Glossary Part One Flashcards
Cash Settlement
A feature of certain types of futures and option contracts that allow delivery or exercise to be conducted with an exchange of cash rather than by delivery of a physical asset in exchange for payment. Stock index futures contracts are the most predominant type of cash-settled contract.
Futures Exchange
An organized exchange where futures contracts and options on futures contracts are traded.
Reference Asset
The underlying asset(s) being protected in a credit derivative
Locals (Scalpers)
Floor traders who trade for their own accounts.
Hedge Accounting
Hedge accounting should be applied when there is clear evidence that a derivatives transaction is driven by the identification of risk and the effective hedging of such risk. Requires that gains and losses on the hedging instrument (derivatives or otherwise) be recognized at the same time that the effects of related changes in the items being hedged are recognized.
Counterparties
The buyer and seller of a derivative contract.
National Instruments
A set of rules and regulations established by the Canadian Securities Administrators that is legally binding in all jurisdictions in Canada.
NI 81-104
Introduced in 2002, National Instrument 81-104 sets out the rules that govern the operation of commodity pools. It allows them to invest in commodities and use leverage and derivatives in ways not permitted for conventional mutual funds.
Principal-Protected Note (PPN)
A debt-like instrument with a maturity date on which the issuer agrees to repay investors the principal. In addition to the principal, investors may receive interest, the rate of which is tied to the performance of an underlying asset.
Bilateral Netting
The consolidation of all swap agreements between two counterparties.
Convergence
The narrowing of the basis as a futures contract nears expiration.
Cooling Degree Day (CDD)
A day in which the average daily temperature is greater than 65° F (18° C). Therefore, air conditioning is likely to be in demand. If the average daily temperature is 85°, for example, the CDD value for that day is 20.
Cost of Carry
Term associated with the cost of holding a commodity or financial asset until it is sold or delivered. The cost of holding a commodity typically includes financing, storage and insurance charges. The cost of holding a financial asset typically includes financing costs less income received such as dividends for stocks and interest for debt instruments.
At-the-Money
When the exercise price of either a put or a call option is the same as the market price of the underlying asset.
Multi-Asset Options
Consists of a family of options whose payoffs depend on the prices of more than one asset.
Unfunded Swap ETF Structure
Under an unfunded swap ETF structure, a swap-based ETF transfers cash equal to a desired notional exposure to the swap provider, which then transfers a basket of collateral assets to the ETF. The total return on this collateral basket is then transferred to the swap provider in exchange for the market return of the index the ETF is trying to replicate.
Hedging
An attempt to reduce risk by making transactions that reduce exposure to market fluctuations. Hedging with derivatives involves taking an opposite position in the derivative instrument of the asset to be hedged (or one that is very close to it) that is equal in size.
Forward Rate Agreement
A forward agreement that is based on interest rates. The parties to a forward rate agreement are able to fix an interest rate for a transaction that is going to take place at some point in the future.
Trading Limits
Exchanges set limits on the amount by which most futures can move, either up or down, during one day’s trading session. If the price moves down by an amount equal to the daily limit, the contract is said to be limit down. If it reaches the upper limit then it is said to be limit up. The limits are designed to calm market panic, and to give market participants time to absorb new information that may have been disseminated.
Hedge Fund-Linked Notes
Principal protected notes in which the return is linked to the performance of an underlying hedge fund, or more commonly, a portfolio of hedge funds.
Intercommodity Spread
A spread that involves the purchase and sale of futures contracts that have different but related underlying assets. The two contracts may trade on the same or different exchanges.
Expiration Date
The date on which a derivative contract becomes void.
Eurodollar
A U.S. dollar deposited in a bank outside of the U.S. The bank could either be a foreign bank or a branch or a subsidiary of a U.S. bank.
Comparative Advantage
The mechanism through which the cost of new or existing debt may be reduced by an interest rate or currency swap. Specifically, two companies with complementary relative advantages may come together and design a swap to reduce the financing costs of both companies.
Market-linked GICs
GICs whose interest is linked to the performance of a market index, mutual fund, basket of securities or some other underlying asset.
Zero-Sum Game
Describes the fact that, commission fees and bid-ask spreads aside, the gain from a derivative contract by one counterparty is exactly offset by the loss to the other counterparty.
Foreign Exchange Agreement
A forward agreement based on a currency.
Mutual Fund-Linked Notes
Principal protected notes in which the return is linked to a particular mutual fund or portfolio of mutual funds.
Fundamental Analysis
The study of an asset’s current and expected supply and demand situation in order to help forecast future price movements.
Margin
An amount of money deposited by both buyers and sellers of futures contracts to ensure performance of the terms of the contract (the delivery or taking of delivery of the commodity or offset of the contract). Margin is not a payment of equity, merely a performance bond or good faith deposit.
Volatility
A derivative instrument whose value depends on a designated measure of volatility.
Liquidity Risk
Risk that a derivative cannot be purchased or sold quickly enough or in the required quantity at a fair price.
Principle of Substitution
The clearinghouse function of acting as the buyer for every seller and the seller for every buyer.
Interest Rate Floor
Essentially a series of European put options on interest rates (as opposed to put options on an underlying debt instrument). The holder of the floor gets paid on each settlement date the amount, if any, by which the reference interest rate is below the exercise or strike price.
Settlement Price
The settlement price is determined at the end of each trading day by the “Pit Committee” of the Exchange. The price usually represents the average of futures prices for trades made toward the end of the day.
Operational Risk
Risk of exposure to loss as a result of inadequate risk management and internal controls by derivative users.
Foreign Currency Option
An option on an exchange rate or exchange rate index.
Portfolio CDS
A CDS written on a basket of underlying assets but that has a predetermined monetary amount, rather than a number of defaults.
Offsetting Transaction
A futures or option transaction that is the exact opposite of a previously established long or short position.
Commodity Futures
Futures contracts that are based on a physical or “hard” asset such as gold, soybeans or crude oil.
Beta
A measure of the responsiveness of a security or portfolio to the market as a whole.
Intermarket Spread
A spread that involves the purchase and sale of futures contracts that have the same underlying asset but trade on different exchanges.
Warehousing
When a swap dealer enters into an agreement with one party, it typically takes some time before it finds and arranges an offsetting agreement with another party. In such cases the dealer has to warehouse the swap and hedge its exposure.
Mini Contracts
Derivative contracts representing a fraction (typically 1/5 or 1/10) of a standard futures or options contract.
Original Margin
The required deposit when a futures contract is entered into.
Funded Swap ETF Structure
Under a funded swap ETF structure, a swap-based ETF transfers cash equal to a desired notional exposure to the swap provider, which then provides the market return of the index the ETF is trying to replicate. To offset the counterparty risk exposure, the swap provider has to post collateral that is pledged to the ETF.
Single-Name CDS
A plain vanilla single asset CDS, which is basically credit protection (insurance).
Long Position
For forward-based derivatives, the party that agrees to buy the asset has the long position in the contract. For option-based derivatives, the party that pays the premium has the long position in the contract.
Managed Futures Fund
Essentially mutual funds that invest in futures markets.
Unsystematic Risk
The risk that a particular stock or group of stocks will underperform the market as a whole.
Interest Rate Collar
A combination of a cap and a floor created by purchasing a cap, while simultaneously selling a floor.
Mark-to-Market Accounting
A method of accounting that applies to speculative and other transactions that do not meet the requirements for hedge accounting. Gains and losses from such trading activities are recorded immediately as income.
Spot Price
the price of an asset on the spot market.
Exercise Price
The price at which an underlying security can be bought or sold if an option contract is exercised. Also known as the strike price.
Whipsaw
Situation where a speculator is forced to close out a position due to an adverse price movement, only to see the price quickly rebound back in the favoured direction.
Index Option
Option contract on a stock index or other financial index.
Structured Products
Investment instruments that combine at least one derivative with traditional assets such as equity and fixed-income securities. The value of the derivative(s) depend on one or more underlying assets
Zero-Coupon Bond Plus Call Option
The oldest PPN structure and the simplest. When this type of PPN is issued, a large portion of the principal is used to purchase a zero-coupon bond whose maturity date and value matches that of the PPN, thereby guaranteeing the PPN principal is returned. The remaining funds—minus fees—are then used to purchase call options on a risky underlying asset to provide a return.
Plain Vanilla Interest Rate Swap
A term used to describe the most basic type of interest rate swap
Spreading
Describes a market strategy that attempts to take advantage of relative price changes between two different but similar futures contracts.
Amortizing Swap
An interest rate swap in which the notional principal amount is reduced over time until it reaches zero.
Forward Currency Exchange Agreement
A forward agreement that is based on foreign exchange. The parties to a forward currency agreement are able to fix a foreign exchange rate for a transaction that is going to take place at some point in the future.
Caplets
The individual option components of an interest rate cap.
Intrinsic Value
For a call option, intrinsic value is calculated by subtracting the exercise price from the market price. For a put option, intrinsic value is calculated by subtracting the market price from the exercise price. For both calls and puts, intrinsic value cannot be less than zero.
Closed-End Fund
A fund with a fixed number of shares outstanding. The shares are bought and sold on a stock exchange instead of being issued and redeemed the way a typical mutual fund does.
Interest Rate Parity
The relationship between the spot and forward foreign exchange rates and the interest rates of two countries. Interest rate parity dictates that the difference between short-term interest rates between two countries should be offset by the forward exchange rate, otherwise an arbitrage opportunity would exist.
Contract for Difference (CFD)
A type of cash-settled over-the-counter derivative contract where the parties agree to honour the difference in price between where a position is opened and where it is closed. One major difference between CFDs and other derivatives is that CFDs have no expiration date.
Open Outcry Auction System
The auction system used in the trading pits on the floor of a futures exchange. All bids and offers are made openly and loudly by public competitive outcry and hand signals.
Intramarket Spread
Also known as a calendar or time spread. Involves buying and selling futures contracts that trade on the same exchange and that have the same underlying interest but different expiry months.
Credit Enhancements
In order to control credit risk, dealers often require credit enhancements such as collateral from their counterparties.
Cross-Hedge
A hedge where the futures contract used has an underlying asset which is similar to but not the same as the physical commodity being hedged.
Forward Agreement
When a forward-based derivative is traded over-the-counter, it is generally referred to as a forward agreement.
Reputation Risk
Risk of damage to a company’s reputation if it fails to act honestly and in good faith with counterparties in derivative dealings.
Underlying Interest
The value of a derivative instrument is based on an underlying interest which may be a commodity such as wheat or a financial product such as a bond or stock, a foreign currency, or an economic/stock index.
Synthetic Equity Position
A position that allows an investor to earn equity returns without actually taking a position in equity.
Bear Put Spread
The simultaneous purchase of a put option and sale of a put option with a lower exercise price on the same underlying asset and with the same expiration.
Time Value
The premium of the option less its intrinsic value.
Warehouse Receipt
Even if an individual decides to take delivery, what is received/delivered in the case of most physical commodities is a warehouse receipt which the seller endorses over to the buyer. The receipt is issued by a storage point authorized by the exchange which confirms the presence and ownership of the underlying asset.
Legal Risk
Risk of a loss because a derivative contract cannot be legally enforced.
Systemic Risk
Risk that a disruption, at a major firm, or in a market segment, or to a settlement system, causes widespread difficulties in other firms, in other market segments, or in the financial system as a whole.
Equity Swap
An equity swap effectively creates a “synthetic” equity position. In an equity swap, counterparty A will make interest payments to counterparty B calculated at a fixed rate of interest on a notional amount of principal for the duration of the swap. In return, counterparty B will make payments to counterparty A equal to the return (or some fraction thereof) of the same notional amount of the agreed upon equity index.
Technical Analysis
The study of past price and volume data in order to anticipate future market movements.
Systematic Risk
Risk of overall stock market weakness.
In-the-Money
The amount of intrinsic value an option has. A call option is in-the-money if the market price of the underlying asset is higher than the exercise price. A put option is in-the-money if the market price is lower than the exercise price.
