OAS (option-adjusted spread)
An investor's required yield on a bond with cash flow uncertainty, due to embedded optionality, should be above the yield on a bond with similar duration but with no cash flow uncertainty.
Obligation Acceleration
A credit event where the holders of a debt obligation demand immediate repayment in full. For example, a covenant breach on one debt instrument leads to the acceleration of other debt obligations. Some emerging market credit default swaps include this as a triggering event.
Obligation Default
A credit event now rarely used in credit derivative documentation. The credit event can be triggered when an occurance such as a covenant breach on one debt instrument makes it possible for other obligations to be accelerated.
Obligor
A party who is in debt to another, e.g., a loan borrower or bond issuer.
Off-balance Sheet Derivative Contracts
Derivative contracts that generally do not involve booking assets or liabilities.
Off-the-run / On-the-run
On-the-run securities are generally those most recently issued. The previous on-the-run securities become off-the-run and continue trading although liquidity us typically concentrated on the new series. Examples include sovereign bonds and credit default swap indices.
Offer (or ask) Quote
The price at which someone is willing to sell.
Offers-wanted-in-competition (owic)
A list of positions on which a counterparty seeks competitive offers in the hope of achieving the best possible price.
Offsetting Order
A transaction that is the exact opposite of a previously established long or short position.
Old R
Inclusion of restructuring as defined in the 1999 credit derivative definitions. Under this provision, a credit event is triggered when a debt obligation is restructured, for example, by having interest payments reduced, having its principal amount reduced, having its maturity extended, becoming subordinated to another obligation or having its currency changed. The key difference is that there is no maturity limitation on the kind of obligations that can be delivered with this version of restructuring. Old R is currently used for most emerging market and Japanese credit default swaps.
On-the-run Index
The current series of an index, e.g., a credit default swap index, which roll every six months. On-the-run indices are typically more liquid than previous series, which are known as off-the-run indices.
Open Interest
Outstanding long and short positions in a particular contract. Exchanges are required to report this data.
Open Outcry
The execution process used on the floors of organized exchanges in which bids and offers are matched by voice communication.
Operational Risk
Potential losses due to failure of processes, people or systems, or from external events.
Option
A financial contract giving the purchaser the right, but not the obligation, to buy (in the case of a call option) or sell (in a case of a put option) a fixed amount of a given asset at a specific price within or by a specified period of time.
Option Premium
The price of an option expressed as a rate or currency amount.
Option Theoretic
An approach to estimating the probability of default of an obligor. The original and still popular example is Robert Merton's model-of-the-firm which states that debt can be valued as a put option on the underlying assets of the firm. This specific example is generally referred to as the "Merton model". Variants of this have been proposed and these are commonly called "structural models" referring to their assumed model/image of the firm/process.
Originator
The financial institution (usually a bank) that extends credit on a facility (usually a loan) which may later be held by another institution through, for instance, a loan sale or loan syndication.
Osaka Securities Exhange (OSE)
An futures and options exchange on Japanese securities and indices.
OTC (Over The Counter)
Refers to transactions negotiated and settled directly between two parties.
OTC Derivatives
Non-standardized privately negotiated derivative contracts transacted off exchanges.
Out-of-The-Money Option
An option with no intrinsic value with respect to the prevailing market price of the underlying asset. If the option were to mature immediately, it would be worthless. For a call price to have intrinsic value, the strike must be less than the underlying price. For a put price to have intrinsic value, the strike must be greater than the underlying price.
Outperformance Option
An option contract that allows the owner to capitalize on diverging performances of two underlying securities.
Overcollateralisation Test (OC test)
Most cashflow CDOs include measures to protect senior note holders in the event of deterioration in the par value of the collateral portfolio. This is known as an overcollateralisation (OC) test or par coverage test. If a deal starts to fail its OC test, cashflows are diverted from more junior classes of notes to pay down the liabilities in order of seniority until the deal is back in compliance with the test. The OC test is passed if the overcollateralisation ratio exceeds a predefined level. The OC ratio is the par value of the portfolio collateral divided by the par value of the deal's liabilities. Therefore, paying down the most senior notes should increase the OC ratio by decreasing the size of the deal's liabilities. A deteriorating OC ratio usually indicates a decline in the credit quality of the portfolio. The par value of the portfolio will decline if there are defaults in the portfolio. In most cashflow CDOs, the downgrade of a portfolio asset to a distressed rating (such as triple C) will also reduce the par value of the portfolio, since in those circumstances, the market value of the asset (or a rating agency recovery assumption) is used in the calculation of the ratio rather than its par value. The other way that the par value of the portfolio changes is as a result of portfolio substitutions. For example, if an asset is sold for 90% of face value and a new asset is bought with the proceeds at 100%, the aggregate amount of the portfolio in par terms will decrease. Conversely, if an asset trading close to par is swapped for a distressed asset, the par value of the portfolio will increase. Such a substitution is therefore known as a 'par building' trade.
Par
The dollar amount assigned to a security by the issuer. For a debt security, par is the amount repaid to the investor when the bond matures, usually $1,000.
Par Value
Also known as face value, the principal amount of a bond. Debt securities may be issued at a premium at par or discount to par. Bonds trade in the secondary market for more or less than the par value, reflecting prevailing interest rates, credit spreads and demand and supply appetite.
Participating Cap
Derivative product providing protection from floating rates rising above a specified level but also limits the benefit of rates declining below a specified floor, in order to reduce the cost. It can be viewed as the simultaneous purchase of an out-of-the-money cap and sale of a lesser amount of in-the-money floors.
Participating Option
An option where the buyer forgoes a certain percentage of potential profits in return for a reduced premium.
Participation Rate
In a constant maturity credit default swap, the proportion of the reference rate at which protection payments are set. For example, the reference rate may be the five-year credit default spread on Ford and the participation rate may be 80%. This means payments are calculated as 80% of the than five-year credit default swap spread on Ford at each quarterly payment date. Participation rates reflect the steepness of the credit curve, with steeper curves translating into lower participation rates.
Path-Dependent Options
An option contract whose value depends on the path taken by the price of the underlying security.
Pay-as-you-go Settlement (PAYG or PAUG settlement)
A form of settlement used in asset-backed credit default swaps which allows two-way payments between the protection buyer and protection seller during the life of the contract. If the reference obligation is affected by interest shortfalls or principal writedowns, the protection buyer compensates the protection seller. These amounts are paid back to the protection buyer if the interest shortfalls or principal writedowns are reversed. The protection buyer has the option of physically settling the credit default swap if there is a principal writedown.
Payer
An option contract giving the option buyer the right to pay the fixed rate on the underlying swap.
Payment Netting
Aggregation of payments due on the same date and in the same currency to a single net payment.
Performance Bond
A good-faith deposit (type of margin) to ensure performance of financial obligations.
Physical Delivery
Settlement of a contract by the delivery or receipt of the underlying commodity.
Physical Settlement
Settlement of a contract by the delivery or receipt of the underlying commodity or security, as opposed to financial or cash settlement.
Pit
The trading floor of some organized exchanges where traders execute buy and sell orders on behalf of their clients.
Plain Vanilla Swap
The simplest form of swap where one party typically pays a fixed amount in exchange for a floating amount. The fixed amount is determined at inception based on a target value, which is typically close to zero.
Points Upfront
A convention for trading credit default swaps where a portion of the protection payments are present-valued and paid upfront, with the remainder paid as a running spread. Trading points (percentage points of the notional) upfront eliminates or reduces the risk that a credit event takes place before the protection seller has received any income from the credit default swap.
Portfolio Insurance
An investment strategy employing combinations of securities, options and futures that is designed to provide downside price protection for the portfolio.
Portfolio Management
Continous review of the portfolio and, if agreed with the client, purchases and sales for the purpose of taking positions and hedging risks.
Position
The net long or short number of contracts held.
Position Limit
The maximum number of long or short contracts an investor is allowed to hold.
Position Trader
A trader who holds open positions based on a directional view of the market, as opposed to a market maker.
Positive Basis Trade
For single name credit trading, a trade in which the trader goes short a bond using the repo market and sells credit default swap protection on the same name. If the basis is positive - that is, the credit default swap spread is greater than the bond spread - the trader can receive income without taking on any default risk.
Potential Exposure
An assessment of the future value of all of the contracts outstanding with an individual counterparty for the purpose of determining default risk.
Pre-petition Debt
Debt that pre-dates a bankruptcy filing.
Preferred Credit Default Swap (PCDS)
A credit default swap (CDS) where the deliverable obligation is preferred stock and where deferral of dividends triggers a credit event.
Premium
The cost to enter into a derivative transaction, usually option contracts. The premium is the combination of intrinsic and time value.
Present Value
The current value of a security's expected cash flows.
Prime
Used as a term to categorize U.S. mortgages representing high quality loans.
Prime Services/Brokerage
Suite of products including clearing and settlement, custody, reporting, and financing of positions for institutional investors.
Principal
The amount of an obligation upon which interest is calculated and which may be exchanged at inception and maturity.
Principal Writedown
A reduction in the principal of a security due to losses. Principal writedowns can be reversed as a result of an improvement in the credit quality.
Priority of Claims
Classification of claims that reflects differences in the rights of creditors. Unsecured creditors frequently are classified together, whereas each secured claim is generally classified separately. Claims within each class must be treated equally and treatment must not unfairly discriminate between creditors (whether or not classified together) of equal priority.
Private Banking
Business with informed and high net worth clients.
Private Equity
Equity investment in non-listed companies. Examples are venture capital and buyout funds.
Probability of Default (PD)
A parameter used in the calculation of economic capital or regulatory capital under Basel II for a financial institution. This is an attribute of the institutions counterparty. The probability of default (also call Expected default frequency) is the likelihood that the counterparty will not be able to honor its commitment (e.g. repay a loan).
Program Trading
Computerized trading used primarily by institutional investors typically for large-volume trades. Orders from the trader's computer are entered directly into the market's computer system and executed automatically.
Protection Buyer
The counterparty that hedges or goes short credit risk in a credit derivative.
Protection Seller
The counterparty that assumes credit risk in a credit derivative.
Protective Put
A put option purchased for an underlying asset that is already owned by the holder of the option. A protective put defends against a drop in the price of the underlying asset.
Purchase and Sale Agreement
A legal contract that obligates a buyer to buy and a seller to sell a product or service.
Put Option
An option to sell an asset, usually at a specified price on or before a specified date.
Put-call Parity
The relationship between European call option prices and European put option prices. The relationship dictates the price of a put given the price of a call with the same characteristics or vice versa.