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Definition: Reference Rate
A reference rate is a rate on the basis of which pay-offs are determined in a financial contract and it is outside the control of the parties involved in the contract. It is a reference rate that neither party has the power to change.
One example of the Reference rates is the London Interbank Offered rate. It is the average interest rate which is determined by the leading banks in London. It estimates the interest rate which the average banks will be charged if lending from the other bank.
Other example is Consumer Price Index or the Unemployment rate.
Reference rate also form the basis of the adjustable rate mortgage. In this case the borrower’s interest rate is the reference rate along with the spread. Usually this reference rate is LIBOR.
Other example of the reference rate is Euribor - Euro Interbank Offered Rate and TIBOR - Tokyo Interbank Offered Rate