Why is LIBOR a risk free rate?

As a forward looking rate, LIBOR contains an element of pricing based on the notion that one bank is taking credit risk on the other for the relevant tenor. As such, interest calculated over a period using a risk-free rate will be lower than interest calculated over the equivalent period at LIBOR.

Does a zero-coupon bond have interest rate risk?

Like virtually all bonds, zero-coupon bonds are subject to interest-rate risk if you sell before maturity. Long-term zeros can be particularly sensitive to changes in interest rates, exposing them to what is known as duration risk. Also, zeros may not keep pace with inflation.

Why is government bond risk free?

Government savings bonds are generally deemed risk free because they are backed by the full faith and credit of the federal government. Most investors feel confident that the U.S. government will not default on its obligations to bond holders.

How is a zero-coupon bond different from a conventional bond?

The difference between a regular bond and a zero-coupon bond is the payment of interest, otherwise known as coupons. A regular bond pays interest to bondholders, while a zero-coupon bond does not issue such interest payments.

What is LIBOR used for?

The London Interbank Offered Rate, or LIBOR, is the most common benchmark interest rate index used to make adjustments to variable-rate loans and credit cards. LIBOR is used by world banks when charging each other for short-term loans.

Why is a zero coupon bonds more sensitive to interest rates?

Zero coupon bonds are more sensitive to interest rate swings than bonds which pay interest semiannually because all the interest payments of zero coupon bonds are accumulated and paid at maturity. The longer the maturity of a bond, the greater the volatility.

Why do zero coupon bonds have no reinvestment risk?

This new rate is called the reinvestment rate. Zero-coupon bonds (Z-bonds) are the only type of fixed-income security to have no inherent investment risk since they issue no coupon payments throughout their lives.

What type of bond is considered risk free?

In practice, government bonds of financially stable countries are treated as risk-free bonds, as governments can raise taxes or indeed print money to repay their domestic currency debt. For instance, United States Treasury notes and United States Treasury bonds are often assumed to be risk-free bonds.

Why Treasury bills are risk free in India?

Treasury bills are zero-coupon securities, issued at a discount to investors. Hence, total returns generated by such instruments remain constant through the tenure of bond, irrespective of economic conditions and business cycle fluctuations.

Do zero coupon bonds have reinvestment risk?

Zero-coupon bonds are the only fixed-income security that has no investment risk as no coupon payments are made. Reinvestment risk is most prevalent when it comes to bond investing, but any sort of investment that produces cash flow will expose the investor to this kind of risk.