Appendix

Reference Rate Models

There are various models to determine benchmark rates. Here are some of the more common models used in traditional finance: Interbank Offered Rate (IBOR): IBOR rates represent the average interest rates at which banks are willing to lend to each other in the interbank market. Examples include: LIBOR (London Interbank Offered Rate) in the UK, EURIBOR (Euro Interbank Offered Rate) in the Eurozone, and TIBOR (Tokyo Interbank Offered Rate) in Japan.

Treasury Yield Curve: Treasury yield curves are widely used as reference rates in financial markets due to the perceived low risk associated with US Treasury securities, as they are backed by the full faith and credit of the government. For example, the United States 10-year Treasury bond.

Central Bank Policy Rate: Central banks set policy rates to influence monetary policy and economic activity, and some financial products reference these rates. Examples include: the Federal Funds Rate in the US, the Bank Rate in the UK, and the European Central Bank's Main Refinancing Rate.

Overnight Reference Rates: Countries may also adopt overnight reference rates based on transactions in the overnight lending markets. Examples include: SOFR (Secured Overnight Financing Rate) in the US, Sonia (Sterling Overnight Index Average) in the UK, and Eonia (Euro Overnight Index Average) in the Eurozone.

Prime Rate: The prime rate is the interest rate that commercial banks charge their most creditworthy customers. It serves as a benchmark for various loans, particularly consumer loans like mortgages and personal loans.

Market-based Rates: Some benchmark rates are derived from market transactions, such as swap rates, which are based on interest rate swaps. These rates provide a basis for pricing various financial instruments.

Customized Benchmark Rates: In some cases, countries may develop customized benchmark rates tailored to their specific financial markets and needs. These rates could be based on a combination of the above factors.

Reference Rate Properties

Reference rates can be segmented based on various underlying properties. Here are some common ways to categorize them:

Subjective vs Objective Inputs: This classification refers to whether the reference rate is determined by subjective judgment or objective data. For example, interbank-offered rates (IBORs) like LIBOR were historically subjective, relying on banks' estimates of borrowing costs. In contrast, rates like SOFR and Sonia are objective, based on actual transactions in overnight lending markets.

Backward vs Forward-Looking: This classification distinguishes between rates that are backward-looking, meaning they are based on historical data, and rates that are forward-looking, meaning they are based on expectations for future interest rates. For example, LIBOR is a backward-looking rate, while some central bank policy rates, like the Federal Funds Rate, are forward-looking.

Unsecured vs Secured: This classification refers to whether the borrowing transactions underlying the reference rate are unsecured (without collateral) or secured (backed by collateral). For example, LIBOR and EURIBOR are unsecured rates, reflecting uncollateralized lending between banks, while rates like SOFR are secured, based on transactions in the secured overnight financing market.

Spot vs Derivative: This classification distinguishes between rates that are directly observed in the spot market and rates that are derived from financial instruments like derivatives. For example, overnight reference rates like SOFR and Sonia are spot rates, reflecting actual transactions in the overnight market. In contrast, swap rates are derivative rates, derived from the pricing of interest rate swaps.

User Group Source: This classification refers to the entities or groups from which the data used to calculate the reference rate is obtained. For example, central bank policy rates are determined by the government while prime rates data are sourced from consumer transactions.