Overnight Index Swap

About Overnight Index Swap:

• It is a derivative instrument where returns under a fixed rate asset are swapped against a pre-determined published index of a daily overnight reference rate for an agreed period of time.
• The primary purpose of an OIS is to manage interest rate risk, particularly the risk associated with fluctuations in the overnight lending rate.
• An overnight index swap rate is calculated each day.
• This rate is based on the average interest rate institutions with loans based on the overnight rate have paid for that day.

How does an OIS work?

• These are instruments that allow financial institutions to swap the interest rates they are paying without having to refinance or change the terms of their existing loan.
• , when two financial institutions create an overnight index swap, one of the institutions is swapping an overnight (floating) interest rate and the other institution is swapping a fixed short-term interest rate.
• To get the swap rolling, both the firms would agree to continue servicing their loans, but at the end of a specified time period whoever ends up paying less interest will make up the difference to the other firm.

What is a derivative?

• It refers to a type of financial contract whose value is dependent on an underlying asset, group of assets, or benchmark. 
• Common derivatives include futures contracts, forwards, options, and swaps.

Q1) What is Cash Reserve Ratio?

The Cash Reserve Ratio (CRR) is a monetary policy tool used by central banks, to regulate the amount of liquid funds that commercial banks are required to maintain with the central bank as a certain percentage of their total deposits. This ratio is set by the central bank and is used to control the money supply in the economy.

Source: Overnight index swap rates at 10-month high; government bond yields rise