A
Alpha9
Member
Should I just accept that the market's best guess at LIBOR in n years' time is the n-year forward rate?
Page 28 of the notes suggests that an (n-year) FRA ( paying LIBOR and receiving fixed 6%) will have zero value if the forward rate is 6%. I think the value will actually be (6% less expected LIBOR) discounted for n years. So the only way this can be zero is if I expect LIBOR to be equal to the n-year forward rate.
Is that about the size of it?
But then I'm not sure where any credit risk of the banks comes in: actual LIBOR tends to be higher than equivalent Treasury Bill rates because of banks' credit risk, according to the solution of 3.13 ("What is LIBOR?") on page 36. Meanwhile we can work out forward rates from spot rates, which don't seem to involve credit risk...
Page 28 of the notes suggests that an (n-year) FRA ( paying LIBOR and receiving fixed 6%) will have zero value if the forward rate is 6%. I think the value will actually be (6% less expected LIBOR) discounted for n years. So the only way this can be zero is if I expect LIBOR to be equal to the n-year forward rate.
Is that about the size of it?
But then I'm not sure where any credit risk of the banks comes in: actual LIBOR tends to be higher than equivalent Treasury Bill rates because of banks' credit risk, according to the solution of 3.13 ("What is LIBOR?") on page 36. Meanwhile we can work out forward rates from spot rates, which don't seem to involve credit risk...