Page 17 - FINAL CFA II SLIDES JUNE 2019 DAY 9

READING 34: THE TERM STRUCTURE AND
LOS 34.i: Describe the TED and LIBOR–OIS spreads.
INTEREST RATE DYNAMICS
MODULE 34.4: SPREAD MEASURES
TED Spread (T” in “T-bill” with “ED” for Eurodollar futures contract):

Amount by which interest rate on loans between banks (3-month LIBOR) > rate on short-term U.S. gov’t debt (3-month T-bills).

For example, if 3-month LIBOR = 0.33% and the 3-month T-bill rate =0.03%, then:

How different from swap spread?
TED spread = swap spread = swap rate − Treasury yield t
t
t
(3-month LIBOR rate) − (3-month T-bill rate) = 0.33% − 0.03% = 0.30% or 30 bps.

It more accurately captures the risk in the banking system (risk of inter-bank lending).

A rising TED spread indicates that market participants believe banks are increasingly likely to default on loans and that risk-free
T-bills are becoming more valuable in comparison

LIBOR-OIS Spread (OIS = Overnight Indexed Swap):

The OIS rate roughly reflects the federal funds rate and includes minimal counterparty risk. The LIBOR-OIS spread is the
amount by which the LIBOR rate (which includes credit risk) exceeds the OIS rate (which includes only minimal credit risk).

Useful measure of credit risk and an indication of the overall wellbeing of the banking system:

• Low LIBOR-OIS spread = a sign of high market liquidity;

• High LIBOR-OIS spread = a sign that banks are unwilling to lend due to concerns about creditworthiness.