OIS VS.

LIBOR
First of all, the OIS (Overnight Indexed Swaps) are interest rate swaps in which a fixed
rate of interest is exchanged for a floating rate that is the geometric mean of a daily
overnight rate. A decade ago, most traders didn’t pay much attention to the
difference between two important interest rates: the Libor and the OIS rate. This is
because before 2008, the spread between both was minimum. The LIBOR-OIS
spread represents the difference between an interest rate with some credit risk and
one that is virtually risk-free. The following graph shows the spread before and during
the financial collapse.

Before the subprime mortgage crisis..

Valuation considered LIBOR as a riskfree

rate.

But,

Its use was called into question because

of credit concerns.

So LIBOR quotes started to rise and

Now they consider that OIS should be

used as the risk-free rate.
(Source: Federal Reserve Bank of St. Louis)

YIELD CURVES
The shape of the yield curve gives an idea of future interest rate changes and
economic activity. There are three main types: normal, inverted and flat.

 The normal or upward sloped curve indicates yields on

long-term bonds may continue to rise, responding to
periods of economic expansion. The longer maturity bonds
have a higher yield compared with shorter-term bonds due
to risks associated with time.
 The flat or horizontal sloped curve may arise from normal
or inverted yield curve depending on changing economic
conditions. The shorter- and longer-term yields are very
close to each other, which is also a predictor of economic
transition.
 The inverted or downward sloped curve suggests yields
on longer-term bonds may continue to fall, corresponding
to periods of economic recession. The shorter-term yields
are higher than the longer-term yields, which can be a sign
of upcoming recession.