EURIBOR, three-month

In contrast to a conpon rate that remains unchanged for the bond s entire life, a floating-rate security or floater is a debt instrument whose coupon rate is reset at designated dates based on the value of some reference rate. Thus, the coupon rate will vary over the instrument s life. The coupon rate is almost always determined by a coupon formula. For example, a floater issued by Aareal Bank AG in Denmark (due in May 2007) has a coupon formula equal to three month EURIBOR plus 20 basis points and delivers cash flows quarterly. 

Floating-rate notes (FRNs) are Eurobonds that have their coupon levels reset periodically, with reference to a money market rate. For dollar-denominated assets, this is LIBOR (the London Inter-bank Offer Rate) as determined by a group of 16 reference banks. The mechanism is run by the British Bankers Association (BBA). The BBA also supervises LIBOR fixings in a number of other currencies. For euros, the most common reference rate is EURIBOR, as determined by a reference group of around 50 banks chosen by European Banking Federation. In both cases, most issues are priced off of the three-month rate, although one-month and six-month rates are also used. 

In this case the investor has effectively bought from XYZ a 3-year floor on 6-month EURIBOR struck at 2% for an up-front premium of around 2 bp (very cheap), equivalent to less than 1 bp p.a. over three years. XYZ deducts 2 bp from its normal EURIBOR margin to offer investors a slightly lower yield of EURIBOR plus 38 bp right now, in return for guaranteeing that the rate cannot fall any lower. XYZ uses 1 bp of the 2 bp deduction to buy the 3-year floor (perhaps from a bank), and keeps the other 1 bp itself. 

LIFFE 3-month EURIBOR futures out to three years... 

We consider three-or-six-month EURIBOR swap yields with maturities ranging from one year to 10 years and find recursively equivalent zero-coupon rates. Swap yields are par yields so the zero-coupon rate with maturity two years R(0,2) is obtained as the solution to the following equation ... 

---

See also in sourсe #XX -- [ , , , ]

---