Traditionally, financial institutions use LIBOR rates as risk – free rates. LIBOR rate is used as benchmark by financial institutions and is known as short - term opportunity cost of capital. It shows at what average price one financial institution can borrow short – term funds on the money market. LIBOR encompasses 5 different currencies and comes in 7 maturities. It is announced once per working day. However, LIBOR rates are not entirely free of credit risk but they are close to that in normal market conditions. There is always a risk that financial institution will default. Of course, LIBOR rates affect interest rates. Fluctuation in the LIBOR interest rates can consequently have effects for interest rates as well as for savings accounts, loans and mortgages.
There are different benchmarks of the interest rates in different regions. For example, the Governing Council of the European Central Bank takes interest rate decisions in the Euro Area. Certainly, the aim of the ECB monetary policy is maintain price stability. The last benchmark interest rate was recorded at 0.05 percent. From 1998 until 2015 interest rate fluctuated from 4.75 percent in October of 2000 to 0.05 percent in September of 2014.
In the beginning of July in 2015 LIBOR rate varied from -0.18 percent up to 0.16 percent (maturity from 1 day to 12 months). As a result, interest rate stayed low at 0.05 percent. If we assume that a chosen financial institution states that the interest rate on one-year deposits is 0.05% per annum (interest rate is measured with annual compounding) and we invest $1000, after one year we will have $1000 x 1,0005 = $1000,5. However, inflation in the Euro area was 0.3%. So, it means that $1000 fridge will cost $1003 in a year. We can see that our one-year deposit with the interest rate of 0.05 percent did not cover inflation rate.
Naturally, we should search for other types of investments. Most of capital management firms which operate in the FOREX market make a profit of 1 – 5 percent per month. Of course, such investments carry a high degree of risk compared to savings accounts, bonds or stocks and might not be suitable to all investors.