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I'm a bit confused about OIS. Is OIS the overnight interest rate or is it a swap. If OIS is the rate at which banks lend overnight, where does the swap come in? Don't they borrow at a fixed rate?
When banks borrow from the Fed, do they borrow at the Fed funds rate or LIBOR? If it is the Fed Funds rate, again this is fixed right?
Instead of looking at LIBOR OIS, can't i look at LIBOR-Fed Funds rate or USDIRS vs OIS to determine liquidity situation in the market
Banks do not borrow money from the central bank. Generally they deposit excess reserves with the central bank and are remunerated on a daily basis at the deposit rate (ECB depo rate, BOE base rate, FED funds rate).
Central banks do have standing facilities to loan money to banks but these are generally expensive and meant as a last resort. They can also give bad impressions on the credit worthiness of the institution if it consistently needs to utilise these measures.
OIS is the overnight indexed swap rate. It is compiled differently in different currencies. In GBP it represents the weighted average of interbank overnight cash transactions reported through a series of brokers over 25mm (don't quote these exact details). In EUR it is compiled by the ECB by aggregating a series of loan rates provided by a selected group of large banks to other banks.
These systematic differences and other factors determine the precise relationship between OIS and the central bank deposit rate in any given currency (look at DKK for a really wacky relationship)
OIS (Overnight Index Swap) is a swap, that is a derivative, with a specified tenor (such as 37 days). It represents a "bet" as to what the geometric average overnight rate (FF rate in the United States) will be for the next 37 days. The banks are lending/borrowing to/from each other overnight in the FF market, but you and I, as traders of OIS, are not borrowing/lending anything, we are just watching on the sidelines and speculating on what the overnight rate among banks will be.
