If you are dealing with interest rate swaps or forward rate agreement market, or hedge funds that charges a performance fee based on benchmark index (Hurdle rate) , you would have come across terms such as SOFR and EURIBOR. In this blog, we will discuss what is SOFR and EURIBOR ? and how they are calculated.
SOFR stands for the Secured Overnight Financing Rate, and it is a benchmark interest rate that is based on the overnight borrowing and lending transactions in the U.S. Treasury repurchase agreement (repo) market.
The New York Federal Reserve Bank calculates the SOFR rate based on the weighted average of the interest rates paid on overnight Treasury repo transactions that occur between financial institutions. The calculation is based on transaction-level data from the Depository Trust & Clearing Corporation (DTCC).
The process of calculating SOFR involves the following steps:
Identify all the repo transactions that take place in the U.S. Treasury market on a given business day.
Calculate the total dollar amount of repo transactions for each Treasury security that is used as collateral.
Calculate the weighted average interest rate for each Treasury security based on the dollar amount of the repo transactions.
Weight the interest rates for each Treasury security based on the dollar amount of the repo transactions, and then take the weighted average of these interest rates to arrive at the overall SOFR rate for that business day.
The SOFR rate is published daily by the New York Fed and is widely used as a benchmark interest rate for a variety of financial products, including loans, bonds, and derivatives.
EURIBOR EURIBOR stands for the Euro Interbank Offered Rate, and it is a benchmark interest rate that is based on the average interest rate at which a panel of European banks offer to lend unsecured funds to other banks in the Eurozone money market for a specified period of time.
The calculation of EURIBOR involves the following steps:
A panel of banks is selected by the European Money Markets Institute (EMMI) to contribute to the calculation of EURIBOR. Currently, the panel consists of around 20 banks that are active in the Eurozone money market.
Each day, the panel of banks submit the interest rates at which they are willing to lend funds to other banks for a range of maturities, from overnight to 12 months. The rates are submitted based on a hypothetical transaction of a certain amount, in a specific currency, and under specific conditions.
The submitted rates are ranked in ascending order, and the highest and lowest 15% of the rates are excluded. The remaining rates are then averaged to calculate the EURIBOR rate for each maturity.
The calculated EURIBOR rates are published on the EMMI website and used as a benchmark interest rate for a variety of financial products, including loans, bonds, and derivatives.
It's worth noting that in 2019, the European Central Bank took over the administration of the EURIBOR from EMMI, and there have been ongoing reforms to strengthen the reliability and accuracy of the benchmark rate.