Tarea.docx

OIS VS. LIBOR First of all, the OIS (Overnight Indexed Swaps) are interest rate swaps in which a fixed rate of interest is exchanged for a floating rate that is the geometric mean of a daily overnight rate. A decade ago, most traders didn’t pay much attention to the difference between two important interest rates: the Libor and the OIS rate. This is because before 2008, the spread between both was minimum. The LIBOR-OIS spread represents the difference between an interest rate with some credit risk and one that is virtually risk-free. The following graph shows the spread before and during the financial collapse. Before the subprime mortgage crisis..

Valuation considered LIBOR as a riskfree rate. But, Its use was called into question because of credit concerns.

So LIBOR quotes started to rise and

(Source: Federal Reserve Bank of St. Louis)

Now they consider that OIS should be used as the risk-free rate.

YIELD CURVES The shape of the yield curve gives an idea of future interest rate changes and economic activity. There are three main types: normal, inverted and flat.  The normal or upward sloped curve indicates yields on long-term bonds may continue to rise, responding to periods of economic expansion. The longer maturity bonds have a higher yield compared with shorter-term bonds due to risks associated with time.  The flat or horizontal sloped curve may arise from normal or inverted yield curve depending on changing economic conditions. The shorter- and longer-term yields are very close to each other, which is also a predictor of economic transition.  The inverted or downward sloped curve suggests yields on longer-term bonds may continue to fall, corresponding to periods of economic recession. The shorter-term yields are higher than the longer-term yields, which can be a sign of upcoming recession.