The London Interbank Offered Rate (LIBOR) is arguably the single most important short-term interest rate in the world. Loans for mortgages, credit cards, small businesses and automobiles are just a few of the credit products that reflect a relationship with LIBOR. Using some basic math and a step-by-step calculations, we can demonstrate how Barclays and other banks extracted wealth from trading partners and customers.
Just bear in mind that LIBOR is the benchmark for short-term loans of varying duration not exceeding one year. Loans are structured on a 31-day month, 360-day year.
To demonstrate how basic interest formula works, simple interest is calculated using real numbers and a LIBOR interest rate quote from last week for a $1 million loan for one month. The interest rate of 0.24875% is the average for this duration.
M(t) denotes the measure of time - the duration of the loan in the number of days. You can notate this formula a different way. The answer will be the same as above.
Interest rate swap formula is where this calculation gets a bit more complicated. Banks will often enter swap agreements with their customers. A 'swap' is an arrangement in which banks will occasionally exchange interest rate payments. Swap agreements provide banks a primary target for market manipulation. In essence, banks have the power of little gods to control the flow of global capital.
Next: How they did it.
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