Glossary of Terms 2

Question 1

Chain-linking

Answer 1

Adjusting an investment index so that it reflects the investment performance of its constituents (and not injections or withdrawals of funds into or out of the market itself).

Question 2

Close Out

Answer 2

The process of establishing an equal and opposite derivative or asset position in order to neutralize or offset the risk of an existing position.

Question 3

Collateral

Answer 3

Assets that are given as security for a loan as a fallback measure to be used in the event of default. By taking collateral, the creditor has an additional source of repayment should its counterparty be unable to perform on its obligations.

Question 4

Contingent Liability

Answer 4

A liability dependent on other events.

Question 5

Credit Spread

Answer 5

A measure of the difference between the yield on a risky and a risk-free security. It is a measure of the risk premium a credit-risky corporate or sovereign entity must pay to attract capital. Credit spreads are used widely as references for credit derivatives.

Question 6

Cyclical Company

Answer 6

A company whose fortunes are very closely linked to the state of the economy. The share price, relative to the rest of the market, will therefore depend on the current state of the economy and any (discounted) expected future changes in the economy.

Question 7

Defensive Company

Answer 7

A company whose fortunes are reasonably immune to the state of the economy. Any security that exhibits less volatility than the market as a whole i.e. its beta is less than 1, providing lower, but more stable, returns.

Question 8

Deflators

Answer 8

Stochastic discount factors which can be applied to a series of cash flows under a set of realistic scenarios to produce market-consistent valuations of assets and liabilities. Sometimes referred to as “state-price-deflators”.

Question 9

Downside Risk

Answer 9

The risk that something bad will happen and a loss will occur. The risk of something going wrong. A risk whose outcome is adverse.

Question 10

Due Diligence

Answer 10

The investigations or care a reasonable person or business should take before entering into an agreement or transaction with another party. This will involve examining the other party and assessing the assets and liabilities that will be acquired as a result of the agreement or transaction.