Libor-OIS spread
Imagine you and your friend decide to play a game where you will lend each other toys every day for a week. You agree that at the end of each day, whoever borrows the toy will pay a little bit of extra money called interest to the lender. The interest is like a thank you for lending the toy.
Now, let’s say you both borrowed toys from each other for a week and each day, you paid your friend 10 cents as interest for borrowing the toy. On the last day of the week, your friend tells you that a new toy store has opened nearby and they are giving away free toys for a week to whoever is willing to lend them some money. Your friend decides to lend some money to the toy store and get free toys for a week. But the toy store only agrees to give toys to those who lend them money if they pay interest based on the LIBOR rate.
The LIBOR rate is like a special interest rate that only big companies can use. Your friend can now lend money to the toy store and earn interest based on the LIBOR rate. But because the LIBOR rate is usually higher than the interest you and your friend agreed upon, your friend can earn more interest by lending money to the toy store than by lending toys to you.
Because your friend is earning more interest by lending money to the toy store, they might not be as interested in lending toys to you anymore. This means that you might have to offer more interest on borrowing toys from your friend. The difference between the LIBOR rate and the interest you and your friend had agreed upon is called the LIBOR-OIS spread.
In summary, the LIBOR-OIS spread is the difference between the interest rate your friend can earn by lending money based on the LIBOR rate, and the interest rate you and your friend had agreed upon for lending toys. When the LIBOR rate is higher than the agreed-upon interest rate, the LIBOR-OIS spread is bigger, and your friend might not be as interested in lending toys to you.
Now, let’s say you both borrowed toys from each other for a week and each day, you paid your friend 10 cents as interest for borrowing the toy. On the last day of the week, your friend tells you that a new toy store has opened nearby and they are giving away free toys for a week to whoever is willing to lend them some money. Your friend decides to lend some money to the toy store and get free toys for a week. But the toy store only agrees to give toys to those who lend them money if they pay interest based on the LIBOR rate.
The LIBOR rate is like a special interest rate that only big companies can use. Your friend can now lend money to the toy store and earn interest based on the LIBOR rate. But because the LIBOR rate is usually higher than the interest you and your friend agreed upon, your friend can earn more interest by lending money to the toy store than by lending toys to you.
Because your friend is earning more interest by lending money to the toy store, they might not be as interested in lending toys to you anymore. This means that you might have to offer more interest on borrowing toys from your friend. The difference between the LIBOR rate and the interest you and your friend had agreed upon is called the LIBOR-OIS spread.
In summary, the LIBOR-OIS spread is the difference between the interest rate your friend can earn by lending money based on the LIBOR rate, and the interest rate you and your friend had agreed upon for lending toys. When the LIBOR rate is higher than the agreed-upon interest rate, the LIBOR-OIS spread is bigger, and your friend might not be as interested in lending toys to you.