Rate Swap
Overnight Indexed Swap
Explanation
An Overnight Indexed Swap (OIS) is a contract between two parties to exchange interest streams :
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Party A pays a fixed rate (known from the start).
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Party B pays a variable rate based on the average of the overnight rates of a benchmark index (e.g. €STR in euros, SOFR in USD).
At the end of the period, the two payments are compared and only the net difference is exchanged.
What is it for?
Hedging against very short-term interest rate risk.
Obtain a reference rate without credit risk (widely used for pricing financial assets).
Compare the cost of short-term financing with a fixed rate.
Numerical example
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Contract: EUR 10 million, maturity 1 year.
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Party A pays 2% fixed.
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Party B pays the average of the €STR overnight (say 1.8%).
In the end, the difference (0.2% of 10 M = 20,000 EUR) is paid by B to A.
