Maybe it's my money. If I bootstrap a USD libor curve using deposits + swaps only I get a 1 yr zero rate around 4.50 which matches the 1 yr USD libor deposit rate. If I use deposits + futures + swaps I get something more like 4.32 for a 1 yr zero rate (same conventions Act/360, simple compounding, annual pay). Given deposits paying high or futures too expensive is there money to be made? I understand part of the deal here is my cost of funds, so I can't really borrow at Libor and invest at Libor and make money.Which rate is a more accurate rate for discounting/computing the PV for a 1 yr period forward from today?Jay

It's almost certainly a timing issue. Libor is set 1x per day. ED futures and and swaps trade continuously. Usually, it doesn't matter all that much, but Libor's been super-volatile lately.

QuoteOriginally posted by: jayMaybe it's my money. If I bootstrap a USD libor curve using deposits + swaps only I get a 1 yr zero rate around 4.50 which matches the 1 yr USD libor deposit rate. If I use deposits + futures + swaps I get something more like 4.32 for a 1 yr zero rate (same conventions Act/360, simple compounding, annual pay). Given deposits paying high or futures too expensive is there money to be made? I understand part of the deal here is my cost of funds, so I can't really borrow at Libor and invest at Libor and make money.Which rate is a more accurate rate for discounting/computing the PV for a 1 yr period forward from today?JayI am curious, what method are you using to compute, say, DF(2)? The LIBOR curve and interpolation will carry you out to t = 1. But a standard two-year swap has cash flows at t = 0.5, t = 1 and t = 1.5 and t = 2. So I am curious what you are doing to discount the cash flow at t = 1.5 to bootstrap DF(2)?

Two different ways - #1 use the a few deposits, say 1M, 2M, then next 7 futures contracts and then 2 yr swaps, on up to 30 yrs. #2 - use deposits 1-11M, then swaps 2yr and up.Given a set of discount pts bootstrapped from the shorter maturity rates, to solve for the intermediate discount pts (13 yrs on a 15 yr swap) we have a cubic spline I think in discount space. Can't remember off the top of my head. The bootstrap logic is good, we've done a lot of testing vs other sources and we are in good agreement.Maybe I've fluffed a day count somewhere along the way. I did a back of the envelope calculation using the front four futures vs the 1 yr libor this morning and it looks tight, but I've haven't checked the bootstrapped curves with this data.

QuoteMaybe it's my money. If I bootstrap a USD libor curve using deposits + swaps only I get a 1 yr zero rate around 4.50 which matches the 1 yr USD libor deposit rate. If I use deposits + futures + swaps I get something more like 4.32 for a 1 yr zero rate (same conventions Act/360, simple compounding, annual pay). credit risk i guess...

The issue is credit premia: 1yr Libor deposit contains the risk of lending to AA-rated bank counterparties for 1yr. ED futures and IR swaps are indexed to 3m Libor, which contains the risk of lending to AA-rated bank counterparties for 3m. You could lend for 1yr at Libor (or close to it - I'm sure given the dash for cash at the moment, if you put an offer around libor in the bookies you would get taken) and do the futures against it, but you are not purely taking a position on interest rates - you have exposed yourself to the default on principal. This would also be the case if you arranged a 3m loan today (there are no offers in the brokers for 3m cash, so you would find this difficult) and forward starting loans priced at around where the EDs are implying 3m Libor to set.The seize-up of funding markets as a result of liquidity puts to SIVs, strains on capital ratios due to write-downs etc, has effectively meant that nobody wants to lend money, so the premia demanded for lending term has increased, and this is reflected in the Libor fixes. A simple way to gauge this is to look at money market basis swap spreads - eg 3m-6m basis swaps, for 1yr maturity, you can pay 6m libor flat and receive 3m libor + 10.875bp. The basis spread represents the credit risk-premia demanded for lending 6m vs 3m on a rolling basis for 1yr.Regarding your question about what rate to use for discounting the payment in 1yr's time: that depends entirely on the credit-worthiness of the counterparty paying you the money. If you have a collateralisation agreement with the counterparty, then use the curve that is build from 3m deposit+futures+swaps (MTM is collateralised with US 3m Libor). If they are AA-rated bank counterparty but there is no collateralisation agreement, then it would be closer to 1yr libor. Kind of varies, but the easiest thing to assume is that you have collateralisation and use the normal 3m deposit+futures+swap curve to discount.

QuoteOriginally posted by: jayTwo different ways - #1 use the a few deposits, say 1M, 2M, then next 7 futures contracts and then 2 yr swaps, on up to 30 yrs.Ah, well you did say "I bootstrap a USD libor curve using deposits + swaps only" hence my question. I.e., futures seemed excluded to me by the "only" part.Quote#2 - use deposits 1-11M, then swaps 2yr and up.Well, this still doesn't answer my initial question. At least, I'm still curious exactly what you're doing.

QuoteThe basis spread represents the credit risk-premia demanded for lending 6m vs 3m on a rolling basis for 1yrI'm curious why the credit risk premium would be higher for 6m than for 3m. If we assume a constant hazard rate, then wouldn't the credit risk premium be roughly equal (in terms of spread) for either tenor? I'm using the approximation: s = h * (1-R) (s=credit spread, h=hazard rate, R=recovery rate). Is there a particular term structure of hazard rates that would lead to this outcome, or is it some other reason?

QuoteOriginally posted by: nshewmakerQuoteThe basis spread represents the credit risk-premia demanded for lending 6m vs 3m on a rolling basis for 1yrI'm curious why the credit risk premium would be higher for 6m than for 3m. If we assume a constant hazard rate, then wouldn't the credit risk premium be roughly equal (in terms of spread) for either tenor? I'm using the approximation: s = h * (1-R) (s=credit spread, h=hazard rate, R=recovery rate). Is there a particular term structure of hazard rates that would lead to this outcome, or is it some other reason?I am no expert on this but I would assume two things. First of all I don't think that you can focus on just one aspect. Apart from credit risk you have liquidity preferences etc. But sticking to credit risk you have to take into account the fact that LIBOR rates assume that you deposit the principal which you do not do in the less credit risky basis swap (but I guess you know that). Take the current setting were there is a lot of uncertainty. Assume that you lend for 3M. After that period you can again observe which counterparties are OK and then choose which one to lend to for the next 3M. Lending directly for 6M exposes you to the same counterparty for 6M. Since the credit risk is higher for the 6M loan you have to be compensated in the basis swap since the 6M rate is "too high" (ie the hazard rate is not constant but positively sloped if we just stick to the credit risk argument). This gives you the basis swap spread. Does that make any sense? I can post a good piece from Danske Bank on basis swaps that say the same thing as I but perhaps more convincingly..Just PM me and I can send it to you tomorrow.

Could anyone send me the piece from Danske Bank on basis swaps that freddiemac mentions? Thanks.