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Libor includes risk. It is riskier to make a 6m loan than two 3m loan. So the 6m Libor curve is not the same as the 3m one. Ther difference is the basis spread. When using a short rate model, you are modelling one curve. As a first approximation, you can deduce the other curves by adding a deterministic basis spread.


This is what banks have been doing for hundreds of years. They borrow short term (mainly through deposits and interbank lending) and lend long term (e.g. mortgages). I would not call it arbitrage, as it is not riskless profit. Apart from credit risk and interest rate risk, there is also liquidity risk. In these type of strategies, the investor has to ...


You wrote Given this, what does the value of 1M LIBOR curve at 1Y point represent? It is a real number X such that: The following deal can be agreed today in the swap market: You will pay me the amount X (fixed in advance) one year from now, and in return I agree to pay you one year from now the amount Y equal to the 1 Month Libor Rate published at that ...

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