Context: The Reserve Bank of India (RBI) is currently reviewing the investment limit for foreign investors in the overnight index swap (OIS) market. This move aims to adjust regulatory frameworks and enhance market dynamics.
Overnight Index Swap
o Liquidity Indicator: The OIS-Libor credit spread reflects system liquidity.
o Wide Spread: A wider spread indicates tightening liquidity in the system.
o Narrow Spread: A narrower spread suggests better liquidity in the system.
o Functionality: Financial institutions use OIS to swap interest rates without refinancing or altering the terms of their existing loans.
o Swap Mechanism: In an OIS, one institution swaps a floating overnight interest rate, while the other swaps a fixed short-term rate. At the end of the agreement, the institution paying less interest compensates the other.
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