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Dear John sir,
I know sir you are going to find this question very strange, and might even question my preparation so far, if i ask this question, but i still wanted to get this topic area cleared. here’s the doubt:
Sir what is the difference between risk free rate and LIBOR?
Thank you for being so considerate and patient:)
The risk free rate is the interest rate at which the riskiness is zero. That does not really exist in practice but we always assume in the exam that government securities are risk free – they pay fixed interest (so no risk there) and the chance of the government defaulting (i.e. not repaying or paying the interest) is minimal (so no risk there).
LIBOR is the London Inter-bank offered rate and is the interest rate that banks charge each other when lending to each other. This fluctuates and so is the rate used for floating rate borrowings in the exam, although the rate applicable to companies will be LIBOR plus a % (depending on the credit riskiness of the company) and the extra % is given in exam questions.
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