libor ois trading

Asia Pac Analytics 2011

Overnight Index Swaps

A guide to OIS tradingJosie von Etzdorf and Francois Choquet

Advanced Specialists

Growth of Short Term IR TradingSingle Currency Interest Rate Swaps and Forwards < 1 y Maturity (in mln)


Libor

• Libor stands for London Interbank Offered Rate, a daily fixing set at 11.00 a.m. London time by the British Bankers’ Association as a set of reference rates for USD, EUR, GBP, JPY, CAD, AUD, NZD, CHF, DKK, SEK.

• Contributor banks post a rate at which they could borrow unsecured money in reasonable market size in the interbank market.

• The rates are averaged after removing the top and bottom quartile.

• {BBAM1<Go>} displays the fixings which are T+2.

BBA USD Libor Fixings

US0003M<INDEX>• The USD 3 month LIBOR fixing is the most used

short term reference rate around the world.• EDA<CMDTY>, the globally most active interest

rate future uses 3 month LIBOR as the underlying notional.

• Floating rate bonds use Libor + (or -) a spread as their coupon. {EF1653262<CORP>DES<GO>}

• Interest Rate Swaps use 3 month LIBOR as the floating reference rate. {USSW5<CRNCY>DES<GO>}

• Corporate loans are typically set with LIBOR plus a spread. {LN302060<CORP>YA<GO>}

Forward Rate Agreements - FRAs

• A derivative which uses a combination of interbank rates and futures to price notional interbank borrowing or lending.

• {EDSF<GO>}• These are actively traded {TPFR<GO>}• {SL3L1HI6<CORP>SWPM<GO>}• The Libor rate 2 days prior to the effective date

is the reference used to settle the contract using money market conventions.

IMM Dates

• FRAs and short term Swaps often trade using IMM (International Monetary Market sector of the Chicago Mercantile Exchange) dates to match Futures expiry.

• Eurodollar futures expire on the third Wednesday of the contract month, thus the last trade is 2 days prior e.g. EDU1<CMDTY> ends on September 21st, thus September 19th.

EDZ1 expires on December 21st, with a last trade on December 19th. {EDA<CMDTY>EXS<GO>}

• The September contract is a notional interbank 3 month deposit with dates matching the futures, thus September 21st to December 21st .

OIS- Overnight-Indexed Swaps• An Overnight-Indexed Swap (OIS) is like a plain vanilla

fixed/floating interest rate swap but the floating leg is a reference published overnight rate, which compounds daily.

• It is usually a short term swap and unlike an interbank deposit, the fact that this is a notional contract means that counterparty risk is minimised.

• For trades with a maturity up to One Year, at maturity the difference between interest accrued at the fixed rate and interest accrued at the compounded floating rate on the agreed notional amount of the swap is settled as a one time payment.

• In the case of longer term swaps, there will be a Monthly, Quarterly, Semi annual or Annual coupon payment dates subject to local market convention.

• {TPOS<GO>}


FRA/OIS spread

• Direct measure of the credit quality of financial institutions.

• A long FRA/OIS spread represents a view on or hedge for deteriorating bank credit quality, thus gives exposure to the spread which increases with worsening bank credit quality.

• Strong correlation between CDS and FRA/OIS spread.


HEDGING WITH FRA-OIS

FRA fixing

FRA settlementTrade

FRA Maturity

OIS Settle

OIS Maturity

2 bus days

2 bus daysOIS

Starts

Swap Dealer Investor FRA Counterparty

Fixed Rate for Forward

Starting OIS Fixed Rate FRA

Expected Payoff at Maturity: 3mL – 3m OIS – Libor/OIS Spread

3 month OIS 3 month Libor

valuation

2 bus days

3 Months 3 Months


FRA/OIS TRADE

Swap Dealer Investor FRA Counterparty

OIS 0.92% FRA 1.17 %

3 month OIS 3 month Euribor

EUR 800mm FRA/OIS 9X12 on the 20th; Trade date: 3/18/2010

Expected Payoff : 3mL – 3m OIS – 25 bpsAt settlement 12/22/2010 = EURIBOR 3M / OIS 3M ≈ 45 bps

Trade P&L at unwind ≈ 20 bps

libor ois trading

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