve requirement. This lowers the demand for borrowing from other banks, and will lower the fed funds rate and help the FOMC reach their target.

Reserve Requirement

The fed requires banks to keep a percentage of cash compared to the amount of deposits they take. e.g. a reserve requirement of 10% means that a bank that has been given $90 million in deposits must keep $9 million as cash. See the current US reserve requirements.

Banks keep cash reserves at the Federal Reserve

Quantitative Easing

OMO is normally used to achieve the interest rate target. But when this reaches 0, it is no longer effective, so instead of short term treasuries, the Fed can buy other securities like long term treasures, bonds, or mortgage backed securities.