The financial world is constantly progressing, and one of the current modifications is the transition from LIBOR (London Inter-bank Offered Rate) to alternative reference cost. Among these choices, the Secured Overnight Financing Rate (SOFR) has won prominence.
How can you define a Secured Overnight Financing Rate (SOFR)?
First, let’s get to know about the meaning of the definition of Overnight rate. The benchmark interest rate that depositary organizations like banks and credit unions charge one another for lending money for a single night can be defined as the Overnight rate. It is however, very closely related to banking operations and liquidity issues. This rate has different names depending on the country. This is known as the Federal Funds Rate in the US.
First, let’s get to know about the meaning of the definition of Overnight rate. The benchmark interest rate that depositary organizations like banks and credit unions charge one another for lending money for a single night can be defined as the Overnight rate. It is however, very closely related to banking operations and liquidity issues. This rate has different names depending on the country. This is known as the Federal Funds Rate in the US.
A general indicator of the charge of the overnight cash borrowing secured by treasury securities is the Secured Overnight Financial Rate (SOFR). Compared to LIBOR, The Secured Overnight Financing Rate (SOFR) serves as the benchmark interest rate for loans.
Defining the importance of the Secured Overnight Financing Rate (SOFR)
The financial institutions make use of SOFR as a benchmark when determining the cost of consumer and business loans. It is also essential in trading derivate which is utilised by businesses and other parties to manage the interest rate risk.
How this is calculated?
The volume-weighted median of transaction data from three repo markets, like Tri-party Repo Market, General Collateral Finance (GCF) Repo Market, and Bilateral Repo Market, is utilized by the New York Fed in its publication of SOFR data.
The rate is assessed based on the weighted average number of transactions from the previous day. Everyday morning, the SOFR rate is posted on the official website by the New York Federal Reserve Bank.
SOFR is based on observable transactions. Unlike LIBOR, SOFR is vulnerable to manipulation owing to its transaction-based nature.
Final Thoughts
SOFR’s introduction act as a benchmark price signifies a shift within the economic panorama. Based on overnight treasury transactions,SOFR is a risk-free rate. The SOFR helps in depicting the current funding method used by financial institutions as it is an overnight secured rate.
