Why is an overnight benchmark harder to use than a term one?
The transition was not free. LIBOR did something the replacements structurally cannot, and pretending otherwise would be dishonest teaching. Here is the real cost, with the arithmetic.
Forward-looking versus backward-looking
LIBOR was forward-looking: the three-month rate was fixed at the start of the period. A borrower knew on day one exactly what the interest payment on day ninety would be. Treasurers could budget; systems could book the cash flow immediately.
An overnight risk-free rate has no term structure at all. There is no three-month SOFR to observe, because SOFR is a single night's rate. The only way to get a period rate out of it is to watch it accrue and compound it — in arrears. The coupon is therefore known only at the end of the period.
The compounding arithmetic
Over n business days, on an actual/360 basis:
compounded rate = [ (1 + r1 × d1 / 360) × (1 + r2 × d2 / 360) × ... × (1 + rn × dn / 360) − 1 ] × 360 / D
where each r is that day's fixing, each d the calendar days it applies to, and D the total days in the period. In words: multiply one day's growth factor by the next, all the way through, then annualise.
Worked example. Suppose the overnight rate sits flat at 5.00% for a 30-day period. The simple average is obviously 5.00%. Compounded:
(1 + 0.05 / 360)^30 − 1 = 0.0041751
annualised: 0.0041751 × 360 / 30 = 5.0101%
Compounding adds about one basis point over a month at that level. Tiny — but not zero, and on $500 million over 30 days:
500,000,000 × 0.0001 × 30 / 360 = $4,167
Small numbers times large balances is the whole character of this market, which is why conventions have to be written down to the decimal.
The conventions that make it workable
Nobody wants to learn their interest payment on the day it is due, so the market built three fixes, all of which trade certainty against a small mismatch:
- Lookback — use fixings from a set number of business days earlier (five is common), so the rate is known before payment.
- Lockout — freeze the rate for the final few days of the period.
- Payment delay — keep the observation period exact and pay a few days later.
And the market built term rates anyway
Demand for a forward-looking rate did not disappear, so CME Term SOFR was constructed from SOFR futures and recommended by the ARRC in July 2021 for specific uses — business loans and certain securitisations. The recommendation came with deliberate restrictions on its use in derivatives, precisely to stop a thin-market benchmark re-forming on top of a deep one. The discipline is the point: a term rate is allowed where the alternative is genuinely impractical, not everywhere.
In the data
The New York Fed publishes the workaround beside the overnight rate: SOFR compounded in arrears over the past 30, 90 and 180 days, and an index of every day's compounding since the first fixing.
All of them look backward, so none says what the next ninety days will cost. On 24 September 2026 overnight SOFR was 3.88% while the 30-day average was 3.70% and the 90-day 3.66%: the Fed had raised its range a week earlier, and the averages had barely begun to absorb it. A borrower paying the 90-day average that day was paying for the quarter that had just ended, not for the one ahead.
Try it now
- Below is every SOFR fixing from 18 August to 24 September 2026. Take the thirty days from 25 August to 24 September: the fixings dated 25 August to 23 September, each applying until the next business day, so a Friday fixing counts three days and 4 September four (7 September was a holiday). Compute the simple average, then the compounded rate using the formula above.
- How many basis points apart are they? Convert that gap into dollars on a $200 million notional, then compare both against the published 30-day average (SOFR30D). Its value for 24 September 2026 is in the table below, with the rest of that day's dollar rates.
- Recompute the compounded figure using a five-business-day lookback: each day takes the fixing from five business days earlier, which is why the SOFR table starts on 18 August. Does the answer change materially, and would you have known it in advance?