Call Option
A spread involving the simultaneous sale of an option with a nearby expiration date and the purchase of an option with a more deferred expiration date, both with the same excercise date. This is also known as a "horizontal" or "time" spread.
Call Risk
For contracts with callability features, this is the risk that the call will be exercised. This risk exists for contracts with explicit call options, such as callable bonds and swaptions and implicit call options, such as refinancing loans or mortgages.
Capital or Risk-based Capital
A risk management concept which requires that the capital of a financial organization be sufficient to protect its counterparties and depositors from on- and off-balance sheet market risks, credit risk, etc. Capital requirements are often simple mechanical rules, but are growing to be more sophisticated risk management technology. The test of a securities business's ability to meet its financial obligation. Capital adequacy rules outline the money that is necessary to support the risks of trading. Stringent rules governing capital adequacy for US brokers have been laid down by the Securities & Futures Association. Commercial banks also face a raft of capital adequacy rules established by international regulators.
Capital Structure Arbitrage
Any of a number of trading strategies designed to arbitrage the relationship between assets issued at different parts of a company's capital structure. Examples include convertible arbitrage (trading convertibles against equity options, for example), trading secured loans versus unsecured bonds of the same issuer and trading senior debt against subordinated debt of the same issuer. Carry The cost of holding an asset (storage, insurance, damage, loss) including the cost of borrowing to purchase it.
Cash CDO
Any of a number of trading strategies designed to arbitrage the relationship between assets issued at different parts of a company's capital structure. Examples include convertible arbitrage (trading convertibles against equity options, for example), trading secured loans versus unsecured bonds of the same issuer and trading senior debt against subordinated debt of the same issuer.
Cash Flow Statement
Calculation and presentation of the cash flow generated or consumed by a company during a financial year as a result of its business, investing and financing activities, as well as the reconciliation of holdings of cash and cash equivalents (cash reserve) at the beginning and end of a financial year.
Cash Settlement
An exchange of cash at maturity (or an earlier date) with respect to a derivatives contract from the party who is out-of-the-money to the party who is in-the-money.
Cash Flow CDO
The term cash flow CDO is often used interchangeably with cash CDO. In a cash flow CDO, the overcollateralisation test is based on the par value of the collateral rather than its market value, as is the case for market value CDOs.
CDO Squared
A CDO in which the underlying collateral consists of other CDO tranches.
CDS Index Protocol
A document published by Isda allowing those participants who adhere to the protocol to settle a CDS contract in cash based on an agreed upon Credit Event fixing and auction in lieu of requiring physical delivery of an underlying reference obligation.
CDS Spread
The amount paid by the Protection Buyer to the Protection Seller with respect to a CDS contract, typically denominated in basis points and paid quarterly. It is also referred to as a premium.
CDX
A family of North American credit indices or baskets of CDS contracts administered by Markit covering Investment Grade, High Yield, and Emerging Markets as its three main classifications.
Close-out Netting
In the event of a default, the close-out netting provisions of the ISDA Master Agreement provide that offsetting credit exposures in effect are netted and one lump sum payment is required from one party to the other for all transactions covered by the Agreement between the two parties.
Collateralized Bond Obligation (CBO)
An ABS structure similar to a CMO but with a portfolio of bonds as collateral, instead of a portfolio of Mortgage Backed Securities. A sponsor transfers the collateral into a Special Purpose Vehicle (SPV), such as a trust or corporation, which has no other assets and which issues claims. A typical CBO has more than one "tranche" or "tier" with junior tranches bearing the greater risk to default on underlying bonds.
Collateralized Debt Obligations (CDOs)
Asset-backed securities based on a portfolio of assets that can include bonds, loans or derivatives. CMOs, CBOs are types of CDOs with mortgages and bonds respectively as underlying collateral.
Collateralized Loan Obligation (CLO)
A type of CDO with a portfolio of commercial or personal loans as collateral. As with other CDOs, the securitization is typically 'tranched' or 'tiered' with junior tranches bearing the greater default risk.
Combined Ratio
Represents the net total of acquisition and administrative expenses and net claims and insurance benefits incurred divided by net premiums earned in a Combination.
Constant Proportion Portfolio Insurance
This is a derivative security that guarantees certain upfront performance provisions by means of a dynamic trading strategy.
Copula
A statistical tool that describes how the distribution of individual risks are combined to form a joint risk distribution by taking into account the correlation of the individual risks with one another. Copulas are used in the valuation of synthetic CDO tranches and other correlation-sensitive products. The Copula considers the individual risk that a given credit will default in concert with a general market downturn (systemic risk) versus the risk that the credit will default independent of market conditions (idiosyncratic risk).
Correlation
Correlation is a statistical measure describing the extent to which prices on different instruments move together over time. Correlation can be positive or negative. Instruments that experience price moves in the same direction and by the same amount approximately have highly positive correlations. Instruments that move together in opposite direction but by nearly the same amount in absolute value have highly negative correlations. Correlation in itself is not constant.
Correlation Smile or Skew
A phenomenon whereby the more senior and more junior tranches of a synthetic CDO exhibit high correlation whereas mezzanine tranches imply low correlation. This is similar in concept to the skew seen in many option markets where different strikes imply different volatilities.
Counterparty Risk
The exposure of one party to the risk of another that a trade might default due to the actions of the other party participating in the transaction. Sometimes the risk of one party in a transaction is one-sided, and sometimes it is bilateral (each has exposure to the other). When a bank lends a company money, the borrower (not Counterparty) has no meaningful credit risk to the bank. When the two agree to enter into a forward exchange contract or swap, the company is at risk should the bank fail, and the bank is at risk should the counterparty fails.
Coupon
This term is often used interchangeably with interest rate, but it actually has a specific meaning relating to an older format of bond issuance called a Bearer Bond. The coupon was a physically detachable coupon attached to the Bearer Bond certificate. The holder was required to present the coupon to a paying agent in order to receive the interest payment due.
Coupon Bond
This is synonymous to a Bearer Bond, a certificate that has warrants or coupons physically attached to it. The holder is required to detach and present the coupons in order to collect payment.
Coupon Stripping
The process of decomposing an interest bearing bond into individual debt instruments each corresponding to the principal amount of each interest coupon as well as the principal portion of the bond.
Covered Call
A trade consisting of a written call option alongwith ownership of the underlying instrument referenced by the call.
Covered Option
An option written in which the writer has an offsetting position in the underlying instrument referenced by the option.
Covered Put
A trade consisting of a put option and a short position on an identical amount of the underlying.
Credit Curve
A credit curve represents the term structure of default probability of a given reference entity much as an interest rate curve represents the term structure of interest rates for a given index, 3 month USD LIBOR for example. As default probability of any entity generally rises over time, usually credit spreads are higher for longer maturities than shorter maturities, although they can become inverted in distress situations.
Credit Default Swap (CDS)
A Swap in which one party pays another a periodic Fee or Premium in return for payment of a principal or notional amount net of actual market recovery in the event of a predefined credit event or default with respect to a given reference entity. The fee might be quarterly, semiannual, or annual. The credit event might be a declaration of bankruptcy or violation of a bond indenture or loan agreement. A credit default swap is similar in concept to insurance on the performance of a given reference entity.The Protection Buyer is the party who pays the premium, and the Protection Seller is obligated to make payment should a credit event take place.
Credit Derivatives
Financial instruments which transfer credit risk connected with loans, bonds or other risk-weighted assets or market risk positions to parties providing protection. This does not alter or reestablish the underlying credit relationship of the original risk-takers (parties selling the credit risks).
Credit Event (ISDA)
This is the event triggering settlement under the CDS contract. Since the original ISDA Agreement in 1999, six categories of Credit Events have been defined: Bankruptcy, Failure to Pay, Debt Restructuring, Obligation default, obligation acceleration, and repudiation/moratorium. In practice, Credit Events are determined by an ISDA committee, and the realized recovery rate is determined by auction rather than requiring physical delivery of a reference obligation.
Credit Event Auction
This is an industry standard mechanism for the purpose of facilitating the settlement of credit derivative trades following a credit event. The auction process determines the realized recovery rate or 'Final Price' of a CDS which determines cash settlement between CDS buyer and seller.
Credit Event Fixing
Process of determining the cash settlement price for a credit derivative using a credit event auction. At the time of publication, credit event fixings are used only for credit indices and are administered by Creditex and Markit Group.
Credit Event Notice
A notice by which the counterparty triggering the credit event (usually the protection buyer) informs the other counterparty that there was a credit event. The notice describes the reasons that make the triggering party believe there has been a credit event.
Credit Index
A credit derivative index is a basket of single name credit default swaps with standardised terms. Unlike other multi-name credit default swaps, index swaps provide unleveraged exposure to the names in the basket.
Credit Linked Note (CLN)
A structured note combining a debt product and an embedded credit derivative, typically a credit default swap.
Credit Risk
Risk of loss from a counterparty in default or from a pejorative change in the credit status of a counterparty that would decrease the value of their obligations.
Credit Spread
The spread between Treasury and non-Treasury securities that are identical in all respects except for quality rating.
Credit Spread Curve
The curve display of the credit spread for a unique reference entity/tier/currency/docclause combination over different tenors.
Credit Spread Swap
A Swap with a payoff that depends on a Credit Spread. For instance, a Swap with a Floating Leg that depends on the Credit Spread.
Credit Swaption
An option to enter a Credit Default Swap.
Credit Trading
Trading in loan or credit-related products.
Credit Value Adjustment (CVA)
The difference between the risk-free portfolio value and the true portfolio value that takes into account the possibility of a counterparty's default.
Cross Hedging
Hedging with a futures contract whose underlying is different, but similar, to the cash instrument.
Cross-currency Swaps
A cross-currency swap is an interest rate swap in which the cash flows are in different currencies. Upon initiation of a cross-currency swap, the counterparties make an initial exchange of notional principals in the two currencies. During the life of the swap, each party pays interest (in the currency of the principal received) to the other. And at the maturity of the swap, the parties make a final exchange of the initial principal amounts, reversing the initial exchange at the same spot rate. A cross-currency swap is sometimes confused with a traditional FX swap, which is simply a spot currency transaction that will be reversed at a predefined date with an offsetting forward transaction; the two are arranged as a single transaction.
Daily Price Limits
The maximum and minimum prices at which a futures contract can be traded. These limits are established by the clearinghouse and are expressed in relation to the previous day’s settlement price.
Daily Settlement
The process in a futures market in which the daily price changes are paid by the parties incurring losses to the parties making profits. The profits and losses are generally settled with a clearing corporation.
Day Order
An order to sell or buy a financial claim canceled if unfilled by the end of the day.
Day Trader
A trader in financial claims who closes out all positions by the end of the trading session.
Dealer
The dealer’s economic function is to make-a-market so market. A potential buyer or seller contacts a dealer, by telephone or on an electronic trading platform, and inquires about the dealer’s quotes (bid or offer). If the quote is acceptable to the potential buyer, he can execute a trade at the offer price (called lifting an offer) or the potential seller can sell at the bid price (hitting a bid). The dealer is the counterparty in either case.
Debenture
A loan raised by a company, paying a fixed rate of interest and which is secured on the assets of the company. Debentures are fixed interest securities in return for long-term loans, they tend to be dated for redemption between ten and forty years ahead of the issue date. They may be secured by a floating charge on the company's assets or tied to specific, named assets.
Debt Products
Tradable instruments representing a liability or claim with respect to assets of one or more private or public sector entities. The phrase also denotes a broader range of instruments including foreign exchange and commodity contracts.
Debt Restructuring (ISDA)
The configuration of debt obligations is changed such that the credit holder is unfavorably affected (maturity extended and/or coupon reduced).
Debt Security
A security representing a loan by an investor to an issuer such as a corporation, municipality, the federal government or a federal agency. In return for the loan, the issuer will repay the debt on a specified date (including interest).
Debt Service
The schedule for repaying interest and principal (or the scheduled sinking fund contribution) on an outstanding debt.
Debt-type (or instrument type)
The form of the credit obligation, (e.g., bank loan, public bond, preferred stock).
Debt Valuation Adjustment
This is a term that takes into account expected gain from institution’s own default. It is simply CVA from counterparty’s perspective, and is added to the market value of the portfolio.
Debtor-in-possession Loan (DIP loan)
Special form of financing provided for companies in financial distress or under Chapter 11 bankruptcy process. Usually, this security is more senior than debt, equity, and any other securities issued by a company. It gives a troubled company a new start, under strict conditions.
Default Correlation
The degree to which the default probabilities of different credits move in tandem.
Default Probability
The likelihood that a debt instrument will default within a stated timeframe.
Default Requirement
The minimum size of a bond or loan default that can trigger a credit event in a credit derivative.
Deferred Acquisition Costs
Expenses of an insurance company which are incurred in connection with the acquisition of new insurance policies or the renewal of existing policies. They include commissions paid and the costs of processing proposals.
Deferred Futures
The more distant delivery months in which futures trading takes place.
Deferred Pay Out Option
An American option where settlement is at expiration.
Deferred Start Option
An option purchased before its life begins.
Deferred Strike Option
An option in which the exercise price is established at a future date based on a defined formula.
Deferred Tax Assets/liabilities
The calculation of deferred tax is based on tax loss carryforwards, tax credit carryforwards and temporary differences between the carrying amounts of assets or liabilities in the published balance sheet and their tax base, and on differences arising from applying uniform valuation policies for consolidation purposes. The tax rates used for the calculation are the local rates applicable in the countries of the companies included in the consolidation; changes to tax rates already adopted on the balance sheet date are also taken into account.
Deferred Taxes
Income tax to pay or receive as a result of temporary differences between the carrying amounts in the financial accounts and the relevant tax base or the value of unused tax losses and unused tax credits. At the balance sheet date, deferred taxes do not yet represent actual amounts receivable or payable from or to tax authorities.
Defined Benefit Plans
For defined benefit plans, the participant is granted a defined benefit by the employer or through an external entity. In contrast to defined contribution arrangements, the future cost to the employer of a defined benefit plan is not known with certainty in advance. To determine the expense over the period, accounting regulations require that actuarial calculations are carried out according to a fixed set of rules.
Defined Contribution Plans
Plans funded through independent pension funds or similar organizations. Contributions fixed in advance (e.g., based on salary) are paid to these institutions and the beneficiary’s right to benefits exists against the pension fund. The employer has no obligation beyond payment of the contributions and is not participating in the investment success of the contributions.
Delayed Settlement Compensation
An amount paid from the seller to the buyer of a loan that has traded in the secondary market under par documentation. The payment is due if the settlement of the trade is delayed beyond the seven-day settlement period regarded as standard. The payment is equal to the margin over Libor on the loan for each day settlement is delayed. Since settlement is routinely longer than T+7, delayed settlement compensation payments are common in the secondary loan market. The purpose of delayed compensation is not to penalise the seller but to transfer to the buyer the amount that it would have received had the settlement taken place on schedule.
Delayed-draw Loan
A loan which may be drawn for a specific period of time to make a specific purchase. The borrower cannot make new drawings on a delayed draw loan once it has been repaid.
Deliverable Obligation
An asset that is eligible to be delivered to the protection seller following a default or that can be used to provide the reference price for cash settlement. Any debt obligation that is pari passu or senior to the reference obligation counts as a deliverable obligation. (However, certain obligations, such as zero coupon bonds and those in minor currencies are usually excluded.) In this way, the reference obligation acts as a marker of the seniority of debt that is referenced in the credit default swap.
Deliverable Obligation Category
In credit default swap documentation, a description of the general type of obligations, such as bond, loan or borrowed money, that can be delivered after a credit event. The precise features of the deliverable obligations are specified in the deliverable obligation characteristics section.
Deliverable Obligation Characteristics
In credit default swap documentation, a list of features that an obligation must include to be deliverable after a credit event. This is comparable to, and in many contracts identical to, the reference obligation characteristics.
Delivery
The process in which a futures contract can be terminated at the expiration of the contract through selling the asset by the short to the long.
Delivery Day
The day an asset is delivered to terminate a futures contract.
Delivery Month
A calendar month during which delivery can be made in a futures contract.
Delivery Notice
The written notice given by a seller indicating his will to make delivery against an open contract.
Delivery Price
The price fixed by the clearinghouse at which deliveries on futures contracts are invoiced.
Delta
The sensitivity of the change in the financial instrument's price to changes in the price of the underlying. In the case of options, an out-of-the-money option has a delta near zero, while a significantly in-the-money option has a delta near one.
Delta Exchange
Process by which the index tranche and its hedge on the main index are traded at the same time, using pre-agreed, industry-standard deltas.
Delta Hedge
An options hedge in which the number of contracts is based on the option delta.
Delta Neutral
Describes a portfolio of related financial securities, in which the portfolio value remains unchanged for small changes in the value of the underlying security. Such a portfolio typically contains options and their corresponding underlying securities such that positive and negative delta components cancel each other, resulting in the portfolio's value being relatively insensitive to changes in the value of the underlying security.
Derivative
A financial contract whose value is derived from the performance of assets, interest rates, currency exchange rates, or indexes. Derivative transactions include a wide assortment of financial contracts such as structured debt obligations and deposits, swaps, futures, options, caps, floors, collars, forwards, or various combinations thereof.
Detachment Point
Also known as exhaustion point, the maximum level of losses in the portfolio to which a synthetic CDO or index tranche is exposed.
Difference Option
An option whose payoff is based on the difference between the prices of two underlyings.
Digital Options
An option whose payoff is a fixed amount if the price of the underlying reaches a predefined level.
Direct Credit Substitute
The Federal Reserve Board's term for a credit enhancement, that is, a means of improving the credit quality of a loan or a bond.
Dirty Price
The quoted bond price, including the accrued interest. In application, in certain non-U.S. bond markets, if you ask your broker a bond's price, he quotes the dirty price. Thus, your check for that amount would be sufficient to buy the bond.
Distressed Documentation
The legal standards used for the trading of many loans in the United States secondary loan market.
Distressed Exchange
During a time of credit distress, debt holders may be effectively forced to accept securities in exchange for their debt claim -- such securities being of a lower value than the nominal present value of their original claim. They may have a lower coupon, delayed sinking funds, and/or lengthened maturity. For historical estimation of default probabilities, this would count as a default event since it can significantly impair value. In the U.S., exchange offers on traded bonds may be either registered with the SEC or unregistered if they meet requirements under Section 3(a)(9) of the Securities Act of 1933.
Distribution Bonds
The main feature of Distribution Bonds, apart from their lower risk profile, is that they address the traditional problem with many income producing investments - the fact that it is sometimes difficult to tell whether it is truly income you are spending - or whether you are simply taking from your capital. Distribution Bonds produce dividends twice a year regardless of the value of the capital - so if you simply spend the dividends, you know with certainty that you are not eating into your capital at all. There are one or two exceptions to this - some investment managers do reserve the right to take from the capital to supplement the income. The value of the underlying funds will vary according to the markets. As a general rule the underlying funds are pretty conservative - though they will include exposure to shares. Several of the leading insurers offer products in this area.
Diversification
A risk management technique that mixes a wide variety of investments within a portfolio, thus minimizing the impact of any security on the overall portfolio performance.
Dividend Capture Hedging Program
A tax strategy in which a corporation tries to earn dividend income by buying stock shortly before the ex dividend date and hedging the price of the stock with short call options or other contracts.
DJSI
Dow Jones Sustainability Indexes are an index family tracking the member companies’ ecological and social achievements.
Documentation Risk
The risk of loss due to an inadequacy or other unforeseen aspect of the legal documentation behind the financial contract.
Double Option
An option to buy or sell but not both. Exercise of the right to buy caused the right to sell to expire.
Down-and-in call/put
An option which becomes effective if the market price of the underlying security drops below a pre-determined price.
Down-and-out call/put
An option that expires worthless if the market price of the underlying security drops below a pre-determined price.
Downstream Quarantee
A contractual provision in which a company guarantees the debt of a subsidiary company.
DTCC
Depository Trust & Clearing Corporation. The DTCC provides clearance, settlement and information services for equities, corporate and municipal bonds, government and mortgage-backed securities and over-the-counter derivatives.
Dual-currency Option
An option that allows the holder to buy either of two currencies.
Dual-strike Option
An interest rate option with one rate for part of the option’s life an another for the rest of its life.
Duration
1. A weighted average of the number of years until a financial instrument's cash flows (e.g., a bond's principal and each of its coupons) arrives. 2. A measure of the sensitivity of the value of a financial instrument (i.e., a sequence of cash flows) to a change in its yield to maturity. The two main variants of Duration are Macaulay Duration and Modified Duration.
Dynamic Hedge
A hedging strategy in which an asset is hedged by selling futures in such as manner that the position is adjusted frequently to take into consideration changes in basis between the prices of futures contract and asset being hedged.