Overnight Index Swaps (OIS)

Overnight Index Swaps (OIS) are interest rate swaps based on a specific currency that exchanges fixed rate interest payments for floating rate payments based on a notional swap principal at regular intervals over the life of the swap contract. The floating rate is based on a specified published index of the daily overnight rate for the OIS currency. For swaps based on the United States dollar (USD), the referenced floating rate is the daily effective federal funds rate or the Secured Overnight Financing Rate (SOFR). For swaps based on the British pound, the referenced floating rate is the sterling overnight index average (SONIA), calculated by the Bank of England.  The primary purpose of OISs is to manage interest rate risk.

Introduced in 1995, overnight index swaps are used to either hedge or speculate on changes in the overnight interest rate. As a hedge, overnight index swaps are used manage interest rate risk and liquidity. The terms of OISs range from 1 week to 2 years or more, with spreads typically ranging from 1.5 to 5 basis points. At maturity, the parties determine the net payment by calculating the difference between the accrued interest of the fixed rate and the compounded rate or geometric averaging of the floating index rate on the notional swap principal. Because there is no exchange of principal and only the net difference in interest rates is paid at maturity, OISs have little credit risk exposure.