SOFR

SOFR is calculated from actual overnight repurchase agreements collateralised by US Treasuries, not from survey submissions. The input pool draws on tri-party repo data, cleared bilateral repo and GCF Repo activity, covering transaction volumes measured in hundreds of billions to over a trillion dollars on a typical day. That depth is the point: the rate rests on observable trades rather than judgement.

The published figure is a volume-weighted median, meaning transactions are ranked by rate and the level at which cumulative volume reaches the halfway point is taken. A median resists distortion from a handful of off-market trades far better than a mean would. The rate is released each business day, referencing the prior business day's activity, and the Fed also publishes 30-, 90- and 180-day compounded averages plus a cumulative SOFR Index that lets users derive the compounded rate between any two dates.

Because SOFR fixes daily, a three-month coupon must be assembled from roughly sixty-odd daily observations. The standard method compounds each day's rate over its own day count, effectively multiplying together factors of one plus the daily rate times days over 360, then converting the product back into an annualised rate. Weekend and holiday rates are carried forward from the preceding business day.

Operational conventions soften the timing problem. A lookback shifts the observation window earlier; a payment delay pushes settlement later; an observation shift moves both rates and their weights back together. Alternatively, forward-looking Term SOFR is derived from SOFR futures and derivatives pricing, giving a rate set at the start of the period in the way market participants were used to. Term SOFR dominates syndicated lending, while compounding in arrears dominates derivatives and much of the bond market.

SOFR anchors the USD overnight index swap curve, which in turn serves as the discounting curve for collateralised derivatives and as the practical proxy for a risk-free term structure. SOFR futures on CME provide the liquid instruments from which forward rates and Term SOFR are extracted. On the cash side, floating-rate notes, agency and GSE floaters, leveraged loans, CLO liabilities and much commercial real estate debt now quote a spread over some SOFR variant.

Coupons on legacy contracts that migrated from LIBOR carry a credit spread adjustment so the new reference plus the adjustment approximates the old rate's historical level; for three-month USD LIBOR the widely used ISDA and ARRC figure is 26.161 basis points. Analysts reading a loan agreement or FRN prospectus should identify which SOFR flavour applies, the lookback or shift convention, any floor, and whether a spread adjustment is embedded.

Expect to classify reference rates by what risk they embed. SOFR is secured and overnight, so it carries essentially no bank credit or term premium; interbank offered rates carried both, which is why the two series diverge sharply during funding stress rather than moving in parallel. Being able to articulate that distinction, and its consequence for valuing a floater or an interest rate swap, matters more than memorising publication details.

You should also be comfortable computing a compounded average from a short series of daily rates, explaining why a coupon compounded in arrears is not known until near payment date, and describing how a SOFR-based curve is bootstrapped from OIS quotes for discounting. Finally, understand why SOFR can print above the policy target around quarter-ends: dealer balance sheet constraints and collateral supply pressures affect repo, and those pressures pass straight through to the index.