Question: The TED spread recently jumped to its highest level since 1987. What could be the reason for this and what could happen to the TED spread during next 12 months?

The TED spread is calculated as the gap between three-month LIBOR (interest rate offered in the London interbank market for three-month loans) and the three-month Treasury bill rate. Below we can see the recent spike in the TED spread:

Chart: TED Spread shoots higher as the risk of lending to banks rises

The TED Spread Premium

The three-month Treasury is virtually risk-free (backed by the full faith and credit of the U.S. government), while lending money to banks can be hazardous to your bottom line.

So, those who lend to banks deserve something in return for taking on that risk — a premium above what they would have earned by buying Treasuries. That premium is called the TED spread.

So, why is the TED spread rising? Banks are not keen to lend money right now, and they are demanding a higher premium to do so. After all, so many financial institutions have fallen by the wayside recently, with new names added to the list daily, and this has severely dampened enthusiasm for lending.

Where will we be 12 months from now? One would hope that the situation will improve, whether through a bailout or via economic Darwinism, but only one thing is certain — we are sailing in uncharted territory.

Ed Ponsi is a Forex and equities instructor for the Online Trading Academy.His name is a globally recognized as a lecturer and teacher, and he is the former Chief Trading Instructor for Forex Capital Markets. To learn more about him, read his bio.

This article originally appeared on The Options Insider Web site.