Credit Risk Reflected in a LIBOR Swap’s Fixed Leg

Summary

The document asks what credit exposure is reflected in the fixed leg of a five-year swap exchanging fixed payments for three-month LIBOR, while setting aside counterparty risk. The response explains that LIBOR represents unsecured interbank borrowing offers, so its level reflects the credit quality of the banks contributing to the rate setting. It characterizes that contributing-bank quality as generally around AA.

The explanation is brief and conceptual: it connects the floating reference rate to interbank credit conditions rather than analyzing swap valuation or deriving a separate fixed-leg spread. It does not quantify how much credit risk appears in the fixed rate, distinguish individual bank credit from the panel average in detail, or discuss changes in LIBOR’s construction over time. The stated rating characterization should therefore be treated as a broad description of the benchmark’s historical setting, not a precise measure for every swap.

Key ideas

• LIBOR reflects unsecured lending rates offered among participating banks.
• The benchmark therefore incorporates the average credit quality of its contributing banks.
• The response characterizes those banks as generally around AA credit quality.
• The document does not quantify the credit component embedded in a particular swap’s fixed rate.

Tags

# Libor Swap Rates


# Libor Swap Rates












In a 5 year Libor Swap, say fixed vs. 3 months Libor, what is the credit risk reflected by the fixed leg ? (I'm ignoring counterparty credit risk). Would the fixed leg reflect 3 month Libor quoting bank credit quality ?

## Answer by AlRacoon (score 1)

https://quant.stackexchange.com/a/39023

LIBOR is the London Interbank Offered Rate. These are the rates that banks are offering to lend to each other and therefore will reflect the average credit quality of the banks that participate in the establishing the setting of the rate, which is generally about a AA credit rating.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.