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What is the Secured Overnight Financing Rate (SOFR)?
The Secured Overnight Financing Rate, or SOFR, is the Alternative Reference
Rates Committee’s replacement for the US dollar London Interbank Offer Rate,
or USD LIBOR, as the market’s key benchmark rate on US dollar-denominated
securities. It represents the broad cost of overnight (one-day) loans, called
overnight repurchase agreements, or simply “repo,” that are collateralized
with US Treasury securities.
How is SOFR calculated?
The Federal Reserve Bank of New York calculates SOFR each day using
transaction-level data from the Bank of New York Mellon on overnight,
specific-counterparty tri-party general collateral repo transactions secured
by Treasury securities, along with GCF Repo transaction data obtained from the
US Department of Treasury’s Office of Financial Research. For more complete
information about SOFR’s administration, along with detail about the
transactions included in the calculation, please visit the
New York Fed’s website.
What are SOFR futures and options on SOFR futures?
SOFR futures are derivative contracts that deliver the equivalent overnight
repo-based financing across specific future quarterly windows. The rate
associated with a futures contract—the three-month compounded average SOFR—is
based on the market’s expectation of the cost of Treasury repo financing each
day throughout the contract’s indicated reference quarter.
Options on SOFR futures are derivative contracts that give the holder the
right, but not the obligation, to buy or sell SOFR futures expiring on (or
before) a specific date for a specific price, called the strike price. The
price of an option, called the option premium, is based on where the market
expects the cost of overnight Treasury repo financing will be relative to the
option’s strike price once the option expires. Thus, option premiums contain
information about the probability that SOFR, over the three months indicated
in the contract’s reference quarter, will be either above or below the strike
price specified in the option contract at expiration.
Both SOFR futures and options on SOFR futures are traded on the Chicago
Mercantile Exchange. For more detail about the contract specifications, please
visit the
CME’s website.
What impact do FOMC decisions have on SOFR?
Federal Open Market Committee decisions affect SOFR through the New York Fed’s
Open Market Trading Desk’s (the “Desk’s”) implementation of monetary policy.
Operationally, the Desk is authorized to conduct repurchase transactions with
its primary dealers and other eligible financial institutions to apply
downward pressure on the federal funds rate and to reverse repurchase
agreements to apply upward pressure on the federal funds rate. The Desk also
has the authority to conduct unscheduled repurchase transactions should
conditions warrant them. Together, these actions can help maintain the federal
funds rate within the FOMC’s target range and support smooth market
functioning. The rates at which repo and reverse repo transactions are
conducted are reflected by SOFR.
For more information about the Desk’s monetary policy implementation, please
go to the
New York Fed’s website.
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