Overnight Index Swap Explained: Benefits and Calculation Guide
By Forex & Brokers DeskUpdated Nov 10, 2026
Definition
An overnight index swap (OIS) is an interest rate swap that exchanges a fixed rate for a compounded overnight benchmark rate, with only the net difference paid and no principal exchanged.
Key takeaways
- Dollar swaps reference SOFR or fed funds, while sterling uses SONIA, euro uses €STR, and yen uses TONA.
- The fixed payer gains if overnight rates average above the fixed rate, and the fixed receiver gains if below.
- Swaps of a year or less usually settle in one net payment at maturity, while longer swaps pay periodically.
- The floating amount is known only in arrears, which complicates cash planning compared with a rate set in advance.
An overnight index swap (OIS) is an interest rate swap in which one party pays a fixed rate and the other pays a floating rate built by compounding a published overnight benchmark over the life of the contract. No principal changes hands. At settlement, the two legs are netted and only the difference is paid. Because the floating leg tracks an overnight rate that carries very little credit risk, OIS rates are widely treated as the market’s closest proxy for a risk-free rate over a given term.
How an Overnight Index Swap Works
An OIS has two legs on the same notional amount:
- Fixed leg: a rate agreed on the trade date, applied simply over the period.
- Floating leg: the realized overnight rate for each business day, compounded across the period.
The overnight index depends on the currency. Dollar swaps reference SOFR (a secured repo rate) or the effective federal funds rate. Sterling swaps reference SONIA, euro swaps reference €STR (which replaced EONIA), yen swaps use TONA, and Swiss franc swaps use SARON.
The party that pays fixed gains if overnight rates average above the fixed rate. The party that receives fixed gains if they average below it. Contracts of a year or less commonly settle in a single net payment at maturity, while longer swaps exchange net payments periodically, often annually.
Calculating an Overnight Index Swap
For a notional N over a period of D calendar days:
Floating leg interest = N × [ Π (1 + rᵢ × dᵢ / 360) − 1 ]
Fixed leg interest = N × K × D / 360
Here rᵢ is the overnight rate for business day i, dᵢ is the number of calendar days that rate applies (usually 1, or 3 for a Friday), and K is the fixed swap rate. For sterling, replace 360 with 365.
Net settlement = floating leg interest − fixed leg interest. A positive result is paid to the fixed payer, and a negative result is paid to the fixed receiver.
Worked Example (Hypothetical)
Assume a one-week USD OIS with a $10 million notional and a fixed rate of 5.30%, running Monday to the following Monday (7 calendar days). The hypothetical overnight fixings are:
| Day | Overnight rate | Days applied | Daily factor |
|---|---|---|---|
| Mon | 5.31% | 1 | 1.00014750 |
| Tue | 5.31% | 1 | 1.00014750 |
| Wed | 5.32% | 1 | 1.00014778 |
| Thu | 5.33% | 1 | 1.00014806 |
| Fri | 5.33% | 3 | 1.00044417 |
- Compound the factors: multiplying the five factors gives about 1.00103539.
- Floating interest: (1.00103539 − 1) × $10,000,000 ≈ $10,353.94.
- Fixed interest: 5.30% × 7/360 × $10,000,000 ≈ $10,305.56.
- Net: $10,353.94 − $10,305.56 = $48.38, paid by the fixed receiver to the fixed payer.
Compounding matters even at this scale. The day-weighted simple average of the fixings is about 5.3229%, but the compounded rate annualizes to about 5.3249%. Over larger notionals and longer tenors, that gap becomes material.
How OIS Is Used
Hedging short-term rate risk. A bank funding itself overnight, or a company with floating-rate borrowing tied to SOFR, can pay fixed on an OIS to lock in its cost for the period. Rising overnight rates then raise its funding cost but also raise what it receives on the swap.
Expressing a rate view. Traders who expect a central bank to cut rates can receive fixed, and those expecting hikes can pay fixed. OIS is one of the most direct ways to trade policy expectations, alongside short-term interest rate futures.
Reading policy expectations. Plotting OIS rates across maturities (one month, three months, one year and beyond) produces the OIS curve. Because the floating leg is essentially the policy-driven overnight rate, the curve shows the average policy rate the market is pricing for each horizon.
Discounting and valuation. Collateralized derivatives are generally valued by discounting their cash flows on the OIS curve of the collateral currency, because posted collateral typically earns the overnight rate.
OIS curves in FX. Forward exchange rates reflect the interest rate differential between two currencies. Desks use each currency’s OIS curve to price forward points and FX swaps and to value cross-currency positions.
Measuring bank stress. Before LIBOR was retired, the LIBOR-OIS spread compared unsecured term interbank borrowing with expected overnight rates. It widened sharply during the 2007 to 2009 financial crisis and became a widely watched gauge of interbank credit strain.
Limitations
- Short-end focus. OIS hedges overnight-linked exposure. It does not hedge credit spreads or a borrower’s own funding premium.
- Basis risk. A loan priced off term SOFR or another reference rate will not move one-for-one with a compounded overnight index.
- Known only in arrears. The floating amount is only known at the end of the period, which complicates cash planning compared with a rate fixed in advance.
- Mark-to-market losses. A hedge that locks in a rate loses value if rates move the other way. Collateral calls can require cash before the swap matures.
- Institutional market. OIS trades over the counter or through clearing houses under ISDA documentation. It is not a retail product.
OIS vs. Similar Terms
OIS vs. a standard interest rate swap. Both exchange fixed for floating. A traditional swap’s floating leg was set in advance from a term rate such as LIBOR, while an OIS compounds a daily rate in arrears. Since LIBOR’s retirement, most new swaps reference compounded overnight rates, so the line has blurred.
OIS rate vs. overnight rate. The overnight rate is a daily fixing. The OIS rate is the fixed rate on a swap of a given tenor, the market’s expectation of the compounded overnight rate over that term.
OIS vs. forex broker “swaps.” The overnight swap or rollover fee charged on a retail forex position held past the daily cutoff is a financing adjustment based on the interest differential between two currencies. It is not an overnight index swap contract.
The Bottom Line
OIS matters to banks, companies with SOFR-linked borrowing, rate traders, and FX desks that price forward points from each currency's OIS curve. It offers a direct way to hedge or bet on overnight rates and to read the policy path the market expects. It does not cover credit spreads or basis risk, and it remains an institutional product unrelated to the rollover fees on retail forex positions.
