Overnight indexed swap

An overnight indexed swap (OIS) is an interest rate

swap where the periodic oating payment is generally
based on a return calculated from a daily compound interest investment. The reference for a daily compounded
rate is an overnight rate (or overnight index rate) and the
exact averaging formula depends on the type of such rate.

LIBOR is risky in the sense that the lending bank loans

cash to the borrowing bank, and the OIS is stable in
the sense that both counterparties only swap the oating
rate of interest for the xed rate of interest. The spread
between the two is, therefore, a measure of how likely
borrowing banks will default. This reects counterparty
credit risk premiums in contrast to liquidity risk premiThe index rate is typically the rate for overnight unse[3]
cured lending between banks, for example the Federal ums. However, given the mismatch in the tenor of the
funds rate for US dollars, Eonia for Euros or Sonia for funding, it also reects worries about liquidity risk as well.
sterling. The xed rate of OIS is typically an interest
rate considered less risky than the corresponding interbank rate (LIBOR) because there is limited counterparty 2 Historical levels
risk.[1][2]
The LIBOROIS spread is the dierence between In the United States, the LIBOROIS spread generally
LIBOR and the (OIS) rates. The spread between the maintains around 10 bps. This changed abruptly, as the
two rates is considered to be a measure of health of the spread jumped to a rate of around 50 bps in early August
banking system.[3] It is an important measure of risk and 2007 as the nancial markets began to price in a higher
liquidity in the money market,[4] considered by many, risk environment. Within months, the Bank of England
including former US Federal Reserve chairman Alan was forced to rescue Northern Rock from failure. The
Greenspan, to be a strong indicator for the relative stress spread continued to maintain historically high levels as
[3]
in the money markets.[5] A higher spread (high Libor) is the crisis continued to unfold.
typically interpreted as indication of a decreased willing- As markets improved, the spread fell and as of Octoness to lend by major banks, while a lower spread indi- ber 2009, stood at 10 bps once again, only to rise again
cates higher liquidity in the market. As such, the spread as struggles of the PIIGS countries threatened European
can be viewed as indication of banks perception of the banks. As of December 2011, the spread again stands at
creditworthiness of other nancial institutions and the 40+ bps level.
general availability of funds for lending purposes.[6]
The LIBOROIS spread has historically hovered around
10 basis points (bps). However, in the midst of the
nancial crisis of 20072010, the spread spiked to an alltime high of 364 basis points in October 2008, indicating
a severe credit crunch. Since that time the spread has declined erratically but substantially, dropping below 100
basis points in mid-January 2009 and returning to 1015
basis points by September 2009.[7]

3 See also
TED spread

4 References
[1] CSFB Zurich note on OIS

Risk barometer

[2] Overnight Index Swaps (OIS), thisMatter.com

[3] Sengupta, Rajdeep and Yu Man Tam. (2008) The
LIBOROIS Spread as a Summary Indicator. Economic
Synopses, Number 25, 2008. Federal Reserve Bank of
St. Louis

Three-month LIBOR is generally a oating rate of nancing, which uctuates depending on how risky a lending
bank feels about a borrowing bank. The OIS is a swap
derived from the overnight rate, which is generally xed
by the local central bank. The OIS allows LIBOR-based
banks to borrow at a xed rate of interest over the same
period. In the United States, the spread is based on the
LIBOR Eurodollar rate and the Federal Reserves Fed
Funds rate.[3]

[4] Zeng, Min (September 20, 2008). Money Flows Back to

Commercial Paper. The Wall Street Journal.
[5] Brown, Matthew; Finch, Gavin (January 12, 2009).
Libor for Dollars Slides Most Since Dec. 17 on Cash
Injections. Bloomberg.com.

[6] Capo McCormick, Liz (January 24, 2008). InterestRate Derivatives Signal Banks Still Reluctant to Lend.
Bloomberg.com.
[7] 3 MO LIBOR OIS SPREAD. Bloomberg.com. January 12, 2009.

External links
Dollar LiborOIS Spread at 2-Year High Amid Europe Bank Concern

EXTERNAL LINKS

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