Why Should You Care About OIS? Overnight Index Swaps (OIS) are not exactly a topic that comes up a lot in dinner-party conversation. In fact, it is probably not a term that comes up in a lot of conversations about the financial markets. However, it is an important concept to understand because the OIS plays a vital roll in a market indicator that many economists and analysts watch every day to determine the health of the credit markets—the LIBOR OIS spread. So let's take a look at what the OIS is all about. (Video on page 2) 
Overnight Index Swaps (OIS) Overnight Index Swaps (OIS) are instruments that allow financial institutions to swap the interest rates they are paying without having to refinance or change the terms of the loans they have taken from other financial institutions. Typically, when two financial institutions create an overnight index swap (OIS), one of the institutions is swapping an overnight interest rate and the other institution is swapping a fixed short-term interest rate. This may sound a bit strange, but here is how it works. Be sure to read our free Special Report: What To Do if You've Lost Money in the Market Downturn Imagine Institution #1 has a $10 million loan that it is paying interest on, and the interest is calculated based on the overnight rate. Institution #2, on the other hand, has a $10 million loan that it is paying interest on, but the interest on this loan is based on a fixed, short-term rate of 2 percent. As it turns out, Institution #1 would much rather be paying a fixed interest rate on its loan, and Institution #2 would much rather be paying a variable interest rate—based on the overnight rate—on its loan, but neither institution wants to go out and get a new loan and they can't renegotiate the terms of their current loans. In this case, these two institutions could create an overnight index swap (OIS) with each other. To set up the swap, both institutions would agree to continue servicing their loans, but at the end of a specified time period—one month, three months and so on—whoever ends up paying less interest will make up the difference to the other institution. For example, if Institution #1 ends up paying an average interest rate of 1.7 percent on its loan and Institution #2 ends up paying an interest rate of 2 percent, Instititution #1 will pay Institution #2 the equivalent of 0.3 percent (2.0 - 1.7 = 0.3) because, according to their agreement, they swapped interest rates. Of course, if Institution #1 ends up paying an average interest rate of 2.2 percent on its loan and Institution #2 ends up paying an interest rate of 2 percent, Instititution #2 will pay Institution #1 the equivalent of 0.2 percent (2.2 - 2.0 = 0.2) because, according to their agreement, they swapped interest rates. Continue to the Page 2 and the video...
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