Glossary
Accrued interest Proportion of interest (coupon) earned on an investment between the last coupon payment until the security value date.
All-or-nothing option See binary option
American option An option that can be exercised at any date prior to expiry. (See European option)
Amortising A principal that is decreasing during the contract period, or is repaid in stages.
Amortising bond A bond that repays the principal in stages over the lifetime of the bond, hence the coupons are gradually reduced. (See perpetual bond)
Annual percentage rate (or APR) (See effective rate, nominal rate)
Appreciation Increase in market value of a security; in particular increase in the value of a currency compared to other currencies. (See depreciation)
APR (annual percentage rate) A rate paid at the end of the year that gives the same return on investment as a more frequently paid rate, where interest is compounded. (See effective rate, nominal rate)
Arbitrage Exploiting the price discrepancies between two products or two markets for riskless profit.
Asian option An option that pays at maturity the difference between the strike and the average price of the underlying during the option life. (See European option, American option)
Asking price Price at which traders sell securities. (See offer, bid)
Asset A valuable holding by a company, e.g. security or tangible commodity. (See liability)
Asset-backed security A security that is collateralised by a tangible asset, such as a property portfolio, and thus derives cashflows from that asset.
Asset swap A swap of cashflows whereby one leg is linked to payments from an asset, whilst the other is linked to the prevailing market rate. (See interest rate swap, currency swap)
At the money An option that has strike set to be equal to the prevailing market price of the underlying asset. (See in the money, out of the money)
Average rate option See Asian option
Average strike option In contrast to Asian options, the strike is set to the average price of the underlying during the option contract; the difference between the strike and the prevailing market price of underlying is paid on exercise.
Backwardation The market condition whereby the forward or futures price of a security is lower than the market spot price. (See contango)
Balance sheet security A financial instrument that appears on a company’s accounts. (See off-balance sheet security)
Banker’s acceptance See bill of exchange
Barrier option The option that is activated or extinguished when the underlying price touches or goes through a barrier. (See knock-in, knock-out)
Base currency In exchange rates, the currency against which the amount of another currency (variable currency) is calculated.
Basis In relation to futures contracts, it is the difference between the underlying cash market price and the futures price. In swaps, it refers to the difference between the tenors of underlying floating rates of two swap legs.
Basis points Used in interest rate quotations to imply 0.01 per cent.
Basis risk The risk of divergence between the two security prices. Also the exposure to two different floating rates, e.g. one-month Libor vs. three-month Libor. (See basis)
Basis swap A swap where both legs are based on a floating rate. (See basis)
Basket option An option that pays to the investor the difference between the option strike and the average price (at exercise) of the basket of underlying assets. (See rainbow option)
Bear market Market that anticipates falls in values of securities. (See bull market)
Bear spread An option-trading strategy involving a sale of a low strike call (put) and purchase of a high strike call (put). Undertaken with expectation of a fall in the value of the underlying. (See bull spread)
Bearer security An unregistered security that pays coupon to whoever is holding it, i.e. it provides anonymity.
Bermudan option An option that can be exercised at pre-agreed dates until expiry. (See American option, European option)
Better performance bond options Allows the buyer to receive the greater of two assets’ returns over a specified period of time as long as they are both positive.
Bid A price at which the trader is willing to purchase the security. (See asking price, offer)
Bid/offer spread The difference between the price at which security can be sold and bought, created by traders to make a profit.
Bill of exchange A money market debt used by a company to finance commercial transactions. If endorsed by a bank, it becomes Banker’s acceptance.
Binary option (or Digital option) An option that pays a fixed amount on exercise, regardless by how much the option is in-the-money as long as it is ITM at expiry (all-or-nothing options), or if it has been ITM at any point until expiry (one-touch options).
Binomial distribution A frequency distribution where only two mutually exclusive outcomes are possible. (See trinomial distribution, normal distribution, log-normal distribution)
Binomial tree A numerical approach to option valuation, whereby it is assumed that the underlying price can, in a very short time interval, move up or down with the probability of those moves assigned. The possible paths the option can take between inception and expiry result in a tree, which is used to value the option premium.
Black model A variation of Black–Scholes model, used to price interest rate derivatives.
Black–Scholes model A mathematical model used to analytically value options. It gives a value of a call, whilst the put value can be derived using put-call parity.
Bond A debt issued by a corporation or a government, usually paying a fixed or a floating coupon until maturity, when the principal is redeemed. (See zero coupon bond)
Bootstrapping A method of deriving zero-coupon yields from a combination of coupon-bearing securities. Used in yield curve construction to calculate discount factors for swap coupon dates.
Box An option trading strategy that exploits price discrepancies between a synthetic long at one strike and a synthetic short at another. It is constructed by buying a call and selling a put with the same strike and expiry (synthetic long) and simultaneously selling a call and buying a put at a different strike and same expiry. (See conversion, reversal)
Broker An individual who is paid a commission for executing customer orders. Also, a person who acts as an intermediary between a buyer and seller, for a fee. A stock exchange broker acts as an agent and must be registered with the exchange where the securities are traded. (See trader)
Bull market Market that anticipates rise in values of securities. (See bear market)
Bull spread An option trading strategy involving a purchase of a low strike call (put) and sale of a high strike call (put). Undertaken with expectation of rise in the value of the underlying. (See bear spread)
Butterfly An option strategy that exploits underlying volatility. Involves simultaneous sale/purchase of a low strike call/put, purchase/sale of two mid-strike calls/puts and sale/purchase of high strike call/put.
Calendar spread (or diagonal spread) A purchase/sale of a security with maturity at one date and simultaneous sale/purchase of the same or similar security that matures at a later date.
Callable bond A bond with in-built optionality that gives the issuer the right to redeem the bond at a date prior to maturity. (See puttable bond)
Call option A contract that gives the holder the right but not the obligation to buy an underlying security at a future date at the price agreed today. (See put option)
Cap A ceiling on the cost of borrowing, typically used when cashflows are due over a longer period of time, such as in swaps. (See floor).
Capital market A market for lending and borrowing funds for a period longer than one year. (See money market).
Capped/collared floater An FRN that sets the limits on a floating coupon rate, either by limiting the potential profit (using caps only), or by fixing both the maximum and minimum level (using collars).
Caption Option to enter into a cap. (See cap, floor, floorption)
Cash market Market for transactions on underlying undertaken now and settled on the full price of the asset.
CD See certificate of deposit
CDO See credit default option
CDS See credit default swap
Certificate of deposit A security issued by a bank to raise funds. Usually registered and coupon bearing.
Cheapest to deliver (or CTD) The bond that is most cost-effective to the seller to deliver under the bond futures contract. Futures are priced based on a notional bond, with several deliverable bonds, each with a conversion factor assigned.
Chooser option An option that gives the buyer the choice whether to exercise call or a put at a later date.
Clean price Price of a bond excluding accrued coupon. (See dirty price)
Clearing house In exchange-trading, an institution linked to the exchange that manages counterparty funds and margin payments.
Cliquet option (or ratchet option) An option with the strike reset at the prevailing underlying price at predetermined dates until option expiry, locking in their intrinsic value.
CMOs See collateralised mortgage obligations.
Collar An investment strategy that limits both the upside and downside exposure to the price of the underlying. It involves simultaneous sale of a call (put) and purchase of a put (call) at different strikes, usually both out of the money.
Collateral A tangible asset that is deposited with the counterparty as insurance against default. Often used to enhance the terms of the deal.
Collateralised mortgage obligations (or CMOs) Securities providing the distribution of risks and returns from a pool of mortgages, tailored to meet client’s needs.
Commercial paper (or CP) A short-term security issued by a corporate or a bank to raise funds, usually zero-coupon.
Commodity A tangible asset, such as agricultural produce, precious metals, base metals or energy products.
Commodity derivative A derivative whose underlying asset is a deliverable commodity (typically settled as contract for differences).
Compound interest Interest that is paid before maturity and reinvested to boost earnings. Generally assumes that the reinvestment rate is the same as the original rate. (See simple interest)
Compounding frequency The frequency at which interest is paid, and hence can be reinvested.
Contango The market condition whereby the forward or futures price of a security is higher than the market spot price. (See backwardation)
Contingent option An option that does not require up-front premium payment. It is only due if the option is exercised; but if the option is ITM, even by an amount smaller than the premium, it must be exercised. The payoff profile is equivalent to a combination of long call/put and short digital call/put.
Continuous compounding A theoretical concept whereby the compounding period is infinitesimally small.
Conversion An option trading strategy that exploits price discrepancies when synthetic short is expensive and underlying relatively cheap. It is constructed by selling a call and buying a put with same strike and expiry (synthetic short) and purchase of the underlying stock/future. (See box, reversal)
Conversion factor In a bond futures contract, a factor assigned to each deliverable bond to make it comparable to notional bond underlying the futures price. Defined as the price of a single unit of a bond that makes its yield equal to the notional coupon.
Convertible bond A bond with the call option attached that gives the holder the right but not the obligation to convert the bond into equity shares in the company that has issued the bond.
Convexity In relation to futures and FRAs, it is the difference between the contracts’ dependence on interest rates. In relation to bonds, it is the curvature of the relationship between the bond price and its yield.
Cost of carry A total cost of an open position.
Counterparty A party taking the opposite side of the deal.
Counterparty risk Exposure to the risk that the counterparty will not meet their obligations under the contract.
Country risk A component of the counterparty risk, associated with the creditworthiness of the counterparty domicile country. (See customer risk, transfer risk)
Coupon Interest paid at pre-determined intervals, based on the underlying principal.
Coupon-bearing security A type of security that pays regular coupons based on a principal amount (nominal amount or face value) as means of return on investment. (See zero coupon)
Coupon swap An interest rate swap, whereby one swap leg pays a fixed rate and another a floating rate. (See asset swap, basis swap)
Covered call/put A sale/purchase of a call/put where the option writer already holds (in case of a call) or has sold forward (in case of a put) the underlying. (See naked option, synthetic transaction)
CP See commercial paper
Credit default A failure to meet contractual obligations due to events associated with reduced credit rating.
Credit default option (or CDO) An option to enter into a credit default swap at a future date.
Credit default swap (or CDS) It is a swap where cashflows are exchanged in case of a credit event associated with debt obligations of a third party.
Credit derivative Security whose value is derived from the credit risk on a reference asset or a third party, rather than the counterparty to the transaction itself.
Credit event An event that affects the counterparty’s ability to fulfil their obligations.
Credit exposure Exposure to the creditworthiness of a counterparty or a security.
Credit rating An assessment of creditworthiness of a legal entity or a security done by an independent agency.
Credit risk Risk associated with creditworthiness of a legal entity or a security.
Credit spread swap A swap that gives protection from smaller downgrades in credit rating of a third party or a reference asset, rather than outright bankruptcy or default.
Creditworthiness An assessment of past and present assets and liabilities of a legal entity as a measure of likelihood of default.
Cross-currency A security that involves two currencies.
Cross-rate An exchange rate between two currencies where neither is a major currency (USD, EUR, GBP). It involves rate calculations against the major currency.
Cross-rate forward A cross-rate applicable to a period commencing in the future.
Currency swap A swap where the swap legs are not paid in the same currency. It usually involves exchange of principals. (See interest rate swap)
Current yield Bond yield calculated as a ratio of coupon to the clean price per unit of 100. (See yield to maturity and simple yield to maturity)
Customer risk A counterparty risk component. The risk that the counterparty will fail to fulfil their obligations. (See country risk, transfer risk)
Cylinder A directional (bullish) option trading strategy, with desire for downside protection. Constructed by buying a low strike put and selling a high strike call together with the purchase of underlying.
Delayed option An option that gives the buyer the right to receive at a future date another option with the strike set at the prevailing market value of the underlying on that date.
Delayed reset floater (or Libor in arrears swap) An instrument that fixes the floating leg of the swap only a few days before the payment is due; which is in contrast to standard swap arrangements where the rate is fixed at the beginning of the reset period and paid at the end.
Deliverable bond A bond that is on the list of bonds that can be delivered under the bond futures contract. It is comparable to the notional bond by multiplication of its price by its conversion factor.
Delta The change of option value with the unit change of the underlying price.
Dependent events In probability, the events whose outcomes are related, i.e. the outcome of one is influenced by the outcome of the other. (See independent events)
Depreciation Decrease in market value of a security; in particular decrease in the value of a currency compared to other currencies. (See appreciation)
Derivative A security whose value is based on or derived from the value of another, referred to as underlying.
Diagonal spread An option strategy where two option contracts of the same type (call or a put) are bought/sold with the different strike and expiry. (See spread, horizontal spread, vertical spread)
Diagonal bear spread A directional option trading strategy, constructed with a sale of a short dated put and a purchase of longer dated further OTM put.
Diagonal bull spread A directional option trading strategy, constructed with a sale of a short dated call and purchase of longer dated further OTM call.
Digital option See binary option
Directional trade A trade entered into by investors with a definite view of the direction the market is likely to take. (See bear market, bull market, volatility trade)
Direct rate An exchange rate between two currencies where at least one is a major currency (USD, EUR, GBP). (See cross-rate)
Dirty price Bond price that includes accrued coupon. (See clean price)
Discount The reduction in value of an asset compared to its nominal value as a compensation for the lack of interest payments. Also, discounting is a way of comparison of future cashflows when brought back to the present day. In particular, in foreign exchange, the amount by which one currency is cheaper in terms of another. (See premium)
Discount factor A link between the present value and the future value of cashflows, calculated as a function of the interest rate reciprocal on the cashflow applied to the holding period.
Distribution A range of values a variable can take. (See binomial distribution, normal distribution, log-normal distribution)
Dividend Profit on equity holding, typically proportionate to the number of shares bought.
Dividend yield A proportion of dividend payments relative to the equity held.
Dual currency bond A bond that pays interest in one currency but is redeemed in another.
Duration (or Macaulay duration) A weighted average time until half of bond proceeds (coupon and principal) are repaid, using present values of the cashflows for weighting.
EDSP Exchange Delivery Settlement Price – an official security price against which all contracts are valued/settled.
Effective rate See APR
Equity (also stock) Ownership in a company. Also all the assets that belong to an individual or legal entity after all the debt is removed.
Equity derivative A financial instrument whose underlying is equity or equity index.
Equity index (also stock index) A measure of performance of equity (stock) market sector, or the market as a whole.
Equity index future A futures contract based on an equity index.
Equity index option An option with equity index or a single stock as an underlying.
Equity index swap An OTC swap where at least one leg is based on percentage change in the value of a chosen equity index.
Eurocurrency A currency other than the legal tender of the country where transaction takes place.
European option An option that gives the holder the right but not the obligation to transact at expiry date only. (See American option, Bermudan option)
Exchange-traded Contracts, such as futures, that are traded on recognised exchanges, rather than OTC. (See stock exchange)
Exchange rate A quotation for an amount of variable currency purchased/sold for one unit of base currency.
Ex-dividend The coupon on security (usually bond) is paid to the seller, rather than the buyer, even though the security has already been sold. It can also refer to a period immediately after the dividend has been paid.
Exercise Option transaction undertaken by the buyer whereby the seller has to fulfil his obligations.
Exercise price (or strike) A pre-agreed level of the value of underlying at which the option transaction can take place.
Expiry Termination of the option contract, i.e. the option cannot be exercised past the expiry date.
Exposure Impact of market movements on the value of security. Also an amount of liability related to a financial transaction.
Extrapolation Calculation of values outside the data range. (See interpolation)
Face value (or nominal value) An amount of underlying on which the contract is based (and coupons, if any, are paid).
Fixed rate Cost of funds that does not change with the market rates.
Floating rate A variable interest rate that is reset at regular intervals to the relevant prevailing market rate.
Floating rate note (or FRN) A long-term lending/borrowing capital market instrument where interest payable is reset at regular intervals to prevailing market rates.
Floor A minimum rate guaranteed on investment, typically used when cashflows are due over a longer period of time, such as in swaps. (See cap, collar)
Floorption An option to enter into a floor. (See floor, cap, caption)
Forward General term for an instrument that is valued at a future date.
Forward cross-rate A exchange rate quotation (involving two currencies, neither of which is a major currency) for a period starting at a future date. (See cross-rate, direct rate)
Forward direct rate A exchange rate quotation (involving two currencies, at least one of which is a major currency) for a period starting at a future date. (See cross-rate, direct rate)
Forward exchange rate An exchange rate quotation applicable to a period starting at a future date.
Forward–forward An interest rate agreement starting on one future date and ending on another, typically involving exchange of principals.
Forward rate agreement (or FRA) A short-period interest rate OTC instrument for a period starting on a future date and ending on another, whereby the present value of the difference between the contract rate and the prevailing market rate is paid at the inception. (See futures)
Forward outright A sale or a purchase of foreign currency at a future date.
Forward-start swap A swap that starts at a pre-agreed date in the future.
FRA See forward date agreement
FRN See floating rate note
Futures An exchange-traded interest rate contract to buy/sell a specific quantity of security at a future date at a price agreed today. Typically only the difference between the contract price and prevailing market price on valuation date is settled. (See FRA, OTC)
Futures price (applicable to interest rate futures) A market quotation 100 interest rate. Makes the behaviour of futures opposite to FRAs, as when rates rise futures prices fall, whilst FRAs rise and vice versa.
Future value A value of a cashflow at a future date achieved by investing the funds (principal and interest) at prevailing market rates. (See present value, time value of money)
Future volatility Volatility that will be present in the market in the future. Used in Black–Scholes and other pricing models, but as it is an unknown quantity it is replaced by estimates, such as implied volatility or historic volatility.
Gamma The change in option delta on unit change in value of underlying.
Greeks A collective term for option value sensitivities to changes in market variables: value of underlying – delta, delta – gamma, volatility – vega, interest rates – rho, time – theta.
Gross redemption yield (or yield to maturity) Bond yield that does not take transaction costs and taxes into account.
GRY See gross redemption yield
Hedge ratio A ratio between the size of a position in an instrument held as a protection against adverse value movements in another, and the size of the position in that instrument. In numerical option valuation it is used in premium valuation formulae.
Hedging Protecting against adverse movements in the market value of an instrument by taking an offsetting position in another instrument(s). (See speculation, arbitrage)
Historic volatility Fluctuations in value of security observed or derived from historical market data. (See implied volatility, future volatility)
Holder A purchaser of a security.
Horizontal spread (or calendar spread) An option strategy where two option contracts of the same type (call or a put) are bought/sold with the same strike but different expiry. (See spread, vertical spread, diagonal spread)
Hybrid security A financial instrument that has properties of two or more unrelated securities.
IMM date International Money Market date – the interest rate futures contracts expiry date (third Wednesday of March, June, September and December).
Implied volatility Volatility that is derived from the current market data, calculated as the volatility introduced into pricing models that would result in the current market price.
Independent events In probability, the events whose outcomes are not related, i.e. the outcome of one is not influenced by the other. (See dependent events)
Index (or equity index or stock index) A collective measure of market performance of a set of equities/stocks.
Index multiplier A monetary amount for each point of movement in a particular equity index.
Indirect rate An exchange rate quotation where the major currency is the base currency and the other currency is a variable currency.
Initial margin In exchange-traded options, funds deposited at the contract inception as a protection against adverse market movements. (See clearing house, margin, variation margin)
Initial public offering (or IPO) A company’s first sale of stock/equity shares to the general public.
Interest rate A cost of funds expressed as a percentage.
Interest rate guarantee A one-period cap or floor, i.e. option on FRA.
Interest rate swap (or IRS) A swap of cashflows based on a notional principal, whereby both swap legs (fixed and floating or floating–floating) are denominated in the same currency. (See swap, basis swap)
Internal rate of return (or IRR) The interest rate applied to a series of present and future cashflows that results in NPV = 0. (See net present value)
Interpolation Calculation of an unknown data point from the set of available data where the unknown lies within the available range. (See extrapolation)
In the money (or ITM) An option that has strike set to be more favourable than the prevailing value of the underlying asset. Hence for call options, the ITM option has the strike lower than the market price, whilst for a put option it is higher. (See at the money, out of the money)
Intrinsic value Part of the option premium that reflects by how much the option is in or out of money compared to the prevailing price of the underlying. (See premium, time value)
IRR See internal rate of return
IRS See interest rate swap
Iteration A mathematical process whereby the calculation is repeated many times in order to estimate an unknown variable value, adjusting the criteria at each turn until preset conditions are met. It is a numerical approach used when the unknown cannot be calculated directly from the available data.
ITM See in the money.
Knock-in/-out A barrier option that is activated/extinguished when the preset level is reached or crossed over.
Ladder option An option similar to cliquet option, but the strike is reset if and when the underlying price reaches predetermined levels during the lifetime of the option.
Leg See swap leg.
Liability An outstanding obligation or debt to another party.
Libid A London interbank borrowing rate at which the London banks of high creditworthiness are prepared to borrow funds from one another. (See Libor, Limean)
Libor A London interbank borrowing rate at which the London banks of high creditworthiness are prepared to lend funds to one another. (See Libid, Limean)
Limean A geometric average between Libor and Libid.
Log-normal distribution Probability distribution where a logarithm of the variable is normally distributed. (See normal distribution)
Long position A position whereby the counterparty is a purchaser of a security. It also refers to surplus of borrowing over lending. (See short position)
Look-back option An option that allows the buyer to set the strike at expiry to the most favourable value the underlying has achieved over the lifetime of the option, also known as ‘no regret option’.
Macaulay duration See duration
Margin A payment due on an open exchange-traded option position. There are two types of margin: initial margin and variation margin. Initial margin is paid at the outset of the contract and its amount reflects the most likely one-day loss on a position. At the contract expiry it is returned to the investor with interest. Variation margin is paid daily to reflect profit or loss on a position.
Marking to market Valuation of a position at official market settlement rates.
Maturity The expiration date of the contract.
Maturity date See value date
Mean In probability and statistics, the arithmetic average of all possible outcomes.
Median In probability and statistics, the central value of all possible outcomes. If all the outcomes were arranged in ascending order according to their frequency then median is the middle value (in the case of an odd number of outcomes) or the average of the two middle values (in the case of an even number of outcomes).
Mode In probability and statistics, the most frequent of all possible outcomes.
Modified duration Proportional change of the bond price relative to the change in its yield. (See duration)
Money market Short-term market (typically less than one year) for lending and borrowing. (See capital market)
Mortgage A property purchase loan, where the property is a collateral.
Mortgage-backed security A financial instrument based on a pool of mortgages, where the prepayment schedules are not known in advance.
Mortgage derivative A contract whereby the investor receives cashflows based on an underlying pool of mortgages.
Naked option An option contract that is bought or sold without owning the underlying (in case of calls) or pre-arrangement of forward sale (in case of puts). (See covered call/put)
Negotiable A type of security that can be bought or sold in the secondary market.
Net present value (or NPV) The sum of all present and future cashflows (positive and negative) discounted back to today. (See internal rate of return)
Nominal amount (or face value) A principal upon which the contract is based.
Nominal rate A rate of interest quoted, regardless of the payment frequency. (See effective rate, APR)
Normal distribution A type of probability distribution that enables calculation of probabilities of outcomes when the variable is continuous (data can take any value).
Notional A standardised amount of security used to calculate cashflows when the principal is not exchanged. In particular, in bond futures contract it is a fictional bond against which all deliverable bonds are measured using conversion factors. (See nominal amount, face value)
NPV See net present value
Off-balance sheet security A financial instrument that does not appear on instrument company’s accounts. (See balance sheet security)
Offer (or ask) A price at which the dealer is prepared to sell a security. (See bid, bid/offer spread)
One touch option See binary option
Open outcry A physical stock exchange trading method whereby the floor trader shouts contract details until a willing counterparty is found.
Option A contract that gives the holder the right, but not the obligation to enter into a transaction on or before a future date at the price agreed today. A premium is due. (See call option, put option)
Option premium Price of the option contract payable at the outset. (See premium, intrinsic value, time value of money)
OTC See over the counter
Out of the money (or OTM) An option that has strike set to be less favourable than the prevailing value of the underlying asset. Hence for call options, the OTM option has the strike higher than the market price, whilst for a put option it is lower. (See at the money, in the money)
Outperformance option See Rainbow option
Outright (or forward outright) A sale or a purchase of foreign currency at a future date.
Over the counter (or OTC) An off-exchange trading market, whereby the counterparties can transact privately or thorough investment banks.
Par A price of a security equal to its face value.
Path dependent option An option that has the payout linked to the path the underlying has taken during the lifetime of the option. (See European, American, Bermudan, Asian, average strike, rainbow, cliquet, ladder option)
Perpetual bond A bond that has no redemption date, i.e. pays coupon indefinitely. (See amortising bond)
Premium In options market, the price of the option contract payable at the outset. It comprises intrinsic value and time value. In foreign exchange, an amount by which one currency is more expensive in terms of another, for future delivery than in spot transaction. (See option premium, discount)
Present value (or PV) The value of future cashflows now, when discounted at a prevailing interest rate. (See time value of money, future value)
Primary market A market where a security is originally issued. (See secondary market)
Probability distribution A mathematical concept that refers to the likelihood of a variable being less or equal to a particular level. (See binomial distribution, normal distribution, log-normal distribution)
Put option An option that gives the holder the right, but not the obligation to deliver an underlying security at a future date at a price agreed today. (See call option)
Puttable bond A bond with in-built optionality that gives the investor the right to sell the bond back to the issuer at a date prior to maturity. (See callable bond)
Quanto option An option with the value related to one underlying, but the payout is linked to another.
Quanto swap A swap where one or both legs are based on an instrument in one currency, but payable in another.
Quantitative analytics A term describing mathematical modelling of traded securities, their underlying sensitivities to market variables and their pricing.
Rainbow option (or outperformance option) An option that, if exercised, pays the buyer the difference between the best price and the strike (for call options) or the worst price and the strike (for put options) from a number of underlying securities. (See basket option)
Ratchet option See Cliquet option
Rate spread option An option contract that offers exposure to the basis between two benchmark rates (e.g. three-month Libor vs. six-month Libor).
Ratio back spread An option trading strategy used to exploit volatility. It exploits increasing fluctuations. Bullish if constructed with calls, bearish if puts are used.
Ratio spread Option trading strategy used to exploit volatility. It exploits decreasing fluctuations. Bullish if constructed with puts, bearish if calls are used.
Redeem To repay the principal of the security. (See redemption)
Redemption Refers to the repayment of the principal. Redemption date is the contractual date at which the security is repaid.
Reinvestment rate The interest rate applicable to the interest received on the principal amount that typically cannot be invested at the rate agreed at contract inception.
Repo (or repurchase agreement) An agreement to buy/sell a security and repurchase it at a later date, equivalent to collateralised lending/borrowing. A purchaser of repo sells the security and receives cash, whilst the opposite transaction is referred to as a reverse repo.
Repurchase agreement See repo
Reversal Option trading strategy used for arbitrage. It exploits price discrepancies when synthetic long is cheap and underlying relatively expensive. Constructed by buying a call and selling a put with the same strike and expiry (synthetic long) and selling underlying stock/future. (See box, conversion)
Reverse floating rate note (reverse FRN) A short-term swap structure that offers an alternative to the classic FRN. Under reverse FRN floating rates fall as the Libor increases (e.g. they pay 10 percent – Libor).
Reverse repo See repo
Rho Measure of option sensitivity to interest rate movements.
Risk-neutral A position indifferent to the market moves. In option pricing it refers to the pricing strategy where a position is comprised of an option and a percentage of underlying in order to make zero profit/loss regardless of market moves.
Rollover Renewal of a loan. Specifically, in futures contracts, it refers to the removal of the expired (nearest) contract in the series and the addition of a new (longest-dated) one.
Rollover date Date of loan renewal. Specifically, in futures contracts, it refers to the date of the removal of the expired (nearest) contract in the series and the addition of a new (longest-dated) one. (See rollover)
Secondary market Market for trading securities after they have been issued. (See primary market)
Securitisation A process where debt from various financial institutions is consolidated and resold in tranches as a separate security to other counterparties.
Security A tradable financial product that has market value.
Settlement date See value date.
Share A share of ownership in a company. A company issues a number of shares with the value proportionate to their size compared to the total market value of equity. The share price at any other time reflects the increase/decrease in equity value. (See equity, stock)
Short position A position whereby the counterparty is a seller of a security. It also refers to surplus of lending over borrowing. (See long position)
Shout option An option that gives the investor the right to ‘shout’ when they wish to reset the strike value, regardless of the underlying value.
Simple interest Interest earned on investment that is paid at maturity only, i.e. no intermittent payments are made; thus there is no reinvestment opportunity.
Simple yield to maturity Bond yield calculated as the ratio of the sum of coupon maturity and principal gain/loss amortised over the time to maturity, and the clean price. Does not account for time value of money. (See current yield, yield to maturity)
Speculation A trading practice based on an expectation of certain market moves, as opposed to arbitrage or hedging.
Spot Refers to the immediate valuation. In most markets the price is taken now, but the settlement is two working days later, to allow for paperwork and bank transfers. (See forward)
Spread The difference between bid and offer price. Also refers to option trading strategy where one instrument is bought and a similar with different strike/date is sold. (See calendar spread, horizontal spread, diagonal spread, diagonal bull spread, diagonal bear spread, horizontal spread, ratio back spread, vertical spread)
Spread option An option that pays the difference between two asset prices.
Stack A set of futures (or FRAs) contracts all purchased on the same day with the intention to enter into consecutive rollovers into further contract with decreasing number of contracts. Designed to cover long-dated exposure where there is no sufficient liquidity in further-dated contracts. (See strip)
Standard deviation A measure of dispersion of all the outcomes around the mean (width of the distribution)
Standard log-normal distribution A log-normal distribution with θ = 0 and m = 1.
Stochastic A process whose behaviour is non-deterministic, i.e. a present state does not fully determine its next state. Used in securities pricing.
Stock See equity.
Stock beta A measure of individual stock volatility compared to the equity index.
Stock exchange An organised marketplace where members trade securities. Members may act either as agents for customers, or as principals for their own accounts. (See over the counter, OTC)
Stock index See equity index.
Stock index future See equity index future.
Stock index option See equity index option.
Straddle An option trading strategy, exploiting market volatility by simultaneous purchase/sale of both call and the put with the same strike and the same expiry. (See strangle)
Strangle An option trading strategy, exploiting market volatility by simultaneous purchase/sale of both call and put with different strikes and the same expiry. (See straddle)
Strike See exercise price.
Strip In derivatives markets, a set of futures (or FRAs) contracts with consecutive delivery dates. Transacted with the intention to cover a longer interest rate period. (See stack) In capital markets, stripping refers to a process of separating bond cashflows (coupon and principal) and trading them as separate securities.
Swap An agreement to exchange payments at regular intervals over a period of time. Exchange of principal at inception and maturity is sometimes incorporated. (See interest rate swap, currency swap)
Swap leg (or leg for short) One side of the swap deal, i.e. a series of cashflows one swap counterparty is obliged to pay.
Swap-linked note A swap in which the redemption value of a short-term note is linked to a long-term swap rate.
Swaption An option on a swap (typically interest rate swap or currency swap).
Synthetic long Purchase of a call and sale of a put with the same strike and expiry. (See synthetic short)
Synthetic long call Purchase of a stock or future and purchase of a put.
Synthetic long put Sale of a stock or future and purchase of a call.
Synthetic short Sale of a call and purchase of a put with the same strike and expiry. (See synthetic long)
Synthetic short call (or covered put) Sale of a stock or future and sale of a put.
Synthetic short put (or covered call) Purchase of a stock or future and sale of a call.
Synthetic transaction A transaction (or a combination of transactions) equivalent to another transaction. For example, simultaneous purchase of a call and a put with the same strike is equivalent to a long futures position, hence the term synthetic long.
Theta Option sensitivity measure, expressed as the change in option value with a decreasing time to expiry.
Tick The minimum allowed futures price change.
Time deposit A non-negotiable deposit.
Time value of money The concept that links the future value of money with the present value of money, i.e. in a positive interest rate environment any cashflow is worth more today than in the future.
Total rate of return See TROR.
Trader Individual who takes positions in securities and their derivatives with the objective of making profits. Traders can be market makers with the objective to earn the bid/ask spread. They can also take proprietary positions in which they seek to profit from the directional movement of prices or spread positions.
Transfer risk A counterparty risk component. The risk that a foreign client will not be able to transfer funds to the bank due to issues with his domestic banking system. (See customer risk, country risk)
Treasury bill A government-issued short-term security with intention to raise funds. Usually zero coupon.
Trinomial distribution A frequency distribution where three exhaustive and mutually exclusive outcomes are possible. (See binomial distribution, normal distribution, log-normal distribution)
TROR (or total rate of return) A swap where one leg is based on the total return (interest payments plus any capital gains or losses for the payment period) from a specified reference asset; whilst the other pays/receives a specified fixed or floating interest rate (most commonly Libor + spread). Both legs are based upon the same notional amount.
Underlying A security upon which a contract depends. In derivatives the value of the derivative product is derived from or based on that security.
Value at risk (or VAR) An amount by which the investment value may fall over a specified period of time at a given level of probability.
Value date (also settlement date or maturity date) A date on which the contract expires and the proceeds are calculated. It may differ from the payment date, due to transaction time.
VAR See value at risk.
Variable currency In exchange rates, the quotation gives the number of units of variable currency needed for the sale/purchase of one unit of base currency.
Variance A measure of fluctuation in value of a variable around its mean. (See standard deviation, probability distribution)
Variation margin See margin.
Vega Option sensitivity measure, defined as the change in option value with respect to the change in the volatility of the underlying.
Vertical spread An option strategy where two option contracts of the same type (call or a put) are bought/sold with a different strike but the same expiry. (See spread, horizontal spread, diagonal spread)
Volatility A measure of fluctuation in the value of the variable. In financial markets it refers to the standard deviation of the continuously compounded return on the underlying. (See historic volatility, implied volatility)
Volatility trade A type of trading strategy utilised by investors with no view on market direction, but an expectation of fluctuations. (See directional trade)
Writer An option seller. (See holder)
Yield The interest rate that can be earned on investment based on the prevailing market rates, rather than coupon, which is based on contractual specifications.
Yield curve The relationship between the interest rate (or cost of borrowing) and the time to maturity of the debt for a given borrower in a given currency.
Yield to maturity (or YTM) The internal rate of return of a bond, i.e. the rate necessary to discount all future cashflows to make the NPV equal to the current price. (See current yield, simple yield to maturity)
YTM See yield to maturity.
Zero-cost collar A collar where the premiums paid and received are equal, netting to zero cost. (See collar, cap, floor)
Zero coupon A type of security that does not pay coupon. It is thus issued at discount to its face value to compensate for the loss of interest payments. (See coupon-bearing security)
Zero coupon bond A bond that does not pay coupon, thus its yield depends on the price discount compared to its face value, which compensates for the lack of interest payments. (See bond)