- LIBOR tracks overnight loan rates between banks.Night image by Yri Hramov from Fotolia.com
LIBOR is the rate that banks charge one another for overnight loans, as calculated on a daily basis by the British Bankers' Association. It is followed worldwide. - An overnight indexed swap is a specialized form of interest-rate swap, in which the floating side of the transaction is equal to the average of an overnight index on each day of the payment period.
- Because of its averaging feature, and because OIS contracts do not involve initial cash flows (which reduces default risk), the OIS rate is less volatile than the LIBOR rate.
- In the early summer of 2007, the LIBOR/OIS spread was just 10 basis points, or bps. In August, as a credit crunch got under way, the spread rose quickly. It reached 85 bps on Sept. 14, 2007, when the Bank of England announced the rescue of Northern Rock, a major mortgage lender in the United Kingdom.
- By the summer of 2008, the LIBOR/OIS spread had settled into what seemed a new normal at around 100 bps. When Lehman Bros. filed for bankruptcy in September 2008, setting off a global bankruptcy crisis, the spread spiked, reaching 365 bps on Oct. 10 of that year.
By the second half of 2009, when there was a general sense that the worst of the crisis was over, the spread returned to its pre-Northern-Rock level.
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