Question

Q1. Evaluate whether these rates (LIBOR and OIS) are risk-free?

Answer 1

London interbank rate are short-term rate that will be charged by bank from each other for the shorter period whereas overnight indexed swap is the rate of the central bank like indexed fund rate in United States of America for a particular period of time.

These rates are not risk free as there are various banks involved who have a greater credit risk during the times of insolvency as we can see at the time of 2008 crisis these rates were implicating that various parties to the London interbank rate were having a risk associated with insolvency and they were not able to fulfill with their obligation so we cannot consider these rates at risk free rate because these are not risk free during the times of the crisis when there is a risk of insolvency and hence we will not be considering London interbank rate along with overnight index swap as risk free.

These rates are not risk free rate and there are certain credit risk which are embedded with them and that will be visible at the time of financial crisis when many of the participants in these interbanking rates and over night swaps default.