Accreting Swap A swap agreement in which the underlying principal increases over the life of the swap.

This allows an investor to match swap payments with its cash flow. For example, a construction company can use this type of swap to finance a project in stages and lock in their funding costs by increasing the notional amount for increased cash flows as more funding is needed for the next stage. Accrual Factor Represents the fraction of a year in a given period. There are two components that make up an accrual factor. The first component uses a day count convention to determine how many days fall in the accrual period, which will be the numerator in the calculation of the accrual factor. The second component is a day count convention to determine the number of days that make up a full period, which will be the denominator in the calculation of the accrual factor. Accrual Method Accrued Interest The current value of the earned portion of the next coupon payment due (but not yet paid) on a transaction or, in other words, the interest that has accumulated on a bond since the last coupon payment at any point up to but not including the valuation date. Accruing Curve The interest rate curve used to determine expected coupon rates. Algorithm A set of steps used to solve a problem using a mathematical formula, e.g. a computer program. American Style Option A call or put option that may be exercised anytime prior to the date of expiry. (The name has nothing to do with location.) Amortization Debt repayment by way of installments over a scheduled period. Each payment usually includes an interest payment as well as payment of the principal debt. Amortizing Transaction A transaction with cashflows based on a notional principal amount whereby the principal amount decreases over time per a scheduled arrangement. Arbitrage The simultaneous purchase and sale of related products in two different markets in order to profit from a discrepancy between the purchase price (undervalued) and the sale price (overvalued), i.e. riskless profit. Asset Back Securities (ABS) A category of securities which are mostly created by consumer debt such as consumer installment or credit card loans but not mortgages. See also Asset Class A specific grouping of investments, such as stocks (equity), bonds (debt), cash (currency) and commodities. The investments in each of the four groups tend to react to risk (such as a rise in interest rates) in a similar way and are governed by the same regulatory requirements. Asset Swap

In a typical asset swap, a dealer buys a bond from a customer at the market price and sells to the customer a floating rate note at par. The dealer then enters into a fixed-for-floating swap with another counterparty to offset the floating rate obligation and the bond cash flows. Attachment/Detachment Level (Credit Derivatives) The lower bound of the risk level of a tranche is the attachment point and the upper bound a detachment point. At-the-money Option An option with strike price equal or very close to the current price of the underlying asset. These options have the most time value. Average Price (Asian) Option Options that allow the buyer to buy (or sell) the underlying asset at the average price instead of the spot price. The payoff is the difference between the strike price and the average price of the underlying asset over a certain time period. Average Rate Cap/Floor Consists of a string of caplets (floorlets). The additional feature is that instead of the rate being based on one single reset rate, the caplet rate is the average of two or more reset rates. Average Strike Option Options that can assure that the average price paid (or received) for an asset over a certain time period is not greater than the final price. These are path dependent because the payoff is based on the difference between the spot price at expiration and an average strike price determined over the life of the option. Barrier Option An option that pays off or ceases to exist if the underlying asset has reached or exceeded a specific price until exercise. This is a path dependent instrument. Base Correlation Implied correlations of tranches with an attachment point of zero (equity tranche). The base correlation number for a hypothetical tranche is created by combining multiple tranches. Base Currency This is also known as the primary currency of a foreign exchange transaction and is usually the domestic currency. Basis The price or rate difference between two similar or related financial instruments, usually the difference (spread) between the cash (spot) price and the futures price of a commodity. Basis Point One hundredth of one percent per annum, i.e. 1 bp = 0.01%. When applied to a price rather than a rate, the term is often expressed as annualized basis points. Basis Point Value The difference in the price of a security when the yield changes by 1 basis point. Sometimes also called a DV01. Basis Risk The risk that the relationship between the differences (spread) of the price or rates of two closely linked financial instruments will change over time.

Basis Swap A swap (either a cross-currency basis swap or a simple basis swap) in which payments are on a different floating-rate basis, for example a three-month LIBOR versus a sixmonth LIBOR. Basket Option An option whose payoff depends on the value of a portfolio (or basket) of assets. Bear Spread Benchmark A standard of comparison (usually a grouping of similar securities) used for judging the performance of a security. Bermudan Option Call or put option which can be exercised on pre-specified days during the life of the option. It is a hybrid between an American and European option. Beta A multiplier that measures the movement of an investment in relation to a movement of a benchmark. For example, if an investment has a beta of 1, then the investment will move in parallel to the index as any number times 1 is that number. However, if the beta is 1.5 and the index moves by 10%, then the investment should be expected to move by 15% as 10% times 1.5 is 15%. Bid-Ask Spread The difference between the price that an investor is willing to pay for a security and the price at which the investor is willing to sell the same security. Binary Option An option in which its payoff is a fixed amount if the underlying is at or above the strike price when it expires. The amount of payoff does not change by the amount of the difference between the underlying and the strike price. Binomial Option Pricing Model A method to calculate possible paths that might be followed by the underlying asset's price over the life of the option. The model works by dividing the time to expiration into a number of time intervals and over each time interval, the model assumes that the price of the underlying moves up or down to certain values. Then from the up or down prices at the next time step, the up and down price is calculated for each scenario until the expiry date. The magnitude of these moves is determined by the volatility of the underlying and the length of the time interval. Black-Scholes Option Pricing Model A method to calculate the price of a European style option (exercise on expiry date only) assuming that the underlying instrument pays a constant dividend, extraneous costs such as taxes are ignored, a constant risk-free interest rate, constant volatility and the price follows a probability distribution that is lognormal (a mathematical statistic: the logarithm of the price is normally distributed) until expiration. Although this model produces a theoretical value, it is considered the industry standard. Bond A loan given to an entity (e.g. a corporation or government) by another party (investor) where the entity agrees to pay a predetermined rate of return (Interest) and repay the loan amount (principal) at a predetermined future date.

Bond Basis A day count method which assumes that each month has 30 days and each year consists of 360 days (30/360). the long (buyer) at a set price and within a certain time frame. The forward contract is an agreement between two counterparties to exchange bonds at an agreed price and time in the future. The futures contract is typically traded on an exchange and the underlying bond is "standardized". "Standardized" means that it is a fictional bond. Bond Option Option to purchase or sell a particular debt security. Exchange traded options are usually on government bonds. Over the counter options are often embedded in corporate debt issues. Bond Rating An evaluation by a rating agency as to the probability that a particular bond issue is likely to default by examining the financial status of the issuer. Well known rating agencies consist of Standard and Poors, Moody's Investor Services, Fitch Investor's Service and Duff and Phelps. Ratings go from AAA, the highest quality, to D the lowest (default). Bond Yield Curve A graph showing returns of bonds with the same bond ratings but differing maturities over the same period of time. Bond-equivalent Yield A calculation that converts fixed income returns whose maturities are less than one year into annual returns for comparison between investments. Book Value The price that is paid for an investment when it is initially purchased (historical cost). Bootstrap A process to determine an interest rate or volatility at a particular time by plotting known rates on a graph to create a curve. Box An option strategy comprised of a long call and a short put with the same strike price as well as a long put and a short call having the same strike price that is higher than the first two options (long call and short put). Brazilian Swap A type of swap where the floating rate is calculated using the Average One-Day Interbank Deposit rate (aka CDI rate, or overnight DI rate) which is an annual rate and is calculated daily by the Central of Custody and Financial Settlement of Securities (CETIP). It represents the average rate of all inter-bank overnight transactions in Brazil. The swap has only one payment, which occurs at maturity. Break-even Forward Rate A forward rate that when combined with the yield earned from a short term deposit produces the same average return as a single long term deposit. This is referred to as the parity method of obtaining a forward rate. Break Forward Contract A forward contract that permits the holder to profit if the price of foreign exchange rises, but puts a floor on losses if it falls. This payoff profile can be obtained using both FX options and forward contracts. Also known as cancelable forward FX contract. Bull Spread

Business Day Convention Used to determine cash flow adjustments for business days. Several methods are used: No date adjustment: Cycle dates are not adjusted for weekends or holidays and are forced to land within a cycle month. Next good business day: Dates are adjusted for weekends and holidays to the next good business day. Previous good business day: Dates are adjusted for weekends and holidays to the previous good business day. Modified following business day: Dates are adjusted to the next good business day unless that day falls in the next calendar month in which case the date is adjusted to the previous good business day. End of month - no adjustment: Dates are adjusted to land on last day of the month. Business Days A jurisdictional holiday list used to adjust reset and coupon dates. Butterfly An option strategy involving three call or put options with strike prices that are equally apart. Buy or sell the option with the lowest strike price, sell or buy twice the quantity at the central strike price and buy or sell the option at the highest strike price. The payoff diagram for this option strategy resembles a picture of a butterfly. Day Count Convention Used for the calculation of an accrual factor, this is the number of days that a financial instrument accrues interest for a partial time period based on the defined interest accruing days that make up a full period. Also known as accrual method. Debenture Unsecured debt usually offered by governments or corporations in order to raise capital. The investor expects to be repaid based on the reputation of the issuer as to the unlikely chance of default. Debt Instrument A written promise to repay a debt. Default Failure to make agreed upon payments on the principal and/or interest. Default Correlations Measures the possibility of one company to default on its obligations and its affect on another company to default on its obligations as well. This is positive default correlation. It is also possible that the opposite (negative) can occur. Default Probabilities Measures the likelihood of a counterparty to fail in its obligation over the life of or for a period of time in the agreement. Deferred Swap A swap in which the payments are deferred for a specified period. Unlike a forward swap, where the entire swap is delayed, in a deferred swap only the payments are deferred. For example, a company wanting to enter a swap, but not wanting cash flows until a future period, may want to defer payment. Face Value The dollar value of a security without including interest or fees. For stocks, it is the original cost of the stock and for bonds, it is the amount of principal payable at maturity.

Factor Model A model that assumes that one or more indices affect the return of a security. Fair Basis Basis is the difference between the spot price and the price of a futures or forward contract on the same underlying asset. A 'fair basis' is one where no arbitrage opportunities exist between the two. Fair Benchmark Price The fixed price for a commodity or index swap that renders the present value of the fixed leg equal to that of the floating leg. Fair Quoted Futures Price The fair total futures price less futures accrued interest from the previous coupon payment to the futures expiration date. Fair Total Futures Price The market price of the bond discounted at the repo rate for the term of the futures contract less the future value at the futures expiration date of the coupons received by holding the bond. Fair Value The price of a financial instrument that a buyer would be willing to pay and a seller would be willing to accept on the open market. The estimate of fair value should take into account prices for similar assets and valuation results such as the present value of all expected future cash flows of a security. Fair Value Hedge A hedge that bases its periodic settlements on changes in value of an asset or liability. This type of hedge is most often used to offset the price risk of a realized asset or liability or an unrealized firm commitment. Financial Instrument A contract between two parties that involves a monetary exchange for some type of debt or asset. Financial Market Also known as a security market, this is a medium designed to bring buyers and sellers of financial instruments together. Fixed for Fixed Swap A foreign exchange currency swap where both counterparties pay a fixed interest rate by using domestic funds to buy foreign funds where interest rates may be cheaper in order to finance a foreign project. Fixed for Floating Swap An arrangement between counterparties in which one party, the fixed rate payer, making fixed payments and the other party, the floating rate payer, making payments which depend on the level of future interest rates. Knock-in Double Barrier Option A European or American call or put option with two barriers whereby the option is deemed worthless unless a barrier is breached during the life of the option, although a rebate may be paid at the expiration date of the option. Knock-out Double Barrier Option

A European or American call or put option with two barriers whereby if either of the two barriers is breached during the life of the option, the option is knocked out" and dies, although a rebate may be paid when a barrier is knocked out. Scale Factor A percentage usually applied (similar to a spread but multiplied) to a parameter such as volatility, forward rates etc. and is particularly useful when cash flow payments are based on a percentage of a parameter (such as Percentage of LIBOR swaptions where a scale factor is applied to the floating leg). Scenario A set of paths that hypothetical risk factors such as interest rates may take at the during a specified time period. For example interest rates may increase, stay the same, or decrease one month from now. Scenario Analysis An examination of how an investment performs using scenarios to predict what will happen under each path taken by the applicable risk factor such as interest rates, volatility, exchange rates etc. Read more about Seagull An FX option strategy using three options structured by the purchase of a call spread which is financed with the sale of an out-of-the-money put in equal amounts and normally priced at zero cost premium. This strategy is designed to hedge against increases in currency. Seasonal Swap A swap in which the principal alternates between zero and some notional principal amount. The principal amount of the swap is designed to hedge the seasonal borrowing needs of a company. For example retail companies might use such swaps to fix rates on loans required only on a seasonal basis for building up inventory. Secondary Market A financial market where all trades other than the first sale of a financial instrument is sold usually through some form of financial intermediary such as a bank. Secured Bond A bond that is backed by assets which can be considered as a form of collateral on the loan so that if a default occurs, the bond issuer will pass the title of the asset on to the investor. Usually these bonds provide lower returns to the investor as compared to unsecured bonds. Secured Debt Similar to a secured bond, this is debt backed by an asset to reduce the risk of the loan. An example is a residential mortgage where the house is considered to be collateral, so if the borrower misses a payment, the lending institution (bank) can seize the house and sell it using the proceeds to pay back the debt. Securitization The process of grouping assets or debt together in order to convert them into marketable securities. Usually the underlying assets cannot be marketed by themselves. For example mortgages can be pooled together (and divided into tranches) to form mortgage backed securities or collateralized mortgage obligations. Asset backed securities are examples of pooled non-mortgage assets such as car loans. Security

A financial contract which is given a value and traded in the financial market that can represent ownership (stock), debt (bond) or the rights to ownership in an underlying asset (derivative). Some securities lack a ready market.