Introduction

In the market of interest rate swap, the collateralization use has become popular for the purpose of reducing or eliminating the risk of counterparty credit. There are two discount rates: London interbank offered rates also called LOBOR and overnight index swap also referred to as OIS.Both discount rates can be used in order to value the interest rate swap portfolio in the United States proprietarytrading groups.

This dissertation would disuse the differencebetween overnight index swap (OIS), London interbank offered rates (LOBOR), LOBOR scandal as well as calculate the payments by OIS rates and LIBOR rates. The ultimate purpose of this study is to critically evaluatewhich discount rate must be used while pricing the derivative instrument.

Difference between London Interbank Offered Rate and Overnight Indexed Swap:

An interest swap is supposed to the contractual agreement which critically evaluates the exchangeofpayments of interest between two parties, with the payment on fixed rate exchanged for the payments on floating rate. All around the world, the market of interest rate swap is considered as the largest market. In addition to this,according to the Bank of International Settlement,an estimated $311.5 trillion are outstanding as of June 2016 in the notional amounts. The interest rate swap acts as the tool which can be used in order to hedge in adverse interest rate movements in the market (Interest Rate Swaps, 2017).

There are many investors and corporations who haveattempted to enter into the agreement of swap with commercial banks and investment. The value of the swap is the difference between floating payments and fixed payments.

For all the short term rate of interests, the LIBOR acts as a benchmark, andtends to measure the average rate of interest of major banks which are receiving short term loans in the interbank market of London.The number of different London interbank rates are almost 15, each of them corresponds to adifferent currency and maturity date.

Has Libor Lost Its Stature In Derivatives Markets Harvard Case Solution & Analysis

LIBOR has been designed in order to provide anaccurate picture of how much it would cost after borrowing short term. Each and every day, there are several banks of the world which are responsible to report the incurred cost to borrow on the London interbank offered rates from the lenders in the interbank market.

Meanwhile, theovernight indexed swap (OIS) represents the central bank rate of the country in the United Statesover the course of time i.e. Fed funds rate which is an interest rate and the federal reserve controls this rate in case, if the corporation or commercial banks seek to convert the fixed interest payments into variable interest payments or vise versa.

The parties do not exchange principle in the basic interest rate swap, but rather the two interest rate streams. It is to notify that the credit risk has always been the major factor which is frequently used in evaluating the rate of overnight indexed swap (OIS).

The spread of LIBOR-IOS tends to be considered as the key measure of the perception of the investor within banking sectorregarding credit risk. Overnight, indexed swap rate is the central policy rate of the bank, unlike London interbank offered rate (LIBOR), in order to determine the rate of overnight indexedswap;the major factor is not the credit risk..............

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