An OIS is used by a financial institution that funds itself overnight and invests in fixed-rate assets when it wants to remove the gap between its funding rate and its investment rate.

Exchanging a fixed rate for a compounded overnight rate

An OIS is a type of interest rate swap that exchanges a fixed rate for a floating rate calculated using compound interest on the overnight rate over a set period1. The overnight rate is the rate on funds borrowed today and repaid on the next business day2. Yen OIS reference TONA (Tokyo Overnight Average Rate), which the Bank of Japan publishes3. The fixed rate of an OIS is called the OIS rate1. The basic mechanism of exchanging fixed and floating rates is covered in Interest Rate Swaps.

Consider a hypothetical example in which Bank A and Securities Firm G enter into a yen OIS with a notional amount of 10 billion yen and a term of 1 year. Bank A pays a fixed rate of 1% a year and receives a floating rate calculated by compounding TONA. Securities Firm G does the opposite. Because the term is 1 year, interest is exchanged only once, at the end of the period. The notional amount is set only to calculate interest, and it is never exchanged itself4.

The floating rate is set at the end of the period by compounding TONA for every business day in the period. This method is called compounding in arrears. As a result, the amount of floating-rate interest is not known until the last day of the period5. The compounding formula, the treatment of holidays, and a day-by-day example are covered in Compounding in Arrears.

Some US dollar OIS reference SOFR (Secured Overnight Financing Rate), which the Federal Reserve Bank of New York (New York Fed) publishes. The Alternative Reference Rates Committee (ARRC) in the United States says that compounding is already established market practice for derivatives that reference SOFR, including OIS6.

Cash flows of a 1-year OIS

For Bank A, the payment at the end of the period is 100 million yen of fixed-rate interest (10 billion yen × 1%), known from the day the trade is agreed. The amount it receives depends on the compounded TONA rate over the period. Interest is calculated as notional amount × rate × days in the period ÷ 3657. If the period is 365 days and the compounded TONA rate turns out to be 1.1%, Bank A receives 110 million yen (10 billion yen × 1.1% × 365 ÷ 365).

↑ Receive　↓ PayFrom Bank A's side (fixed-rate payer)Start dateYear 1+110 million yenCompounded TONA−100 million yenFixed
Figure 11-year OIS cash flows for Bank A
Figure description

These are the payments of Bank A, the fixed-rate payer, assuming the compounded TONA rate is 1.1%. Nothing changes hands on the start date, including the notional amount. At the end of the period, 1 year later, Bank A pays 100 million yen of fixed-rate interest and receives 110 million yen of floating-rate interest calculated by compounding TONA. All the payments fall on that one date at the end of the period, and in practice only the net 10 million yen changes hands.

Amounts due on the same date are settled by exchanging only the difference (net settlement)8. The table below shows Bank A's net amount for three assumed compounded TONA rates. A positive net amount is received by Bank A, and a negative one is paid by Bank A.

Compounded TONA rate (assumed) Received: floating interest (million yen) Paid: fixed interest (million yen) Net (million yen)
0.9% 90 100 −10
1.0% 100 100 0
1.1% 110 100 10

The net amount is settled after the last day of the period. The Study Group on Risk-Free Reference Rates (the Study Group), for which the Bank of Japan acts as secretariat, gives an example in its document. In the example, on the last day of the period (the maturity date), the Bank of Japan publishes the final figure for the previous business day's TONA at around 10:00 a.m., and the parties then use it to calculate the floating amount. The net amount is settled 2 business days after the maturity date9.

Expectations for the overnight rate and gains and losses

The fixed-rate payer in an OIS gains if the compounded overnight rate over the period ends up above the OIS rate, and loses if it ends up below. In the example in the previous section, Bank A receives 10 million yen if the compounded TONA rate is 1.1%, and pays 10 million yen if it is 0.9%. Securities Firm G, which receives the fixed rate, has gains and losses of the opposite sign to Bank A's.

OIS rates strongly reflect the market's expectations for the overnight rate over the period5. In Japan, the Bank of Japan's guideline for money market operations states the level around which the Bank will encourage the uncollateralized overnight call rate, that is, TONA, to remain10. So when expectations of a change in monetary policy shift, yen OIS rates move too. The Bank of Japan's Financial System Report cites growing expectations of Bank of Japan rate hikes as the reason the 3-month OIS rate rose in the second half of fiscal 202511. When market OIS rates move after a trade is agreed, the expected payments over the rest of the term change, and the market value of the trade moves12. The Study Group's document describes OIS trades built on expectations for the outcome of each Monetary Policy Meeting (MPM) as MPM trades13.

OIS rates are also a basis for building term rates from an overnight risk-free rate (RFR). A Bank of Japan document gives two examples of term RFRs: the fixed rate paid in exchange for the overnight RFR compounded in arrears (the OIS rate), and a rate derived from the prices of interest rate futures14. TORF (Tokyo Term Risk Free Rate) is a term rate based on yen OIS rates315.

Hedging rate mismatches and discount curves

A typical use of OIS is hedging by financial institutions that fund themselves at a cost linked to the overnight rate and invest in fixed-rate assets. An OIS in which the institution pays a fixed rate and receives a floating rate to close the gap between its funding and investment rates is called an ALM (asset and liability management) swap1617. Another use is buying a fixed-rate bond, such as a government bond, with overnight funding and combining it with an OIS of the same term as the bond. The fixed rate received on the bond is paid away through the OIS, and the compounded overnight rate is received instead, to match the rate on the borrowing. This structure is called an asset swap16.

Consider a hypothetical example in which Bank C holds 10 billion yen of 1-year fixed-rate bonds paying 1.3% a year, and funds them by borrowing overnight and rolling the loan over every day. Assume its borrowing rate equals the compounded TONA rate over the period. If Bank C enters into an OIS with a notional amount of 10 billion yen and a fixed rate of 1%, paying the fixed rate and receiving compounded TONA, its margin for the year is as follows.

Compounded TONA rate (assumed) Margin without OIS (million yen) OIS net (million yen) Margin with OIS (million yen)
0.9% 40 −10 30
1.0% 30 0 30
1.1% 20 10 30

Without the OIS, a rise in TONA increases the interest on the borrowing, and the margin shrinks to 20 million yen at 1.1%. With the OIS, the amount received on the OIS covers the extra interest on the borrowing, so the margin is 30 million yen (10 billion yen × (1.3% − 1%)) whatever the level of TONA. On the other hand, if TONA falls to 0.9%, the margin stays at 30 million yen instead of the 40 million yen it would have been without the OIS. An OIS fixes the margin, but the institution gives up the larger margin it would earn when rates fall.

OIS rates are also used as discount rates when calculating the market value of derivatives. For trades in which cash collateral is exchanged, the practice is now to value future cash flows by discounting them at OIS rates18. When collateralized derivatives are valued on a discount curve built from OIS rates, the risk of that discount curve moving can be hedged with OIS of the same tenor19.

Counterparty risk and clearing

The overnight rate that the floating leg of an OIS references is a rate for lending for a single day, so the bank credit risk it contains is very limited20. OIS rates therefore also behave much like risk-free rates21. An OIS trade itself, however, carries counterparty risk: the risk that the other party cannot pay the net amount.

Yen OIS are OTC derivatives. According to the Study Group's document, compiled from information as of March 2018, almost all trades were cleared through Japan Securities Clearing Corporation (JSCC), a central counterparty22. Because the central counterparty steps in between the parties and becomes the counterparty to each side, it reduces the counterparty risk between the parties23. JSCC clears yen OIS that reference TONA, where the trade is between JSCC clearing participants and meets conditions on the term, notional amount and other items24.

Trading terms for yen OIS

The Study Group's document sets out the basic trading terms for yen OIS. The reference rate is the final figure for TONA, the notional amount is in units of 1 billion yen, the fixed rate is quoted in steps of one-eighth of a basis point (1bp is 0.01%), and holidays follow the Tokyo calendar825. At the time of the document, interest was paid once a year for terms of 1 year or more, and only once at maturity for terms under 1 year. From March 26, 2018, JSCC added 6-month, 3-month and 1-month interest payment frequencies for the OIS it clears26.

How it differs from an interest rate swap on TIBOR

An OIS and a fixed-for-floating interest rate swap that references TIBOR (Tokyo Interbank Offered Rate) both exchange a fixed rate for a floating rate. They differ in when the floating rate is set and in how much bank credit risk it contains28.

Trade Floating rate When the floating rate is set Bank credit risk
OIS TONA compounded in arrears At the end of the interest period Very limited
Interest rate swap (TIBOR) TIBOR Before the interest period Included

TIBOR is a term rate at which banks lend to other banks without collateral, so it includes bank credit risk. Interbank rates for unsecured lending, such as TIBOR and LIBOR (London Interbank Offered Rate), are collectively called IBORs. The Study Group's document says IBORs suit products in which the rate should reflect bank credit risk, while RFRs and OIS rates suit the many derivatives whose reference rate does not need to include credit risk28. JSCC also clears basis swaps that exchange the OIS floating rate for the TIBOR floating rate24.

Notes

  1. Study Group on Risk-Free Reference Rates, "日本円ＯＩＳ（Overnight Index Swap）─取引の概要と活用事例─" (Yen OIS: overview of transactions and examples of use, April 2018, in Japanese), "２．OIS とは何か" (2. What is OIS?) and "（OIS の定義）" (Definition of OIS), page 3 (page 5 of the PDF). ↩ ↩2

  2. Bank of Japan, "コール市場" (The call market), 教えて！にちぎん (in Japanese). It says that most trades in the uncollateralized call market are overnight trades, in which funds are delivered on the day the trade is agreed and repaid on the next business day. ↩

  3. Study Group on Risk-Free Reference Rates, "日本円ＯＩＳ（Overnight Index Swap）─取引の概要と活用事例─" (April 2018, in Japanese), "参照指数" (Reference index) under "基本的な取引方式" (Basic trading terms), page 5, and Bank of Japan, "金融システムレポート" (Financial System Report (April 2024), in Japanese), "BOX4 最近の金利動向" (Box 4: Recent developments in interest rates), page 92 (page 97 of the PDF; TORF appears there as a 3-month OIS rate). An English version of the report is available: "Financial System Report (April 2024)". ↩ ↩2

  4. Central Council for Financial Services Information, "4-2 金利スワップの仕組み（やさしいデリバティブ）" (How interest rate swaps work, Easy Derivatives, in Japanese). It says that an interest rate swap does not exchange principal, and that a principal amount is set in advance to calculate interest. ↩

  5. Study Group on Risk-Free Reference Rates, "日本円ＯＩＳ（Overnight Index Swap）─取引の概要と活用事例─" (April 2018, in Japanese), "（変動金利の受払額が金利計算期間の満期日に確定）" (The floating amount is fixed on the maturity date of the interest calculation period) under "②OIS レートの性質" (Nature of OIS rates), page 8, and the opening of "３．OIS の活用事例" (3. Examples of OIS use), page 7. The opening says that the OIS rate "翌日物金利に対する市場見通しを強く反映する" (strongly reflects market expectations for the overnight rate; our translation). ↩ ↩2

  6. Alternative Reference Rates Committee, "SOFR Floating Rate Notes Conventions Matrix" (August 2019), the item comparing compounded and simple averages. It says that compounding is established market practice for SOFR-referencing derivatives, including OIS. ↩

  7. Study Group on Risk-Free Reference Rates, "日本円ＯＩＳ（Overnight Index Swap）─取引の概要と活用事例─" (April 2018, in Japanese), "変動金利の計算方法" (Floating rate calculation method) under "基本的な取引方式" (Basic trading terms), page 5, and the calculation of the fixed payment in "例２" (Example 2), page 6. The document annualizes the compounded floating rate using the actual number of days in the period and a 365-day year. ↩

  8. The same document, "基本的な取引方式" (Basic trading terms), page 5. ↩ ↩2

  9. The same document, "例２：１年未満のOIS 清算取引で、満期時のみに利払いを行うケース" (Example 2: a cleared OIS of less than 1 year with interest paid only at maturity), page 6. ↩ ↩2

  10. Bank of Japan, "金融市場調節方針の変更について" (Change in the Guideline for Money Market Operations, June 16, 2026, in Japanese), item 1, page 1. An English version is available: "Change in the Guideline for Money Market Operations", item 1, page 1. ↩

  11. Bank of Japan, "金融システムレポート" (Financial System Report (April 2026), in Japanese), "２．2025 年度下期の国内金融市場" (2. Domestic financial markets in the second half of fiscal 2025) under "Ⅱ．金融資本市場から観察されるリスク" (II. Risks observed in financial and capital markets), page 11 (page 16 of the PDF). An English version of the report is listed on the Bank of Japan's website: "Financial System Report (April 2026)". ↩

  12. Society of Actuaries, "Interest Rate Swaps" (Financial Mathematics Study Note), "6 Market Value", page 15. It says that the market value of a swap is the present value of the expected future payments, calculated at the rates at that time, so the value changes if rates differ from those when the fixed rate was set. ↩

  13. Study Group on Risk-Free Reference Rates, "日本円ＯＩＳ（Overnight Index Swap）─取引の概要と活用事例─" (April 2018, in Japanese), "（MPM トレード）" (MPM trades), page 10. The document says that its examples of use do not recommend any particular trade (page 7). ↩

  14. Bank of Japan, "LIBOR 公表停止後のドル調達プレミアムのモニタリングにおける留意点について" (Points to note in monitoring the dollar funding premium after the cessation of LIBOR, Bank of Japan Review, February 2022, in Japanese), footnote 4 (page 7 of the PDF). ↩

  15. QUICK Benchmarks Inc. website, home page (in Japanese). It writes TORF as "TORF（東京ターム物リスク・フリー・レート）" (TORF (Tokyo Term Risk Free Rate); our translation). ↩

  16. Study Group on Risk-Free Reference Rates, "日本円ＯＩＳ（Overnight Index Swap）─取引の概要と活用事例─" (April 2018, in Japanese), "（アセット・スワップ）" (Asset swaps) and "（ALM スワップ）" (ALM swaps) under "①基本的な活用事例" (Basic examples of use), page 9. ↩ ↩2

  17. Bank of Japan Financial System and Bank Examination Department, "企業年金の運用戦略からみた金融安定への含意 ―英国債市場の混乱からの教訓―" (Implications of corporate pension fund investment strategies for financial stability: lessons from the turmoil in the U.K. gilt market, Bank of Japan Review 2023-J-2, January 2023, in Japanese), footnote 2, page 7. An English version is available: "Corporate Pension Funds' Investment Strategies and Financial Stability: Lessons from the Turmoil in the UK Gilt Market" (Bank of Japan Review 2023-E-3, March 2023), footnote 2, page 7. It says, "LDI is a form of asset and liability management (ALM) for the comprehensive management of assets and liabilities." ↩

  18. Takashi Kawakami, "ヘッジ取引におけるデリバティブ信用評価調整の影響についての考察" (A study of the effects of credit valuation adjustments of derivatives on hedging transactions, in Japanese), Kinyu Kenkyu, Institute for Monetary and Economic Studies, Bank of Japan (April 2018), page 123 (page 5 of the PDF). ↩

  19. Study Group on Risk-Free Reference Rates, "日本円ＯＩＳ（Overnight Index Swap）─取引の概要と活用事例─" (April 2018, in Japanese), "（デリバティブのディスカウント・リスクのヘッジ）" (Hedging the discount risk of derivatives), page 10. ↩

  20. Study Group on Risk-Free Reference Rates, "日本円のリスク・フリー・レートの特定に関する報告書" (Report on the Identification of a Japanese Yen Risk-Free Rate, December 2016, in Japanese), "② 他通貨圏におけるリスク・フリー・レートとの関係性" (Relationship with risk-free rates in other currency areas), page 4 (page 6 of the PDF). An English version is available: "Report on the Identification of a Japanese Yen Risk-Free Rate", "(2) The relationship of a JPY risk-free rate with risk-free rates in other currencies" under "2-2. Conclusion of the Study Group", pages 4–5. ↩

  21. Study Group on Risk-Free Reference Rates, "日本円ＯＩＳ（Overnight Index Swap）─取引の概要と活用事例─" (April 2018, in Japanese), "（信用リスクはごく限定的）" (Credit risk is very limited) under "②OIS レートの性質" (Nature of OIS rates), page 8. ↩

  22. The same document, "（OIS の定義）" (Definition of OIS), page 3, and "（OIS の取引形態）" (How OIS are traded), page 4. The document was compiled from information as of March 2018. ↩

  23. Japan Securities Clearing Corporation, "金利スワップ 債務負担" (Interest rate swaps: assumption of obligations, in Japanese), and Study Group on Risk-Free Reference Rates, "日本円ＯＩＳ（Overnight Index Swap）─取引の概要と活用事例─" (April 2018, in Japanese), "（清算適格取引の拡充）" (Expanding eligible trades for clearing), page 12. An English version of the JSCC page is available: "IRS Clearing". The Study Group's document says that more trades using a central counterparty would help, among other things, to reduce the credit risk of counterparties to interest rate swaps. ↩

  24. Japan Securities Clearing Corporation, "清算対象取引（金利スワップ）" (Eligible trades for clearing: interest rate swaps, in Japanese; page checked in September 2026), the table of eligible products and the conditions under "3．スワップの種類" (items 2, 4, 5, 8, 9, 10, 11 and 13; the article uses clearing participants, term, remaining term, notional amount, day count and calendar). An English version is available: "Clearing Products". Basis swaps are No. 5 in the table and item b of "3．スワップの種類". ↩ ↩2 ↩3

  25. Society of Actuaries, "Interest Rate Swaps" (Financial Mathematics Study Note), "1 Background", page 3 (page 4 of the PDF). It says, "A basis point is 1/100 of 1%." ↩

  26. Study Group on Risk-Free Reference Rates, "日本円ＯＩＳ（Overnight Index Swap）─取引の概要と活用事例─" (April 2018, in Japanese), "例１" (Example 1) and "例２" (Example 2), page 6, and Chart 5, "JSCC における金利支払頻度の追加" (Additional interest payment frequencies at JSCC), in "（清算適格取引の拡充）" (Expanding eligible trades for clearing), page 12. ↩

  27. The same document, "（事務・システム面の対応）" (Operations and systems) and "（会計面の対応）" (Accounting) under "４．OIS 利用に当たっての留意事項" (4. Points to note when using OIS), page 11. ↩ ↩2

  28. The same document, "（１）IBOR とOIS レートの性質の違い" ((1) Differences in the nature of IBOR and OIS rates), pages 7–8. ↩ ↩2