Overnight Indexed Swap

"Overnight indexed swap": (OIS). A fixed rate interest rate swap against a floating rate index such as SONIA, EURONIA or EONIA. The two parties to the OIS agree to exchange the difference between the interest accrued at an agreed fixed interest rate for a fixed period (for example 3 months) on an agreed notional amount, and the interest accrued on the same amount, by compounding the reference index daily over the term of the swap. Settlement is made net at an agreed date after maturity (in the sterling market settlement is on the maturity date) so the principal never changes hands. The LIBOR-OIS spread is the difference between LIBOR and the OIS rate for the same period and is widely used as an indicator of the credit standing or riskiness of the banking sector. The reason for this is that the LIBOR rate includes a credit element for the risk in lending to a bank, whereas the OIS swap rate has a much reduced credit component since no principal changes hands in a swap.
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