Glossary of terms

A:

• annual rate of return - Rate of return.
• arbitrage - 1) A transaction that generates a risk-free profit; 2) a leveraged speculative transaction; and 3) the activity of engaging in either of the above two forms of arbitrage transactions.
• Asian option - An option whose expiration value depends on the average value of an underlier over a specified period.
• at-the-money - A condition where the value of an option's underlier equals the option's strike price.
• average option - An Asian option.
• average price option - An average rate option
• average rate option - A form of Asian option whose payoff is linked to the average underlier value over a specified period.
• average strike option - A form of Asian option whose strike equals the average underlier value over a specified period.

B:

• backwardation - A condition where spot prices exceed forward prices.
• Bank for International Settlements - An international organization which fosters international monetary and financial cooperation and serves as a bank for central banks.
• basis point - A hundredth of a percent.
• basis risk - Risk from exposure to uncertain spreads.
• basket option - An option on a portfolio or "basket" of underliers.
• bear spread - A put spread.
• beta - A metric of systematic risk.
• bid-ask spread - The difference between prices at which dealers are willing to buy or sell.
• bid-offer spread - Bid-ask spread.
• Black-Scholes (1973) option pricing formula - The original option pricing formula published by Black and Scholes in their landmark (1973) paper. Used to price European options on non-dividend-paying stocks.
• Black-Scholes Theory - Another name for option pricing theory.
• Black's model - Black (1976) option pricing formula

C:

• calendar spread - 1) the difference between the values of a single variable at two points in time—see spreads; 2) a long-short futures spread with both contracts on the same underlier but with different maturity months—see futures spread; and 3) An options spread with options expiring on different dates—see options spread.
• call - An option to purchase an asset.
• call spread - An options spread comprising a long-short position in call options.
• cash-flow-at-risk - A category of cash-flow risk measures.
• cash flow risk - Risk due to uncertainty in future reported cash flows.
• cash instrument - An instrument whose value, unlike that of a derivative instrument, is determined directly by the markets.
• cash settlement - 1) in trading, settlement on the trade date—see settlement; 2) a derivative instrument has cash settlement if it settles for a cash payment in lieu of physical delivery of an underlier—see physical settlement, cash settlement.
• CFTC - Commodity Futures Trading Commission.
• closeout netting - The netting of obligations on derivative instruments that are terminated early.
• collar - An options spread comprising a long call and short put.
• collateral - Assets held to secure an obligation.
• Commodity Futures Trading Commission - The regulator of futures and options exchanges in the United States.
• contango - A condition where forward prices exceed spot prices.
• corporate risk management - Practices that serve to optimize risk taking in a context of book value accounting.
• correlation matrix - A symmetric matrix indicating all the correlations of a random vector.
• crack spread - A spread between crude and refined oil prices.

D:

• default intensity - An "instantaneous" rate of default.
• default mode - A mode of analysis for a portfolio credit risk model.
• default model - A type of model that assess the likelihood of default by an obligor.
• default probability - The likelihood that a counterparty will default on an obligation.
• delivery month - For physically settled futures contracts, the month during which delivery occurs.
• delivery price - The price to be paid under a forward contract.
• delta - The Greek factor sensitivities measuring a portfolio's first order (linear) sensitivity to the value of an underlier.
• delta approximation - A linear approximation for how a portfolio's value will change in response to a small change in an underlier's value.
• delta hedge - A type of hedge that is widely used by derivative dealers to reduce or eliminate a portfolio's exposure to some underlier.
• derivative - Derivative instrument.
• derivative approximation - In calculus, an approximation for a function constructed from its derivative.
• derivative instrument - An instrument that derives value from the value of some commodity, energy, or other financial instrument.
• derivatives pricing theory - The body of financial theory used by financial engineers to value derivative instruments.
• dynamic hedging - A technique that is widely used by derivatives dealers to hedge gamma or vega exposures.

E:

• exchange for physicals - An alternative to physical settlement offered by many futures exchanges.
• exchange traded - Traded on a formal exchange such as the New York Stock Exchange or Chicago Board of Trade.

F:

• face value - Par value.
• FFA - Forward Freight Agreement
• forward - Forward contract.
• forward trade - A trade for settlement on some future (post spot) date.
• free onboard (FOB) - A method for settling physical commodity trades.
• fund of funds - An investment fund that invests in other investment funds.
• future - An exchange-traded derivative that is similar to a forward.
• futures spread - A long-short futures position

G:

• gamma - The Greek factor sensitivities measuring a portfolio's second order (quadratic) sensitivity to the value of an underlier.
• Greeks - A set of factor sensitivities used for measuring risk exposures related to options or other derivatives.

H:

• hedge fund - A largely unregulated investment fund that specializes in taking leveraged speculative positions.
• hedging - The taking of offsetting risks.

H:

• high-water mark - In investment management, a provision that an incentive fee will not be payable until any prior losses have first been made up.
• historical VaR - A category of VaR measures that employ an historical transformation.
• historical volatility - A volatility estimated from historical data.

I:

• implied volatility - A volatility inferred from an option price.
• in-the-money - A condition where an option has a positive intrinsic value.
• initial margin - An amount of money that must be on deposit with a broker before you can put on a futures position.
• intercommodity spread - A futures spread where the contracts are for different underliers.

L:

• liquidity - Term used in various senses, all relating to availability of, access to, or convertibility into cash.
• liquidity risk - Risk due to uncertain liquidity.
• long position - A position that is long an asset or otherwise has positive exposure to some financial quantity.
• long-short position A position that is long one asset and short another.
• long/short strategy Market timing, usually in an equity market.
• long volatility - Holding a positive vega position.

M:

• margin 1) Collateral. 2) Daily settlement payment on a futures position.
• margin account An account holding funds available for making margin payments.
• margin call - A demand for additional margin.
• mark-to-market - The act of assigning a market value to an asset.
• mark-to-market exposure - Credit exposure calculated from instruments' current market values.
• mark-to-market mode - A mode of analysis for a portfolio credit risk model.
• market neutral - Having balanced long and short positions resulting in no net exposure to broad market moves.
• market neutral strategy - Speculative trading strategy that seeks to exploit relative mispricings between instruments while avoiding systematic risk.
• market risk - Exposure to the uncertain market value of a portfolio.
• market value - A valuation assigned to an asset based on the price it might fetch in the market.
• Monte Carlo method - Any numerical method that employs statistical sampling to solve problems.

N:

• net return - Has two possible meanings. Most common is as a metric of return taking into account items such as management fees, custody fees and trading costs. Less common is as an alternative word for simple return.
• netting - The offsetting of cash flows or other obligations against each other.
• no arbitrage condition - A condition where prices in market offer no opportunities for arbitrage.
• normal distribution - A continuous probability distribution whose probability density function has a "bell" shape.
• notional amount - The quantity of an underlier to which a derivative instrument applies.
• notional limit - A risk limit based upon notional amount as a crude exposure metric.

O:

• operational risk - Risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events.
• operations risk - Risk associated with the day-to-day operation of a non-financial firm.
• opportunity costs - Transaction costs arising from orders that are not fulfilled on the day they are placed.
• option - A type of derivative instrument.

P:

• option holder - The party to whom an option grants rights, usually the purchaser.
• option issuer - Option writer
• option premium - The purchase price of an option.
• option pricing theory - The body of financial theory used by financial engineers to value options and other derivative instruments.
• option spread - A position combining two or more options on a single underlier.
• option valuation - Any procedure for assigning a market value to an option.
• option writer - The party who grants an option, usually the seller of an option.
• out-of-the-money - A condition where an option is neither at-the-money nor has any intrinsic value.
• OTC - Over the counter.
• over the counter - Traded in some context other than a formal exchange.

P:

• paper market - A market in which transactions are cash settled.
• par value - A stated value for a security.
• physical delivery - A derivative instrument has physical delivery if it settles with actual delivery of some underlier.
• physical market - A market in which transactions are physically settled.
• physical settlement - Settlement of a derivative instrument with physical delivery of an underlier.
• portfolio theory - A body of theory relating to how investors optimize portfolio selections.
• pre-settlement risk - Credit risk of default on a derivative instrument prior to final settlement.
• prime broker - A brokerage firm that provides bundled services to a hedge fund.
• put - An option to sell an asset.
• put-call parity - A relationship between the prices of European put and call options on the same underlier.
• put spread - An options spread comprising a long-short position in put options.

Q:

• quant - A financial engineer.

R:

• ratchet cap - A cap whose strike is reset to the current rate for each caplet.
• ratchet floor - A floor whose strike is reset to the current rate for each floorlet.
• ratchet option - An option that periodically "locks in" profits.
• rate of return - Annualized return.
• ratio call spread - A call spread in which there is not a one-to-one ratio between the numbers of long and short calls
• ratio put spread - A put spread in which there is not a one-to-one ratio between the numbers of long and short puts.
• return on assets - A standard accounting performance metric.
• return on risk-adjusted capital - A risk-adjusted performance metric.
• rho - The Greek factor sensitivity measuring a portfolio's first order (linear) sensitivity to the risk-free rate.
• risk averse - Preferring less risk to more.
• risk committee - A board level committee with responsibility for issues related to financial risk management.
• risk factor - A random variable whose value will affect the value of a portfolio.
• risk limit - A limit placed upon risk taking activity for the purpose of avoiding excessive risk.
• risk management - Generally means financial risk management, but other meanings are possible.
• risk management department - A department within a firm that is responsible for financial risk management.
• risk manager - A professional who performs duties related to risk management.
• risk measure - An operation for quantifying a risk.
• risk measurement - A number obtained from applying a risk measure.
• risk metric - An interpretation of the measurements obtained from a risk measure.
• risk neutral - Indifferent to risk.
• risk oversight committee - A committee of senior managers with responsibilities related to financial risk management.
• ROA - Return on assets.
• rollover risk - Risk that an issuer will be unable to roll over its maturing commercial paper into new commercial paper.

S:

• Sarbanes-Oxley Act of 2002 - US legislation enacted in response to the accounting scandals of 2001-2002.
• SEC - Securities and Exchange Commission
• settlement - In finance, performance on a contractual obligation.
• settlement date - The date on which a trade settles—delivery of what is being traded in exchange for payment.
• settlement price - A price set for a futures contract at the close of trading for the purpose of calculating margin payments.
• settlement risk - A form of credit risk that arises at the settlement of a transaction.
• short (n.) - a short seller; (v.) to sell short; (adj.) having a net negative position in an asset or otherwise having negative exposure to some financial quantity.
• short position - A position that is short an asset or otherwise has negative exposure to some financial quantity.
• short seller - Someone who sells an asset short.
• short volatility - Holding a position that has negative vega.
• simulation analysis - Scenario analysis performed as a Monte Carlo analysis.
• simple return - A standard metric of return.
• specific risk - That component of an instrument or portfolio's market risk that is uncorrelated with the overall market.
• spot price - The daily assessment price for the underlying shipping or commodity market
• spot settlement - Settlement of a trade almost immediately—within a number of trading days that is standardized for each market.
  - A trade for spot settlement.
• spread - 1) a difference between two variables—see Spreads; 2) a long-short futures position—see Futures Spread; and 3) a position comprising two or more options—see Options Spread; 4) see also interest rate spreads.
• spread option - An option on a spread.
• spread risk - Risk due to exposure to some spread.
• spread trading - Trading of futures spreads.
• standard deviation - A parameter describing the dispersion of a probability distribution.
• stop-loss limit - A market risk limit based upon incurred mark-to-market loss.
• straddle - An options spread comprising a long put and a long call both with the same strike price.
• strangle - An options spread comprising a long put and a long call, both with out-of-the-money strike prices.
• stress testing - A simple form of scenario analysis typically used to assess market risk.
• strike price - The price specified by an option at which an asset is to be purchased or sold.
• swap - A derivative whereby two parties exchange cash flow streams.
• swaption - An option on a swap.
• systematic risk - That component of an instrument or portfolio's market risk that is correlated with the overall market

T:

• theta - The Greek factor sensitivity measuring a portfolio's first order (linear) sensitivity to the passage of time.
• tightness - Bid-ask spread as a component of liquidity.
• time series - A series of observations made over a period of time.
• time value - A component of the market value of an option.
• timing risk costs - Transaction costs arising from market movements during the period between an order being placed and that order being filled.
• total return - A return on investment calculated from accumulate values reflecting only price appreciation and income from dividends or interest.
• transaction costs - Direct costs associated with transacting trades.
• transformation procedure - One of the three essential components of a VaR measure.
• tunnel - A type of derivatives hedge.

U:

• underlier - A primary instrument or variable upon which the value of a derivative instrument depends.
• unexpected loss - A risk metric related to the second moment of a portfolio's losses due to default over a specified horizon.
• universal volatility model - Any of a class of option pricing models that model volatility skew by combining elements of local volatility, jump-diffusion and stochastic volatility models.

V:

• value-at-risk - A category of market risk measures.
• value date - The date on which a trade is intended to settle.
• vanilla derivative - A derivative instrument that is simple or of a common form.
• vanilla option - A simple put or call option.
• vanilla swap - One of a few standardized forms of swaps that are widely quoted in the markets.
• VaR - Value-at-risk.
• VaR horizon - The period of time over which a VaR measure assesses a portfolio's market risk.
• VaR implementation - An implementation of a VaR measure, generally as software on a computer.
• VaR limit - A market risk limit that uses some VaR metric to quantify and limit risk.
• VaR measure - A set of operations by which a portfolio's VaR is calculated.
• VaR measurement - The numerical value a VaR measure assigns to a portfolio's market risk.
• VaR metric - An interpretation of a VaR measure.
• VaR model - The financial theory, mathematics, and logic that motivate a VaR measure.
• variance - A parameter describing the dispersion of a probability distribution.
• variation margin - A margin payment to restore a margin account to the initial margin level.
• vega - The Greek factor sensitivity measuring a portfolio's first order (linear) sensitivity to the implied volatility of an underlier.
• volatility skew - A condition where implied volatilities vary by strike.
• volatility smile - A condition where implied volatilities for in-the-money and out-of-the-money strikes exceed those for at-the-money strikes.
• volatility surface - A function describing implied volatilities' dependence on both strike and expiration.
• volatility term structure - A curve that describes volatility as a function of expiration for a given strike.
• volume-weighted average price - The average price paid for an instrument in all trading of that instrument during a given day.

W:

• wrangle - An options spread that is long (short) both a ratio call spread and a ratio put spread.

Y:

• yield - Any of several metrics of the income or return to be earned from an investment.
• yield curve - A graph of yields as a function of maturity.
• yield curve risk - Term structure risk.
• YTM - Yield to maturity.