Tuesday, August 21, 2007

Overnight Index Swap

One of you asked me through the shout-box to explain about this. Here I go.

Before we go on to learning a bit about this concept, let us first take a look at what a swap is in the first place. Traditionally, it is the exchange of one security for another to change the maturity (bonds), quality of issues (stocks or bonds), or because investment objectives have changed. Recently, swaps have grown to include currency swaps and interest rate swaps. If firms in separate countries have comparative advantages on interest rates, then a swap could benefit both firms. For example, one firm may have a lower fixed interest rate, while another has access to a lower floating interest rate. These firms could swap to take advantage of the lower rates. That is they exchange their interest rates with one another.

There are a number of swap contracts that can be entered into by two parties. Basis Rate Swap, Bond Swap, Commodity Swap, Credit Default Swap, Currency Swap, Interest Rate Swap, Non Deliverable Swap - NDS, Swap Spread, Total Return Swap, Variance Swap, Volatility Swap etc. You can get to know about each of them from the Financial Dictionary.

So in a swap, you exchange (swap) what you have with another one that is possessed by the counterparty to the contract. Now, let’s look at Overnight Index Swap. It is an interest rate swap involving a fixed rate being exchanged for a published index of an overnight reference rate. Usually there will be an independent third party which calculates the index of the reference rate. The OIS provides a flexible hedging tool for banks and corporate treasurers.


dips said...

"OIS" is the function of what ie what are the factors that determines that ois rate should go up or down .

ramkyc said...

In short, I can say that it is 'market conditions' which determine the swap.

The index has some underlying rates, from which the index is calculated. What determines whether or not a fixed rate one has, needs to be swapped with the indexed rate, depends on the view that one holds about the movement of interest rates -- both the fixed one and the index.

Anonymous said...

Do you know where one can find daily updated information on the web for the LIBOR/OIS spread? I would like to be able to view it in a chart with variable time spreads. I looked on Bloomberg but could not find it. Thank you.

ramkyc said...

No very sure; but I think you can try any of the software available like Dash Board FX Pro which are given away free with even some virtual money for practice. They do give you access to live market data.

Currency Rates said...

An overnight indexed swap (OIS) is an interest rate swap where the periodic floating rate of the swap is equal to the geometric average of an overnight index over every day of the payment period. The index is typically an interest rate considered less risky than the corresponding interbank rate.