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FRM Part I · FRM Exam Part I · Properties of Interest Rates

Which statement about reference rates is most accurate following the global move away from LIBOR?

SOFR is an overnight rate built from secured repo transactions backed by US Treasuries, so it is close to risk-free and is not an unsecured term rate. LIBOR was the unsecured rate embedding bank credit risk, which is the key difference.

  1. ASOFR is a forward-looking, unsecured term rate that includes bank credit risk
  2. BSOFR is an overnight rate based on secured repurchase transactions collateralized by US Treasuries and is nearly risk-freeCorrect
  3. CThe federal funds effective rate is a secured rate based on Treasury repo trades
  4. DOvernight risk-free rates embed a term credit spread by construction

Explanation

SOFR is derived from overnight Treasury repo transactions, so it is secured, backward-looking and nearly free of credit risk. LIBOR was the unsecured term rate with bank credit risk. The fed funds effective rate reflects unsecured overnight interbank lending.

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