Glossary of Market Terms

Glossary of Market Terms
Global Markets Training 1

Accreting Swap: An interest rate swap in which the notional principal increases over
time according to an agreed schedule. Clients might want an accreting swap if the
notional principal on their debt is expected to rise. See Amortising Swap.
Accrual Note: A note on which interest is only received if rates stay within certain
agreed bands. Enables investors to benefit from the view that a given market index will
remain within a specified range over the life of the product. The maximum coupon
achievable is when the index sets within the range for every day in the accrual period.
The index can be based on LIBOR, FX or Constant Maturity Swap rates. The volatility
of the index and the forward rates are taken into account when pricing the coupon.
Accrual Notes are at the higher risk end of investment products and hence offer
substantially higher returns compared to vanilla investment products. Can also be
structured as Accrual Swaps, with the exchange being a libor flow (plus or minus a
spread) for a fixed flow, the fixed flow only being paid if the rate is within a specified
range. Also called a Corridor Note or Range FRN.
Accrual Swap: See Accrual Note.
Accrued Interest: Interest that is due but hasn't yet been paid. It most often comes into
play when buying bonds in the secondary market. Bonds usually pay interest every six
months, but it is earned (accrued) by bondholders every day. If you buy a bond halfway
between interest payment dates, you must pay the seller for the three months' interest
accrued but not yet received. You get the money back three months later when you
receive the interest payment for the entire six-month period.
Actual/360: An interest convention where the interest is calculated as the principal

times the interest rate times the days in the period over 360. This basis is commonly
used for Eurocurrency Libor rates, except Sterling and Belgian Francs.
Actual/365: Also known as Actual/Actual. An interest convention where the interest is

calculated as the principal times the interest rate times ()days in the period in a normal
year over 365) plus (days in the period in a leap year over 366)). eg the period from
2/Nov/99 to 2/May/2000 would be (60/365) + (122/366). eg used for the accrued
interest on Euro denominated government bonds.
Actual/365 Fixed: An interest convention where the interest is calculated as the

principal times the interest rate times the days in the period over 365. Leap years are
not counted. This basis is commonly used for sterling interest rates, including libor. It is
also used for Belgian franc Libor. Actual/365 Fixed is sometimes confused with
Actual/365. See Actual/365.
Actuals: The physical or underlying cash asset.
Agency Brokers: Brokers who only act as agents and do not deal as market makers or
principals.
Agent: A person or firm acting on behalf of another, the latter being one of the
principals to the deal

Alpha : The difference between a shares expected return and its long run equilibrium
return.
American Depository Receipt (ADR): Certificates traded on U.S. stock exchanges or

over the counter, representing ownership of a specific number of shares of a foreign
stock.
American Option: An option contract that may be exercised at any time between the
date of purchase and the expiration date. See European Option.
Amortising Swap: An interest rate swap in which the notional principal reduces over
time according to an agreed schedule. A t might want an amortising swap if there is a
planned reduction in debt (ie if the debt itself amortises). See Accreting Swap.
Annuity: A series of regular payments over a defined period of time. Bought by paying
a lump sum today.
Arbitrage: The purchase or sale of an instrument and simultaneously taking an equal

and opposite position in a related instrument to profit from mispricing. eg sell a bond
future, borrow money to buy the bond (or repo the bond) and then wait until maturity
and deliver the bond. If the futures are mispriced then there will be a risk free arbitrage
profit. Carried out by an Arbitrageur.
Arbitrageur: See Arbitrage.
Arbitrage Channel: The bid-offer spread range defines a channel. If the financial
instrument price is outside of that channel (either above or below) then an arbitrage
transaction is constructed. Common in Foreign Exchange, Forward Rate Agreements,
Futures.
Asset : Anything owned by a corporate, financial institution or individual.
Asian Option: There are two types of Asian (Average) options. (1) An average rate
option whose payoff depends on the difference between the average underlying price
over the period and the pre-specified strike. (2) An average strike option where the
strike is not set at inception but is deferred until expiry, when the average of the
underlying becomes the strike and the payoff is the difference between this strike and
the final asset value.
Ask : See Offer.
Asset Backed Commercial Paper (ABCP) : Asset backed commercial paper market
uses securitisation techniques to create short-term funding backed by trade receivables.
An SPV is set up by an investment bank (the SPV is often called an ABCP conduit) in
order to buy the trade receivables and issue the commercial paper.
Asset Backed Security : An asset backed security is a bond that is supported or

backed by a separate pool of assets. The originator of the underlying assets (typically
a bank or other type of financial institution) sells them to a special purpose vehicle
(SPV). The SPV issues bonds or notes to investors to pay for the assets it has bought
from the originator. Investors receive interest and return of principal on their tranches of
bonds from the interest and principal flows in the asset pool. See Mortgage Backed
Securities.
Asset and Liability Management (ALM) : The process whereby financial institutions
manage the interest rate risk of their assets and their liabilities (FX risk may also be
involved).
Asset Swap : A package of a cash credit instrument and a corresponding swap that
transforms the cash flows of the non-par instrument (bond or loan), into a par (floating
interest rate) structure. Asset swaps typically transform fixed rate bonds into par
floaters, bearing a net coupon of Libor plus a spread, although cross-currency asset
swaps, transforming cash flows from one currency to another are also common.
ATM : See At-The-Money.
At-The-Money (ATM) : An option is at-the-money if the strike price of the option is

equal to the market price of the underlying security. See In-the-Money.
Average Rate Option : See Asian Option.
Back Office : The support operation of a financial institution which deals with
settlements, clearing, position documentation etc.
Barrier Option : An option which dies if an agreed price or rate is reached (the option
knocks out). Alternatively, an option which only comes alive when a price or rate is
reached (a knock in option). Barriers are cheaper than vanilla options.
Basis: The difference between the cash price and the futures price of an asset or
commodity. Cash - Futures = Basis. See Basis Trade; Gross Basis; Net Basis.
Basis Point : one hundredth of one percent or 0.01% or 0.0001.
Basis Risk : (1) inability to create a perfect hedge using futures because of their
standardised nature (2) risk inherent in a basis trade (see Basis Trade).
Basis Swap : An interest Rate swap in which both legs are floating rate, but based on
different indices eg Libor and the commercial paper rate. The term basis swap can also
be used where both rates are floating and the currencies are different.
Basis Trade : Simultaneous entry into both a cash position for a particular product and
an equal and opposite futures position on the same underlying. Basis traders try to
profit from a change in the relationship between the cash price and futures price (ie a
change in the basis).
Basis Trading Facility (BTF) : LIFFEs system which allows for the simultaneous
execution of cash and futures trades (ie basis trades) to reduce execution risk.
Basket : a group of bonds or securities that are bought and sold as a single unit. Also
refers to some derivatives transactions where the underlying represents a group of
securities.

Bear Call Spread: The purchase of a call with a high strike price against the sale of a
call with a lower strike price in the expectation of rising prices.
Bear Market (bear/bearish): When prices are declining, the market is said to be a
"bear market"; individuals who anticipate lower prices are "bears." Situations believed to
bring with them lower prices are considered "bearish."
Bear Put Spread: The purchase of a put with a high strike price against the sale of a
put with a lower strike price in expectation of declining prices.
Bearer Bond : A bond not registered in anyone's name. Rather, whoever holds the
bond (the "bearer") is entitled to collect interest payments.
Bearish: When market prices tend to go lower, the market is said to be bearish.
Someone who expects prices to trend lower is "bearish."
Bermudan Option : An option which can be exercised on several dates or over several
defined periods. eg a six month option which can be exercised in, say, the fourth weeks
of months four five and six, but not at any other time. Sometimes called a Mid-Atlantic
option.
Bermudan Swaption : A swaption which can be exercised on several dates or over

several defined periods. See Swaption.
Better of Two Equity Indices Swaps : The swap pays the higher return on two indices
versus libor. See Equity Swap.
Bid: the price quoted to buy a financial product or instrument.
Binary Option : An option with a pre-agreed payoff eg an option which pays $100 as
long as it is in the money at expiry. Also called a Digital Option.
Binomial Option Pricing Model : A method of pricing options which involves building a
binomial tree or price distribution, valuing the option at each node of the tree and
discounting back to today.
Black : The Black option pricing model (named after Fischer Black) can be used to
price options on forward rates, such as interest rate caps and floors. See Cap; Floor.
Black Scholes : The name of an option pricing model which underpins many other
models. Named after Fischer Black and Myron Scholes who developed the model.
Blended Equity Index Swap : A Quanto Equity Index Swap in which there are different
notional principal amounts on the two legs. The counterparty therefore receives a blend
of the return on two equity indices. See Quanto Equity Index Swap; Equity Index Swap.
Bobl : Medium term German government debt
Bond : An interest-bearing security that obligates the issuer to pay a specified amount
of interest for a specified time, usually several years, and then repaythe bondholder the
face amount of the bond.

Bond Rating : A judgement about the capacity of a bond issuer to fulfil its obligation to
pay interest and repay principal when due. See Moodys, Standard & Poors.
Bond Swap : Replacing bonds in a portfolio with bonds that are expected to perform
better.
Bootstrapping : The process of calculating PV factors or zero coupon rates from the
cash yield curve.
Bought Deal : A method of issuing bonds. The lead manager of the issue buys the
bonds at a set price and then arranges for the sale of those bonds to investors. See
Fixed Price Reoffer.
Break-even : Refers to a price at which an option's cost is equal to the proceeds

acquired by exercising the option. The buyer of a call pays a premium. His break-even
point is calculated by adding the premium paid to the call's strike price. For a put
purchaser, the break-even point is calculated by subtracting the premium paid from the
put's strike price.
Broker : An agent who executes trades (buy or sell orders) for customers. He receives
a commission for these services.
BTAN : Bons a Taux Annuel Normalise. Medium-term French government debt.
BTF : See Basis Trading Facility.
Bull Call Spread : The purchase of a call with a low strike price against the sale of a
call with a higher strike price; prices are expected to rise.
Bull Market (Bull/Bullish) : When prices are rising, the market is said to be a "bull
market"; individuals who anticipate higher prices are considered "bulls." Situations
arising which are expected to bring higher prices are called "bullish."
Bulldog Bond : A sterling bond issued in the UK by a foreign issuer.
Bullet Repayment : Where the principal on a financial product is all redeemed at

maturity (as with most bonds), as opposed to over the life of the instrument (as with
bank loans).
Bull Put Spread : The purchase of a put with a low strike price against the sale of a call
with a higher strike price; prices are expected to rise.
Bullish : The belief that prices will rise, a tendency for prices to move up.
Bund : Long term German government debt.
Butterfly Spread : Established by buying an at-the-money option, selling two out-of-the

money options, and buying an out-of-the money option.
Cable : The market term used to describe the /US$ exchange rate.

Calendar Spread: The sale of an option with a nearby expiration against the purchase
of an option with the same strike price, but a more distant expiration. The loss is limited
to the net premium paid, while the maximum profit possible depends on the time value
of the distant option when the nearby expires.
Call Option: A contract giving the buyer the right to purchase something within a
certain period of time at a specified price. The seller receives money (the premium) for
the sale of this right. The contract also obligates the seller to deliver, if the buyer
exercises his right to purchase.
Call Protection : See No Call.
Callable Bond : A bond which the issuer has the right to buy back at a specific date if it
wishes. Made up of a bond and a receivers swaption. Used to provide flexibility for the
issuer - refinancing if rates fall, for example. Also can be combined with a swap and
another swaption to create a synthetic floating rate debt with a reduced cost of funding.
See Multi-Callable Bond; No Call.
Callable Swap : Also called a Cancellable Swap. The buyer of a Callable Swap earns
the right to terminate the swap on specified dates in the future, usually on each
settlement day. A Callable Swap is essentially a combination of a swap and a
Bermudan swaption. The swaption premium is built into the fixed or floating rate so a
Cancellable Swap has no upfront cost. The holder of the option simply receives a lower
rate. A Cancellable Swap is suitable for users who wish to enter into a swap but do not
want to be locked into it in case rate movements make it unfavourable. A Cancellable
Swap enables them to cancel the deal and negotiate more favourable terms when rates
change.
Cancellable Swap : See Callable Swap.
Cap : An interest rate cap is a series of interest rate options which pay out if rates rise
above the cap level (strike). Can be used to guarantee a maximum cost of funds on a
floating rate loan (whilst still taking advantage of lower rates should they occur). See
Floor; Black.
Capital Gain or Loss : The difference between the price at which you buy an
nvestment and the price at which you sell it. Adding the capital gain or loss to the
income received from the investment yields the total return.
Capital Market : the market for financial assets such as bonds, notes, equities etc,
typically with maturities greater than one year (less than one year maturities are found
in the money markets).
Capital Protected Credit Linked Note (CLN) : A credit linked note where the principal
is partly or fully guaranteed to be repaid at maturity. In a 100% principal guaranteed
credit-linked note, only the coupons paid under the note bear credit risk. Such a
structure can be seen as (i) a Treasury strip and (ii) a stream of risky annuities
representing the coupon, purchased from the note proceeds minus the cost of the
Treasury strip. See Credit Linked Note.

Caption : An option on a cap. Might be used when a hedger is unsure if a cap will be
needed in the future or not ie the hedger does not want to pay the full up-front cost
today of a normal cap. An example of a Compound Option. See Cap; Compound
Option.
Carrying Charges: See Cost of Carry.
Cash Commodity/Cash Market: The actual or physical commodity. The market in

which the physical commodity is traded, as opposed to the futures market, where
contracts for future delivery of the physical commodity are traded. Also is often used to
refer to spot markets. See also Actuals.
Cash and Carry Arbitrage : The sale of a bond futures contract and simultaneous
purchase of the bond in the cash market. The trade is carried out because the futures
are trading at a higher price than the fair futures price. See Cheapest to Deliver.
Cash Settlement : Instead of having the actuals delivered (in a futures contract, for
example), cash is transferred on settlement.
Certificate of Deposit (CD) : A large time deposit with a bank, having a specific
maturity date and yield stated on the certificate. CDs usually are issued with $100,000
to $1,000,000 face values.
Charting : When technicians analyse the markets, they employ graphs and charts to
plot the price movements, volume, open interest, or other statistical indicators of price
movement.
Cheapest to Deliver : Bond futures have a range of deliverable bonds giving the seller
of futures the choice as to which one he delivers to meet the contractual obligations.
The deliverable bond that generates for the seller of futures in a cash and carry
arbitrage trade the greatest profit or least loss is known as the cheapest to deliver bond
or CTD bond.
Chooser Option : At a specific date the option buyer chooses whether the option is a
call or a put. The strike and maturity are predetermined and are normally the same for
the call and the put. Similar to a straddle (ie buy a call and buy a put) but cheaper,
because holder must choose at a predetermined date. A good way of speculating on
extreme moves. The choice date is key - if the choice date is today then the premium
is the maximum of the premiums on the call and the put. If the choice date is at
maturity then it is the same as a straddle and the premium equals the call premium plus
the put premium.
Clean Price : The price of a bond excluding accrued interest. Bond prices are usually
quoted on a clean basis. The actual price paid for the bond (the dirty price) will be the
clean price plus accrued interest.
Clearing Margin : Funds deposited by a futures commission merchant with its clearing
member.

Clearing Member : A clearinghouse member responsible for executing client trades.

Clearing members also monitor the financial capability of their clients by requiring
sufficient margins and position reports.
Clearing House : An agency associated with an exchange which guarantees all trades,
thus assuring contract delivery and/or financial settlement. The clearing house becomes
the buyer for every seller, and the seller for every buyer.
Cliquet Option : Options whose strike is reset at predetermined dates and intrinsic
value is locked in. Takes away some of the need for timing the market. More expensive
than a Vanilla option. Also called a Ratchet. Similar to a Ladder Option. See Ladder
Option.
Close Out : the act of extinguishing a position in the market eg a purchase if the
original transaction was a sale and vice versa.
CLO : see Collateralised Loan Obligation.
CMO : See Collateralised Mortgage Obligation
CLN : See Credit Linked Note.
Collar : Usually refers to a combination of interest rate caps and floors eg a corporate
which has a floating rate debt can buy a cap and sell a floor to create a collar. The
corporate will have a maximum and minimum cost of funds ie it knows its cost of funds
will be within a certain range. Collars are primarily used to reduce the up-front cost of a
vanilla cap. Collars can be constructed as zero cost if the premiums on the call and put
are the same. The word collar is sometimes also used to describe a Range Forward
(because the payoff diagram for a currency range forward will look the same as for an
interest rate collar). See Cap; Floor.
Collateralised Loan Obligation (CLO) : A form of securitisation. Loans are pooled

together by a bank and sold to a special purpose vehicle (SPV). The SPV issues
securities using the loans as collateral. The bank frees up capital and can take on more
business.
Collateralised Mortgage Obligation (CMO) : A form of securitisation and a type of

Mortgage Backed Security (MBS) . Mortgages are pooled together and sold to a special
purpose vehicle (SPV). The SPV issues securities using the mortgages as collateral.
The securities are divided into different classes according to their prepayment schedule.
See Prepayment Risk.
Commercial Paper: Borrowing in the form of short-term paper, also known as CP or

ECP (Euro Commercial Paper). Usually redeemed at par and traded on a discount
basis.
Commission (Futures) : The fee which clearing-houses charge their clients to buy and
sell futures and futures options contracts. The fee that brokers charge their clients is
also called a commission.

Compound Option : An option on another option. An up-front premium is paid, then at

an agreed date the holder has the right to buy another specified option and pay a
second premium. The initial and second premium on a compound option are less than
the premium of a regular option with the same expiry and the same strike. However, if
the compound option buyer chooses to pay the second premium to maintain the option
the total of the two premiums paid will be greater than the premium of a regular option.
Constant Maturity Swap (CMS) : A swap which typically has one floating leg based on
a short term rate (eg six month libor) and the other floating leg based on a long term
rate (say the 5 year swap rate or the ten year swap rate, which is reset every six
months). Used primarily for taking views on the shape of the yield curve. Also called a
Yield Curve Swap.
Contingent Payment : Often used with reference to Credit Derivatives. A payment is

made only if a certain event occurs ((ie the payment is contingent upon the credit event
occurring). See Credit Derivative; Credit Event.
Contract for Differences : Cash settled instruments such as Forward Rate

Agreements (FRAs).
Contrarian : An investor who thinks and acts in opposition to the conventional wisdom.
When the majority of investors are bearish, a contrarian is bullish, and vice versa.
Convergence : The coming together of futures prices and cash market prices on the
last trading day of a futures contract.
Conversion Factor : A figure published by the futures exchange used to adjust a bond
futures hedge for the difference in maturity and coupon between the bond futures
contract specifications and the bonds being hedged.
Conversion Premium : The conversion premium in a convertible bond reflects the

additional cost over the parity that investors have to pay to purchase the convertible
bond rather than equity. See Parity.
Conversion Price : The conversion price is determined at the time of issuance and
indicates the price at which the issuer grants the convertible bond holder the right to
purchase ordinary shares.
Conversion Ratio : The Conversion Ratio indicates the number of shares a convertible
bond holder would receive on exercising the right to convert the convertible bond into
equity.
Conversion Value : See Parity.
Convertible Bond : A bond that can be converted into a predetermined number of

shares of equity in the same company. See Exchangeable Bond.
Convexity : Convexity is the second derivative of changes in the price of a bond for
changes in its yield to maturity. It measures changes in modified duration as yields
change. Any financial product which has discount factors in it will exhibit convexity (eg
Swaps, FRAs, Bonds). See Modified Duration.
Corridor Note : See Accrual Note.
Cost of Carry : The cost of buying an asset today and carrying it through to a
particular date. Typically means borrowing costs (perhaps through a Repo). See Cash
and Carry Arbitrage.
Coupon : The rate of interest payable on a bond (sometimes also used to mean the
fixed rate on a swap).
Coupon Stripping : Taking a coupon bond and selling each of the coupons and
principal separately as zero coupon bonds in their own right. See Zero Coupon Bond.
Counterparty Risk : Exposure to potential loss from a counterparty that cannot make
good on its payments or obligations over the term of the contract.
Covenant : A stipulation in loan or bond documentation which restricts the borrowers

freedom of action (eg relating to interest cover, net worth, gearing) while the loan is
outstanding.
Covered Position: A transaction which has been offset with an opposite and equal
transaction.
Covered Warrant : A call option on the shares of a corporate issued by a bank (or
other entity), where the bank has hedged itself by holding shares in the company
Credit Default Swap : A type of credit derivative. A credit default swap is a contract
whereby one party (the protection seller) agrees to receive periodic payments, typically
expressed in basis points, in return for making a contingent payment to a second party
(the protection buyer) following a default on a specific security or loan. It can be
structured as a Credit Default Exchange Swap where two counterparties agree to make
payments to each other contingent on a credit default occurring on the specified
reference assets. See Basis Point, Credit Derivative, Credit Linked Note.
Credit Derivative : Can be broadly defined as a derivative contract whose value

changes with regard to changes in the credit risk of an underlying reference credit. For
specific definitions see Credit Default Swap, Total Return Swap, Credit Spread Option.
Credit Event : Refers to factors such as missing a payment on a loan, breaches of

bond or loan covenants, bankruptcy etc. Credit Derivative documentation will refer to
specific Credit Events which set off Contingent Payments. See Credit Derivative;
Contingent Payment.
Credit Linked Note : A Credit linked note (CLN) is a structured note that combines a
debt asset and a credit derivative. It is a security typically issued from a Special
Purpose Vehicle (SPV), with redemption and/or coupon payments linked to the
occurrence of a credit event. Credit-linked notes may also be issued on an unsecured
basis directly by a corporation or financial institution.
Credit Option : Put or call options on the price of either (a) a floating rate note, bond, or
loan or (b) an asset swap package, consisting of a credit-risky instrument with any

payment characteristics and a corresponding derivative contract that exchanges the

cash flows of that instrument for a floating rate.
Credit Rating : Given by a rating agency to indicate a borrowers capacity to pay

interest and principal on a bond or note issue.
Credit Risk : Exposure to potential loss from default or credit deterioration of a

reference asset.
Credit Spread : The difference between the yield on bonds of a particular class of
credit rating and the benchmark government bond.
Credit Spread Options : Options on credit spreads. Options on credit spreads allow
investors to isolate credit risk from market risk and to express a view about an assets
credit risk profile in the future. They can be used to earn premium income, to profit from
spread tightening or widening, and to buy securities on a forward basis at favourable
prices. Credit spread options are normally written on bonds. They represent a bilateral
financial contract in which the protection buyer pays an up-front premium, and receives
the present value of the difference between the spread prevailing on the exercise date
between the yield of the reference obligation and some benchmark yield (usually
Treasuries or Libor) and the strike spread, if positive (a credit spread cap or call), or
alternatively if negative (a credit spread floor or put). See Credit Spread.
CTD Bond : see Cheapest to Deliver.
CUPS : Currency Protected Swap. See Diff Swap.
Currency Protected Swap (CUPS) : See Diff Swap.
Cum Dividend/Cum Interest : The trading status of a share or bond such that the
buyer is entitled to receive the next interest or dividend payment. The alternative is ex
dividend or ex interest, where the seller retains the right to receive the next interest or
dividend flow.
Currency Risk : Foreign exchange rates give rise to uncertainty for corporates and
financial institutions that have foreign assets and liabilities (corporates use the phrase
transactions risk to cover foreign currency receivable and payable exposures). See
Transaction Exposure.
Currency Swap : Used to gain access to a particular currency or reduce the cost of
funds in a particular currency. A contract whereby two counterparties agree to
exchange interest flows in separate currencies (eg counterparty A pays and
counterparty B pays $). Usually also include actual exchange of principal amounts at
inception and maturity (counterparty A pays $ principal and counterparty B pays
principal at the start of the swap, and these flows are reversed at the end).
Cylinder : See Range Forward.
DAX : The major German share index, covering 30 shares.

Dealer : Somebody who trades financial assets for the institutions own account.
Dealing : Entering into financial transactions with customers for the institutions own
account (also called trading).
Debenture : A bond secured on the general credit quality of the issuer.
Deep Discount Bonds : Bonds issued at a discount to par value and redeemed at par
or a premium to par. They may pay a low coupon or none at all (see Zero Coupon
Bond).
Deep out-of-the-money: Used to describe an option that is unlikely to go into-the-

money prior to expiration. An arbitrary term.
Default : Failure by a counterparty to fulfil its obligations on a financial instrument or

product eg failure to repay interest or principal on a bond, failure to make a margin call
in a futures transaction, failure to make interest payments in a swap.
Default Risk : See Default.
Delivery: The transportation of a physical commodity or financial product (actuals or

cash) to a specified destination in fulfilment of a futures contract.
Delivery month: The month during which a futures contract expires, and delivery is
made on that contract.
Delta : The delta of an option measures the change in the option premium for a given
change in price of the underlying asset or security. See Delta Hedging.
Delta Hedging : Hedging a written call option position by using the option delta to
calculate how much of the underlying asset to buy. See Delta.
Derivative : A financial product whose value changes with movements in an underlying

asset, index or interest rate.
Diff Swap : A Diff Swap is a floating / floating interest rate swap where the interest
rates are those of two different currencies. Payments are however made in only one
currency to eliminate foreign exchange exposure. Diff Swaps are suited to users who
wish to take a view on the relative change in the shapes of the yield curves of two
different countries. Where it is felt that the forward curves of the two countries carry an
anomalous relationship a diff swap can be entered into to take advantage of this. The
single currency nature of the payment eliminates foreign exchange considerations
which would otherwise complicate the view. Also called Quanto Swaps and Currency
Protected Swaps (CUPS).
Digital Option : See Binary Option.
Dirty Price : The actual price payable to buy a bond. The clean price plus any accrued
interest. See Clean Price.

Discount : The difference between the current price of a bond and its face
(redemption) value.
Discount Factor : See Present Value Factor.
Double Libor Reverse Floater : See Reverse Floating Rate Note.
DTB : Deutsche Terminbourse - the German derivatives exchange.
Duration : A measure of a bonds price sensitivity to changes in interest rates. The

greater is the duration the greater is the bond price sensitivity. See Macauley Duration
and Modified Duration.
e : See Exponential.
ECP : See Commercial Paper.
EDSP : Exchange Delivery Settlement Price, the price determined by the exchange at
which futures contracts are settled at delivery (usually an average of traded prices over
a set period).
Equity Swap : Vanilla equity swaps are very straightforward, and look and work
like floating versus floating interest rate swaps, except that one of the floating rates
represents the total return on an equity index. The total return on an equity index
includes both dividends and price performance. It can thus be either positive or
negative, depending on how the market performs. The swap uses a notional principal,
just like an interest rate swap, which is never exchanged, but is used to calculate the
payments owing on both sides of the swap. The swap allows investors to earn a return
on the index without actually having to buy and sell shares. The swap could be
structured with a notional principal which changes - a Variable Principal Equity Swap -
which allows index tracking. Also could be structured as a Two-Way Equity Swap which
allows for the total returns on two different stock market indices to be exchanged . See
also Quanto Equity Index Swap; Blended Equity Index Swap; Better of Two Equity
Indices Swap.
Embedded Option : An option (interest rate, FX or commodity) which is an integral part

of a bond, affecting its price and sometimes its redemption value. Bonds with
embedded options are called structured products.
European Option : An option contract that may be exercised only on its expiry date.
See American Option.
Eurobond : A bond not subject to the regulatory control of the authorities of the
currency in which it is denominated (not to be confused with a bond issued in Euros).
Exchange : An association of persons who participate in the business of buying or

selling futures contracts or futures options.

Exchangeable Bond : Similar to a Convertible Bond, except it is exchangeable into

equity of a second company. eg a German bank may own the equity of a corporate
which it wants to sell - it can do so by issuing a bond in its own name but exchangeable
into the equity of the corporate.
Ex Dividend/Ex Coupon : See Cum Dividend/Cum Coupon
Execution Risk : A problem which can occur when trying to carry out an arbitrage trade
(eg Cash and Carry in the Futures Market) by entering into two markets at once - it is
possible that the price in the second market may change whilst the trade in the first
market is being placed, resulting in losses.
Exercise : To implement the right under which the holder of an option is entitled to buy
(in the case of a call) or sell (in the case of a put) the underlying security.
Exercise Price : See Strike Price.
Exotic Option : See Path Dependent Option.
Expiration: An option is a wasting asset; i.e., it has a limited life. At the end of its life, it
either becomes worthless (if it is at-the-money or out-of-the-money), or is exercised for
the amount by which it is in-the-money.
Expiration Date: The final date when an option may be exercised.
Exponential (e) : The base for natural logarithms (e=2.71828182). Provides a simple
way of calculating continuously compounded rates. eg e0.05 = 1.05127 or the
continuously compounded rate of 5% is 5.127%.
Extendible Swap : An interest rate swap in which the fixed rate payer has the right to
extend the maturity.
Factor Sensitivity : Measures the change in the value of a financial product (eg a
swap) to a change in a particular point on the yield curve. The impact on the swap is
measured by increasing one by one the interest rate at each defined point of the yield
curve (6 month, 12 month, 2 years, 3 years etc). ie the 6 month rate is increased, the
impact on the swap measured, then it is put back to its original rate. Then the same is
done with the 12 month rate and so on. The sum of all of the factor sensitivities for a
swap will equal the PVBP (for a parallel shift) for the swap. See PVBP.
Fair Price : See Fair Value.
Fair Value : The theoretical price at which a financial product should trade such that
there are no arbitrage opportunities (often in relation to futures or options contracts).
Fannie Mae : The acronym for the Federal National Mortgage Association (US), which
buys mortgages on the secondary market, repackages them and sells pieces to
investors. See Securitisation, Mortgage Backed Securities.

Financial Futures: Include interest rate futures, currency futures, and index futures.
Allow the trading of forward interest rates, forward exchange rates and other forward
prices.
First to Default Basket Default Swap : A type of Credit Derivative - specifically a type
of Credit Default Swap. Basket Default Swaps can be used to buy and sell protection on
baskets of securities or portfolios of assets where default protection is traded on each of
the constituent securities or loans in the portfolio. eg counterparty A makes periodic
payments to counterparty B on a basket of securities (say, 4 securities) and receives a
contingent payment if any of the reference credits experiences a credit event, at which
point the swap terminates. See Credit Derivative; Credit Default Swap.
Fixed Leg : Refers to the fixed payments in an interest rate swap.
Fixed Price Reoffer : A bond issuance technique where the lead manager of the issue
distributes the bonds to the management group who then place the bonds with
investors. They are not permitted, however, to place the bonds at a price below the
fixed price agreed in advance until the syndicate is broken. The syndicate is only
broken by the lead manager when most of the issue has been placed at the agreed
fixed price.
Fixed Reverse FRN : See Reverse Floating Rate Note.
Floating Leg : Refers to the floating payments in an interest rate swap.
Floating Rate Note (FRN) : A bond which pays a floating rate of interest, usually reset
every three or six months.
Floor : An interest rate floor is composed of a series of interest rate options which pay
out if rates fall below the floor level (strike). Can be used to guarantee a minimum return
on floating rate invested funds (whilst still taking advantage of higher rates should they
occur).
Floor Broker: A person who executes orders on the trading floor of an exchange on
behalf of other people. They are also known as pit brokers.
Floortion : An option on an interest rate Floor. See Floor.
Floor Trader: Exchange members present on the exchange floor who make trades on
their own behalf. They may be referred to as scalpers or locals.
Foreign Exchange : A market for buying and selling currencies either spot (deal done
today) or forward (deal done today for delivery at a forward date).
Forward Contract: A contract entered into by two parties who agree to the future
purchase or sale at an agreed price of a specified asset, currency, index or interest rate.
The key point is that the parties are locking in a guaranteed rate or price known today.
eg a forward foreign exchange contract could be used to hedge a currency exposure. A
UK corporate which will receive US$ in 3 months time can sell $ forward. The corporate
is hedged, but should the US$ move in its favour (US$ strengthens) the corporate
cannot receive the benefit. This should be contrasted with options, which give much

more flexibility (but of course there is an up-front premium to be paid). See Option. See
Forward Exchange Rate.
Forward Exchange Rate : The rate calculated today for the exchange in a future
period of two currencies. The forward rate is dependent on the interest differentials
between the two currencies. See Forward Contract.
Forward Foreign Exchange Contract : See Forward Contract.
Forward Interest Rate : The rate of interest calculated today for a transaction in the
future. See Forward Rate Agreement.
Forward Pricing: The practice of locking in a price agreed today for a future
transaction. See Forward Rate Agreement and Forward Contract.
Forward Rate : Refers to either forward exchange rate or forward interest rate. See
Forward Contract and Forward Rate Agreement.
Forward Rate Agreement : Where counterparties agree to pay or receive the

difference between the forward interest rate agreed at the beginning of the contract
and Libor at the end of the contract. Payments are made based on an agreed notional
principal. Can be used for hedging loans or deposits. An example of a Contract for
Differences.
Freddie Mac : Federal Home Loan Mortgage Corporation (US); it operates similarly to
Fannie Mae.
FRN : See Floating Rate Note.
FTSE 100 : Financial Times Stock Exchange Index. The index of the top 100 listed
shares (by market capitalisation) in the UK.
FTSE Eurotop 100 : An index containing the top 100 shares in Europe (including UK).
Fundamental Analysis : The study of specific factors, such as economic,

demographic, government policy, annual report and accounts, which influence supply
and demand and, consequently, prices in the market place.
Futures : See Futures Contract.
Futures Contract : A standardised and binding agreement to buy or sell on an

organised exchange a predetermined quantity and quality of a specified commodity,
asset, foreign currency or interest rate at a future date.
Future Flow Securitisation : The securitisation of future trade receivables. Common in

emerging market securitisations. See Securitisation
Futures Strip : A series of futures contracts. eg the 3 v 9 futures strip (ie the forward
rate in three months for six months) from January would include the futures contracts of
March and June. The Strip Rate would be the forward rate calculated from these
contracts.

Gamma : A measure of the change in an options delta for a given change in the
underlying asset price. See Delta.
Garman and Kohlhagen : A currency option pricing model, derived from Black and
Scholes.
Gearing : See Leverage.
Gilt Edged Market Makers (GEMMS) : Market makers obliged to quote firm two way
prices for gilts.
GEMMS : See Gilt Edged Market Makers.
Ginnie Mae : Government National Mortgage Association, which buys up mortgages in

the secondary market and sells them to investors via securities.
Gilts : Sterling denominated UK government securities.
Greeks : People who come from Greece (!) Used in option risk management to refer to
option price sensitivities. See Delta, Gamma, Vega, Theta, Rho.
Gross Basis : Calculated as Bond Clean Price - Futures Price x Conversion Factor.
The Gross Basis is traded in a Basis Trade. See Clean Price; Conversion Factor; Basis
Trade.
Haircut : The collateral required in a repo over and above the cash lent out. The holder
of the collateral is subject to market risk. If interest rates rise during the repo period, the
value of the bond/collateral will fall. The buyer could own securities with a market value
less than the amount loaned out. One way to address the market risk issue is that the
amount loaned will be less than the market value of the securities being pledged. This
difference is known as the margin or the haircut eg for a 10m bond and a haircut of
2% the seller will receive proceeds of 9,800,000. See Repurchase Agreement.
Hedge Fund : Hedge funds use alternative investment strategies to achieve superior
returns relative to risk. Performance objectives range from conservative to aggressive.
The term hedge fund is fairly broad and includes any private pool of capital that
charges a management fee and performance fee.
Hedge Ratio: The number of futures contracts needed to hedge an underlying cash
position.
Hedger: One who hedges; one who attempts to transfer the risk of price change by
taking an opposite and equal position in the same or closely allied market.
Hedging: See Hedger.
High Yield : Bonds rated below investment grade ie below BBB- for Standard and
Poors and below Baa3 for Moodys. Also known as speculative grade bonds, non
investment grade bonds or (infamously) junk bonds. Unrated securities can also be

classified as high yield if they trade at a wider spread than other corporates and at a
level which is more comparable with other high yield bonds.
Historic Volatility : The volatility of the price of an asset or financial instrument over a
past period.
Holder : The purchaser of an option.
Implied Repo Rate : The rate on a repo which would give a break-even P/L on a Cash
and Carry Bond Futures Arbitrage. See Cash and Carry arbitrage.
Implied Volatility : The volatility calculated by inputting the premium, strike, asset
price, maturity and interest rate(s) into an option pricing model. In other words the
markets perception of future volatility can be implied from current option prices.
Index: A specialised average. Stock indexes may be calculated by establishing a base

against which the current value of the stocks, commodities, bonds, etc., will change; for
example, the S&P 500 index uses the 1941-1943 market value of the 500 stocks as a
base of 10.
Index Amortising Swap (IAS) : A swap in which the principal changes according to the
change in a specific index.
Initial Margin : When a customer establishes a futures position, he is required to make

a minimum initial margin deposit to assure the performance of his obligations.
Interest Rate Futures : Futures contracts traded on short term and long term financial
instruments eg three month time deposits and government bonds.
In-The-Money (ITM) : A call is in-the-money when the underlying price is greater than
the strike price. A put is in-the-money when the underlying futures price is less than the
strike price. In-the-money options have intrinsic value. See Call; Put; Intrinsic Value;
Out-Of-The-Money.
Institutional Investors : Mutual funds, banks, insurance companies, pension

funds and others that buy and sell stocks and bonds in large volumes.
Intrinsic Value: The amount an option is in the-money, calculated by taking the

difference between the strike price and the market price of the underlying asset.
Interest Only (IO) Strip : A specific type of mortgage backed security. With IO strips
interest is received by investors only on any outstanding principal in the mortgage pool.
So, as interest rates rise, prepayments on the mortgages fall and the value of IO strips
tends to rise (because interest is received on a greater expected principal amount).
Interest Rate Swap : A financial transaction in which two counterparties agree to

exchange fixed flows for floating interest flows for a set period of time on an agreed
notional principal. eg counterparty A pays a fixed rate to counterparty B and
Counterparty B pays a floating rate to counterparty A. The swap allows a counterparty
to change the interest basis on which an underlying loan or asset (See Asset Swap) is
based. See Currency Swap.

Inverted Yield Curve : A yield curve that is downward sloping, such that short term
interest rates are higher than longer term interest rates. Indicates an expectation of a
fall in interest rates.
Investment Grade : Bonds of a high level of credit quality. Specifically, a bond rated
BBB- or above by Standard & Poors and rated Baa3 or above by Moodys. Any other
bond is known as a High Yield bond.
Invoice Amount : The amount paid by the buyer to the seller when a future is
delivered.
IO Strip : See Interest Only Strip.
Issuer : A corporate, financial institution, government, supranational or state that raises

money by borrowing in the bond market.
ITM : See In-The-Money.
Junk Bond : See High Yield.
Kick-In FRN : An FRN whose floating coupon Kicks-In (ie changes) to a fixed rate if a
certain pre-specified floating rate is reached. It is an example of a Trigger structure.
Investors buy them to enhance their yield - they do not believe the yield curve. See
Trigger.
Ladder Option : An option whose strike is reset (several times) during the life of the
option. The strike is usually reset when a specific asset price has been reached. The
intrinsic value is locked in. The more steps the more expensive it will be compared with
a vanilla option (the more steps the more it resembles a lookback). Calls generally
used with rising ladders, puts with falling ladders. See Cliquet Option; Lookback Option.
Leverage: The control of a larger sum of money with a smaller amount. Leverage can
be achieved with futures or options, for example
LIA Swap : See Libor-In-Arrears Swap.
Libid : See London Inter Bank Bid Rate.
Libor : See London Inter Bank Offered Rate.
Libor-In-Arrears (LIA) Swap : A swap in which one of the legs is a fixed rate and the
other is Libor-in-Arrears (ie Libor set and paid at the end of each period, rather than set
at the beginning and paid at the end of each period as with a normal swap). Used to
take a view on short term forward rates. Can also be structured with one leg as Libor-In-
Arrears and the other leg as Libor plus or minus a spread.
LIFFE : London International Financial Futures Exchange. The main derivatives

exchange in the UK. Trades derivatives in equities, bonds, interest rates, indices and
commodities. It does not trade currency futures.

Limean : See London Inter Bank Mean rate.
Liquidity : The ability to quickly convert an investment portfolio to cash without

suffering a noticeable loss in value.
Liquid Market : A market which allows quick and efficient entry or exit at a price close
to the last traded price. The ability to liquidate or establish a position quickly is due to a
large number of traders willing to buy and sell.
Locals (futures) : The floor traders who trade primarily for their own accounts.
Although "locals" are speculators, they provide the liquidity needed by hedgers to
transfer the risk of price change. Also called scalpers.
London Inter Bank Bid Rate (Libid) : The rate at which leading banks offer to take
deposits from other leading banks.
London Inter Bank Mean Rate (Limean) : The average of Libor and Libid.
London Inter Bank Offered Rate (Libor) : The rate at which leading banks offer to
make deposits with other leading banks.
Long : One who has purchased a financial product or instrument, but has not taken any
action to offset the position. A trader with a long position hopes to profit from a price
increase.
Long-the-Basis: A trader who owns the underlying and hedges his position with a short
futures position is said to be long-the-basis. He profits from the basis becoming more
positive. This trade involves buying the cash bond and selling the future. The buyer of
the basis will profit if the gross basis remains high; i.e. the difference between the clean
bond price that the trader owns and the equivalent futures price remains large.
Lookback Option : An option in which the payoff - for a call - is the difference at
maturity between the asset price and the lowest price achieved over the option period.
For a put the payoff would be the difference at maturity between the asset price and the
highest price achieved over the option period. Clearly lookback options are expensive
because the most advantageous price is always achieved.
Lot : Another word for a contract.
Macauley Duration : The weighted average life of a bond. The greater is Macauley
duration the greater is the sensitivity of the bond price to changes in interest rates. See
Modified Duration.
Maintenance Margin: The minimum level at which the equity in a futures account must
be maintained. If the equity in an account falls below this level, a margin call will be
issued, and funds must be added to bring the account back to the initial margin level.
The maintenance margin level generally is 75% of the initial margin requirement.

Margin: Margin in futures is a performance bond or "earnest money." Margin money is

deposited by both buyers and sellers of futures contracts, as well as sellers of futures
options. See Initial margin
Margin Call: A call from the futures clearinghouse to a clearing member (variation
margin call), or from a broker to a customer (maintenance margin call), to add funds to
their margin account to cover an adverse price movement. The added margin assures
the brokerage firm and the clearinghouse that the customer can purchase or deliver the
contract, if necessary.
Mark-to-Market (MTM) : the process of recalculating the value of financial instruments

or open positions (often on a daily basis) given current prices. The purpose is to
determine that days unrealised profit or loss.
Market Maker : Traders who make firm two-way prices for securities.
Market Risk : Exposure to potential loss from an adverse movement in market prices
and rates.
MTM : See Mark-to-Market.
MATIF : Marche a Terme Internationale de France - the French futures market.
Maturity : The due date for financial instruments. eg a bond with a five year maturity
will be repaid (redeemed) in five years time.
MBS : See Mortgage Backed Securities.
Mean Reversion : The tendency for interest rates to revert back to a mean (average)
level.
Modified Duration : Measures the percentage change in bond price for a one basis
point change in yield. eg a Modified Duration of 4.5 means the bond price will change
by 0.045 % for a one basis point change in yield. Can therefore be used to predict the
actual change in the price of a bond for a given change in interest rates PVBP =
Modified Duration x Bond Price x 0.01%. NB If market participants talk about duration
they will nine times out of ten be referring to Modified Duration rather than Macauley
Duration.
Money Market : The wholesale market for short term (usually up to one year) money,
including deposits, treasury bills, commercial paper.
Money-Market Fund : A mutual fund that invests in short-term corporate and

government debt and passes the interest payments on to shareholders. A key feature of
money-market funds is that their market value doesn't change, making them an ideal
place to earn current market interest with a high degree of liquidity.
Monte Carlo : A European Principality where rich people go to play. Also used to
describe a specific option pricing method - Monte Carlo Simulation. This method
generates a path of prices for the underlying asset, and the option is priced at maturity
(within the model). The method is then repeated, with a second option price determined.

Many thousands of trials are then carried out, and the average of all the trials is the final
option price. Often used to price Path Dependent Options.
Moodys : A ratings agency. See Ratings
Mortgage Backed Securities (MBS) : A form of securitisation. Mortgages are pooled

together and sold to a special purpose vehicle (SPV). The SPV issues mortgage
backed securities using the mortgages as collateral. See Securitisation, Prepayment
Risk.
Multi-Callable Bond : A bond which can be recalled by the issuer on several specified
dates. See Callable Bond.
Mutual Fund : A professionally managed portfolio of stocks and bonds or other

investments divided up into shares. Minimum purchase is often $500 or less, and
mutual funds stand ready to buy back their shares at any time. The market price of the
fund 's shares, called the net-asset value, fluctuates daily with the market price of the
securities in its portfolio.
Naked : When an option writer sells a call without owning the underlying asset.
Naked Call Writing : See Naked.
NC : See No Call.
Nearby : The futures contract month with the earliest delivery period.
Negative Yield Curve : See Inverted Yield Curve.
Net Basis : The profit made in a Basis Trade. Calculated as Coupon Income - Gross
Basis + Finance Costs. See Basis Trade, Gross Basis.
Net Present Value (NPV) : The value today of a series of cash flows that will be
received at future time periods. The cash flows are discounted using present value
factors. See Present Value Factor.
No Call : Refers to the period of call protection in a callable bond. Eg No Call 5 would
mean that the bond cannot be called for five years (often written NC 5).
Notional Principal : The amount which a financial contract is based on, but which is
not actually exchanged eg the notional principal in a Swap or FRA.
OAT : Obligation Assimilable du Tresor Long term French government debt.
Offer : A price quote to sell a financial product or instrument.
One Way Floater : This product allows an investor to take a view on interest rates and
receive an enhanced return over Libor, say, with a constantly resetting floor ensuring
that payments can never decrease. A One Way Floater is essentially a swap where the
investor pays a vanilla fixed/floating rate in exchange for an enhanced coupon subject
to certain conditions. There is a cap on the increase in the coupon over the previous

fixing but at the same time the coupon can never go down as the previous coupon
becomes the new minimum. Hence the name One Way Floater, the coupon can only go
up. See Interest Rate Swap, Cap, Floor.
On Special : See Special.
Open Interest : For futures, the total number of contracts not yet liquidated by offset or
delivery; i.e. the number of contracts outstanding.
Open Outcry: Oral bids and offers made in the trading rings or pits.
Option Pricing Model : A mathematical model which calculates the theoretical value of
an option (ie its premium). See Black Scholes, Binomial Option Pricing Model.
Open Repo : A repo in which the term is not specified at the outset. An open repo
agreement can be terminated at any time by either party giving notice. See Repurchase
Agreement.
Option Seller: See Writer.
Option Contract: A derivative contract giving the buyer the right, but not the obligation,
to buy or sell a specific asset, index, rate or instrument at a specified price within a
certain time period. It is unilateral because only one party (the buyer) has the right to
demand performance on the contract. If the buyer exercises his right, the seller (writer
or grantor) must fulfil his obligation at the strike price, regardless of the current market
price of the asset. See Derivative; European Option; American Option.
Option Premium : See Premium.
Origination : The business of designing and issuing securities to fulfil a clients debt
capital market requirements.
OTC : See Over-The-Counter.
Out-of-the-money (OTM) : A call option is out-of- the-money when the strike price is
above the underlying asset price. A put is out-of-the-money when the strike price is
below the underlying futures price. See In-The-Money, Option.
Overbought: A term to describe a market in which the price has risen relatively quickly
- too quickly to be justified by the underlying fundamental factors.
Oversold: A description for a market in which prices have dropped faster than the
underlying fundamental factors would suggest.
Over-The-Counter (OTC) : Describes markets which trade products outside of an

exchange ie directly amongst banks or directly between banks and their clients eg
Swaps, FRAs. In the Global Markets division at Deutsche bank OTC refers to the group
that transacts interest rate derivatives and structured products.
Par : The face value of a stock or bond. Also called par value.

Par Bond : A bond that is currently trading at a price that is the same as its face or
redemption value (100%).
Parity : Parity represents the value in a convertible bond if it is converted to equity

immediately. Also known as Conversion Value.
Par Swap : A swap in which the PV of the fixed leg cashflows is equal to the PV of the
floating leg cashflows (it has zero NPV). In other words, a par swap is a fair exchange
of cashflows. A par swap would have a zero NPV at inception.
Participating Cap : See Participating Forward
Participating Forward : Participating options (the same as Participating Forwards,

which is a somewhat confusing term) are options whereby the holder receives only
some of the benefit (not all of it) if the option is not exercised. He will participate in
beneficial price or rate moves whilst being protected from adverse moves. Participating
Forwards are cheaper than Vanilla Options (because the latter benefit from all of the
upside, minus the premium cost). Participating option hedges involve buying a put and
selling a call with the same strike but in different proportions. eg a German corporate
which is long $ (ie will receive $) can buy a $ put and sell a $ call (in different
proportions) to participate in any upside whilst protecting the downside. The structure
can be made to be zero cost. Also can be used to refer to participating caps, where only
a certain percentage of the gain in rates rising above the strike is received by the buyer.
See Options, Caps.
Path Dependent Option : An exotic option, the value of which depends on the path
the price of the underlying asset takes over the term of the option. eg lookback options
and barrier options are examples of path dependent options. Often they are priced
using Monte-Carlo techniques. See Lookback Option; Barrier Option; Monte Carlo.
Pit: The area on the trading floor of an exchange where futures trading takes place.
Placing : An issue of securities where the issuing house places the securities directly
with its own clients rather than inviting applications from wider afield.
Plain Vanilla : See Vanilla.
PO Strip : See Principal Only Strip.
Premium : The price paid by a buyer to purchase an option. It represents the

probability weighted intrinsic value of the option discounted back to today.
Premium (Convertible Bond) : See Conversion Premium.
Prepayment Risk : Refers to the risk in classic mortgage backed securities that the
mortgages in the pool will be repaid by borrowers quicker than expected (probably
because interest rates have fallen making it attractive to repay fixed rate mortgages).
Investors in the mortgage backed securities will have to refinance at a lower interest
rate. See Mortgage Backed Securities.

Present Value : Todays value of the cashflows in an asset or financial instrument

when discounted (or present valued) back to today.
Present Value of a Basis Point (PVBP) : See PVBP.
Present Value Factor : Also known as a discount factor. It is the scaling factor which,
when multiplied by a future cashflow gives the value of that cashflow today. eg a
present value factor of 0.9345 when multiplied by a cashflow of $1.07 in one years
time gives a value today of $1.00. The present value factor is calculated as Present
Value/Future Value, or, in our case 1/1.07 = 0.9345.
Price Limit: The maximum price rise or decline permitted by a futures exchange.
Price Value of a Basis Point : see PVBP.
Primary Market : The new issue market for securities.
Principal : (1) The amount redeemed on a bond. (2) The amount which a financial
contract is based on eg notional principal in a Swap or FRA.
Principal Only (PO) Strip : A type of mortgage backed security. PO strips are
purchased at a discount on a presumed prepayment schedule. As interest rates fall
prepayments rise and principal is received earlier by PO investors - hence giving a
higher return (although reinvested at a lower rate). See Mortgage Backed Security.
Prospectus : The document that describes a securities offering.
Put : An option contract giving the buyer the right to sell a particular asset or index at a
specified price within a certain period of time. A put is purchased in expectation of lower
prices. The seller receives the premium as compensation for accepting the obligation to
accept delivery, if the put buyer exercises his right to sell. If prices are expected to rise,
a put may be sold.
Put-Call Parity : Refers to the relationship between the price of calls, puts and the
underlying. Buying a call, selling the underlying asset and investing the present value
of the strike should be equal to the value of a put. It is therefore possible to use this
relationship to calculate put values.
PVBP : Present Value of a Basis Point (or sometimes called Price Value of a Basis
Point). PVBP gives the change in price of a financial product (eg an interest rate swap)
for a parallel change of one basis point in the yield curve.
PVf : See Present Value Factor.
Quanto Equity Swap : A Two-Way Equity Swap where the FX risk has been
eliminated. All of the payments and receipts in the swap are made in one currency.
Quanto Option : An option on an asset in one currency that is denominated in another

currency. For example, a Euro denominated bond that is dependent on US interest
interest rates.

Quanto Swap : See Diff Swap.
Quotation: Often referred to as a "quote." The bid or offer (ask) price.
Range Forward : A hedge where the hedger buys a put and sells a call to hedge being
long the underlying asset. The result is that the hedger knows that an exchange rate
within a particular range will be achieved. eg a German corporate which is long $ (ie
will receive $) would buy a $ call and sell a $ put with different strikes to create a range
forward. It is primarily used to reduce the up-front cost of a vanilla option. If it is
structured so that the call and put premiums are the same it is called Zero Cost. Also
called a Cylinder or a Collar.
Range Note : See Accrual Note.
Ratchet Option : See Cliquet Option.
Rating : See Credit Rating.
Reference Asset : The underlying loan, security or basket of loans and securities on
which a derivative transaction is based.
Relative Performance Swap (Equity) : See Equity Swap.
Relative Performance Swap (Credit) : An investor takes a view on the credit spread
between say the constant maturity five year swap rate and a corporate bond. The
investor pays the constant maturity rate and receives the total return on the bond
(receives price appreciation and coupons, pays any price depreciation). The investor in
this case believes that the spread will tighten.
Repo : See Repurchase Agreement.
Repurchase Agreement : A repo is an agreement to sell a bond with a simultaneous

agreement to repurchase the bond at a later date. A repo effectively enables the holder
of a bond to borrow money while using the bond as collateral with the lender.
Resistance: A horizontal price range where price hovers due to selling pressure.
Reverse Cash and Carry Arbitrage : A bond futures arbitrage in which the futures are
bought and the underlying bonds are sold. The trader believes that the futures are
trading relatively cheaply to fair value.
Reverse Floating Rate Note : A floating rate note in which the interest is a fixed rate
minus libor. eg the rate might be 10% - libor. Investors buy it because they believe libor
will fall faster than the curve implies. It can also be structured as a Double Libor
Reverse FRN eg it might pay 15% - (2 x libor). This gears up the return for the investor
compared with a normal reverse FRN. A Fixed Reverse FRN would pay a fixed rate for
a specified number of years and then a fixed rate minus libor coupon.
Reverse Repo : A reverse repo is an agreement to buy a bond with a simultaneous

agreement to sell the bond at a later date. The counterparty doing a reverse repo is
effectively lending out cash on a secured basis. See Repurchase Agreement.

Rho : Rho is a measure of the sensitivity of an option price to changes in interest rates.
Samurai Bond : A Yen bond issued in Japan by a foreign issuer.
Scalper: A floor trader who buys and sells quickly to take advantage of small price
fluctuations.
Schatz : Medium term German government debt.
Secondary Market : A market that provides for the purchase or sale of previously
issued securities or financial products. The general name given to stock exchanges, the
over-the-counter market and other marketplaces in which stocks, bonds, mortgages and
other investments are sold after they have been issued and sold initially.
Securitisation : The packaging together of a pool of assets to be sold to a special

purpose vehicle which issues securities while using the assets as collateral. For banks,
securitisation frees up capital and allows them to take on more assets.
Settlement Date : The date at which the cash in a financial transaction is received/paid.
Foreign exchange, for example, has a settlement date two days after the deal is agreed.
Short : Someone who has sold a financial instrument or product.
Short-the-Basis: Selling the basis in a bond futures basis trade. This trade involves
selling the cash bond and buying the future. The traders view is that the price of the
cash bond and the future will converge; gross basis will decline. This will take place if
the bond the trader has sold stays or becomes CTD. See Basis Trade; Cheapest-To-
Deliver.
Short Selling : A technique used to take advantage of an anticipated decline in the

price of a security or to hedge a position. In a short sale, the investor (1) borrows the
security from a counterparty and (2) immediately sells it. Then, if the investor guessed
right (or if the hedge was indeed needed) and the price of the security declines, he can
replace the borrowed securities by (3) buying them at the cheaper price.
Shout Option : Similar to Ladder and Cliquet. The holder shouts to reset the strike
and lock in any intrinsic value. Cheaper than a lookback. Good for investors with a view
on the timing of a future temporary move in the market. See Ladder Option; Cliquet
Option.
Sinking Fund : Financial reserves set aside to be used exclusively to redeem a bond
or preferred stock issue and thus reassure investors that the company will be able to
meet that obligation.
Special : If there is a limited supply of a particular security it is said to be on special.

The repo rate for the security will decrease (because there is short supply of the
security relative to demand), the bond becomes more expensive to buy and its yield will
tend to fall as the bond becomes expensive. A condition of limited supply may be
referred to as a short squeeze (particularly in a Basis Trade) as those who are short the
bond find it difficult (and expensive) to buy the issue.
Special Purpose Vehicle (SPV) : Typically relates to securitisation. A corporate or

bank which wants to securitise its assets sets up a special purpose vehicle that does
nothing more than buy those assets and use them as collateral to sell securities. The
corporate or bank thus manages to get the assets off its balance sheet and may still
receive fees for managing the assets.
Spot: Todays cash market price of an asset or financial product.
Spot Currency Transaction : A transaction in the foreign exchange market for which
delivery and settlement take place two business days (T+2) after the day of the trade (to
allow the transfer of cashflows).
Spot FX : See Spot Currency Transaction.
Spread: 1) The bid-offer spread ie the difference between buy and sell quotes 2) the
credit spread - the difference between the yield on bonds of a particular class of credit
rating and the benchmark government bond 3) Positions held in two different futures or
options contracts, taken to profit from the change in the difference between the two
contracts' prices.
SPV : See Special Purpose Vehicle.
Stack Hedge : A three month futures hedge in which all of the hedge is made of futures
from the same contract month, even if the underlying exposure is longer than one the
period covered by that contract month. The hope is that this will be a better hedge than
a Strip Hedge. See Strip Hedge.
Standard & Poors : A credit rating agency. See Credit Rating.
Step-Up Note : A note in which the fixed coupon rises at a particular date eg it may pay
5% for three years and then 5.5% for the next seven years. A Step-Up Callable Note
would be a step-up note which the issuer has the right to redeem at a particular date
(usually the same date as when it steps up).
Straddle: An option trade. A straddle is formed by going long a call and a put of the
same strike price (long straddle), or going short a call and a put of the same strike price
(short straddle).
Strike Price: The specified price at which an option contract may be exercised. Also
known as exercise price.
Strip : See Futures Strip.
Strip Hedge : A three month futures hedge which involves several futures contract
delivery months eg March, June, September. The hedger hopes to fix in the Strip Rate.
See Futures Strip; Stack Hedge.
Strip Rate : See Futures Strip.

Strips : Separately Traded Registered Interest and Principal Security. The stripping of
coupons from a bond to create zero coupon bonds or strips.
Structured Product : A financial instrument designed to meet specific issuer and

investor needs which may involve the use of embedded swaps and options.
Stub Period : The time period between today and the start of the nearest three month
futures contract.
Support: A horizontal price range where price hovers due to buying pressure.
Swap : See Interest Rate Swap.
Swaption : An option on a swap. A payers swaption gives the holder the right to pay
fixed in an interest rate swap if he so wishes. A receivers swaption gives the holder the
right to receive fixed in an interest rate swap. A payers swaption could be bought to
hedge the floating rate debt cost of a major stage in a project financing, for example - if
rates have risen at the end of the life of the option it will be exercised to allow the
project to pay fixed in a swap. If rates have fallen then the option is allowed to die and
the swap is not entered into.
Synthetic : See Synthetic Position.
Synthetic Position : The creation of a position or asset by using a combination that

might include the cash markets, forwards, futures or options eg buying a put and selling
a call will create a synthetic forward or future position. Synthetic positions are often
linked to Arbitrage opportunities.
Technical Analysis: Technical analysis uses charts to examine changes in price

patterns, volume of trading, open interest, and rates of change to predict and profit from
trends. Someone who follows technical rules (called a technical analyst) believes that
prices will anticipate changes in fundamentals.
Term Repo : A repo in which the term is predetermined as part of the agreement.
Different to an open repo, where the repo remains open until either party to the contract
terminates it.
Term Structure of Interest Rates : The shape of the interest rate yield curve. Shows
yields for given maturities.
Theta : Measures the sensitivity of an option price to changes in time to expiry.
Thin Market : A market with little trading and poor liquidity.
Thirty/Three Sixty : More commonly written as 30/360. Assumes each month has thirty
days and there are twelve months each of thirty days in the year. 30/360 is used for
calculating accrued interest on domestic US$ bonds. 30/360 is often used for
calculating interest on swaps.

Tick: The minimum allowable price fluctuation (up or down) for a futures contract.
Different contracts have different size ticks. Eg the three month sterling contract has a
tick value of 12.50 (500,000 Face Value x 0.01% x 3/12 = 12.50).
Tier 1 : Refers to the core capital that a bank maintains as part of its capital adequacy.
Primarily made up of equity and disclosed reserves.
Tier 2 : The second layer of a banks capital base.
Tier 3 : The third layer of a banks capital base.
Time Decay : The propensity of the time value in an option to decay or erode as expiry
draws nearer (other things equal).
Time Value: The portion of the option premium that is attributable to the amount of time
remaining until the expiration of the option contract. Time value is whatever value the
option has in addition to its intrinsic value. The premium of an out-of-the money option
constitutes the time value (because there is zero intrinsic value) of the option and
reflects the probability that the option will move into-the-money before expiration. There
also may be some time value in the premium of an in-the-money option, which reflects
the probability of the option moving further into the money. See Intrinsic Value.
Total Rate of Return Swap : A bilateral financial contract in which the total return of a
specified asset is exchanged for another cash flow. One counterparty (the TR payer)
pays the total return (interest plus fees plus price appreciation less price depreciation)
of a specified asset, the reference obligation, and (usually) receives Libor plus a spread
from the other counterparty (the TR receiver). Price appreciation or depreciation may be
calculated and exchanged at maturity or on an interim basis. Allows investors to
exchange the total economic returns of an asset for fixed or floating interest payments
or vice versa. They provide a synthetic method to access off balance sheet assets or
manage portfolio risk more efficiently.
Transaction Exposure : A foreign currency risk eg when a UK corporate knows it will

receive US$ in three months time - if strengthens then the corporate loses, if
weakens it gains. The risk can be hedged using options or forward foreign exchange
contracts. See Forward Contract.
Trader : see Dealer.
Translation Exposure : Often called a paper exposure because it does not involve
actual cash. Imagine a UK corporate which has a German subsidiary. At year-end the
German subsidiary has profit of 400m euros. If this is kept in Germany there is no cash
impact on the business but the P&L of the UK parent will vary with the exchange rate -
even though profits or losses from FX changes have not been crystallised because the
Euros have not been exchanged for . The key point is that very few corporates will pay
for derivatives to hedge a paper exposure. There are also Balance Sheet Translation
exposures. eg if the same German subsidiary has machinery worth 600m Euro, then its
value will vary in the parent companys consolidated accounts as the Euro/ rate
changes. Again, this is a paper exposure.

Treasury Bills : Short term government securities issued on a discount basis eg T-bills
in the US.
Treasury Bonds : Long term government bonds - refers to US government bonds with
a life of more than ten years.
Treasury Notes : Medium term notes issued by the US government.
Trigger : Refers to Trigger Notes and Trigger Swaps. These are products which, when
a defined event occurs, change from one interest basis to another. See Trigger Swap.
Trigger Swap : A Trigger Swap operates in the same way as a vanilla swap with the
exception that the swap is cancelled or the swap rate changes if the underlying rate
passes a specified trigger. An investor trigger is designed to enhance the return from a
floating rate bond. The investor enters into a swap paying the coupon and receiving a
higher floating rate in exchange for the risk that if the trigger is exceeded a fixed rate will
be paid instead. Usually the fixed rate is equal to the trigger rate so the investor
immediately receives an unfavourable return once the trigger is breached.
Uncovered call writing : A short call option position in which the writer does not own
an equivalent position in the underlying security represented by his option contracts.
See Naked.
Uncovered put writing : A short put option position in which the writer does not have a
corresponding short position.
Underlying : The actual rate or price that an option is based upon (the underlying might
be interest rates, FX rates, commodity prices etc).
Underlying Futures Contract : The futures contract covered by an option.
Underwriter : a member of a new issue syndicate who buys a new issue of securities
from the issuer at a fixed price. The member then arranges for the sale of the securities
to investors. See Fixed Price Reoffer.
Up-Front Cost : Often refers to the premium paid today or up-front for an option. Can
also mean any lump sum paid at the start of a structured product, or refer to the present
value of future cashflows paid today.
Vanilla : Refers to any financial product which is the most basic (and often most liquid)
of its kind. eg a Vanilla Option (just a normal Call, say) or a Vanilla Swap (just a normal
fixed for floating swap). Also called Plain Vanilla.
Variable Principal Equity Swap : See Equity Swap.
Variation Margin Call: A margin call from the clearinghouse to a clearing member.
These margin calls are issued when the clearing member's margin has been reduced
substantially by unfavourable price moves.
Vega : Measures the sensitivity of an options price to changes in volatility. Also known
as Kappa.

Volatile: A market which often is subject to wide price fluctuations is said to be volatile.
This volatility may sometimes be due to a lack of liquidity.
Volatility : A measure of the fluctuation in the market price of the underlying asset,
index, rate or financial product. Mathematically, volatility is the annualised standard
deviation of returns.
Warrant : An (option) instrument issued by a company giving the holder the right to buy
new shares in the company at the strike price on an agreed date or range of dates.
Often issued as a package of bonds with detachable warrants.
Wasting Asset: A term often used to describe an option because of its limited life.
Shortly before its expiration, an out-of-the-money option has only time value, which
declines rapidly. For an in-the-money option, only intrinsic value is left upon expiration.
At the end of its life, an option that has no intrinsic value is worthless, ie it has wasted
away.
Withholding Tax : Tax deducted at source on the payment of dividends or interest.
Writer : One who sells an option. A "writer" (or grantor) obligates himself to deliver the
underlying asset to the option purchaser, should the purchaser exercise his right to buy
the underlying.
Yankee Bond : A US dollar bond issued in the US by a foreign issuer.
Yield : The return on a security taking into account both income and price appreciation.
Yield Curve : A plot of the relationship between interest rate yields and time to maturity
(the Term Structure of Interest Rates). Often used to analyse government bonds,
corporate bonds and swaps.
Yield Curve Swap : See Constant Maturity Swap.
Zero Cost Collar : See Range Forward.
Zero Cost Range Forward : See Range Forward.
Zero-Coupon Bond : A bond that has no coupons. These "zeros" sell at a deep
discount to face value and are especially suitable for long-term investment goals with a
definite time horizon because their yield is known if held to maturity.
Zero Coupon Rate : An interest rate in which all of the interest is paid at the end of a
period. eg for a two year period the interest would be paid at the end of year two (there
would be no interim coupons or cashflows). Alternatively, could be the rate on a zero
coupon bond that pays no coupons but is sold at a deep discount to par.

Glossary of Market Terms

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Global Markets Training 1

Accrual Swap: See Accrual Note.

Actual/360: An interest convention where the interest is calculated as the principal

Actual/365: Also known as Actual/Actual. An interest convention where the interest is

Actual/365 Fixed: An interest convention where the interest is calculated as the

Actuals: The physical or underlying cash asset.

Global Markets Training 2

American Depository Receipt (ADR): Certificates traded on U.S. stock exchanges or

Arbitrage: The purchase or sale of an instrument and simultaneously taking an equal

Arbitrageur: See Arbitrage.

Asset : Anything owned by a corporate, financial institution or individual.

Ask : See Offer.

Asset Backed Security : An asset backed security is a bond that is supported or

ATM : See At-The-Money.

At-The-Money (ATM) : An option is at-the-money if the strike price of the option is

Average Rate Option : See Asian Option.

Basis Point : one hundredth of one percent or 0.01% or 0.0001.

Global Markets Training 4

Bermudan Swaption : A swaption which can be exercised on several dates or over

Bid: the price quoted to buy a financial product or instrument.

Bobl : Medium term German government debt

Global Markets Training 5

Break-even : Refers to a price at which an option's cost is equal to the proceeds

BTAN : Bons a Taux Annuel Normalise. Medium-term French government debt.

BTF : See Basis Trading Facility.

Bulldog Bond : A sterling bond issued in the UK by a foreign issuer.

Bullet Repayment : Where the principal on a financial product is all redeemed at

Bund : Long term German government debt.

Butterfly Spread : Established by buying an at-the-money option, selling two out-of-the

Global Markets Training 6

Call Protection : See No Call.

Cancellable Swap : See Callable Swap.

Global Markets Training 7

Carrying Charges: See Cost of Carry.

Cash Commodity/Cash Market: The actual or physical commodity. The market in

Global Markets Training 8

Clearing Member : A clearinghouse member responsible for executing client trades.

CLO : see Collateralised Loan Obligation.

CMO : See Collateralised Mortgage Obligation

CLN : See Credit Linked Note.

Collateralised Loan Obligation (CLO) : A form of securitisation. Loans are pooled

Collateralised Mortgage Obligation (CMO) : A form of securitisation and a type of

Commercial Paper: Borrowing in the form of short-term paper, also known as CP or

Global Markets Training 9

Compound Option : An option on another option. An up-front premium is paid, then at

Contingent Payment : Often used with reference to Credit Derivatives. A payment is

Contract for Differences : Cash settled instruments such as Forward Rate

Conversion Premium : The conversion premium in a convertible bond reflects the

Conversion Value : See Parity.

Convertible Bond : A bond that can be converted into a predetermined number of

Corridor Note : See Accrual Note.

Covenant : A stipulation in loan or bond documentation which restricts the borrowers

Credit Derivative : Can be broadly defined as a derivative contract whose value

Credit Event : Refers to factors such as missing a payment on a loan, breaches of

Global Markets Training 11

payment characteristics and a corresponding derivative contract that exchanges the

Credit Rating : Given by a rating agency to indicate a borrowers capacity to pay

Credit Risk : Exposure to potential loss from default or credit deterioration of a

CTD Bond : see Cheapest to Deliver.

CUPS : Currency Protected Swap. See Diff Swap.

Currency Protected Swap (CUPS) : See Diff Swap.

Cylinder : See Range Forward.