Glossary of Derivatives Glossary

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An accreting principal is one which increases during the life of the deal. See amortising, bullet.
Accreting swap
Swap whose notional amount increases during the life of the swap (opposite of amortising swap).
Accrued interest
The proportion of interest or coupon earned on a bond from the previous coupon payment date until the value date.
Accumulated value
The same as future value.
A day/year count convention taking the number of calendar days in a period and a "year" of 360 days.
A day/year convention taking the number of calendar days in a period and a "year" of 365 days. Under the ISDA definitions used for interest rate swap documentation, act/365 means the same as act/act.
A day/year count convention taking the number of calendar days in a period and a "year" equal to the number of days in the current coupon period multiplied by the coupon frequency. For an interest rate swap, that part of the interest period falling in a leap year is divided by 366 and the remainder is divided by 365.
Agency securities
In the United States, securities issued by government-sponsored entities, such as the Government National Mortgage Association (GNMA) and the Federal Home Loan Mortgage Corporation (FHLMC).
All or nothing
Digital option. This option’s put (call) pays out a pre-determined amount ("the all") if the index is below (above) the strike price at the option’s expiration. The amount by which the index is below (above) the strike is irrelevant; the payout will be all or nothing.
All-in price
See dirty price.
An American option is one which may be exercised at any time during its life.
An amortising principal is one which decreases during the life of a deal, or is repaid in stages during a loan. Amortising an amount over a period of time also means accruing for it pro rata over the period. See accreting, bullet.
An investment providing a series of (generally equal) future cash flows.
An increase in the market value of a currency in terms of other currencies. See depreciation, revaluation.
The process of buying securities in one country, currency or market, and selling identical securities in another to take advantage of price differences. When this is carried out simultaneously, it is in theory a risk-free transaction. There are many forms of arbitrage transactions. For instance in the cash market a bank might issue a money market instrument in one money centre and invest the same amount in another centre at a higher rate, such as an issue of three-month US dollar CDs in the United States at 5.5% and a purchase of three-month Eurodollar CDs at 5.6%. In the futures market arbitrage might involve buying three-month contracts and selling forward six-month contracts.
Someone who undertakes arbitrage trading.
(autoreggressive conditional heteroscedasticity) A discrete-time model for a random variable. It assumes that variance is stochastic and is a function of the variance of previous time steps and the level of the underlying.
An Asian option depends on the average value of the underlying over the option’s life.
See offer.
Probable future economic benefit obtained or controlled as a result of past events or transactions. Generally classified as either current or long-term.
Asset & Liability Management (ALM)
The practice of matching the term structure and cash flows of an organisation’s asset and liability portfolios to maximise returns and minimise risk. Also includes the deliberate mis-matching of cash flows to take account of views on the short-term yield curve.
Asset allocation
Distribution of investment funds within an asset class or across a range of asset classes for the purpose of diversifying risk or adding value to a portfolio.
Asset securitisation
The process whereby loans, receivables and other illiquid assets in the balance sheet are packaged into interest-bearing securities that offer attractive investment opportunities.
Asset swap
An interest rate swap or currency swap used in conjunction with an underlying asset such as a bond investment. See liability swap.
Asset-backed security
A security which is collaterised by specific assets – such as mortgages – rather than by the intangible creditworthiness of the issuer.
Asset-risk benchmark
Benchmark against which the riskiness of a corporation’s assets may be measured. In sophisticated corporate risk management strategies the dollar risk of the liability portfolio may be managed against an asset-risk benchmark.
At-the-money (ATM)
An option is at-the-money if the current value of the underlying is the same as the strike price. See in-the-money, out-of-the-money.
A method of issuing bonds where institutions submit bids to the issuer on a price or yield basis. Auction rules vary considerably across markets.
Average cap
Also known as an average rate cap, a cap on an average interest rate over a given period rather than on the rate prevailing at the end of the period. See also average price (rate) option.
Average price (rate) option
Option on a currency's average exchange rate or commodity's average spot price in which four variables have to be agreed between buyer and seller: the premium, the strike price, the source of the exchange rate or commodity price data and the sampling interval (each day, for example). At the end of the life of the option the average spot exchange rate is calculated and compared with the strike price. A cash payment is then made to the buyer of the option that is equal to the face amount of the option times the difference between the two rates (assuming the option is in-the-money; otherwise it expires worthless).
The validation of a model by feeding it historical data and comparing the results with historical reality.
The situation when a forward of futures price for something is lower than the spot price (the same as forward discount in foreign exchange). See contango.
Balance sheet
Statement of the financial position of an enterprise at a specific point in time, giving assets, liabilities and stockholders’ equity.
The Exchange Rate Mechanism (ERM II) of the European Union links the currencies of Denmark and Greece in a system which limits the degree of fluctuation of each currency against the euro within a band (of 15 per cent for the drachma and 21/4 per cent for the krone) either side of an agreed par value.
Banker’s acceptance
See bill of exchange.
In its simplest form, a position consisting of long positions in short- and long-dated bonds, and no holding of a medium-dated bond. A barbell portfolio would consist of a portfolio of very short-dated and very long-dated bonds.
A transaction undertaken on the London Stock Exchange.
Barrier option
A barrier option is one which ceases to exist, or starts to exist, if the underlying reaches a certain barrier level. See knock out/in.
Base currency
Exchange rates are quoted in terms of the number of units of one currency (the variable or counter currency) which corresponds to one unit of the other currency (the base currency).
The underlying cash market price minus the futures price. In the case of a bond futures contract, the futures price must be multiplied by the conversion factor for the cash bond in question.
Basis point
In interest rate quotations, 0.01 per cent.
Basis rate
The rate applicable in a basis swap.
Basis risk
A form of market risk that arises whenever one kind of risk exposure is hedged with an instrument that behaves in a similar, but not necessarily identical way. For instance a bank trading desk may use three-month interest rate futures to hedge its commercial paper or euronote programme. Although eurocurrency rates, to which futures prices respond, are well correlated with commercial paper rates they do not always move in lock step. If, therefore, commercial paper rates move by 10 basis points but futures prices dropped by only 7 basis points, the 3 bp gap would be the basis risk.
Basis swap
An interest rate swap where both legs are based on floating rate payments.
Basis trade
Buying the basis means selling a futures contract and buying the commodity or instrument underlying the futures contract. Selling the basis is the opposite.
Basket option
Option based on an underlying basket of bonds, currencies, equities or commodities.
Bear spread
A spread position taken with the expectation of a fall in value in the underlying.
Bearer bond
A bond for which physical possession of the certificate is proof of ownership. The issuer does not know the identity of the bondholder. Traditionally the bond carries detachable coupon, one for each interest payment date, which are posted to the issuer when payment is due. At maturity the bond is redeemed by sending in the certificate for repayment. These days bearer bonds are usually settled electronically, and while no register of ownership is kept by the issuer, coupon payments may be made electronically.
A bond whose terms set a standard for the market. The benchmark usually has the greatest liquidity, the highest turnover and is usually the most frequently quoted. It also usually trades expensive to the yield curve, due to higher demand for it amongst institutional investors.
The sensitivity of a stock relative to swings in the overall market. The market has a beta of one, so a stock or portfolio with a beta greater than one will rise of fall more than the overall market, whereas a beta of less than one means that the stock is less volatile.
The price at which a market maker will buy bonds. A tight bid-offer spread is indicative of a liquid and competitive market. The bid rate in a repo is the interest rate at which the dealer will borrow the collateral and lend the cash. See offer.
The two-way price at which a market maker will buy and sell stock.
Big figure
In a bond price quotation, the price omitting the decimal portion. For example, if the 10-year benchmark is quoted as 109.15-21, the big figure is 109. See points.
Bilateral netting
The ability to offset amounts owed to a counterparty under one contract against amounts owed to the same counterparty under another contract – for example, where both transactions are governed by one master agreement. Also known as cherry-picking.
A bill of exchange is a payment order written by one person (the drawer) to another, directing the latter (drawee) to pay a certain amount of money at a future date to a third party. A bill of exchange is a bank draft when drawn on a bank. By accepting the draft, a bank agrees to pay the face value of the obligation if the drawer fails to pay, hence the term banker’s acceptance. A Treasury bill is short-term government paper of up to one year’s maturity, sold at a discount to principal value and redeemed at par.
Bill of exchange
A short-term, zero-coupon debt issued by a company to finance commercial trading. If it is guaranteed by a bank, it becomes a banker’s acceptance.
Binomial tree
A mathematical model to value options, based on the assumption that the value of the underlying can move either up or down a given extent over a given short time. This process is repeated many times to give a large number of possible paths (the "tree") which the value could follow during the option’s life.
BIS (Bank for International Settlements)
Known as the central bank for central banks, an international organisation situated in Basel, Switzerland, which acts as the central bank for sovereign entities. It produced the "Basel accord" in 1988, implemented in 1992, which established capital requirements for banking institutions based on the risk-weighting of their assets; it also produced rules on the capital treatment of derivative instruments.
A widely used option pricing formula devised by Fischer Black and Myron Scholes.
Blended interest rate swap
Result of adding forward swap to an existing swap and blending the rates over the total life of the transaction.
The trading, analytics and news service produced by Bloomberg LP; also used to refer to the terminal itself. Introduced by ex-Salomon Brothers trader Mike Bloomberg.
Bond basis
An interest rate is quoted on a bond basis if it is on an act/365, act/act or 30/360 basis. In the short term (for accrued interest, for example), these three are different. Over a whole (non-leap) year, however, they all equate to 1. In general, the expression "bond basis" does not distinguish between them and is calculated as act/365. See money-market basis.
Bond-equivalent yield
The yield which would be quoted on a US treasury bond which is trading at par and which has the same economic return and maturity as a given treasury bill.
A method of deriving the term structure of interest rates from market bond prices and yields, using successive bonds to calculate the spot rate along the maturity term structure. In mathematics, a method of solving simultaneous equations in which the first equation contains one unknown, the next equation contains two unknowns and so on. The result obtained by solving the first equation is used to solve the second equation, and so on.
Basis point value. The price movement resulting from a one basis point change in yield.
Break forward
A product equivalent to a straightforward option, but structured as a forward deal at an off-market rate which can be reversed at a penalty rate.
Broken date
A maturity date other than the standard ones (such as 1 week, 1, 2, 3, 6 and 12 months) normally quoted.
Members of the London Stock Exchange who may intermediate between customers and market makers; may also act as principals, transacting business with customers from their own holdings of stock.
Bull spread
A spread position taken with the expectation of a rise in value in the underlying.
Sterling domestic bonds issued by non-UK domiciled borrowers. These bonds trade under a similar arrangement to Gilts and are settled via the Central Gilts Office (now CREST).
A loan/deposit has a bullet maturity if the principal is all repaid at maturity. See amortising.
Opposite of sell/buy-back.
The exchange rate for sterling against the US dollar.
The European Union’s Capital Adequacy Directive.
Calendar spread
The simultaneous purchase/sale of a futures contract for one date and the sale/purchase of a similar futures contract for a different date. See spread.
Call option
An option to purchase the commodity or instrument underlying the option. See put.
Call price
The price at which the issuer can call in a bond.
Callable bond
A bond which provides the borrower with an option to redeem the issue before the original maturity date. In most cases certain terms are set before the issue, such as the date after which the bond is callable and the price at which the issuer may redeem the bond.
Cancellable swap
Swap in which the payer of the fixed rate has the option, usually exercisable on a specified date, to cancel the deal (see also swaption).
A series of borrower’s IRGs, designed to protect a borrower against rising interest rates on each of a series of dates.
Capital market
Long term market (generally longer than one year) for financial instruments. See money market.
Capital structure arbitrage
A trade strategy pursued by hedge funds and banks. It involves a play of a company's debt against its equity. Generally this is done using derivatives rather than cash instruments, so it involves putting a on a long/short Credit Default Swap position in a specific reference entity name against a short/long equity option position in the same name. Both are usually OTC although one could trade the latter as an exchange-traded option. The idea is to make money because of either perceived mispricing of the debt against the equity or one expects the relative value of one against the other to change in a particular direction.
Option on a cap.
See cash market.
Cash market
The market in instruments that represent actual cash, which is an on-balance sheet asset. For example, an interbank deposit of £10 million represents £10 million by value of funds placed in the deposit institution. Bonds are cash instruments.
The US market term for basis trading, an arbitrage-type trade in which a simultaneous position in cash bond and associated bond futures contract is put on, with a view to exploiting price differentials between the spot price of the bond and the future price implied by the current price of the bond future. A cash-and-carry trade is a long bond/short futures position, while the opposite of short the bond and long the future is known as a reverse cash-and-carry.
The Chicago Board of Trade, one of the two futures exchanges in Chicago, USA and one of the largest in the world.
See certificate of deposit.
Centrale de Livraison de Valeurs Mobilieres; a clearing system for Euro-currency and international bonds. Cedel is located in Luxembourg and is jointly owned by a number of European banks. Subsequently renamed Clearstream on merger with Deutsche Bourse.
The same as cap.
Central Gilts Office
The office of the Bank of England which runs the computer-based settlement system for gilt-edged securities and certain other securities (mostly bulldogs) for which the Bank acts as Registrar. Subsequently merged with CREST.
Central limit theorem
The assertion that as sample size, n, increases, the distribution of the mean of a random sample taken from almost any population approaches a normal distribution.
Certificate of Deposit (CD)
A money market instrument of up to one year’s maturity (although CDs of up to five years have been issued) that pays a bullet interest payment on maturity. After issue, CDs can trade freely in the secondary market, the ease of which is a function of the credit quality of the issuer.
Central Government Net Cash Requirement.
Central Government Borrowing Requirement.
CGO reference prices
Daily prices of gilt-edged and other securities held in CGO which are used by CGO in various processes, including revaluing stock loan transactions, calculating total consideration in a repo transaction, and DBV assembly. Also known as CREST prices or DMO prices.
Cheapest to deliver (CTD)
In a bond futures contract, the one underlying bond among all those that are deliverable, which is the most price-efficient for the seller to deliver.
See bilateral netting.
Classic repo
Repo is short for "sale and repurchase agreement" – a simultaneous spot sale and forward purchase of a security, equivalent to borrowing money against a loan of collateral. A reverse repo is the opposite. The terminology is usually applied from the perspective of the repo dealer. For example, when a central bank undertakes repos, it is lending cash (the repo dealer is borrowing cash from the central bank).
Clean deposit
The same as time deposit.
Clean price
The price of a bond excluding accrued coupon. The price quoted in the market for a bond is generally a clean price rather than a dirty price.
Clearing house
The body that settles trades on a futures exchange, and which acts as the counterparty to every transaction. The clearing house is able to guarantee settlement by charging margin to all exchange participants, which is used to establish a default fund.
The international bond market clearing system, resulting from a merger between CEDEL and Deutsche Bank.
Close-out netting
The ability to net a portfolio of contracts with a given counterparty in the event of default. See also bilateral netting.
Closing leg
In a repo transaction, the termination of the trade when the bonds (or other assets) are returned against receipt of borrowed funds and repo interest.
Central Moneymarkets Office which settles transactions in Treasury bills and other money markets instruments, and provides a depository (in the UK). Now merged with CREST.
Current mark-to-market value. See current exposure and replacement cost.
The simultaneous sale of a put (or call) option and purchase of a call (or put) at different strikes – typically both out-of-the-money.
Something of value, often of good creditworthiness such as a government bond, given temporarily to a counterparty to enhance a party’s creditworthiness. In a repo, the collateral is actually sold temporarily by one party to the other rather than merely lodged with it.
Commercial paper
A short-term security issued by a company or bank, generally with a zero coupon.
Commodity swap
Swap where one of the cash flows is based on a fixed value for the underlying commodity and the other is based on a floating index value. The commodity is often oil or natural gas, although copper, gold, other metals and agricultural commodities are also commonly used. The end-users are consumers, who pay a fixed-rate, and producers.
Competitive bid
A bid for the stock at a price stated by a bidder in an auction. Non-competitive bid is a bid where no price is specified; such bids are allotted at the weighted average price of successful competitive bid prices.
Compound interest
When some interest on an investment is paid before maturity and the investor can reinvest it to earn interest on interest, the interest is said to be compounded. Compounding generally assumes that the reinvestment rate is the same as the original rate. See simple interest.
Compound option
Option on an option, the first giving the buyer the right, but not the obligation, to buy the second on a specific date at a pre-determined price. There are two kinds. One, on currencies, is useful for companies tendering for overseas contracts in a foreign currency. The interest rate version comprises captions and floortions.
The total price paid in a transaction, including taxes, commissions and (for bonds) accrued interest.
The situation when a forward or futures price for something is higher than the spot price (the same as forward premium in foreign exchange). See backwardation.
Contingent option
Option where the premium is higher than usual but is only payable if the value of the underlying reaches a specified level. Also known as a contingent premium option.
Continuous compounding
A mathematical, rather than practical, concept of compound interest where the period of compounding is infinitesimally small.
Contract date
The date on which a transaction is negotiated. See value date.
Contract for differences
A deal such as an FRA and some futures contracts, where the instrument or commodity effectively bought or sold cannot be delivered; instead, a cash gain or loss is taken by comparing the price dealt with the market price, or an index, at maturity.
Conventional gilts (included double-dated)
Gilts on which interest payments and principal repayments are fixed.
Conversion factor
In a bond futures contract, a factor to make each deliverable bond comparable with the contract’s notional bond specification. Defined as the price of one unit of the deliverable bond required to make its yield equal the notional coupon. The price paid for a bond on delivery is the futures settlement price times the conversion factor.
Convertible currency
A currency that may be freely exchanged for other currencies.
A measure of the curvature of a bond’s price/yield curve (mathematically).
Corporate bond
A cash debt instrument that has been issued by a corporate, and is therefore an IOU issued by the company and which it is obliged to redeem in accordance with its contractual terms.
Correlation matrices
Statistical constructs used in the value-at-risk methodology to measure the degree of relatedness of various market forces.
The same as collar.
Cost of carry
The net running cost of holding a position (which may be negative) – for example, the cost of borrowing cash to buy a bond less the coupon earned on the bond while holding it.
Counterparty risk weighting
See risk weighting.
Country risk
The risks, when business is conducted in a particular country, of adverse economic or political conditions arising in that country. More specifically, the credit risk of a financial transaction or instrument arising from such conditions.
The interest payment(s) made by the issuer of security to the holders, based on the coupon rate and the face value.
Coupon swap
An interest rate swap in which one leg is fixed-rate and the other floating-rate. See basis rate.
A statistical measure of how much two ransom variables are related to each other.
To cover an exposure is to deal in such a way as to remove the risk – either reversing the position, or hedging it by dealing in an instrument with a similar but opposite risk profile. Also the amount by how much a bond auction is subscribed.
Covered call/put
The sale of a covered call option is when the option writer also owns the underlying. If the underlying rises in value so that the option is exercised, the writer is protected by his position in the underlying. Covered puts are defined analogously. See naked.
Covered interest arbitrage
Creating a loan/deposit in one currency by combining a loan/deposit in another with a forward foreign exchange swap.
See commercial paper.
Credit (or default) risk
The risk that a loss will be incurred if a counterparty to a derivatives transaction does not fulfil its financial obligations in a timely manner.
Credit derivatives
Financial contracts that involve a potential exchange of payments in which at least one of the cash flows is linked to the performance of a specified underlying credit-sensitive asset or liability. Payment is made by the seller of credit protection, to the buyer, in the event of a specified credit event.
Credit risk (or default risk) exposure
The value of the contract exposed to default. If all transactions are marked to market each day, such positive market value is the amount of previously recorded profit that might have to be reversed and recorded as a loss in the event of counterparty default.
Credit spread
The interest rate spread between two debt issues of similar duration and maturity, reflecting the relative creditworthiness of the issuers.
Credit value-at-risk (CVAR)
See value-at-risk (VAR).
Credit-equivalent amount
As part of the calculation of the risk-weighted amount of capital the Bank for International Settlements (BIS) advises each bank to set aside against derivative credit risk; banks must compute a credit-equivalent amount for each derivative transaction. The amount is calculated by summing the current replacement cost, or market value, of the instrument and an add-on factor.
The paperless share settlement system through which trades conducted on the London Stock Exchange can be settled. The system is operated by CRESTCo and was introduced in 1996.
Commissioners for the Reduction of the National Debt, formally responsible for investment of funds held within the public sector e.g., National Insurance Fund.
See cross-rate.
Generally an exchange rate between two currencies, neither of which is the US dollar. In the American market, spot cross is the exchange rate for US dollars against Canadian dollars in its direct form.
See cheapest to deliver.
literally "with dividend", stock that is traded with interest or dividend accrued included in the price.
Cumulative default rate
See probability of default.
Currency option
The option to buy or sell a specified amount of a given currency at a specified rate at or during a specified time in the future.
Currency swap
An agreement to exchange a series of cash flows determined in one currency, possibly with reference to a particular fixed or floating interest payment schedule, for a series of cash flows based in a different currency. See interest rate swap.
Current assets
Assets which are expected to be used or converted to cash within one year or one operating cycle.
Current exposure
The risk exposure, whether this is market, credit or operational risk, to liabilities that are ongoing.
Current liabilities
Obligations which the firm is expected to settle within one year or one operating cycle.
Current yield
Bond coupon as a proportion of clean price per 100; does not take principal gain/loss or time value of money into account. See yield to maturity, simple yield to maturity.
The same as collar.
Delivery against collateral – receipt against payment. Same as DVP.
Daily range
The difference between the high and low points of a single trading day.
Day count
The convention used to calculate accrued interest on bonds and interest on cash. For UK gilts the convention changed to actual/actual from actual/365 on 1 November 1998. For cash the convention in sterling markets is actual/365.
DBV (delivery by value)
A mechanism whereby a CREST/CGO member may borrow from or lend money to another CREST/CGO member against overnight gilt collateral. The CREST/CGO system automatically selects and delivers securities to a specified aggregate value on the basis of the previous night’s CREST/CGO reference prices; equivalent securities are returned the following day. The DBV functionality allows the giver and taker of collateral to specify the classes of security to included within the DBV. The options are: all classes of security held within CREST/CGO, including strips and bulldogs; coupon bearing gilts and bulldogs; coupon bearing gilts and strips; only coupon bearing gilts.
Daily earnings at risk.
In the US market, an unsecured domestic bond, backed by the general credit quality of the issuer. Debentures are issued under a trust deed or indenture. In the UK market, a bond that is secured against the general assets of the issuer.
Debt capital
Capital raised by governments and corporate institutions that is raised through issuance of bonds.
Debt Management Office (DMO)
An executive arm of the UK Treasury, responsible for cash management of the government’s borrowing requirement. This includes responsibility for issuing government bonds (gilts), a function previously carried out by the Bank of England. The DMO began operations in April 1998.
Default correlation
The degree of covariance between the probabilities of default of a given set of counterparties. For example, in a set of counterparties with positive default correlation, a default by one counterparty suggests an increased probability of a default by another counterparty.
Default probability
See probability of default.
Default risk
See credit risk.
Default risk exposure
See credit risk exposure.
Default start options
Options purchased before their "lives" actually commence. A corporation might, for example, decide to pay for a deferred start option to lock into what it perceives as current advantageous pricing for an option that it knows it will need in the future.
Deferred strike option
Option where the strike price is established at a future date on the basis of the spot foreign exchange price prevailing at that future date.
Deliverable bond
One of the bonds which is eligible to be delivered by the seller of a bond futures contract at the contract’s maturity, according to the specifications of that particular contract.
Transfer of bonds (in settlements) from seller to buyer.
Delivery versus payment (DVP)
The simultaneous exchange of securities and cash. The assured payment mechanism of the CGO achieves the same protection.
The change in an option’s value relative to a change in the underlying’s value.
A decrease in the market value of a currency in terms of other currencies. See appreciation, devaluation.
Strictly, any financial instrument whose value is derived from another, such as a forward foreign exchange rate, a futures contract, an option, an interest rate swap, and so on. Forward deals to be settled in full are not always called derivatives, however.
An official one-off decrease in the value of a currency in terms of other currencies. See depreciation, revaluation.
Digital option
Unlike simple European and American options, a digital option has fixed payouts and, rather like binary digital circuits, which are either on or off, pays out either this amount or nothing. Digital options can be added together to create assets that exactly mirror index price movements anticipated by investors. See one touch all-or-nothing.
An exchange rate quotation against the US dollar in which the dollar is the variable currency and the other currency is the base currency.
Dirty price
The price of a bond including accrued interest. Also known as the "all-in" price.
The amount by which a bond is trading below par. In FX markets, amount by which a currency is cheaper, in terms of another currency, for future delivery than for spot.
Discount house
In the UK money market, originally securities houses that dealt directly with the Bank of England in T-bills and bank bills, or discount instruments, hence the name. Most discount houses were taken over by banking groups and the term is not now generally used, as the BoE now also deals directly with clearing banks and securities houses. Following closure of Gerard & King in 2000, the only remaining discount house is Cater Allen (part of Abbey National group).
Discount rate
The method of market quotation for certain securities (US and UK treasury bills, for example), expressing the return on the security as a proportion of the face value of the security received at maturity – as opposed to a yield which expresses the yield as a proportion of the original investment.
Discount swap
Swap in which the fixed-rate payments are less than the internal rate of return on the swap, the difference being made up at maturity by a balloon payment.
Dividend discount model
Theoretical estimate of market value that computes the economic or the net present value of future cash flows due to an equity investor.
The UK Debt Management Office.
The Debt Management Report, published annually by HM Treasury.
Down-and-in option
Barrier option where the holder’s ability to exercise is activated if the value of the underlying drops below a specified level. See also up-and-in option.
Down-and-out option
Barrier option where the holder’s ability to exercise expires if the value of the underlying drops below a specified level.
Dual currency option
Option allowing the holder to buy either of two currencies.
Dual currency swap
Currency swap where both the interest rates are fixed rates.
Dual strike option
Interest rate option, usually a cap or a floor, with one floor or ceiling rate for part of the option’s life and another for the rest.
A measure of the weighted average life of a bond or other series of cash flows, using the present values of the cash flows as the weights. See modified duration.
Duration gap
Measurement of the interest rate exposure of an institution.
Duration weighting
The process of using the modified duration value for bonds to calculate the exact nominal holdings in a spread position. This is necessary because £1 million nominal of a two-year bond is not equivalent to £1 million of say, a five-year bond. The modified duration value of the five-year bond will be higher, indicating that its "basis point value" (bpv) will be greater, and that therefore £1 million worth of this bond represents greater sensitivity to a move in interest rates (risk). As another example consider a fund manager holding £10 million of five-year bonds. The fund manager wishes to switch into a holding of two-year bonds with the same overall risk position. The basis point values of the bonds are 0.041583 and 0.022898 respectively. The ratio of the bpvs are 0.041583/0.022898 = 1.816. The fund manager therefore needs to switch into £10m * 1.816 = £18.160 million of the two-year bond.
Delivery versus payment, in which the settlement mechanics of a sale or loan of securities against cash is such that the securities and cash are exchanged against each other simultaneously through the same clearing mechanism and neither can be transferred unless the other is.
Early exercise
The exercise or assignment of an option prior to expiration.
The European Currency Unit, a basket composed of European Union currencies, now defunct following introduction of euro currency.
Effective rate
An effective interest rate is the rate which, earned as simple interest over one year, gives the same return as interest paid more frequently than once per year and then compounded. See nominal rate.
Efficient frontier method
Technique used by fund managers to allocate assets.
Efficient market
Attributed to Eugene Fama (1970), a market in which asset prices reflect all price-relevant information.
Embedded option
Interest-rate sensitive option within a debt instrument that affects its redemption. Such instruments include mortgage-backed securities and callable bonds.
A money market deal commencing on the last working day of a month and lasting for a whole number of months, maturing on the last working day of the correlation.
The same as vega.
The residual interest in the net assets of an entity that remains after deducting the liabilities.
Equity options
Options on shares of an individual common stock.
Equity warrant
Warrant, usually attached to a bond, entitling the holder purchase share(s).
Equity-linked swap
Swap where one of the cash flows is based on an equity instrument or index, when it is known as an equity index swap.
Equivalent life
The weighted average life of the principal of a bond where there are partial redemptions, using the present values of the partial redemptions as the weights.
See exchange rate agreement.
The same as vega.
The reference rate for the euro currency, fixed in Brussels.
The name for the domestic currency of the European Monetary Union. Not to be confused with Eurocurrency.
An international clearing system for Euro-currency and international securities. Euroclear is based in Brussels and managed by Morgan Guaranty Trust Company.
A Eurocurrency is a currency owned by a non-resident of the country in which the currency is legal tender. Not to be confused with euro.
The issue of gilts (or other securities) denominated in euro.
The international market in which Eurocurrencies are traded.
A European option is one that may be exercised only at expiry. See American.
Exchange controls
Regulations restricting the free convertibility of a currency into other currencies.
Exchange rate agreement
A contract for differences based on the movement in a forward-forward foreign exchange swap price. Does not take account of the effect of spot rate changes as an FXA does. See SAFE.
Futures contracts are traded on a futures exchange, as opposed to forward deals which are OTC. Option contracts are similarly exchange traded rather than OTC.
Ex-dividend (xd) date
A bond’s record date for the payment of coupons. The coupon payment will be made to the person who is the registered holder of the stock on the xd date. For UK gilts this is seven working days before the coupon date.
To exercise an option (by the holder) is to require the other party (the writer) to fulfil the underlying transaction. Exercise price is the same as strike price.
Exotic option
Usually referred to simply as an "exotic", a non-standard or non-vanilla option that differs from conventional options, in one or more ways. Examples included path-dependent options such as Asian or lookback options.
Expected (credit) loss
Estimate of the amount a derivatives counterparty is likely to lose as a result of default from a derivatives contract, with a given level of probability. The expected loss of any derivative position can be derived by combining the distributions of credit exposures, rate of recovery and probabilities of default.
Expected default rate
Estimate of the most likely rate of default of a counterparty expressed as a level of probability.
Expected rate of recovery
See rate of recovery.
An option’s expiry is the time after which it can no longer be exercised.
Risk to market movements.
Exposure profile
The path of worst-case or expected exposures over time. Different instruments reveal quite differently shaped exposures profiles due to the interaction of the diffusion and amortisation effects.
Extinguishable option
Option in which the holder’s right to exercise disappears if the value of the underlying passes a specified level. See also barrier option.
The process of estimating a price or rate for a particular value date, from other known prices, when the value date required lies outside the period covered by the known prices. See interpolation.
Face value
The principal amount of a security generally repaid ("redeemed") at maturity, but sometimes repaid in stages, on which the coupon amounts are calculated. Also known as nominal amount.
See Libor fixing.
Floating rate
An interest rate set with reference to an external index. Also an instrument paying a floating rate is one where the rate of interest is refixed in line with market conditions at regular intervals such as every three or six months. In the current market, an exchange rate determined by market forces with no government intervention.
Floating rate CD
CD on which the rate of interest payable is refixed in line with market conditions at regular intervals (usually six months).
Floating rate gilt
Gilt issued with an interest rate adjusted periodically in line with market interbank rates.
Floating rate note
Capital market instrument on which the rate of interest payable is refixed in line with market conditions at regular intervals (usually six months).
A series of lender’s IRGs, designed to protect an investor against falling interest rates on each of a series of dates.
Option on a floor.
In general, a deal for value later that the normal value date for that particular commodity or instrument. In the foreign exchange market, a forward price is the price quoted for the purchase or sale of one currency against another where the value date is at least one month after the spot date. See short date.
Forward band
Zero-cost collar, that is one in which the premium payable as a result of buying the cap is offset exactly by that obtained from selling the floor.
Forward break
See break forward.
Forward exchange agreement
A contract for differences designed to create exactly the same economic result as a foreign exchange cash forward–forward deal. See ERA, SAFE.
Forward price
The price agreed today for an asset that will be delivered to the buyer at a date in the future.
Forward rate agreement
Short-term interest rate hedge. Specifically, a contract between buyer and seller for an agreed interest rate on a notional deposit of a specified maturity on a predetermined future date. No principal is exchanged. At maturity the seller pays the buyer the difference if rates have risen above the agreed level, and vice versa.
Forward swap
Swap arranged at the current rate but entered into at some time in the future.
Another term for an interest rate effective from a forward short date. Also a short-term exchange of currency deposits.
See forward rate agreement.

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