Wall street journal swap rates

Finance Case Study

the "Has LIBOR lost its Stature in Derivatives Markets?" is the case taught you have to read and use the data in the case and do some research to do the questions.

2. the second word document is the instructions, you have to follow the instructions to do the project and answer the questions in it. Do not write more than 250 words for the first and third questions. Do more calculation and processes in the second question.

3. The rest three pdf are the basic knowledge you need to know and they teach you how to do the swaps correctly. Please read them. Thank you very much.

HAS LIBOR LOST ITS STATURE IN DERIVATIVES MARKETS?1 Ken Mark wrote this case under the supervision of Professor Walid Busaba solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. This publication may not be transmitted, photocopied, digitized or otherwise reproduced in any form or by any means without the permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) cases@ivey.ca; www.iveycases.com. Copyright © 2016, Richard Ivey School of Business Foundation Version: 2016-10-31

It was April 5, 2016, in New York, and the management of a large U.S. proprietary trading group was debating what discount rate to use to value the group’s interest-rate swap portfolio. The group had a substantial interest-rate swap portfolio laid over its fixed-income fund. The counterparties to the swaps were major U.S. banks, and the deals were collateralized. The question was which of the two reference rates—the London interbank offered rate (LIBOR) or overnight indexed swap (OIS) rate—was a more appropriate discount rate. Members of the management team needed to consider that derivative pricing practices had evolved in recent years as market participants refined their pricing approaches to capture the elements underlying the pricing of derivative transactions in a changing market. The increased use of collateral (in derivative transactions) was driven by an increased focus in the over- the-counter market on credit risk and funding risk management, as well as by the migration of derivative activity to clearing houses where transactions were typically fully collateralized. As a result, certain collateralized derivatives may be presumed to require valuation based on discounting at the OIS rate. The head of the management team noted that there was talk from the Bank of England about an alternative, nearly “risk-free” reference rate that could potentially be launched during 2016. There was also a rumour that OIS rates—whether in U.S. dollars, euros (euro overnight index average), or pounds sterling (sterling overnight index average)—were becoming more popular reference rates in financial transactions and securities, some of which might end up in the group’s fixed-income fund. He wondered whether it was time to substitute some of the maturing LIBOR-based interest-rate swaps with OISs. THE LONDON INTERBANK OFFERED RATE The increasing use of futures contracts to hedge against interest-rate risk sparked demand for a reference rate on which these contracts could be based. In 1986, the British Bankers’ Association (BBA) posted the first LIBOR rates for three currencies: the U.S. dollar, the Japanese yen, and the British pound.

1 This case has been written on the basis of published sources only.

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Page 2 9B16N058 At its inception, LIBOR was actually three separate rates based on average rates charged by panels of banks for each currency. The BBA selected a minimum of eight contributor banks per panel, and each bank submitted its estimated cost to borrow a “reasonable” amount of currency for a short period of time from another bank. The BBA worked with a steering group consisting of market practitioners on the LIBOR rate fixing process. By 2008, LIBOR rates were posted for 10 currencies in total and 15 maturities per currency (see Exhibit 1). A total of 15 different maturities—from an overnight rate to a 12-month rate—was collected for each currency from each contributor by 11 a.m. each day. Contributors—often treasurers at their banks— assessed how much working capital their banks needed to meet the maturing liabilities on their balance sheets. In preparing their LIBOR submissions, the contributors answered the question, “At what rate could you borrow funds, were you to do so by asking for and then accepting interbank offers in a reasonable market size just prior to 11 a.m.?”2 BBA’s third-party contractor, Thomson Reuters, managed the process on its behalf, and contributors relied on a secure online system to enter their submissions. Only the middle two quartiles of rates were used in each LIBOR calculation. To calculate the LIBOR rate for a particular currency and maturity date, the arithmetic mean of the middle two quartiles of submissions was used. Although there were 150 rates in total, these rates were collectively known as “BBA LIBOR,” in reference to the organization that managed the rate-setting process. Here is additional information on LIBOR: BBA LIBOR is not a compounded rate but is calculated on the basis of actual days in funding period/360. Therefore the formula is as follows: interest due = principal × (libor rate/100) × (actual no of days in interest period/360). Please note that for GBP, the calculation basis is 365 days. It is also important to work out the exact/actual number of days in the funding period which is not always 90 days for a 3 month deposit but could e.g. be 89 or 91 days. If you have a funding period of, for example, 45 days you could extrapolate between the 1 and the 2 month rate to arrive at the correct BBA LIBOR rate. All currencies are fixed on a spot basis on each London Business Day apart from Sterling, which is fixed for same day value. EUR rates are fixed on each Target Business Day regardless of whether it is a London Business Day.3 One criticism of LIBOR was that banks did not need to use the announced LIBOR rate when borrowing from each other. Another was that most of the interbank borrowing market was focused on money borrowed for a week or less. Thus, panel representatives had to make educated guesses when submitting their interbank borrowing rates for the majority of the rates requested. Nevertheless, LIBOR was used as a benchmark for financial contracts, including futures, mortgages, and consumer loans. In 2012, it was used in financial instruments with a total value of US$450 trillion.4 An estimated 95 per cent of the contracts that referenced LIBOR were for maturities of three months or

2 Jamie Dunkley and Harry Wilson, “Libor Explained: The Real Cost of Money or Just a Fix?” The Telegraph, March 17, 2011, accessed September 9, 2016, www.telegraph.co.uk/finance/newsbysector/banksandfinance/ 8386513/Libor-explained-the-real-cost-of-money-or-just-a-fix.html. 3 “BBA LIBOR: Definition and Conventions,” Treasury and Finance Info, accessed September 9, 2016, www.treasuryandfinance.info/TF/bba-libor-definition-and-conventions.html. 4 “BoE Says Plans to Introduce Libor Alternative Next Year,” The Irish Times, March 18, 2015, accessed September 9, 2016, www.irishtimes.com/business/financial-services/boe-says-plans-to-introduce-libor-alternative-next-year-1.2144052; All currency amounts are in U.S. dollars except where otherwise specified.

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Page 3 9B16N058 longer. LIBOR accurately reflected what actual interbank borrowing rates could be, according to the International Monetary Fund.5 LIBORs had been found to be reasonably accurate, most of the time tracking closely similar benchmarks that were tied to actual unsecured bank funding rates, such as those for commercial paper. The glaring exception was the period immediately after the September 2008 failure of the New York investment banking firm Lehman Brothers, which triggered a global financial crisis. The three-month U.S. LIBOR diverged from two similar publicly available short-term rates: the Intercapital New York funding rate (ICAP NYFR)6 and the three-month rate on eurodollar deposits, which were U.S. dollar-denominated deposits at banks located outside the United States. It had been nearly four years since a number of criminal settlements by Barclays Bank suggested collusion and fraud in the setting of the LIBOR. Barclays was accused of manipulating the rate up or down depending on the positions held by its internal trading desks. Furthermore, traders at Barclays had allegedly colluded with rate setters at other banks to influence rate submissions from these other banks. After a lengthy investigation, the process by which LIBOR was calculated was reviewed, and stewardship of the rate was transferred from the BBA to Intercontinental Exchange Benchmark Administration in February 2014. HOW—AND WHY—LIBOR WAS MANIPULATED Starting around 2003, Barclays’s traders began trying to manipulate the LIBOR rate by asking their bank’s LIBOR rate contributor to influence the rate based on their trading positions. Barclays’s traders also worked with contacts in other banks to influence their rates. LIBOR was also manipulated during the global financial crisis of 2007–2008, when banks such as Barclays, not wishing to signal to the markets that they were in trouble, submitted LIBOR estimates that were artificially low. The International Monetary Fund provided further information on this phenomenon: In part, LIBOR may have been lower after the Lehman failure because of an unintended consequence of a British Bankers’ Association rule meant to ensure that banks reported their borrowing costs truthfully: immediate publication of individual banks’ reports. While normally this would encourage honesty, in 2007–08 this safeguard may have backfired. Banks were reportedly loath to suggest that they were having trouble obtaining funds by reporting a rate higher than other banks were being charged. So to mask its liquidity problems, a bank with funding problems had an incentive to report lower rates than it really believed it would be offered. Indeed, a number of studies have suggested that banks submitted lowball rates after the collapse of the investment bank Bear Stearns in March 2008 as well as after the Lehman collapse six months later.7

5 John Kiff, “What Is LIBOR?” Finance & Development 49, no. 4 (December 2012), accessed September 9, 2016, www.imf.org/external/pubs/ft/fandd/2012/12/basics.htm. 6 ICAP is an interdealer broker and a provider of global market information and commentary for professionals in the international financial markets. The ICAP NYFR is a survey-based measure of one- and three-month unsecured bank funding costs. A daily NYFR poll is taken during the morning in New York, when the eurodollar market is most active. The banks are asked to submit a rate where a representative institution would likely be able to obtain funding in the market. ICAP NYFR is positioned by ICAP as a U.S. rate alternative to LIBOR. Richard Leong, “ICAP to Launch U.S. Rate Alternative to LIBOR,” Reuters, May 1, 2008, accessed September 9, 2016, www.reuters.com/article/usa-rates-icap- idUSN0139330120080501; “ICAP Launches NYFR Fixings,” BusinessWire, June 10, 2008, accessed September 9, 2016, www.businesswire.com/news/home/20080610006387/en/ICAP-Launches-NYFR-Fixings-SM. 7 John Kiff, “What Is LIBOR?” Finance & Development 49, no. 4 (December 2012), accessed September 9, 2016, www.imf.org/external/pubs/ft/fandd/2012/12/basics.htm.

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Page 4 9B16N058 Barclays agreed in June 2012 to pay fines totalling about $450 million to regulators in the United Kingdom and the United States. Other banks were also under investigation for misreporting LIBOR rates, and bank equity analysts estimated that fines and lawsuits could total almost $50 billion. The case of Thomas Hayes, a former trader for both UBS Group AG (UBS) and Citigroup Inc., illustrated how LIBOR rates were influenced. LIBOR rate contributors did not estimate their rates with data only; they also relied on the opinions of others in their network, according to an article in Bloomberg BusinessWeek about Hayes’s actions at UBS: During his time as a junior trader in London, Hayes had gotten to know several of the 16 individuals responsible for making their bank’s daily submission for the Japanese yen. His stroke of genius was realizing that these men mostly relied on interdealer brokers, the fast-talking middlemen involved in every trade, for guidance on what to submit each day.8 Via instant message, Hayes conveyed to these interdealer brokers his target for yen LIBOR for that day. In return, every time a contributor from a bank called to ask for the dealer’s opinion on LIBOR’s direction, the dealer would provide an answer that would work to Hayes’s advantage. As for Hayes, his profit and loss on the LIBOR-linked trades could move from a $20 million loss to an $8 million profit depending on the LIBOR rate. Each basis point movement in LIBOR was worth hundreds of thousands of dollars on Hayes’s 400 billion yen (US$3.3 billion) position. It was so important to Hayes that he formalized the relationship with the broker in question, negotiating an additional £15,000 a month for the broker’s LIBOR-related “services.” UBS, via a spokesperson, denied the institution had any knowledge of why the additional payments were being arranged.9 THE INVESTIGATION AND RESULT U.S. and European regulatory authorities led a detailed investigation into the LIBOR rigging scandal that resulted in $9 billion in fines paid by banks such as Barclays, Citigroup, Deutsche Bank, J.P. Morgan, Rabobank, Royal Bank of Scotland, Société Générale, and UBS. The investigation uncovered close cooperation between traders and brokers in the various banks and over 2,000 instances of wrongdoing by UBS employees alone. Yet, only one person received a prison sentence for his involvement in the scandal to date. On August 3, 2015, Hayes was sentenced to 14 years in prison after he was found guilty of conspiring to manipulate LIBOR. The prosecutor alleged that Hayes led a group of 25 traders and brokers from 10 firms to influence LIBOR.10 In his defence, Hayes’s lawyer claimed that LIBOR manipulation was widespread throughout the industry for at least five years prior to Hayes’s employment at UBS, and that Hayes’s superiors were aware of his efforts. Hayes was the only participant found guilty of rigging LIBOR, and a lawyer unconnected with the case suggested that it was Hayes’s decision to testify in court, combined with his contradictory statements, that led to his conviction. “In this case, Hayes’ pivotal decision to testify has proven disastrous. It would have been better for Hayes to have remained silent,” said David Corker, a partner at law firm Corker Binning

8 Liam Vaughan and Gavin Finch, “Was Tom Hayes Running the Biggest Financial Conspiracy in History? Or Just Taking the Fall for One?” Bloomberg BusinessWeek, September 13, 2015, accessed September 9, 2016, www.bloomberg.com/news/articles/2015-09-14/was-tom-hayes-running-the-biggest-financial-conspiracy-in-history-. 9 Ibid. 10 Gavin Finch and Liam Vaughan, “Former Libor ‘Ringmaster’ Hayes Gets 14 Years for Libor Rigging,” Bloomberg BusinessWeek, August 3, 2015, accessed September 9, 2016, www.bloomberg.com/news/articles/2015-08-03/former-libor- ringmaster-hayes-guilty-of-manipulating-rates.

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Page 5 9B16N058 in London.11 On January 28, 2016, the U.K. Serious Fraud Office closed its investigation against six brokers after finding them not guilty of the charge of helping Hayes in his manipulation of LIBOR.12 LIBOR AFTER THE SCANDAL—REFORM OR REPLACE? The calls for a replacement to LIBOR came as early as 2011, when evidence of misconduct first came to light. In Britain, Martin Wheatley, managing director of the U.K. Financial Services Authority, was asked by the Chancellor of the Exchequer to analyze the LIBOR scandal to see if a wider policy response was needed. He prepared a comprehensive list of recommendations for reform in response (see Exhibit 2). In summary, Wheatley proposed that LIBOR be retained as the standard benchmark, but that the various rate submissions be backed up by data to suggest they were a true reflection of estimated borrowing costs. The reported rate submissions would be released publicly only after a three-month lag, to remove the incentive for banks to influence their rate submissions to signal financial strength. Criminal sanctions were proposed for banks that had deliberately tried to manipulate the rates submitted.13 A new firm—the Intercontinental Exchange (ICE)—would administer LIBOR, and the benchmark would switch from being known as BBA LIBOR to be called ICE LIBOR.14 ICE LIBOR ICE LIBOR fixed the rate in five currencies: the Swiss franc, the euro, the pound sterling, the Japanese yen and the U.S. dollar. (Rate fixing in the Danish krone, Swedish krona, Canadian dollar, Australian dollar, and New Zealand dollar was terminated due to the absence of persistent trading activity to support credible rate submissions.) ICE maintained a reference panel of between 11 and 18 contributor banks for each currency in question (see Exhibit 3). Submissions were received and ranked in descending order, with the highest and lowest quartiles of submissions excluded. Thirty-five rates were produced each business day: seven for each currency (see Exhibit 4). In March 2015, the Bank of England indicated it would create a working group to identify an alternative to LIBOR. It intended specifically to base the new rate on actual transactions between banks, not on bankers’ estimates. As of April 5, 2016, the working group had not released any information about this alternative. Other alternative benchmarks were being suggested, including OISs. U.S. OVERNIGHT INDEX SWAPS An OIS was an interest rate swap where two parties exchanged a floating rate for a fixed interest rate on a notional amount. The term of the contract ranged from one week to two years or more. In the United States, the floating rate was based on an overnight rate index: the effective federal funds rate, as issued daily by the U.S. Federal Reserve (see Exhibit 5). At settlement dates, both parties agreed to exchange the difference between interest accrued at the fixed rate and interest accrued at the floating rate (see Exhibit

11 Ibid. 12 Graham Ruddick, “Brokers Found Not Guilty of Libor Fraud Label Trial a Farce,” The Guardian, January 28, 2016, accessed September 9, 2016, www.theguardian.com/uk-news/2016/jan/28/sixth-broker-found-not-guilty-in-libor-trial. 13 John Kiff, “What Is LIBOR?” Finance & Development 49, no. 4 (December 2012), accessed September 9, 2016, www.imf.org/external/pubs/ft/fandd/2012/12/basics.htm. 14 “ICE Benchmark Administration (IBA): ICE LIBOR,” Intercontinental Exchange, Inc., accessed September 9, 2016, www.theice.com/iba/libor.

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Page 6 9B16N058 6). John Hull and Alana White provided more information about OIS in an article that contrasted these with LIBOR: Overnight indexed swaps are interest rate swaps in which a fixed rate of interest is exchanged for a floating rate that is the geometric mean of a daily overnight rate. The calculation of the payment on the floating side is designed to replicate the aggregate interest that would be earned from rolling over a sequence of daily loans at the overnight rate. In U.S. dollars, the overnight rate used is the effective federal funds rate. In Euros, it is the Euro Overnight Index Average (EONIA) and, in sterling, it is the Sterling Overnight Index Average (SONIA). 15 OIS swaps tend to have relatively short lives (often three months or less). However, transactions that last as long as five to ten years are becoming more common. For swaps of one-year or less there is only a single payment at the maturity of the swap equal to the difference between the fixed swap rate and the compounded floating rate multiplied by the notional and the accrual fraction. If the fixed rate is greater than the compounded floating rate, it is a payment from the fixed rate payer to the floating rate payer; otherwise it is a payment from the floating rate payer to the fixed rate payer. Similarly to LIBOR swaps, longer term OIS swaps are divided into 3-month sub-periods and a payment is made at the end of each sub-period.16 Market participants monitored the OIS market as an indicator of the functioning of the interbank credit market. In particular, they looked at the LIBOR-OIS spread, which was the difference between LIBOR and OIS rates of equal maturity. Three-month LIBOR-OIS spreads were typically around 10 basis points. If the spread became larger, this was usually taken as a sign that banks were less willing to lend to each other. A smaller spread typically indicated there was a higher level of liquidity in the market. The three- month LIBOR-OIS spread widened to a high of 364 basis points in October 2008, only returning to typical levels a year later, in September 2009 (see Exhibit 7).17 Observers suggested the large movements in LIBOR meant it was neither the best benchmark reference rate in the market nor a risk-free rate. Derivative contracts were valued, or marked to market, by discounting their payoffs at the risk-free rate, and LIBOR was widely accepted as a proxy for this rate for the respective maturities. LIBOR rates for maturities up to one year were published daily and, for longer maturities, could be derived from LIBOR- based interest-rate swap rates. While LIBOR might continue to underlie derivative contracts until and if a replacement were found, were OIS rates a more suitable proxy for the risk-free rate? Observers argued that the three-month OIS rate reflected the credit risk associated with a sequence of overnight federal funds interbank loans, which was minimal compared to the risk of a three-month interbank loan, as evidenced by the wide spread between the two during the financial crisis. PricewaterhouseCoopers’ Dataline newsletter made this observation:

Discounting derivative cash flows using OIS may represent a change in practice for end-users. Many valuation systems used by end-users continue to use LIBOR-based discounting in their

15 On April 1, 2016, the EONIA rate was −0.335% per cent and the SONIA was 0.4651 per cent. “Daily Sterling overnight index average (SONIA) lending rate,” Quandl, accessed September 9, 2016, www.quandl.com/data/BOE/IUDSOIA-Daily- Sterling-overnight-index-average-SONIA-lending-rate; “Eonia interest rate,” global-rates.com, accessed September 9, 2016, www.global-rates.com/interest-rates/eonia/eonia.aspx. 16 John Hull and Alana White, “LIBOR vs. OIS: The Derivatives Discounting Dilemma,” Journal of Investment Management 11, no. 3 (April 2013): 6–7, accessed September 9, 2016, www.joim.com/libor-vs-ois-derivatives-discounting-dilemma/. 17 Keith Jenkins, “LIBOR-OIS Spread Increase Suggests Collateral Concern,” Bloomberg, May 6, 2010, accessed April 5, 2016, www.bloomberg.com/news/articles/2010-05-06/libor-ois-spread-widening-suggests-money-market-collateral-concern- rising.

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derivative valuation models as a default setting. However, many systems and service providers are now supporting OIS discounting. Based on the guidance in ASC 820 [updated FASB Codification of Paragraph 5 of SFAS No. 157]18 . . . valuations derived using LIBOR-based discounting for certain products transacted under certain terms may no longer be representative of fair value.19

VALUING THE INTEREST-RATE SWAP PORTFOLIO: LIBOR OR OIS? To inform the debate further, the head of the management team referenced an outstanding $100 million notional principal swap with nine months until maturity (from April 1, 2016) and quarterly interest settlements. In the swap, the group would receive a 2 per cent fixed rate in return for paying the three- month LIBOR rate. The team head projected detailed calculations of how the swap could be valued using the LIBOR and OIS rates prevailing on April 5, 2016 onto the screen. To price a derivative instrument, such as an interest-rate swap, valuation models typically estimated the future contractual cash flows the counterparties agreed to exchange periodically over the life of the contract. Historically, the mid-market value of the transaction had been approximated by discounting those cash flows based on the LIBOR discount rate to reflect the time value of money. What were the arguments for and against valuing the swap with LIBOR versus OIS, and which one should the financial institution use? Going forward, should OIS replace LIBOR as the reference rate in interest rate swaps?

18 ASC is the accounting standards codification section of the Financial Accounting Standards Board (FASB). Deliotte’s description of ASC 820—Fair Value Measurements and Disclosures notes that it “applies to U.S. GAAP that require or permit fair value measurements or disclosures and provides a single framework for measuring fair value and requires disclosures about fair value measurement. The Topic defines fair value on the basis of an ‘exit price’ notion and uses a ‘fair value hierarchy,’ which results in a market-based—rather than entity-specific—measurement.” Deliotte, accessed September 9, 2016, www.iasplus.com/en-us/standards/fasb/broad-transactions/asc820. According to the FASB’s “Summary of Statement No. 157,” the fifth paragraph reads as follows: This Statement emphasizes that fair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, this Statement establishes a fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from sources independent of the reporting entity (observable inputs) and (2) the reporting entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The notion of unobservable inputs is intended to allow for situations in which there is little, if any, market activity for the asset or liability at the measurement date. In those situations, the reporting entity need not undertake all possible efforts to obtain information about market participant assumptions. However, the reporting entity must not ignore information about market participant assumptions that is reasonably available without undue cost and effort. “Summary of Statement No. 157,” Financial Accounting Standards Board, accessed September 9, 2016, www.fasb.org/summary/stsum157.shtml. 19 PricewaterhouseCoopers, “Derivative Valuation: The Transition to OIS Discounting,” Dataline—A Look at Current Financial Reporting Issues no. 2013-25 (December 10, 2013): 4, accessed April 5, 2016, www.pwc.com/us/en/cfodirect/assets/pdf/dataline/dl-2013-25-ois-discounting.pdf.

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Page 8 9B16N058

EXHIBIT 1: INFORMATION ON THE BBA LIBOR RATE FIXING PROCESS BY CURRENCY

Source: Case authors, accessed April 4, 2016, www.global-rates.com/interest-rates/libor/libor-information.aspx.

EXHIBIT 2: THE WHEATLEY REVIEW OF LIBOR

A TEN-POINT PLAN FOR COMPREHENSIVE REFORM OF LIBOR Regulation of LIBOR 1. The authorities should introduce statutory regulation of administration of, and submission to, LIBOR,

including an Approved Persons regime, to provide the assurance of credible independent supervision, oversight and enforcement, both civil and criminal. . . .

Institutional reform 2. The BBA should transfer responsibility for LIBOR to a new administrator, who will be responsible for

compiling and distributing the rate, as well as providing credible internal governance and oversight. This should be achieved through a tender process to be run by an independent committee convened by the regulatory authorities. . . .

3. The new administrator should fulfil specific obligations as part of its governance and oversight of the

rate, having due regard to transparency and fair and nondiscriminatory access to the benchmark. These obligations will include surveillance and scrutiny of submissions, publication of a statistical digest of rate submissions, and periodic reviews addressing the issue of whether LIBOR continues to meet market needs effectively and credibly. . . .

The rules governing LIBOR 4. Submitting banks should immediately look to comply with the submission guidelines presented in this

report, making explicit and clear use of transaction data to corroborate their submissions. . . . 5. The new administrator should, as a priority, introduce a code of conduct for submitters that should clearly define:

• guidelines for the explicit use of transaction data to determine submissions; • systems and controls for submitting firms; • transaction record keeping responsibilities for submitting banks; and • a requirement for regular external audit of submitting firms. . . .

MARKET CONVENTIONS Currency Number of

Contributors Quotation

Basis Fixing Basis

AUD 8 a/360 spot CAD 12 a/360 spot CHF 12 a/360 spot DKK 8 a/360 spot EUR 16 a/360 spot GBP 16 a/365 same day JPY 16 a/360 spot NZD 8 a/360 spot SEK 8 a/360 spot USD 16 a/360 spot

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Page 9 9B16N058

EXHIBIT 2 (CONTINUED) Immediate improvements to LIBOR 6. The BBA should cease the compilation and publication of LIBOR for those currencies and tenors for

which there is insufficient trade data to corroborate submissions, immediately engaging in consultation with users and submitters to plan and implement a phased removal of these rates. . . .

7. The BBA should publish individual LIBOR submissions after 3 months to reduce the potential for

submitters to attempt manipulation, and to reduce any potential interpretation of submissions as a signal of creditworthiness. . . .

8. Banks, including those not currently submitting to LIBOR, should be encouraged to participate as widely

as possible in the LIBOR compilation process, including, if necessary, through new powers of regulatory compulsion. . . .

9. Market participants using LIBOR should be encouraged to consider and evaluate their use of LIBOR,

including the consideration of whether LIBOR is the most appropriate benchmark for the transactions that they undertake, and whether standard contracts contain adequate contingency provisions covering the event of LIBOR not being produced. . . .

International co-ordination 10. The UK authorities should work closely with the European and international community and contribute

fully to the debate on the long-term future of LIBOR and other global benchmarks, establishing and promoting clear principles for effective global benchmarks. . . .

Source: United Kingdom, H.M. Treasury, “Box 1.B: A Ten-Point Plan for Comprehensive Reform of LIBOR,” The Wheatley Review of LIBOR: Final Report (London: HM Treasury, 2012), 8–9, accessed April 5, 2016, www.gov.uk/government/uploads/system/uploads/attachment_data/file/191762/wheatley_review_libor_finalreport_280912.p df.

EXHIBIT 3: ICE LIBOR CONTRIBUTOR BANKS AND CURRENCIES

BANK/Currency USD GBP EUR CHF JPY Lloyds TSB Bank plc X X X X X Bank of Tokyo-Mitsubishi UFJ Ltd X X X X X Barclays Bank plc X X X X X Mizuho Bank, Ltd. X X X Citibank N.A. (London Branch) X X X X Cooperatieve Rabobank U.A. X X X Credit Suisse AG (London Branch) X X X Royal Bank of Canada X X X HSBC Bank plc X X X X X Santander UK Plc X Bank of America N.A. (London Branch) X BNP Paribas SA, London Branch X X Crédit Agricole Corporate & Investment Bank X X X Deutsche Bank AG (London Branch) X X X X X JPMorgan Chase Bank, N.A. London Branch X X X X X Société Générale (London Branch) X X X X X Sumitomo Mitsui Banking Corporation Europe Limited X The Norinchukin Bank X X The Royal Bank of Scotland plc X X X X X UBS AG X X X X X

Source: Intercontinental Exchange, “Panel Composition,” ICE, accessed April 25, 2016, www.theice.com/iba/libor.

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EXHIBIT 4: LIBOR RATES* (as of April 5, 2016)

Libor Rates (USD) Latest Wk ago High Low

Euro Libor Rates Latest Wk ago High Low

Libor Overnight 0.3794 0.3745 0.3831 0.112 Euro Libor Overnight -0.39043 -0.39186 -0.09571 -0.39329

Libor 1 Week 0.396 0.39355 0.402 0.1413 Euro Libor 1 Week -0.37429 -0.37429 -0.08786 -0.37643

Libor 1 Month 0.4402 0.435 0.44185 0.1785 Euro Libor 1 Month -0.33214 -0.32986 -0.02286 -0.33214

Libor 2 Month 0.5225 0.5195 0.5256 0.2205 Euro Libor 2 Month -0.27929 -0.27714 -0.00143 -0.28114

Libor 3 Month 0.6301 0.6286 0.64195 0.2712 Euro Libor 3 Month -0.25114 -0.24886 0.01 -0.25114

Libor 6 Month 0.9041 0.9109 0.9174 0.3984 Euro Libor 6 Month -0.136 -0.13929 0.06929 -0.14014

Libor 1 Year 1.2215 1.23115 1.2447 0.68465 Euro Libor 1 Year -0.01529 -0.01714 0.195 -0.02757

Pound Libor Rates Latest Wk ago High Low

Yen Libor Rates Latest Wk ago High Low

Pound Libor Overnight 0.4825 0.48 0.485 0.44563

Yen Libor Spot/Next -0.08971 -0.05729 0.05429 -0.15229

Pound Libor 1 Week 0.48719 0.48781 0.49675 0.47406

Yen Libor 1 Week -0.07686 -0.15243 0.06 -0.18029

Pound Libor 1 Month 0.50881 0.51069 0.51438 0.50194

Yen Libor 1 Month -0.06571 -0.07514 0.07357 -0.08529

Pound Libor 2 Month 0.55 0.54906 0.55188 0.53388

Yen Libor 2 Month -0.01014 -0.015 0.09214 -0.03

Pound Libor 3 Month 0.5875 0.58813 0.59288 0.56594

Yen Libor 3 Month -0.00457 -0.00557 0.10071 -0.01129

Pound Libor 6 Month 0.74013 0.74038 0.76 0.68188

Yen Libor 6 Month 0.02264 0.02343 0.13943 -0.00629

Pound Libor 1 Year 1.00213 1.0115 1.08431 0.96713

Yen Libor 1 Year 0.10286 0.11229 0.26114 0.078

52-WEEK 52-WEEK

52-WEEK 52-WEEK

* LIBOR rates are quoted with a compounding frequency that corresponds to the term. For example, the spot LIBOR three- month rate would earn an interest rate equivalent to 0.25 × 0.6301% every three months. For the spot LIBOR six-month rate, the corresponding interest rate equivalent would be 0.5 × 0.9041% semi-annually. Source: Excerpted from “Market Data Center,” The Wall Street Journal, accessed April 5, 2016, http://online.wsj.com/mdc/public/page/2_3020-libor.html.

For the exclusive use of Y. Zhang, 2020.

This document is authorized for use only by Yue Zhang in Derivatives 2020 taught by CATALIN STEFANESCU, American University from Apr 2020 to May 2020.

Page 11 9B16N058

EXHIBIT 5: FEDERAL FUNDS RATE (As of April 5, 2016)

Latest Wk ago High Low Effective rate 0.38 0.39 0.40 0.06 Target rate 0.25-0.50 0.25-0.50 0.25-0.50 0-0.25 High 0.5625 0.5625 0.59 0.31 Low 0.30 0.30 0.35 0.02 Bid 0.37 0.37 0.55 0.04 Offer 0.50 0.38 0.56 0.08

Federal funds [ Effective Date: 12/17/2015 ] 52-WEEK

Source: Excerpted from “Money Rates,” The Wall Street Journal, accessed April 5, 2016 http://online.wsj.com/mdc/public/page/2_3020-moneyrate.html.

EXHIBIT 6: USD OVERNIGHT INDEX SWAPS—SETTLEMENTS (as of April 5, 2016)

Source: Case authors using data from Bloomberg, accessed April 5, 2016.

Term 06:00 EDT 1 Week 0.36000 2 Week 0.36000 3 Week 0.36100 1 Month 0.36200 2 Month 0.36600 3 Month 0.37950 4 Month 0.39200 5 Month 0.40200 6 Month 0.41400 9 Month 0.44550

For the exclusive use of Y. Zhang, 2020.

This document is authorized for use only by Yue Zhang in Derivatives 2020 taught by CATALIN STEFANESCU, American University from Apr 2020 to May 2020.

Page 12 9B16N058

EXHIBIT 7: TWO– AND 10–YEAR TRENDS IN THE THREE-MONTH LIBOR-OIS SPREAD

0

0.5

1

1.5

2

2.5

3

4/28/2006 4/28/2007 4/28/2008 4/28/2009 4/28/2010 4/28/2011 4/28/2012 4/28/2013 4/28/2014 4/28/2015

US-LIBOR-US OIS Spread April 28, 2006–March 31, 2016

Source: Case authors using data from Bloomberg, accessed April 5, 2016.

0

0.05

0.1

0.15

0.2

0.25

0.3 1/

31 /1

4 2/

28 /1

4 3/

31 /1

4 4/

30 /1

4 5/

31 /1

4 6/

30 /1

4 7/

31 /1

4 8/

31 /1

4 9/

30 /1

4 10

/3 1/

14 11

/3 0/

14 12

/3 1/

14 1/

31 /1

5 2/

28 /1

5 3/

31 /1

5 4/

30 /1

5 5/

31 /1

5 6/

30 /1

5 7/

31 /1

5 8/

31 /1

5 9/

30 /1

5 10

/3 1/

15 11

/3 0/

15 12

/3 1/

15 1/

31 /1

6 2/

29 /1

6 3/

31 /1

6

US-LIBOR-US OIS Spread January 31, 2014–March 31, 2016

I

3/31/2016

For the exclusive use of Y. Zhang, 2020.

This document is authorized for use only by Yue Zhang in Derivatives 2020 taught by CATALIN STEFANESCU, American University from Apr 2020 to May 2020.