Question

Explain and analyze the following :
1- operation of federal markets and euro dollar markets
2- the importance of federal funds rate and LIBOR
3- LIBOR manipulation scandal and regulatory outcomes

3000 words + references

Answer 1

1- Operation of Federal Markets-:

• The Federal Reserve buys and sells government securities to control the money supply and interest rates. This activity is called open market operations.
• The Federal Open Market Committee (FOMC) sets monetary policy in the United States, and the Fed's New York trading desk uses open market operations to achieve that policy's objectives.
• To increase the money supply, the Fed will purchase bonds from banks, which injects money into the banking system. It will buy bonds to reduce the money supply.

Operation of Euro Dollar Markets-:

A eurodollar is U.S. currency held in banks outside the U.S. (typically in Europe). Eurodollars are not the same thing as euros, the currency of the European Union.

How Does a Eurodollar Work?

The eurodollar market began in the 1950s, when the Soviet Union began moving its dollar-denominated oil revenue out of U.S. banks in order to prevent the U.S. from freezing its assets.

Let's assume XYZ Company moves $10 million from its Wells Fargo account in New York to a London bank. XYZ Company receives a eurodollar time-deposit certificate from the London bank. The London account balance is in dollars, and any interest earned on the account accrues in dollars as well. The London bank may use the funds to make loans, perhaps in the United States. Most eurodollar deposits pay interest and have fixed maturities (since they are time deposits).

Dollars do not have to be deposited in a European bank to be considered eurodollars; the Bahamas, the Cayman Islands, and non-European countries are also popular. Foreign branches of American banks can also accept eurodollars.

The eurodollar market includes U.S. and foreign corporations, individuals, and foreign governments. London is a major eurodollar center because its markets operate during the American and Asian markets.

The markets depend on a supply of depositors willing to move their dollars from American banks to foreign banks. Eurodollar banks could have liquidity problems if this supply falls, and many banks have standby lines of credit with U.S. banks to prevent this.

2- The importance of federal fund are -:

• The federal funds rate is the interest rate target at which banks borrow and lend excess reserves from one another on an overnight basis.
• A committee of the Federal Reserve sets a target federal funds rate eight times a year, based on prevailing economic conditions.
• The federal funds rate can influence short-term rates on consumer loans and credit cards.
• Investors also pay attention to the federal funds rate because a rise or fall in rates can sway the stock market.

The importance of LIBOR are -:

The five-letter acronym, LIBOR, stands for London Interbank Offered Rate, but its significance spreads far beyond the City of London or even Europe. Indeed, the LIBOR rate it is one of the most globally significant numbers in finance. Banks, financial institutions, and credit agencies all over the world look to LIBOR to set their own interest rates. There are currently outstanding contracts worth trillions of dollars spread across different maturities from overnight to 30 years that all reference the benchmark LIBOR. According to the UK Treasury, the value of financial contracts tied to LIBOR touches $300 trillion. However, this does not include consumer loans or adjustable rate home mortgages. According to the ICE Benchmark Administration, “In total, hundreds of trillions of dollars’ worth of interest rate exposure is tied to ICE LIBOR.”

One of the main reasons LIBOR is used so widely is because of the way the rate is calculated and constructed. LIBOR represents the lowest borrowing rate among banks and big financial institutions. Other rates are fixed on top of the LIBOR. This is often expressed as “LIBOR + X bps” where, bps stands for basis point and X is the premium charged over and above the LIBOR rate by the lender to the borrower. Thus any increase or decrease in the base rate (which is the LIBOR rate) impacts contracts tied to LIBOR or based on it as a benchmark.

LIBOR is commonly used as the floating rate for interest rate swaps, future contracts, mortgages, student loans, and even corporate funding. LIBOR is also used for setting the settlement prices for interest rate future contracts that help companies to hedge interest rate exposure. LIBOR provides a fair idea to central banks and other important institutions about the expectations on interest rates and linked developments.

3 LIBOR manipulation Scandal -:

The LIBOR scandal, which came to light in 2012, involved a scheme by bankers at many major financial institutions to manipulate the London Interbank Offered Rate (LIBOR) for the purposes of profit. The LIBOR, which is calculated daily, is supposed to reflect the interest rate that banks pay to borrow money from each other. It is also the basis for determining the rates charged on many other kinds of loans. Evidence suggested that this collusion had been going on since at least 2005, possibly earlier than 2003.