Fed Funds, SOFR, and OIS: Rates, Swaps, and Long-Term Pricing
Summary
The document distinguishes three related but different concepts. The Effective Federal Funds Rate measures unsecured overnight borrowing between financial institutions. SOFR represents overnight Treasury repo borrowing, which is secured by Treasury collateral. An Overnight Indexed Swap is a contract whose floating leg references an overnight rate that is reset and compounded daily, while the other leg pays a fixed rate. The overnight reference can be SOFR, Federal Funds, or another rate, so OIS names the swap structure rather than one particular benchmark.
For a ten-year SOFR swap, the response describes dealer practice as building a Treasury curve and quoting or pricing the swap relative to it. It says that using SOFR futures to construct a long-dated curve is theoretically possible, but futures liquidity was described as concentrated in the first few years; dealers therefore commonly hedge medium- and long-term swaps with Treasuries and take swap-spread risk. These are practical explanations, not a complete valuation derivation. The quoted spread and market conventions are time-sensitive and should not be treated as current pricing.
Key ideas
- The Federal Funds Effective Rate measures unsecured overnight interbank borrowing.
- SOFR reflects overnight repo transactions backed by Treasury collateral.
- An OIS exchanges a fixed leg for a floating leg linked to a daily overnight rate.
- Long-dated SOFR swap pricing may be built relative to a Treasury curve, with Treasury hedges exposing dealers to swap-spread risk.
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# Difference between OIS and SOFR? # Difference between OIS and SOFR? Basic question: I am a bit curious what are the differences between Fed Fund Rate, OIS and SOFR? All three, as I understand are based on overnight collateralized transactions? (Please correct if I am wrong) And how is 10y SOFR rate calculated as SOFR is based on overnight rate only? Is it simple compounding? ## Answer by dm63 (score 7, accepted) https://quant.stackexchange.com/a/74821 The Fed Funds Effective Rate is the overnight unsecured borrowing rate between financial institutions. It is published on Boomberg's FEDL01 page. SOFR is an overnight interest rate which represents the average rate for overnight Treasury repo transactions (ie secured loans backed by Treasury collateral). OIS is a style of interest rate swap. It stands for Overnight Indexed Swap. An OIS has a fixed rate on one leg and an overnight rate, reset daily and compounded daily until the payment date, on the floating side. The overnight rate could be either Fed Funds or SOFR or a different rate. Possible confusion arises because up until the invention of SOFR, an OIS was assumed to refer to Fed Funds. But in fact it could be either. ## Answer by RiskNeutral (score 0) https://quant.stackexchange.com/a/83576 I will attempt to answer your question "how is 10y SOFR rate calculated as SOFR is based on overnight rate only?" given that others have already responded to your other queries. I'm not exactly sure what you are asking, but I believe you're wondering how to derive a 10-year SOFR swap rate given that SOFR is an overnight rate. For the 10-year SOFR swap rate, market makers build a Treasury curve and price the 10-year SOFR swap as a spread to this curve. Currently, 10-year SOFR swaps trade approximately 55 basis points below the 10-year Treasury yield. While it's theoretically possible to build a curve and price the swap based on SOFR futures contracts, this isn't practical as liquidity only exists in the first 2-3 years of SOFR futures. Dealers who make markets in medium or long-term SOFR swaps (e.g., 10-year SOFR swaps) typically hedge with Treasuries and therefore take on swap spread risk.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.