What type of index is utilized in an overnight index swap (OIS)?

An overnight index swap (OIS) specifically utilizes an overnight interest rate index as its reference rate. This type of index reflects the interest rate for overnight borrowing between banks, providing a benchmark for the swap's floating leg. The OIS is typically used to hedge against or speculate on short-term interest rate movements.

This mechanism allows parties to lock in a fixed rate over a specified term while exchanging payments based on the fluctuations of the overnight rate. The overnight index usually involves rates such as the effective federal funds rate or other similar benchmarks, tailoring the swap to effectively manage interest rate risk over short timeframes.

Other types of indices, such as average monthly interest rates, fixed annual interest rates, or daily closing stock prices, do not accurately reflect the nature and purpose of OIS, which is focused on short-term borrowing costs rather than longer-term or equity-related metrics. Thus, the correct answer highlighting the index used in this context is indeed tied to an overnight interest rate.