I'm just starting a pricing class and am a little confused by a statement in a class reading (a fed report). It goes something like this:
"A bank borrowing at the 3-month LIBOR rate of 2.10 percent that enters into a swap to receive at the 3-month OIS rate of 2 percent has a borrowing cost equal to the effective federal funds rate plus 10 basis points."
I'm not sure how does the fed funds rate come into the picture here. Is it assumed that the bank initially borrows the principal at fed funds rate and now has to pay a net 10 bps interest in this swap deal which adds up to a total effective borrowing cost of fed funds rate + 10 bps?
Could someone please clarify? Any input would be appreciated.
Thanks in advance.