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ABS
      Asset-Backed Security (q.v.).
Accrual Note
      A note that accrues daily interest only when the index rate (e.g., LIBOR) falls
      within some range (such as under 6.5%). A Fixed (Floating) Rate Accrual Note
      accrues interest that is a spread over the corresponding ordinary Fixed (Floating)
      Note. The spread compensates for the probability that the note will accrue no
      interest over some day.
AC-DC Option
      An option that the owner could choose to become at some future date either a
      Call or a Put. Another name for a Hermaphrodite Option (q.v.).
Accreting Swap
      A Swap (q.v.) for which the Notional Amount (q.v.) increases during its life.
Act-of-God Bond
      A Catastrophe Bond (q.v.). (Source: Sophie Belcher, "USAA to Try Again with
      Hurricane Bond, Derivatives Week, 5/5/97.)

ADR
        American Depository Receipt (q.v.).

All Ordinaries Index
      An index of stock prices on the Australian Stock Exchange.

alpha
        The amount that an investment's average rate of return exceeds the riskless rate,
        adjusted for the inherent systematic risk. One way to compute alpha is to regress
        an investment's excess rate of return (rate of return minus the riskless rate)
        against the market portfolio's excess rate of return. The intercept in this
        regression is an estimate of the risk-adjusted excess rate of return.

American Depository Receipt
     A receipt indicating a claim on some number (less than one, one, or more than
     one) of shares in a foreign corporation that a Depository Bank holds for U.S.
     investors.

Amortizing Swap
     A Swap (q.v.) for which the Notional Amount (q.v.) decreases during its life.

APO
        Average Price Option (q.v.).

Arbitrage
       1. The act of buying something at a low price in one market and simultaneously
       selling it for a higher price in another.
       2. Buying something at the lowest price available in the market, rather than
       stupidly paying the higher price.
       3. Doing a spread trade – i.e., selling one thing and using the proceeds to buy a
       second thing.
       4. (Yield Curve Arbitrage) Doing a spread trade that exploits anomalies in the
       yield curve.
       5. (Statistical Arbitrage) Taking a calculated gamble that the two sides of a
       spread trade will move in your favor, back to a more normal relationship.

Atlantic spread
       Long (short) an American option and short (long) the otherwise identical
       European option – hence, long (short) the value of early exercise. (Stephen R.
       Gould)

ARGO
       A J.P. Morgan SPV (q.v.), originated in 1994. It hedges the swap leg with puts.
       (Source:
       http://emwl.oyster.co.uk/contents/publications/euromoney/em.96/em.96.04/em.96
       .04.12.html)

Asian Option
      Definition: An Average Price Option (q.v.).
      Example: Some banks offer their retail customers an equity-linked CD that
      repays principal, plus a form of "average return" on the S&P 500 that amounts to
      an Average Price Call Option.
      Application: Some hedgers use an Asian Option as a one-stop way to hedge the
      price risk of regular purchase or sale of a constant amount of a currency or
      commodity.
      Pricing: One can ordinarily price an Average Price Option satisfactorily by using
      an adjusted volatility and dividend yield in the Black-Scholes-Merton pricing
      model. If the underlying source of risk is an exchange rate, the price of gold or
      silver, a share price, or an equity index, then the "square root of three" rule for
      the volatility may apply. For underlying oil price risk that rule may not work so
      well.
      Risk Management: With underlying currency, precious metal, or equity risk, one
      can ordinarily delta hedge an Asian Option with a single position in the
      underlying. With underlying oil risk and averaging over a long period, delta
      hedging an Asian Option may require hedging in oil futures contracts with several
      different delivery dates.
      Comment: Rarely, the expression, Asian Option, may indicate an Average Strike
      Option (q.v.).

ask (asked)
      The price at which a dealer (market maker) stands ready to sell. Ordinarily the
      ask exceeds the bid (q.v.), and the bid-ask spread is what the dealer stands to
       make by quickly turning around one unit of product. Also known as offer, offered,
       or offering price.

Asset-Backed Bond
      A bond that is also an Asset-Backed Security (q.v.). An Asset-Backed Bond is to
      an Asset-Backed Security as a Mortgage-Backed Bond is to a Mortgage-Backed
      Security.

Asset-Backed Security (ABS)
      A "fixed income" security that pays its coupon and principal from a specific
      revenue stream and has a specific asset as collateral. Collateral has included
      accounts receivable for aircraft, automobile and r.v. loans, credit card
      receivables, health club contracts, lottery winnings, mortgages, real property, and
      taxi medalions. Sources of revenue have included payments on various loans,
      credit card payments, mortgage payemts, rent, royalities, lotter payments,
      mortgage debt service, and rent from real estate. An Asset-Backed Bond may or
      may not have an issuer's or guarantor's full faith and credit behind it. A special
      case is an Asset-Backed Bond (q.v.).

       The revenue stream and collateral may support more than one "class", "piece",
       or "tranche", just a corporation's assets may support shares and bonds. Thus,
       the ABS, whose value depends on the underlying revenue stream and collateral,
       is a Derivative Product in the same sense that financial economists have long
       recognized that corporate shares and bonds are Derivatives, whose prices
       depend on the underlying asset value and cash flow.

Asset Swap
      A Swap that converts a fixed- (floating-) coupon asset into a floating- (fixed-)
      coupon asset. This is in contrast to the more familiar (Liability) Swap that
      converts a fixed- (floating-) coupon liability into a floating- (fixed-) coupon liability.

ATM
       At-the-money (q.v.).

At-the-money
      Having a strike price that equals the spot price.

At-the-money forward
      Having a strike price that equals the forward price.

Average Price [Call or Put] Option
     An Option – Call or Put – whose underlying price is an average over time of a
     risk factor.
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back months
     Futures contracts with delivery dates in the more distant future.

bankruptcy futures
     The futures contract based on the CME Quarterly Bankruptcy Index. The CME
     computes the index daily, based on personal and business bankruptcy filings,
     with personal bankruptcies getting 96% of the weight. (Aaron Luchetti,
     "Commodity Traders May Go for Broke With Novel Contract," WSJ, 4/3/98.)

basis point
      One percent of one percent of a principal amount or Notional Value (q.v.). Also,
      known as "bp" – pronounced "bip". For example, the on-the-run Ten-year
      Treasury might have a coupon of 6.5%, and the 10-year Swap Spread over that
      might be 22 basis points.

basis risk
      The name attached to the random gains or losses a hedger realizes, when he
      hedges with something that has an imperfect correlation with his underlying
      position.

benchmark notes
     Agency notes aimed at filling the partial vacuum in the Treasury note market,
     now that the deficit appears somewhat under control. Fannie Mae began issuing
     benchmark notes, and Freddie Mac and other agencies have followed.
     Apparently, the U.S. Treasury is considering halting its auction of two-, three-,or
     five-year notes. (Guy Dixon and Ross A. Snel, "Bonds Stay Put as Traders Wait
     for Jobs Report; Fannie Mae to Offer Additional Benchmark Notes," WSJ,
     5/5/98.)

Bernoulli Option
     See Introducing: the Bernoulli Option in "Derivative Games".

Best-of-Two Option
      A payoff which equals the maximum of two option payoffs, such as the maximum
      of a call on asset 1 and a put on asset two. Cf. Worst-of-Two Option.

Bet Option
      A Binary Option. (q.v.)
bid
      The price at which a dealer (market maker) stands ready to buy. Ordinarily the
      bid is less than the ask (q.v.), and the bid-ask spread is what the dealer stands to
      make by quickly turning around one unit of product.
big dogs
      Traders who do large volume. As in "You can't pee like a puppy if you want to run
      with the big dogs."
Binary Call (Put) Option
      Typically, a Binary Call (Put) Option (q.v.) that pays off nothing if the underlying
      risk factor is below (above) the strike, and a constant amount if the risk factor
      exceeds (is below) the strike.
Binary Option
      An option with a payoff function that has two levels, such as zero dollars or one
      million dollars.
blank check company
      A public, shell company with few or no assets, income, products, services,
      activities, business plan, management team, employees, or anything else that an
      ongoing business ordinarily has -- except for registration with the SEC. A private
      company can use a blank check company to go public via a "reverse merger"
      without doing an expensive IPO. An unscrupulous stock promoter can also use a
      blank check company to defraud sleepy investors. (Schellhardt, Timothy D. "As
      'Blank-Check' Firms Regain Allure, Businessman Lines Up Numerous Suitors."
      WSJ, 10/29/99.)
BISTRO
      Definition: An acronym for either of the following, depending on who's talking and
      who might be listening.
      1. Broad Index Secured Trust Offering. J.P.Morgan's preferred vehicle for
      transferring a significant amount of diverse credit risk to an SPV.
      2. BIS Total Rip Off. An alternative definition of unknown meaning.
BOBL
      German Federal Debt Obligations (BundesOBLigationen). (Source:
      http://www.exchange.de/dtb/BOBL-future.html)
BOBL Futures
      The DTB Futures contract on a notional medium term (3.5 - 5 years) debt
      security of the German Federal Government or the Treuhandanstalt, with a
      notional interest rate of 6%. The BOBL (q.v.) and other instruments qualify.
      (Source: http://www.exchange.de/dtb/BOBL-future.html)
BOBL Futures Option
      An American option that settles into a BOBL Futures (q.v.) contract. Payment of
      the option premium is "futures-style", which means none of it occurs immediately,
      and a piece of it occurs with each daily mark-to-market. An implication of this is
      that the "buyer" (really, the "long") may pay no premium and the "seller" (really,
      the "short") may pay all the premium! (Source:
      http://www.exchange.de/dtb/BOBL-future-option.html)
Boolean trades
      Definition: Trades based on orders that contain Boolean logic, including the
      concepts of “if”, “if and only if”, “or”, and “and”.
      Example: “I want to sell Microsoft at 75 if and only if I can buy IBM at 110 and
      buy Intel at 120.”
      Source: Hal R. Varian, “Boolean Trades and Hurricane Bonds,” Wall Street
      Journal, 5/8/00.
Bowie Bond
         A specific, $55 million issue of 10-year Asset-Backed Bonds (q.v.) that British
         rock star David Bowie issued and Prudential Insurance Co. bought. The specific
         collateral consists of royalties from 25 of Mr. Bowie's albums that he recorded
         before 1990.
         Source: Bloomberg News, 2/20/97
B-Piece
         Definition: A security from the riskier tranche of a two-tranche ABS (q.v.) deal. It
         receives the residual income from the underlying collateral and takes second
         place in line for the collateral in case of default. In terms of income and collateral,
         B-pieces are to the ABS‟s assets as common shares are to a corporation‟s
         assets. (The analogy breaks down when it comes to taxation and control.)
         Example: A bank with large credit card operations issues ABS‟s backed by credit
         card receivables. The A-piece has a AAA rating and little credit risk. If the
         economy heads south, then the B-piece may not pay off in full.
         Application: Dividing an ABS issue into senior and junior pieces permits the
         issuer to tap two types of investor. The more (less) risk averse investor that
         wants to avoid (place) a bet on the performance of the underlying assets can buy
         the A-Piece (B-Piece).
         Pricing and Risk Management: This is difficult. The whole point of having a B-
         piece is to have a place to put the return that is more difficult to price and the risk
         that is more difficult to manage. Then, people who are more talented at pricing
         derivatives and managing their risk will buy these pieces. Pricing the A-Pieces is
         nearly as easy as pricing Treasuries, and their risk is mainly market risk.
         Comment: Not for the timid or naive.
         Source: Cecile Gutscher, "SEC Is Examining Whether Some Underwriters Are
         Marketing Bonds at Artificially Low Yields", Wall Street Journal, 5/2/97).
8/28/01 Bulldog bond
         Definition: A bond, denominated in British pounds sterling, that a company or
         government that is foreign to the U.K. issues in the U.K. bond market.
         Example: A Brazilian company might issue £100 million of debt in London.
         Source: Edna Carew, The Language of Money.
Bullet Bond
         Definition: A Bond that Amortizes (q.v.) fully on a single date. Its cash flows
         consist of regular coupon payments of interest and a final repayment of principal.
         Example: An ordinary, 30-year, noncallable Treasury bond with a semiannual
         coupon.
         Application: A Bullet Bond is a commonplace way of raising capital.
         Pricing: A Bullet Bond is a portfolio of Zero Coupon Bonds (q.v.), so its value is
         the value of the portfolio.
         Risk Management: A common way to measure a fixed income portfolio‟s risk is
         by its Duration (q.v.) or DV01 (q.v.), and its Convexity (q.v.). Consequently, one
         might combine a Bullet Bond with other fixed income instruments in a portfolio, in
         an effort to control the portfolio‟s Duration and Convexity.
         Comment: When a layman thinks of a bond, this is the bond.
BUND
     German Federal Government Bonds (BUNDesanleihen) . (Source:
     http://www.exchange.de/dtb/BUND-future.html)
BUND Futures
     The DTB Futures contract on a notional long term (8.5 - 10 years) debt security
     of the German Federal Government or the Treuhandanstalt, with a notional
     interest rate of 6%. The BUND (q.v.) and other instruments qualify. (Source:
     http://www.exchange.de/dtb/BUND-future.html)
BUND Futures Option
     An American option that settles into a BUND Futures (q.v.) contract. Payment of
     the option premium is "futures-style", which means none of it occurs immediately,
     and a piece of it occurs with each daily mark-to-market. An implication of this is
     that the "buyer" (really, the "long") may pay no premium and the "seller" (really,
     the "short") may pay all the premium! (Source:
     http://www.exchange.de/dtb/BUND-future-option.html)
Bundle
     A Strip (q.v.,#2) of consecutive, quarterly Eurodollar or Euroyen futures
     contracts. Markets, such as Simex offer a Bundle as a convenient package of
     futures contracts, without the execution risk inherent in building up the Strip,
     contract by contract. A trader can use Bundles and Packs (q.v.) to implement
     bets on the change in shape of the Forward Curve.
Buy-Write
     An investment strategy that consists of buying an asset and selling a call on it.
     Thus, the investor sells upside potential to elevate the rest of his payoff function.
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-C-
cabinet trade
      A trade that allows options traders to close out deep out-of-the-money options by
      trading at a price equal to one-half tick. (Elizabeth Lekan, Chicago Mercantile
      Exchange)

calendar spread
      A spread trade (q.v.) involving one long position and one short position.
Callable Bond
      Definition: A (noncallable) Bullet Bond (q.v.), minus (i.e., short) a Call Option
      (q.v.) on the bond. The Call Price as a function of calendar time is the Call
      Schedule.
      Example: The U.S. Treasury issued a long sequence of Callable Bonds, callable
      five years before maturity.
      Application: A Callable Bond is a way to make a bet about refinancing costs at
      the Call Date. The issuer is betting that interest rates will drop, the bond price will
      rise, he will call the bond, and he will refinance at a lower rate. The bondholder
      takes the other side of that bet.
       Pricing: The Callable Bond is equivalent to a portfolio, so its value should equal
       the value of the portfolio, namely, the value of the Bullet Bond minus the value of
       the Call Option.
       Risk Management: An issuer could offset the short position in the Bond Option
       (q.v.) by buying a corresponding Receiver Swaption on a Swap with the same
       coupon as the Bond.
       Comment: For a given coupon rate the Callable Bond will be worth less than the
       noncallable bond. Hence, for a given price (such as par) the Callable Bond will
       have a higher coupon rate.
Call Option
       The right, but not the obligation to buy the underlying asset at the previously
       agreed-upon price on (European) or anytime through (American) the expiration
       date.
Cap
       A strip of Caplets (q.v.) - that is, a portfolio of Caplets with sequential accrual
       periods. Also known as a Ceiling.
Caplet
       An Interest Rate Option to pay fixed in an FRA (q.v.). Its payoff is proportional to
       that of a Call Option on a floating rate of interest.
Caption
       An option on a Cap (q.v.).
car
       The size of one futures contract, based on the idea that some commodity futures
       contracts historically called for the delivery of one railroad car of the underlying
       commodity.
carry trade
       Definition: A trade that consists of borrowing and paying interest in order to
       finance the purchase of an investment that pays a greater interest or a dividend
       stream.
       Example: In a single currency, borrowing short-term and buying bonds leads to a
       carry that is the coupon minus the interest on the borrowing. The yen carry trade
       consists of borrowing yen in the Tokyo market and paying the currently (1999)
       low yen rate, buying dollars in the spot market, and buying dollar bonds paying
       higher coupons.
       Application: The idea is to collect the positive carry, interest and dividends
       received, minus interest paid.
       Pricing: The trade is initially worth about zero, except for small transaction costs.
       Risk Management: The major risk is the depreciation in price of the long asset
       and appreciation in price of the short asset. However, if you get rid of that risk,
       then you essentially take off the trade.
       Comment: The yen carry trade has been a popular trade for hedge funds and
       others, with the yen rate around one percent and the dollar rate around five
       percent. However, by 6/12/99 Gretchen Morgenson was able to write, "The dollar
       fell 2.5 percent against the yen in four days of trading." That‟s an annualized,
       continuously compounded rate of about 950%!
      Source: Gretchen Morgenson, "Once Again, Wall St. Worries About Hedge
      Funds," New York Times, 6/12/99.
Catastrophe Bond
      Definition: A Bond that promises a coupon (and principal, in some cases) that
      starts out high, but drops after a suitable catastrophe occurs. A suitable
      catastrophe might be an earthquake or hurricane of sufficient magnitude and
      within a particular region.
      Catastrophe Bonds may be ABS's (q.v.). The underlying assets may include a
      pool of Treasury securities. The underlying income stream might be reinsurance
      premiums. The ABS issue may have two or more classes of securities.
      Example: A recently proposed (as of 5/30/97) USAA, Inc. Catastrophe issue has
      a principal protected class (secured by Treasury Zero Strips) and a principal
      variable class that would become worthless after a hurricane did $1.5 billion of
      damage anywhere from Maine to Texas.
      Application: The natural issuer of a Catastrophe Bond is an insurance company
      or a government agency such as the California Earthquake Authority – any
      organization exposed to claims resulting from the underlying catastrophe. The
      Catastrophe Bond is in theory and perhaps even in practice a highly efficient way
      of paying outside investors (i.e., outside the insurance industry, including the
      reinsurance market) to share the risk of the catastrophe with the vast general
      capital market. It is a simple extension of the time-honored concept of
      securitization.
      Pricing: Equilibrium of supply and demand.
      Risk Management: Traditional hedging is impossible. Diversification is possible.
      Comments:
      The holder of a Catastrophe Bond is short a Bet, Binary, or Digital Option (all of
      which q.v.). The Catastrophe Bond is an ideal instrument for an unscrupulous
      security salesman to present to unsuitably naive retail or even institutional
      customers, who lack any concept of that game's odds, or perhaps even its basic
      rules. Thus, it has excellent potential as a successor to the sometimes abusive or
      fraudulent sales of poorly understood Florida real estate, securitized receivables,
      mortgage-backed securities and derivatives, limited partnership interests in real
      estate and oil exploration, etc.

      I predict confidently three things:
      (1) Competent underwriters of Catastrophe Bonds will not play Russian roulette
      by holding large positions in them in their investment portfolios for long periods.
      They will distribute the bonds as soon as possible.
      (2) Accordingly, almost all of these Catastrophe Bonds will end up in the
      portfolios of institutional investors, high-rolling individual investors, and retail
      customers – many of whom will have no idea what they're getting into.
      (3) In at least one exceptional case, some manager of a Catastrophe Bond (or
      Derivatives) desk will convince his naive boss that "the market has badly
      underestimated the real value of certain Catastrophe Bonds (Derivatives), and
      we should take them into inventory, temporarily." At that point the chips are down
      and the outcome – "heroism" or disaster – is up to fate.
       Comment: Scholars are praising cat bonds and other derivatives for attracting
       low-cost capital into the industry. (Robert Hunter, "Cat Fever," Derivatives
       Strategy, February 1998, p. 6.) However, it's not clear that society is better off if
       the newcomers are paying to much for claims based on catastrophic claims.
Catastrophe Futures
       The ill-fated futures contract that the CBOT introduced in 1993. The underlying
       risk factor was the Property Claims Service (PCS) index, which was too broad an
       index for most natural hedgers to use. (Source: Robert Clow, "Coping with
       catastrophe," Institutional Investor, December 1996, pp. 138.)
Catastrophe Options
       The CBOT's option contracts on several regional indexes of losses. The option
       on the Eastern Catastrophic contract boomed as Hurricane Fran smashed the
       Carolinas in the fall of 1996. (Source: Robert Clow, "Coping with catastrophe,"
       Institutional Investor, December 1996, pp. 138.)
       Catastrophe options come in two main varieties: (1) Property Claims Services
       (PCS) options pay out (European style) based on an index of all claims against
       property insurance companies. (2)Single-Cat options pay out (American or one-
       touch style) based on a single, large atmospheric or seismic disaster in a single
       region (northeast, southeast, east, midwest, or west) or in California, Texas, or
       Florida. ("A New Take on Cat Options," Derivatives Strategy, February 1998, pp.
       5-6.)
Catastrophe Swaps
       Contracts similar to standard reinsurance contracts and traded on New York's
       Catastrophe Exchange. (Source: Robert Clow, "Coping with catastrophe,"
       Institutional Investor, December 1996, pp. 138.)
CD
       Certificate of Deposit (q.v.).
Ceiling
       A Cap (q.v.).
Certificate of Deposit
       A sort of bank savings account that ties up the depositor's money until the
       certificate matures, and acts more like a bill, note, or bond than a traditional
       savings account.
CFD
       Contract for Difference (q.v.).
       Chase Secured Loan Trust Note (CLST)
       Definition: Chase Bank's preferred vehicle for transferring a large amount of
       diverse credit risk into an SPV.
CHIPS
       Common-Linked Higher Income Participation Securities (sm). Bear Stearns'
       proprietary Equity Linked Debt Security (q.v.).
clean price
       Definition: The quoted bond price without the accrued interest. (Cf. dirty price.)
       Application: In the U.S. bond market, if you ask your broker a bond's price, he
       quotes the clean price. However, your check for that amount would be insufficient
       to buy the bond, because you must also pay the amount of the accrued interest
       since the previous coupon date.
CMO
       Collateralized Mortgage Obligation (q.v.).
CMT Derivative
       A Derivative Product, such as a Swap or Option, based on the CMT Yield (q.v.).
       These are tricky to price.
CMT Yield
       Constant Maturity Treasury Yield. Every day the Federal Reserve Board
       publishes the yield for a hypothetical Treasury having each standard maturity,
       such as two years, even though such an instrument doesn't exist. Every time the
       Fed issues a new, on-the-run Treasury, the CMT yield equals the observable
       market yield. Between those issue dates the CMT and closest on-the-run yields
       can differ.
Collar
       A portfolio of two options with the same underlying risk factor and expiration date:
       a long call with a higher strike and a short put with a lower strike. An investor with
       long (short) exposure to the underlying factor can go short (long) a collar,
       retaining exposure to the factor within a range, while limiting downside exposure
       at the cost of upside potential.
Collateralized Bond Obligation (CBO)
       Definition: An ABS (q.v.) structure similar to a CMO (q.v.), but with a portfolio of
       bonds as collateral, instead of a portfolio of Mortgage Backed Securities (q.v.)
       and/or mortgage loans. A sponsor transfers the collateral into a Special Purpose
       Vehicle (SPV), such as a trust or corporation, which has no other assets and
       which issues claims. A typical CBO has more than one "tranche" or "tier", and a
       more junior tranche has more risk of default.
       Example: For example, a CBO might have senior, junior (or mezzanine), and
       subordinated (or equity) tranches. The senior tranche, like senior debt, has first
       claim on the collateral‟s cash flows to cover its interest and principal payments.
       The junior tranche has second claim. The equity tranche claims the residual.
       Application: Junk bond money managers create CBOs to create highly rated
       bonds and highly speculative "equity" out of a portfolio of junk bonds.
       Pricing: Predicting default rates is the most difficult aspect of pricing these bonds.
       Risk Management:
       Comment: Agencies, such as Moody‟s Investors Service and Standard and
       Poor‟s Corp., assign credit ratings.
       Source: (Pimbley, Joseph. "LC: Evaluating Risk in Russian Roulette Notes and
       CBOs." DW, 7/17/95, p. 7.)
Collateralized Loan Obligation (CLO)
       Definition: An ABS (q.v.) structure similar to a CMO (q.v.), but with a portfolio of
       commercial or personal loans as collateral, instead of a portfolio of Mortgage
       Backed Securities (q.v.) and/or mortgage loans. A sponsor transfers the
       collateral into a Special Purpose Vehicle (SPV), such as a trust or corporation,
       which has no other assets and which issues claims. A typical CLO has more than
       one "tranche" or "tier", and a more junior tranche has more risk of default.
      Example: A CLO might have senior, junior (or mezzanine), and subordinated (or
      equity) tranches. The senior tranche, like senior debt, has first claim on the
      collateral‟s cash flows to cover its interest and principal payments. The junior
      tranche has second claim. The equity tranche claims the residual. For example,
      National Westminster transferred $5 billion of loans from its balance sheet to an
      asset-backed trust October 1996 and created an early and large CLO.
      Application: Some commercial banks have created CLOs to create highly rated
      bonds and highly speculative "equity" out of a portfolio of loans. A CLO allows a
      bank to remove loans from its balance sheet and reduce its required reserves,
      yet keep contact with the borrowers and fees from servicing the loans.
      Pricing: Predicting default rates is the most difficult aspect of pricing CLOs. In the
      case of investment grade loans, this is less of a problem than it is with problem
      loans.
      Risk Management:
      Comment: Agencies, such as Moody‟s Investors Service and Standard and
      Poor‟s Corp., assign credit ratings.
      Source: Jodi D'Amico, "COLLATERALIZED LOAN OBLIGATIONS -CHANGING
      THE WAY BANKS DO BUSINESS," http://www.van-
      kampen.com/nz/Fixed_Income_Newsletter/23-3.htm.

Collateralized Mortgage Obligation (CMO)
      A portfolio of claims against a portfolio of mortgages and/or Mortgage-Backed
      Securities. The claims separate naturally into "tranches" that differ by the rules
      defining their interest and principal payments. One of the charms of the CMO is
      the wide range of possible rules. However, the sum over all tranches of the CMO
      interest (principal) payouts must equal the sum over all mortages and/or MBS's
      of interest (principal) payments – except for any difference due to servicing or the
      issuer's residual. The CMO is archaic, and the REMIC (q.v.) is a more current
      vehicle for derivatives of a portfolio of mortgages.
Commission Bancaire
      The French Banking Commission. The Banque de France‟s "general secretariat"
      for enforcing compliance of French credit institutions with applicable laws and
      regulations, as well as principles of good business practice and standards of
      sound finances. http://www.banque-france.fr/us/finance/regle/3c.htm
Common Share
      A sort of Call Option (q.v.) on the assets of the corporation, because the common
      shareholder gets those assets if he pays off everyone else with a claim against
      the assets. The Common Share represents a fractional ownership interest in the
      corporation, it has voting rights, and may receive a dividend.
Common Stock
      A collective term for Common Shares (q.v.).
Compound Option
      An option on an option. Also known as a Split Fee Option (q.v.). A special case of
      an Installment Option (q.v.).
concentration risk
      According to "Risk Concentrations Principles," which the BIS released in 12/99,
      risk concentrations in financial conglomerates come in seven categories of
      exposures, to: individual counterparties, groups of individual counterparties,
      counterparties in specified geographical locations, counterparties in industries,
      counterparties in products, key business services (such as back-office services),
      and natural disasters. (BIS Examines Concentration Risk, 2/2000, p. 11.)
Confirm
      Confirmation (q.v.).
Confirmation
      A document that defines a Derivatives contract that a dealer has just entered with
      a customer. The Confirmation ordinarily incorporates one or more ISDA (q.v.)
      documents by reference. The Confirmation comes after the oral agreement –
      ordinarily over the telephone – which the dealer ordinarily records and saves for
      months.
continuation structure
      A design for a DPC (q.v.) that does not liquidate when the related name defaults.
      Cf. termination structure.
Continuous Accrual Currency Option with a One-Touch Knock-out Range
      A Derivative Product that accrues nominal value at a constant rate for every day
      that the index exchange rate stays within the accrual range, then loses all value
      when the index strikes either side of the knock-out barrier range. (Source: Victor
      Kremer and William Rhode, "Dollar Gyrations Lead Investors to Exotics,"
      Derivatives Week, 2/3/97.)

      The term, "Option", is a misnomer, because no one has a true option, not even
      one as trivial as for an ordinary European Call Option.
      The product's value is a decreasing function of volatility. Thus, during a period of
      high anticipated volatility it is possible to buy the product inexpensively. If the
      index remains within the range, then the percentage payout is relatively large.
Contract for Difference
      Definition: An OTC Currency Forward Contract that settles for a cash amount,
      perhaps in a third currency, without requiring the exchange of the two underlying
      currencies.
      Example: Instead of settling a Forward Contract by having party A deliver
      10,000,000 DEM (worth 6,000,000 USD) in Germany and party B deliver
      600,000,000 JPY (worth 6,100,000 USD) in Tokyo, party B would deliver the net
      dollar value of the two payments (100,000 USD) in New York.
      Application: The CFD would reduce the problem of Herstatt Risk (q.v.).
      Pricing: Prices for the two legs of the transaction should be readily visible in the
      liquid currency markets.
      Risk Management: This tool is for managing market risk, while managing
      settlement risk.
      Comment:
      Source: Laure Edwards, "Chase Manhattan Offers an Answer to BIS Concerns,"
      Financial Trader 4 (June 1997), p. 7.
Convertible Bond
     A Bond that the owner can convert into Common Shares under specific terms. A
     Convertible Bond is an ordinary Bond, plus the option to exchange the Bond for
     the Shares.
Convexity
          1. The sensitivity of a financial instrument's Modified Duration (q.v.) to its
             yield.
          2. The second derivative of a financial instrument's value with respect to its
             yield.
Corridor Note
      An Accrual Note (q.v.).
"Costless" Collar
      Definition: A Collar (q.v.) in which the proceeds of the sale of the short Call option
      exactly finance the purchase of the long Put option.
      Application: This strategy helps a trader get close to "flat". This can be
      particularly useful for a money manager who is close to having a good
      measurement period and doesn't want to screw it up in the last moment. Also, it
      may be a good tax play for an investor who really wants to sell out, but doesn't
      want to pay capital gains taxes.
      Comment: The term may mislead beginners in Derivatives markets, who might
      take it at face value. However, of course, the dealer or market maker wouldn't do
      the trade at no cost. In fact, the cost is roughly the bid-ask spread of one of the
      Collar's component options. Particularly in OTC option markets, the name,
      "Costly Collar", would be more appropriate, because bid-ask spreads require the
      buyer to give up much upside participation for little downside protection.

Credit Default Swap
      A Swap in which A pays B the periodic fee, and B pays A the floating payment
      that depends on whether a predefined credit even has occurred, or not. The fee
      might be quarterly, semiannual, or annual. The floating payment would likely
      occur only once, and might be proportional to the discount of the reference loan
      below par. The credit event might be a declaration of bankruptcy or violation of a
      bond indenture or loan agreement.

Credit Derivatives
      Derivative Products with payoffs that depend on risk factors related to credit
      quality, such as yield spread over Treasuries, price discount from par, or a "credit
      event." A credit event might be a drop in credit rating or some sort of failure, such
      as occurrence of default, insolvency or bankruptcy.

       One goal of Credit Derivatives is to split credit risk from market risk. The key
       concept here is that credit risk is an undesirable element, akin to pollution. When
       you allow a market for pollution, people who don't want it sell it at at market price
       to the parties who mind it the least or handle it the best.

       Credit Derivatives already come in a variety of flavors, and infinitely many types
      are possible. However, nearly all current structures are variations on Call or Put
      Options (q.v.) on Credit Spreads (q.v.), Binary Options (q.v.), or Knockout
      Options (q.v.). In the last two cases the trigger is a "credit event". Typically, the
      payoff depends on the state of the world some time – as much as months – after
      the event. Here are some examples of Credit Derivatives:
          1. Notes that Bankers Trust and CSFP issued in 1993, which promised large
             coupons if the reference asset didn't suffer a "credit event" – namely,
             default or sufficient deterioration in its credit rating – and small coupons if
             it did. The spread of the large coupon over ordinary debt depended on the
             reference asset's credit quality, and was sometimes 80 - 100 b.p. (over
             LIBOR). This is a sort of Binary Option that is a function of the credit
             event.
          2. A Binary Option that Bankers Trust offered, with a payoff that depended
             on the credit performance of a basket of bonds. If any of the bonds
             defaulted, then a counterparty paid Bankers Trust a fee.
          3. A Call or Put Option on a credit spread over Treasuries.
          4. A One-Touch (q.v.) Knockin Put (q.v.) Option on the value of a corporate
             bond.
          5. A One-Touch (q.v.) Knockin Put Option (q.v.) on the lowest value of n
             corporate bonds in a portfolio.
Credit Linked Note
      Definition: A note that pays interest and repays principal that depends on a credit
      event, such as bankruptcy and default.
      Example: Swiss Bank Corporation issued global floating rate notes, which it
      would redeem for 51% of par value or 100% of the value of a reference security
      (a similar bond from the same issuer, less the credit exposure), if a particular
      credit event occurs.
      Application: The usual, speculation and hedging.
      Pricing:
      Risk Management:
      Comment:
      Source: "Swiss Bank Ready to Offer Big Note Issue," WSJ, 9/7/97.

Credit Option
      Definition: An Option with a payoff that depends on credit quality, without bearing
      ordinary interest-rate risk.
      Example: The Option to Exchange private debt for U.S. Treasury debt.
      Natural Buyers and Sellers: See Credit Derivatives.
      Pricing: Pricing an Option to Exchange () private and Treasury debt would
      involve a hybrid option model, having characteristics of equity and debt option
      pricing.
      Hedging: One could try to dynamically hedge the delta risks.
      Comment: Pricing and hedging might be difficult, and market manipulation may
      be an issue for a thinly traded underlying instrument.
Credit Option on Brady Bonds (COBRA)
      A credit spread option (q.v.) with a payoff that depends on the yield spread
      between a Brady bond and another bond – usually, a comparable maturity
      Treasury. (Gary L. Gastineau and Mark P. Kritzman, Dictionary of Financial Risk
      Management, Frank J. Fabozzi Associates, 1996.)
Credit Risk
      The risk of loss from not receiving one's reward for being on the right side of a
      bet about a market move, due to the losing counterparty's failure to meet his
      obligations.

Credit Spread
      1. An option spread trade – long one option, short another – that generates cash.
      2. The excess of the yield on a note with credit risk over a comparable note
      without credit risk.
Credit Spread Option
      Definition: An Option with a payoff that depends on a Credit Spread (q.v.).
      Example: A one-year European Call (q.v.) on Mexican par bond credit that pays
      Max[0, 147 bp - (Mexican Brady Bond Yield - Yield on corresponding U.S.
      Treasury)].
      Application: To spread credit risk associated with lending or assume credit risk
      without lending.
      Pricing:
      Risk management:
      Comment:

Credit Spread Swap
      Definition: A Swap with a payoff that depends on a Credit Spread (q.v.).
      Examples: A Swap with a Floating Leg () that depends on the Credit Spread.
      Application: A lender who might share its credit exposure to a risky counterparty.
      Pricing: Requires advanced techniques or SWAG Pricing (q.v.).
      Risk management: Dynamic Hedging (q.v.) based on PV01s (q.v.), etc.
      Comment: Not for the cautious.

Credit Swap
      Definition: A Swap whose value depends on underlying credit quality, preferably
      without bearing ordinary interest-rate risk.
      Examples: A Total Return Swap (q.v.) with underlying risky debt might qualify,
      although this has a heavy dose of interest rate risk. An Outperformance Swap,
      with a payoff proportional to the excess of the rate of return on the risky debt over
      the rate of return on a comparable Treasury bond, would be a clearer example. A
      Total Return Swap plus an ordinary Interest Rate Swap () that offsets the interest
      rate risk. The exchange of a constant fee per period versus a binary floating
      payment of either zero or a Credit Event Payment. A Credit Spread Swap.
      Application: See Credit Derivatives for applications.
      Pricing and Risk management: See the specific type of Credit Swap.
      Comment: Pricing and hedging might be difficult, and market manipulation may
      be an issue for a thinly traded underlying instrument.
Cross Currency Option
      Definition: An option to exchange units of one currency for units of another, as
      seen from the point of view of a third currency. A Margrabe Option (q.v.) with
      underlying currency risk.
      Example: A New York trader might consider an option to pay 1.5 DEM for 100
      JPY as a Cross Currency Option. A trader in Frankfurt might call that a call on
      yen. A trader in Tokyo might consider it a put on Deutschemarks.

Cross Currency Swap
      A Swap (q.v.) that involves payments in two currencies. For example, the fixed
      payment might be in DEM and the floating payment might be proportional to JPY
      LIBOR. In addition, the swap involves an exchange at maturity of Notional
      Amounts (q.v.) in the two currencies at the original exchange rates.

crossed market
      A market where the bid (q.v.) exceeds the ask (q.v., also known as asked, offer,
      offered). In a normal market the bid is less than the ask, and the difference – the
      bid-ask spread – would be the market maker's profit on a round trip in the stock.
      We would not expect to see a crossed market with a single market maker. In a
      market with more than one market maker, one market maker may show the best
      bid and another the best offer, and these may cross. However, a crossed market
      indicates an arbitrage opportunity and cannot last, in equilibrium.

CUBS
       Customized Upside Basket Securities (q.v.). Bear Stearns's proprietary debt
       securities, with participation in moves in an average over time of the index value
       of a basket of securities, but with downside protection. The underlying average
       equals an arithmetic average of the index values on the 24th of each month from
       issue through maturity. Thus, the underlying price is an average, and any
       optionality is an option on an arithmetic average. The holder may not redeem
       CUBS before maturity.

       For example, Bear Stearns listed a CUBS issue on 7/25/95 that matures on
       7/24/98. The underlying index is a mischmasch of biotech, energy, and other
       stocks. The CUBS issue price is $3.33. The CUBS gives 90% participation in
       price moves. The minimum payoff is $3.00.

currency swap
      The exchange of specified amounts of currencies on one (nearby) date,
      exchange of specified amounts of currencies in opposite directions on a future
      date, and (possibly) exchange of specified coupons in between. A currency swap
      is like the exchange of bills, notes, or bonds in different currencies.
CUSIP
     The acronym for the Committee on Uniform Securities Identification Procedures.
     "The CUSIP Service Bureau seeks to assign unique numbers and standardized
     descriptions [to securities] in a timely and accurate manner, using its best efforts
     to use primary or reliable sources of information."
     Proposed by: Matthew Foss.
     Source: http://www.cusip.com/cusip/cusip/index.html.
CUSIP number
     A unique identifier for securities, consisting of nine alphanumeric characters. The
     first six uniquely identify the issuer. The next two (alphabetic or numeric) identify
     the issue. Two numeric digits indicate an equity issue. Two alphabetical
     characters or a mix of alphabetical and numerical indicate a debt issue. The ninth
     digit is the check digit.
     Standard & Poor's owns and operates the CUSIP Service Bureau, which
     maintains the CUSIP system.
     Proposed by: Matthew Foss
     Source: http://www.cusip.com/cusip/cusip/index.html.
DAX
     A stock performance index (dividends added in) composed of the 30 most
     actively traded German blue chip stocks on the Frankfurt Stock Exchange.
     (Source: http://www.exchange.de/fwb/indices.html#dax)

DAX Futures
    A cash-settled Futures contract based on the DAX (q.v.) stock performance
    index. (Source: http://www.exchange.de/dtb/daxfuture.html)

DAX Futures Option
    An American option that settles into a DAX Futures (q.v.) contract. Payment of
    the option premium is "futures-style", which means none of it occurs immediately,
    and a piece of it occurs with each daily mark-to-market. An implication of this is
    that the "buyer" (really, the "long") may pay no premium and the "seller" (really,
    the "short") may pay all the premium! (Source:
    http://www.exchange.de/dtb/daxfuture-option.html)

DAX Option
    A cash-settled, European option on the DAX (q.v.) stock performance index.
    (Source: http://www.exchange.de/dtb/daxoption.html)

DCS
       Direct Credit Substitute (q.v.).

deck
       A floor broker's (q.v.) stack of customer orders.

Degree-Day
     A unit of measure for the deviation of a day's average temperature from the
     arbitrary standard of 65 degrees Fahrenheit. The U.S. Energy Information
       Administration publishes indexes of accumulated Degree Days. If the average
       temperature one day is 75 (55) degrees, then the index increases (decreases)
       ten Degree-Days on that day. Degree-days come in two varieties – Heating
       Degree-Days and Cooling Degree-Days. When the average temperature is
       above (below) 65 degrees, then the number of cooling (heating) Degree-Days
       increases.
       (Source: Victor Kremer, "Utility to Make First Use of Degree-Day Swaps,
       Derivatives Week, 5/5/97.)

Degree-Day Swaps
     A Swap (q.v.) that receives (pays) a floating payment proportional to the change
     in Degree-Days (q.v.) over the accrual period, and pays (receives) a fixed
     payment. Dealers of such swaps claim that they are good hedges of heating
     costs, because (1) a negative number of Degree-Days over the accrual period
     results in (2) a positive number of Heating Degree-Days, which leads to (3) a
     negative floating payoff, which is (4) a hedge for the resulting positive heating
     costs, because (5) a large number of Heating Degree-Days translates into both a
     large volume of energy and a high price for it. (Source: Victor Kremer, "Utility to
     Make First Use of Degree-Day Swaps, Derivatives Week, 5/5/97.)

       However, this argument has some problems. First, energy cost is a U- or V-
       shaped function of Degree-Days. Heating Degree-Days lead to heating costs,
       and Cooling Degree-Days lead to cooling costs. Second, nobody knows what
       that function is. Consequently, Degree-Days Swaps will have some Basis Risk
       (q.v.).

Delivery Point
      In a Futures Contract (q.v.) the location where the short must deliver the
      underlying "commodity" to the long. This can be crucial in the case of physical
      products, transportation bottlenecks can make it easier for the longs to squeeze
      the shorts. In April, 1996, the CBOT tried to eliminate Toledo, Ohio as a delivery
      point. Farmers and processors who favored delivery there complained to the
      CFTC, which delayed approval of the change in the contract. (Source: "CBOT
      Gets Warning Concerning Changes in Certain Contracts, WSJ, 5/6/97.)

derivative
      1. Not original, secondary, originating in or transformed from something else.
      2. fin. A short form of "derivative product" (q.v.).
      3. chem. A substance or compound obtained from or derived from another
      substance or compound.
      4. math. The instantaneous rate of change of a function with respect to a change
      in an argument: df(x)/dx. For example, acceleration is the first derivative of
      velocity with respect to time. In a financial context, we call some such derivatives,
      with respect to time or market risk factors, "sensitivitites" or Greeks. For example,
      the Greek, delta, is the first derivative of option value with respect to underlying
      price.
derivative product
      A financial contract whose value depends on a risk factor, such as
       the price of a bond, commodity, currency, share, etc.
       a yield or rate of interest
       an index of prices or yields
       weather data, such as inches of rainful or heating-degree-days,
       insurance data, such as claims paid for a disastrous earthquake or flood,
      etc. Also known as "derivative", for short.

Derivative Products Company (DPC)
       A subsidiary that exists solely as a secure home for some of its parent‟s financial
       transactions, contracts, and derivative products (q.v.). The DPC‟s credit rating
       typically exceeds the parent‟s, because the parent infuses it with a large amount
       of capital, compared to the credit exposure that that DPC counterparties have to
       it. In case the parent is insolvent or bankrupt, the DPC might either continue
       (continuation structure, q.v.) or terminate (termination structure, q.v.).
Digital Option
       A Binary Option (q.v.).

Direct Credit Substitute
       The Federal Reserve Board's term for a credit enhancement, that is, a means of
       improving the credit quality of a loan or a bond.
dirty price
       Definition: The quoted bond price, including the accrued interest. (Cf. clean
       price.)
       Application: In certain non-U.S. bond markets, if you ask your broker a bond's
       price, he quotes the dirty price. Thus, your check for that amount would be
       sufficient to buy the bond.
Discount rate
       The rate of interest that the Bundesbank (Buba) charges for granting "rediscount
       credit". Typically, the discount rate is the lowest rate at which the Buba lends.
domestic market
       The securities market in a country where securities of that country‟s companies
       and governments trade.
       Example: Bank of America securities that trade in the U.S. trade in the domestic
       market.
       Source: http://www.jobs.washingtonpost.com/wp-
       srv/business/longterm/glossary/a_m/domestic_market.htm
DPC
       Derivative Products Company (q.v.).
DTB
       Deutsche Terminbörse. The Futures and Options Exchange associated with the
       Frankfurt Stock Exchange (Frankfurter Wertpapierbörse, FWB) in Frankfurt,
       Germany.
Duration
      1. A weighted average of the number of years until a financial instrument's cash
      flows (e.g., a bond's principal and each of its coupons) arrives.
      2. A measure of the sensitivity of the value of a financial instrument (i.e., a
      sequence of cash flows) to a change in its yield to maturity. The two main
      variants of Duration are Macaulay Duration (q.v.) and Modified Duration (q.v.).

DV01
       The change in the dollar value of a bond (conventionally, one with a Par Value of
       100) when its yield falls one basis point. Also known as PV01, PVBP, DVBP.
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-E-
ECB
       European Central Bank (q.v.).

ECN
       An acronym for either electronic communications network or electronic crossing
       network. An electronic market place. Examples are Island and Archipelago. At
       least one ECN is able to submit orders directly to NASDAQ and some may be
       applying to the SEC to qualify as stock markets.

Edge Act Corporation, Edge Corporation
     Definition: A bank subsidiary corporation with a federal or state charter, created
     under the Edge Act (1919) to engage in international banking and investing.
     FRB Regulation K defines the equivalent "Edge Corporation" as a corporation
     formed under section 25(a) of the Federal Reserve Act (12 USC 611-631).
     (Source: Federal Reserve System Regulation K, 12 CFR 211; as amended
     effective October 8, 1993.)
     Application: Unlike its U.S. parent bank, the subsidiary can own a bank outside
     the U.S. and can invest in foreign commercial and industrial corporations.
     Comment: The motivation of the act was to allow U.S. firms more flexibility in
     competing with foreign firms.

ELKS
       Equity Linked Securities (sm). Salomon Brothers Inc's proprietary Equity Linked
       Debt Security (q.v.). A debt obligation of Corporation A, equivalent to a buy-write
       on one share of Corporation B. The ELKS is like a PERCS (q.v.), except that the
       company that issues the stock issues the PERCS, and another company issues
       the ELKS. Salomon Brothers Inc issued the first ELKS in 1993.

Embeddo
    An Embedded Option.
Endowment Warrant
     A Call Options on shares, where the strike price grows at the rate of interest, but
     shrinks by the amount of the dividends that the share pays. In essence, the buyer
     of an Endowment Call Warrant uses the dividends from the shares to pay off the
     strike price, but is not obligated to complete the transaction. If at expiration the
     balance reaches zero, then the buyer may take delivery without further payment.
     If the balance reaches a positive amount, then the buyer may pay that amount
     and take delivery. If the balance reaches a negative amount, then the buyer may
     settle in cash for the value of the shares plus the absolute value of the balance.
     (Source: Australian Financial Review Dictionary of Investment Terms.)

Equity-Linked Debt Security
      Fixed-income, equity-linked debt securities of corporation A, that participate in
      the change in price of the "linked" common stock of corporation B.

      Four main examples, listed on the American Stock Exchange, include Salomon
      Brothers' ELKS (sm) (q.v.), Bear Stearns' CHIPS (sm) (q.v.), Lehman Brother's
      YEELDS (sm) (q.v.), and Morgan Stanley's PERQ's (sm) (q.v.). These four pay
      quarterly interest at a fixed percentage rate.
      (Source: http://www.amex.com)

Equity Swap
      A Swap (q.v.) in which one of the payment streams derives from an equity
      instrument. For example, in one sort of ordinary Equity Swap, each period, Party
      A receives (and Party B pays) the capital gains on an equity investment of a
      given notional amount, while Party B receives (and Party A pays) a floating
      interest payment based on LIBOR and the same notional amount. This swap is
      practically equivalent to buying the underlying equity with 100% borrowing (zero
      margin) and realizing the gain or loss each period.
      Equity Swaps are useful for obtaining leverage, avoiding withholding taxes, and
      enjoying the returns from ownership without legally owning anything.
7/28/00 equivalent
      A concept in probability theory that means that two probability measures (q.v.)
      assign a probability of zero to precisely the same sets.
      Example: If the probability space corresponding to two flips of a fair coin is  =
      {HH, HT, TH, TT}, and two probability measures, P(.) and Q(.), both assign a
      probability of zero to the empty set, P( = Q( = 0, and to no other set, then
      they are equivalent probability measures.
7/28/00 equivalent martingale measure
      Any probability measure (q.v.) that is "equivalent" (q.v.) to the true probability
      measure, and under which a random variable (q.v.) -- such as an asset price or
      the ratio of two asset prices -- is a martingale (q.v.).
      Application: In Arrow-Debreu equilibrium, there exists an equivalent martingale
      measure, under which the ratio of two asset prices is a martingale.
Euribor
      Euro Interbank Offered Rate. The Brussels-based European Banking
      Federation‟s Euro-denominated counterpart to LIBOR. As of January, 1999,
      Euribor seems to be winning its battle for acceptance over the British Bankers
      Association‟s Euro LIBOR (q.v.), but London still hopes to win the war for the
      financial business. On 1/7/99 LIFFE announced plans for new contracts, based
      on five- and ten-year Euribor swaps.
Euroclear
      A major system settling securities trades.

Eurojunk
      High-yield corporate bonds of European companies. Of course, the high yield is
      compensation for a high probability of default.
      For example, Richard Branson‟s Virgin Group financed its new, V2 Music
      Holdings PLC label with L74 million in high yield bonds, rather than using a
      venture capitalist.
Euro LIBOR
      The British Bankers Association‟s Euro-denominated analog to dollar LIBOR. As
      of January, 1999, the European Banking Federation‟s Euribor (q.v.) seems to be
      winning its battle for acceptance over Euro LIBOR, but London still hopes to win
      the war for the financial business. On 1/7/99 LIFFE announced plans for new
      contracts, based on five- and ten-year Euribor swaps.
European Central Bank
      The institution that the European Monetary Union has put in charge of
      maintaining the value of its currency, the euro. (Dagmar Aalund, "What's the
      Euro?", The Wall Street Journal, 9/28/98.)

EX
      One of J.P. Morgan's SPVs (q.v.). Source:
      http://emwl.oyster.co.uk/contents/publications/euromoney/em.96/em.96.04/em.96
      .04.12.html)

Exchange Option
     An option to exchange one asset for another. A Margrabe Option (q.v.).

Exotic Option
      Any Option that is well out of the ordinary, hence not a "Plain Vanilla" Option.
      The list of Exotic Options changes over time. It grows as dealers innovate new
      and marvelous options, and shrinks as a jaded market grows accustomed to
      products that once thrilled it.
external market
      The market outside a country‟s borders for securities that its companies
      governments issue. The Eurosecurities market. Example: Bank of America debt
      that trades in Asia and Europe trades in the external market for securities of U.S.
      companies. Source: http://www.jobs.washingtonpost.com/wp-
      srv/business/longterm/glossary/a_m/external_market.htm
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-F-
fading a big dog
      Buying (selling) when a big dog (q.v.) is selling (buying).

Fairway Bond or Note
        Another name for Accrual Note (q.v.), Corridor Note (q.v.), or Range Note (q.v.).
        It accrues interest if and only if the index rate stays within a range (analogous to
        a golf ball staying on the fairway).

Fannie Mae
      Federal National Mortgage Association. The largest player in the secondary
      mortgage market.

Fiona
        Frankfurt Interbank Overnight Average (q.v.).

Flex Option
      An exchange-traded options that does not have the standard terms of listed
      options. The customer and the market maker can negotiate various terms, such
      as strike price and expiration date.

Floor
        A strip of Floorlets (q.v.). Cf. Cap.

floor broker
       A local (q.v.) who trades for customer accounts, on commission.

Floorlet
      An Interest Rate Option to receive fixed in an FRA (q.v.). Its payoff is proportional
      that to that of a Put Option on a floating rate of interest.

Floortion
       An option on a Floor (q.v.).
floor trader
       A local (q.v.) who trades for his own account, trying to buy low and sell high.

foreign market
      The securities market inside a country‟s borders for securities of foreign
      companies and governments. Example: Bank of America securities trade in
      Tokyo in the Japanese foreign market (the Samurai market). Nomura securities
      trade in New York in the U.S. foreign market (the Yankee market). Further
      examples are the Bulldog (q.v.), Matador (q.v.), and Rembrandt (q.v.) markets.
       Source: http://www.jobs.washingtonpost.com/wp-
       srv/business/longterm/glossary/a_m/foreign_market.htm

Forward Contract
     A contract to exchange (buy or sell) an underlying instrument for a fixed forward
     price at a specific, future delivery date. In certain cases – but not always – the
     Forward Price exceeds the spot price by the cost of carrying the underlying asset
     from the spot delivery date to the forward delivery date. The cost of carry is an
     increasing function of the rate of interest and storage costs, and a decreasing
     function of the rate of dividends, interest, or other cash flows from the underlying
     instrument. Cf. Futures Contract.

Forward Forward Curve
     The Forward Curve at a specific future date, based on today's Forward Curve.

Forward Rate Agreement
     A contract calling for one counterparty to receive the fixed FRA rate and pay the
     floating rate (e.g., LIBOR) for a particular accrual period in the future, and for the
     other counterparty to do the reverse. Settlement is at the beginning of the accrual
     period, when the markets resolve the uncertainty about the floating rate, mainly
     because that reduces the credit risk associated with the contract. Cf. Swaplet.

Frankfurt Interbank Overnight Average
      An average of overnight DEM interest rates that uses the Frankfurt market's
      fixing system. (Source: IFR's online version of "Derivatives: Action in Japan,"
      IFR, 5/3/97, http://www.ifrpub.com/ifrstart.htm)

Freddie Mac
      Federal Home Loan Mortgage Association. The second largest player in the
      secondary mortgage market.

front months
       Futures contracts with delivery dates in the nearer future.

Futures Contract
      An exchange-traded contract that on its last trading day settles into a Forward
      Contract (q.v.). The Futures Price and the corresponding Forward Price differ
      systematically in a world where interest rates are stochastic, and the difference
      depends on the correlation between the underlying spot price and the price of the
      zero coupon bond that matures on the last trading day.

Futures Option
      A listed option that settles into a Futures Contract (q.v.).

Gilt Strip
     A Zero Coupon Bond that is either a coupon or the principal of a UK government
     bond, trading separately. The UK counterpart of Strips (q.v.) on U.S. Treasury
     notes and bonds.
Green Shoe option
     Definition: An underwriter's right to issue more than the stated number of shares
     of an issue. Named after the Green Shoe Company, which was the first issuer to
     grant an underwriter such an option.
     Application: For example, if Underwriter offers 1,000,000 of ABC's shares at $10
     and investors oversubscribe the issue, Underwriter can require ABC to issue
     another 100,000 shares at $10.
     Comment: It's good for Underwriter. It's good for the investors in the 100,000
     shares. Not so great for the other shareholders, but two out of three ain't bad!
     Source: IFCI, http://risk.ifci.ch/00011628.htm.

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-H-
Haircut
      The excess of an asset's market value over either (a) the regulatory capital value
      or (b) the loan for which it can serve as adequate capital.

Hamster Option
     A form of Range Option that SBC created. I can describe it no better than
     Professor S. Trautmann explained it to me: "The German noun Hamster has the
     same meaning as the English noun hamster: it is the name of a small rodent. But
     HAMSTER is also a acronym standing for Hoffnung Auf MarktSTabilitaet in Einer
     Range (literally: Hope on market stability in a given range). It really is a pun as in
     German the verb 'hamstern' has the meaning of 'to hoard'. HAMSTER options
     hoard the fixed amount one gets for every day the underlying stays in the
     prespecified range. What is earned cannot be lost anymore."

Hamster-Optionen
     Hamster Options (q.v.).

Heavy Hitter List
     A list of wealthy individuals who qualify as substantial investors for the purpose of
     investing in hedge funds, commodity pools, etc.

Hermaphrodite Option
     An option that the owner could choose to be either a Call or a Put. Another name
     for a "AC-DC" option (q.v.).

Herstatt risk
      Definition: The risk to Counterparty A in the settlement of a foreign currency
      transaction with Counterparty B, that A would deliver its payment to B, but B
      might not pay, as agreed. If A and B deliver their payments in different time
      zones, then Herstatt risk occurs regularly. However, in 1994 a report indicated
      that Herstatt risk lasts more than one day in a significant portion of transactions.
      The eponymous Bankhaus Herstatt defaulted on a number of currency
      transactions when it failed in 1974.
      Example: Bank A might agree to deliver DEM in Frankfurt at 3 p.m., in exchange
      for Bank B‟s delivery of USD in New York at 3 p.m. on the same day. Although
      the times appear the same, the New York delivery comes later, because of the
      difference in time zones.
      Comment: The potential for Herstatt risk has increased enormously, over the
      past decades, as daily currency transactions increased from about $10 billion in
      1973 and about $1.25 billion in 1995. Actual defaults have been few, but when
      Barings collapsed, it failed to deposit $47.8 million worth of pesetas in a
      Deutsche Bank branch in Spain. Efforts to avoid the problem include bilateral
      "netting" arrangements, extended hours for the FedWire system, and clearing
      houses.
      References: "Ghostbusters," The Economist, 3/16/96. .

HH List
      Heavy Hitter List.

Hurricane Bond
      A form of Catastrophe Bond (q.v.), where the catastrophe is a hurricane.
      (Source: Sophie Belcher, "USAA to Try Again with Hurricane Bond, Derivatives
      Week, 5/5/97.)
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-I-
Index Amortizing Swap
      A swap whose Notional Amount (q.v.) amortizes (declines) each period by an
      amount that depends on the level of one or more interest rates. This gives the
      IAS a superficial resemblance to a mortgage loan or mortgage-backed security,
      which has optional prepayment. This superficial similarity has been the basis for
      a sales pitch to institutions with a large prepayment risk to hedge. Alas, the basis
      risk is large enough to discourage intelligent, experienced – or even merely
      intelligent – professionals from hedging this way. The IAS – like the legendary
      House of the Rising Sun, in New Orleans – has been the ruin of many a poor
      boy.

Inflation-Linked Bonds
        Inflation-Linked Bonds have coupons that depend on the rate of inflation or a
        related index. They have two main structures.
      1. Capital Indexed Bonds. The principal accretes according to the CPI or another
      price index or deflator. The bond's coupon is a fixed percent of the accreted
      principal.
      2. Floating Rate Bonds. The principal is fixed, but its coupon floats. The floating
      rate depends on inflation or something related, such as the rate of change in the
      CPI or on the Treasury Inflation Protected Security (TIPS) variable coupon rate.
      A flurry of issues have hit the market in 1997. Issuers include Federal Home
      Loan Banks, JP Morgan & Co. Inc., Sallie Mae, Salomon Brothers, Toyota Motor
      Credit Corporation, the U.S. Treasury.
      The two main unresolved issues of Inflation-Linked Bonds are how large and
      variable (1) the coupon and (2) the market price should be.The real yields on
      Inflation-Linked Treasury Bondsbegan large enough to surprise many observers,
      and has fallen little in a few months. Some observers believe that these high real
      rates are sustainable and have historical precedent. Others believe that they are
      the result of investor uncertainty about the market and will fall over time.
      (Jonathan Clements, "Second Thoughts: Inflation-Tied Bonds Offer an Intriguing
      Option for Investors," Wall Street Journal, 3/11/97.)
      Advocates for the U.S. market envisioned a bond with a variable coupon and a
      stable price. However, the experience with Australian Capital Indexed Bonds is
      that the price varies significantly. (Wesley Phoa, "Inflation-Linked Bonds; are they
      too safe or too exciting?", Financial Trader 4 (2), p. 30.)

Installment Option
       An option on an option on an option ...

Installment Warrant
       Aussie for what is simultaneously a Compound Option (q.v.) and a Warrant (q.v.),
       and which apparently confers some of the benefits of ownership. "They involve
       two payments: an initial payment followed by a second, which includes fees and
       interest, paid optionally about 14 months afterwards. In the meantime, depending
       on the issuer, the instalments confer full dividends, franking credits and voting
       rights." (Source: Australian Financial Review Dictionary of Investment Terms.)

interest bought/sold date
      The "value date" (q.v.). (J.P. Morgan Glossary of terms for global sovereign bond
      markets.)

Interest-Only (IO) Tranche
      A CMO (q.v.) Tranche (q.v.) that receives a portion of only the CMO's underlying
      principal payments.

internal market
      The securities market within the boundaries of a particular country, consisting of
      the domestic market (q.v.) and the foreign market (q.v.). Example: Most Daimler
      Chrysler debt trades in the German internal market. Source:
       http://www.jobs.washingtonpost.com/wp-
       srv/business/longterm/glossary/a_m/internal_market.htm

International Swaps and Derivatives Association
      The principal trade association for Swap and Derivatives dealers, as well as
      allied organizations.

ISDA
       International Swaps and Derivatives Association (q.v.).

Inverse Floater
      A Floating Rate Note with a coupon that decreases as the underlying index rate
      increases (e.g., a simple Inverse Floater's coupon rate might be 11.5% minus
      LIBOR). The Replicating Portfolio (q.v.) for a simple Inverse Floater is long a pair
      of Fixed Rate Notes and short a Floating Rate Note. Commonly, an Inverse
      Floater's coupon has a ceiling and a floor, (e.g., no more than ten percent, never
      negative). Thus, its replicating portfolio is the same as for a simple Inverse
      Floater, plus long a Cap and short a Floor.


-J-
Jamming
       Definition: Executing a large sell (buy) order in stages by asking for a market on
       a small size, hitting the bid (offer), then repeating the process with a different
       market maker, ultimately driving the price considerably lower (higher).
       Application: "It is entirely against proper market etiquette in foreign exchange and
       gold, but somewhat permissible in fixed income trading. You never jam a friend."
       (Nassim Taleb)
Jelly Roll
       A roll that a trader does using synthetic Forward Contracts (q.v.). Each synthetic
       Forward Contract consists of a long call and a short put, on the same underlying
       instrument, with the same strike and expiration.

Jump Z
     A last-pay "companion" (sort of residual) tranche of a REMIC (q.v.) that "jumps"
     into first-pay status if interest rates fall or prepayments are rapid. The desired
     effect of the jump provision is to promote positive convexity (like a bond), rather
     than negative convexity (like a mortgage) in another tranche.

       (Source: "Derivative Mortgage Securities Glossary," Dean Witter, Mortgage
       Backed
       Securities Department, Derivative Products
Derivatives Dictionary (K-M)                   TM
                                                               Last revised:


               ABCDEFGHIJKLMNOPQRSTUVWXYZ#



-K-
Kitchen Sink Bond or MBS
      A bond or CMO into which issuers have dumped "everything but the kitchen
      sink," including "garbage" such as miscellaneous MBSs, CMO tranches, and
      derivatives. Some people call the contents of the KSB the "toxic waste" of
      derivatives transactions.
      Issuers include agencies such as Fannie Mae or Freddie Mac and securities
      firms such as Bear Stearns and CS First Boston.
      One selling point has been that their components are so diverse that some will
      increase in value while others decrease, thus reducing overall risk. However, in
      fact, in the middle of 1994 enough of the components went south to seriously
      hurt investors in some kitchen sink bonds.

Knockin Option
     An option that "comes to life" when a trigger event occurs. Typically when a price
     crosses a particular barrier it pulls the trigger. (Cf. Knockout Option.)

Knockout Option
     An option that "dies" when a trigger event occurs. Typically when a price crosses
     a particular barrier it pulls the trigger. (Cf. Knockin Option.)
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-L-
Ladder Option
     An option somewhere between a Lookback (q.v.) and a European Option. A
     Ladder Call Option has one or more "Rungs" (price levels) above the initial spot
     level. The Call's payoff equals the greater of a European Call's payoff or the
     excess over Strike (q.v.) of the highest Rung that the underlying price reaches.
     For example, suppose that the Underlying Price is 100 and a Ladder Call has a
     Strike at 105 and Rungs at 115 and the Underlying Price reaches 120 before
     Expiration, then falls back to 98, the Ladder Call pays 15 = 120 - 105. If the
     Underlying price never gets above 109, then falls back to 98, the Ladder Call
     expires worthless.125. If

Ladder Periodic Cap
     A Periodic Cap (q.v.) that depends not on LIBOR at the end of the previous
     period, but on the highest or lowest rung of the Ladder that LIBOR reached
    during that period. The Ladder is a predetermined set of LIBOR levels, such as
    4.00%, 3.50%, 3.00%, etc. The Ladder can change from period to period. The
    Ladder Periodic Cap is a special case of the Lookback Periodic Cap (q.v.).
    (Source: Dehnad, Kosrow. "Learning Curve; Lookback and Ladder Periodic
    Caps." DW, October 25, 1993.)
LASER
    Paribas Capital Markets' Liquid Asset Swap with Enhanced Return. A kind of
    SPV (q.v.) that Moody's rated A1. The initial US dollar one-year issue contained
    a repackaged Swiss franc private placement priced at six-month Libor plus 25bp.
    In the event of a failure of the Laser security, holders receive the underlying
    coupon and principal payments. (Source:
    http://emwl.oyster.co.uk/contents/publications/euromoney/em.96/em.96.04/em.96
    .04.12.html)

LEAPS
    Long-term Equity AnticiPation Securities. Listed Call and Put Options on shares
    and indexes, with expirations out as much as two years. Ordinary listed Calls and
    Puts expire within nine months. LEAPS permit investors to express longer-term
    views, without buying the underlying instruments.

LEPO
       In a normal market the bid is less than the ask, and the difference – the bid-ask spread – would
       be the market maker's profit on a round trip in the stock. In a crossed market, the bid price
       exceeds the ask (offer) price. In an OTC market one market maker may show the best bid and
       another the best offer, and these may cross. A crossed market cannot last, in equilibrium.
       A Low Exercise Price Option (q.v.) traded on the Australian Stock Exchange
       (q.v.) or SOFFEX (Switzerland). (Source: Australian Stock Exchange.)

LIPS and TRIPs
       Indexed Principal Swaps, i.e., Amortizing Swaps, where amortization depends on
       the change in LIBOR (LIPS) or some Treasury yield (TRIPS).
life assurance [insurance] bonds
       Bonds backed by life insurance policies. The idea is that life insurance
       companies are good at underwriting insurance risks, collecting premiums, and
       servicing the policies, but needn‟t tie up their money for the duration.
       Examples: USAA, Swiss Winterthur, Swiss Re, and Tokio Marine & Fire have
       issued such bonds. CSFB, Goldman Sachs, Lehman Brothers, and Merrill Lynch
       have brought the issues to investors. Good news: This is a logical next step in
       disintermediation. The cash flows are relatively predictable, in contrast to cash
       flows on "catastrophe bonds" (q.v.).
       Bad news: Investors will be dealing against experts in adverse selection (q.v.)
       and moral hazard (q.v.).
       Source: "An earthquake in insurance," The Economist, 2/28/98.
loan participation fund
       A mutual fund that buys unrated or "junk" bonds that are thinly traded. If it doesn't
       use an independent pricing service to put a value on the fund, then it can
        basically set the price, itself. This makes the daily at 4 p.m. net asset value
        (NAV) of questionable validity.

local
        A trader in a futures trading pit, either a floor trader (q.v.) or a floor broker (q.v.)

locked market
      A market where the bid (q.v.) equals the ask (q.v., also known as asked, offer,
      offered). In a normal market the bid is less than the ask, and the difference – the
      bid-ask spread – would be the market maker's profit on a round trip in the stock.
      We would not expect to see a locked market with a single market maker. In a
      market with more than one market maker, one market maker may show the best
      bid and another the best offer, and these may lock. However, savvy customers
      would not let the market makers cover their costs, and a locked market could not
      last, in equilibrium.
Lombard rate
      The rate of interest charged on a Lombard loan.

Lombard loan
     A secured loan the Bundesbank makes, based on the pledge of high grade
     securities, intended for emergencies, with limited availability.
Lookback Option
     An option with a payoff based on the path of some risk factor from the option's
     inception until its expiration. Examples of lookback options include a Call (Put)
     with (a) underlying price equal to the maximum (minimum) of the reference price
     during the option's life, and a given strike, or (b) underlying price equal to the
     reference price at the option's expiration, and strike equal to the minimum
     (maximum) of the reference price during the option's life.

Lookback Periodic Cap
     A Periodic Cap (q.v.) that depends not on LIBOR at the end of the previous
     period, but on the highest or lowest level that LIBOR reached during that period.
     (Source: Dehnad, Kosrow. "Learning Curve; Lookback and Ladder Periodic
     Caps." DW, October 25, 1993.)

Low Exercise Price Option
     An extremely deep in-the-money European Call Option traded on the ASX (q.v.)
     options market, with strike price between one and ten cents. Since the strike
     price is so low, the LEPO's owner is extremely likely to exercise it, and it is
     roughly equivalent to a Forward Contract (q.v.) with a low price. The LEPO owner
     receives no dividends, but has nearly the same exposure to a move in the
     underlying stock price as if he owned a share. I.e., the LEPO's delta is nearly
     unity. (Source: Australian Stock Exchange.)
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-M-
Macaulay Duration
     1. A measure of the sensitivity of a financial instrument's value to a change in its
     yield. Macaulay Duration is an overestimate, and Modified Duration (q.v.) is a
     more precise measure.
     2. The weighted average of time until a financial instrument pays its cash flows.
     Each weight is proportional to the present value of the associated cash flow.
     3. Modified Duration (q.v.), times 1 + y/n , where y is the yield and n is the
     number of coupon payments per year.

market
     A real or virtual place where people trade things. For example, people trade
     securities in the securities market, bonds in the bond market, commodities in the
     commodities market, currency in the foreign exchange market, futures contracts
     in the futures market, options in the options market, and shares in the stock
     market.Cf. domestic market and foreign market, internal market and external
     market.
market maker
     A trader who will at that moment is willing and able to either buy or sell at stated
     bid and ask prices. Also known as scalper (q.v.) or scalp-beggar (q.v.).

Market Risk
     The risk of loss from being on the wrong side of a bet about a market move.

Margrabe Option
     The option to exchange one asset for another. Margrabe (1978) showed several
     applications for this sort of option (margin account, corporate exchange offer, and
     standby commitment) and derived a model for pricing this option. Other people
     discovered numerous additional examples of this option. The Cross Currency
     Option (q.v.) is a prime example. The option goes also by the names Exchange
     Option (q.v.) and Outperformance Option (q.v.).
     Source: Gary L. Gastineau and Mark P. Kritzman, Dictionary of Financial Risk
     Management, Frank Fabozzi, 1996.

Market Index Target-Term Securities
     Merrill Lynch's registered derivative product, with a payoff that is the greater of
     (a) some minimum and (b) issue price times the sum of unity and the rate of
     increase in value of the underlying price. MITTS don't allow the owners to
     redeem, nor the issuers to call early. The MITTS is equivalent to a position in the
     underlying index, plus a protective put.

      For example, Merrill Lynch has listed on the American Stock Exchange an issue
      of MITTS with an underlying index proportional to an average of the prices of the
      ten highest-yielding Dow-Jones Industrials, and maturity on 8/15/06. The
      minimum payoff of this issue is 124% of the issue price.
Marché à Terme Internationale de France (MATIF)
      The French derivatives exchange, which dominates trading in contracts based on
      instruments denominated in the French Franc.
martingale
      1. A device that keeps a horse's head in position with its rows of teeth more or
      less horizontal.
      2. A gambling strategy that involves betting one unit, then doubling the bet, until
      the gambler wins. The strategy appears to assure the gambler a profit of one unit
      at the end of each string of bets. The problem is that the gambler's -- and house's
      -- resources are finite. Consequently, the strategy isn't operational.
      3. A stochastic process for which the expected change equals zero, e.g.,
      equivalent martingale measure (q.v.).
      Application: During the 1960s the martingale stochastic process was a standard
      model for a fair game, hence for stock price movements in an efficient market.
martingale measure
      Any probability measure (q.v.) under which a stochastic variable is a martingale
      (q.v.), i.e., its expected change equals zero.
      Example: Consider the probability measure that assigns a probability of 1/2 to a
      head or a tail, and for which successive coin tosses are independent. Then let
      X(n) be the random variable that starts at zero and increases by one with each
      "heads" outcome and decreases by one with each "tails" outcome. Then E[X(n)-
      X(n-1)|X(n-1)] = 1/2 (1) + 1/2 (-1) = 0, and X(n) is a martingale.
measure
      A function that maps a set into the positive portion of the real line.
      Examples:
      1. Length is a measure for subsets of the real line. Add the lengths of subsets of
      contiguous points in a set to get a positive real number.
      2. Area is a measure for sets in the Cartesian plane. Take any rectangular set of
      points and compute its area by multiplying length by width to get a non negative
      real number.
      3. Probability measure (q.v.).
Matador market
      Spain‟s foreign market (q.v.). Example: Some Exxon debt trades in the Matador
      market.
Maus-Optionen
      Markt Aufstehen Und Sicherheit Optionen. Range Options that pay off like Call
      Options when the market rises securely within a narrow, upward sloping corridor,
      but otherwise expire worthless.

MBS
      Mortgage Backed Security (q.v.).

Mid-Curve Option
     A short-term American option on a CME-listed Eurodollar Futures Contract with
     delivery in one or two years. The crucial innovation here is that an ordinary CME
        Futures Option on the ED contract with delivery in one year (two years) expires in
        one year (two years), while the Mid-Curve Option initially expires in six months.
        Thus, the Mid-Curve provides a more focused (and less expensive) way to
        express a view on the news that develops in the next six months about the level
        of short-term interest rates that we will observe one or two years into the future.
        (Sources: Aaron Lucchetti, "Exotic Option Wins Followers on Wall Street," Wall
        Street Journal, 5/6/97. http://www.cme.com/market/interest/serialmc.html)

Millenium Bond
       Definition: A Bond that matures in 1000 years.
       Example: Lehman Brothers underwrote a 1000-year issue for Safra Republic
       Holdings SA.
       Application: A Millenium Bond reduces the need for refinancing and reinvesting.
       Pricing: The Safra issue yielded 98 basis points over the 30-year U.S. Treasury
       bond. Price and yield should be nearly reciprocals.
       Risk Management: One might hedge them by shorting Safra‟s previous 100-year
       maturity bonds. However, as a practical matter their duration should be close to
       that of the U.S. Treasury‟s Long Bond.
       Comment: If the British government could issue perpetuities ("consols") to
       consolidate its debt, then why can‟t a corporation issue bonds maturing in 1000
       years?
       Source: "Ratings & Briefs," Financial Trader 4 (11), p. 8.
MIPS
       Monthly Income Preferred Shares (q.v.).

MITTS
        Market Index Target-Term Securities (q.v.).

Model Risk
     The risk of loss due to weakness of the financial model(s) that a business uses
     for pricing inventory and managing risk.

Modified Duration
   1. A measure of the sensitivity of a financial instrument's value to a change in its
      yield.
   2. The first derivative of a financial instrument's value with respect to a change in its
      yield.
   3. Macaulay Duration (q.v.), divided by 1 + y/n , where y is the bond yield and n is
      the number of coupon payments per year.
money market rates
        Interest rates on short-term instruments, including bankers‟ acceptances, commercial paper,
        LIBOR, and U.S. Treasury bills. The accrual rate to maturity equals the quoted rate times a day
        count fraction that has 360 in the denominator. The days in the numerator might be actual days or
        days according to a 30/360 calendar.
Monte Carlo Simulation
      A technique for approximating a probability distribution by generating uniformly
      distributed pseudo random numbers and transforming them into the required sort
      of random numbers. In option pricing one ordinarily works with lognormal random
      interest rates, prices, and indexes. If one constructs the probability distributions
      correctly, then a Derivative Product's value equals the expected discounted value
      of its payoff (in the limit as the number of random paths approaches infinity).
      (See http://www.sbcm.com/hot/current.htm for more information)

Monthly Income Preferred Shares.
     Monthly Income Preferred Shares (or Stock) - which most people call MIPS or
     Mips, for short - are Preferred Shares (q.v.) that pay monthly dividends. MIPS are
     callable after some period of call protection, and convertible into common shares.
     Some observers see MIPS as tax-deductible equity, in effect. Some in the
     Treasury department see this as abusive, and want a crackdown. Goldman,
     Sachs & Co. pioneered them circa October 1993. Cf. Step-Down Preferred
     Stock.

      The parent corporation (Parent) creates a subsidiary (Sub) or limited partnership
      to issue the MIPS. Sub sells MIPS for cash and lends the cash to Parent or buys
      Parent's notes. Parent pays interest to Sub, which pays monthly preferred
      dividends to its security holders. In at least one case Parent had the option to
      defer interest for up to five years. That would mean that MIPS holders might
      receive no dividends for five years.

      One variation on the MIPS structure involves an offshore Sub, which pays
      dividends to investors without withholding tax.

      Part of the motivation for MIPS seems to be reduction of taxes paid by the issuer
      and its direct or indirect security holders. Parent issues debt and pays interest, so
      Parent may deduct interest expense. Subsidiary issues preferred shares and
      pays dividends, so corporations that buy MIPS get a dividend exclusion. This
      shifts the tax burden to parties besides security holders of Parent and Sub.

      Texaco, Inc., USX Corp., ConAgra Inc., and others issued more than $2.5 billion
      in the first year MIPS existed. Merrill Lynch and Smith Barney have issued similar
      securities.

      The masochistic or meticulous among you may like to view legal documents from
      Edgar, pertaining to a proposed offering of MIPS, by Capital Holding Corp., with
      help from Goldman, Sachs. See also U.K. Mips.

Monster ABS
     An enormous Asset-Backed Security (q.v.). (For example, see "Natwest
     Prepares Monster Loan-Backed ABS," BondWeek, 3/10/97. This one was worth
     about $1.65 billion.)
Morgan Stanley - Capital International
     The Morgan Stanley unit that maintains a wide range of global stock market
     indexes for approximately 20 countries and a variety of regions.

Mortgage Backed Security
     A security, such as a bond, pass-through, CMO, or REMIC that derives its cash
     flows and market value from underlying Mortgage Backed Securities and/or
     Mortgage Bonds, Loans, and/or Notes.

Mortgage Bond, Loan, or Note
     A Bond, Loan, or Note plus a security interest in a piece of property, commonly
     real property (land and/or buildings). A residential mortgage loan typically
     contains a prepayment option, which is the borrower's call option on the loan and
     which becomes valuable when interest rates decline. Also, in practice, the lender
     sells the homeowner a put option on the pledged home, struck at the loan's
     balance.

MSCI
     Morgan Stanley - Capital International (q.v.).
M-squared
     A way of measuring the performance of an investment portfolio, namely the
     average rate of return on a portfolio that (a) consists of investment in T-bills and
     the investment portfolio and (b) has the same standard deviation as the relevant
     benchmark portfolio. Thus, if an investment portfolio‟s M-squared is greater (less)
     than the return on the benchmark portfolio, then the investment portfolio‟s risk-
     adjusted return is better (worse) than that of the benchmark. (Noelle Knox, "Slice,
     Dice and Scrutinize: Risk Measurements Draw a Crowd," NYT, 4/5/98, p. 45.)

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Naked Dog Basket
     The "Basket" is a portfolio of Brady Bonds that someone issued in exchange for
     rescheduled debt of certain developing countries. One might suppose that some
     people consider such a bond to be a "Dog". The "Dog Basket" is "Naked",
     because the terms of the contract call for stripping the yield on U.S. long bond
     from the gross return on the portfolio. So the coupon on the "dogs" depends on
     the "stripped spread" between the long bond rate the the Brady Bond yield.
     (Described in the Financial Times, 11/16/94, p. V.)

Nondeliverable Forward
       A cash-settled, forward contract, typically on a nonconvertible or thinly traded
       foreign currency (probably from an emerging or submerging (q.v.) market) or two
       such currencies, that settles into a convertible currency (typically the USD). The
       cash value is a function of the contract's reference rate(s) on the fixing date,
       typically, two business days before the value date. Its main atraction is avoiding
       currency controls. (Source: William Rhode, "Learning Curve: Nondeliverable
       Swaps, Derivatives Week, 5/5/97.)

Nondeliverable Swaps
     A Swap (q.v.) that would be equivalent ideally to a Cross-Currency Swap (q.v.),
     except that it settles instead in USD. Typically, the NDS omits delivery of the
     underlying currency at maturity. In simpler cases, the parties offset this omission
     with the appropriate Nondeliverable Forward (q.v.). In more complicated cases,
     the parties don't offset it, and pricing is more difficult. "One player at a U.S. bank
     uses a combination of risk tolerance, onshore interest rate levels and her own
     currency forecast to price NSDs." The NDS's appeal stems largely from its ability
     to circumvent prohibitions against converting currencies at market prices.
     (Source: William Rhode, "Learning Curve: Nondeliverable Swaps, Derivatives
     Week, 5/5/97.)

Notional Amount
      A stated amount in a Derivatives Contract, on which the Derivative's payments
      depend. The Notional Amount is most analogous to the principal amount of a
      bond.

[le] Notionnel
       "Notional bonds", the long-term, French bond futures contract on the MATIF
       (q.v.).
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OATS
          1. Order Audit Trail System. The NASD‟s new (as of 1998), SEC-approved
             system for keeping detailed, *time-stamped records of every trade.
             (http://investor.nasd.com/notices/9833ntm.txt)
          2. Obligations assimilables du trésor. French government bonds, with either
             fixed and floating coupons, available in book-entry form. Not traded
             overseas, but available as ADRs in the U.S.
             (http://www.rcmfinancial.com/o.htm)
Obligations Assimilables du Trésor (OATs)
      French government bonds with original maturities of 5-30 years, the underlying
      assets for French bond futures and option contracts. (http://www.cean.caisse-
      epargne.fr:5281/html/obligassi.html)
Off-the-Run Treasury
       A former On-the-Run Issues (q.v.), after the Treasury issues the new On-the-
       Run.

OIS
       Overnight Indexed Swaps (q.v.).

One-Touch Option
     An Option that pays off as soon as the trigger price touches the barrier. Often, it
     is a Binary Option (q.v.).

One Way Collared Note
     A One Way Floating Rate Note (q.v.).

One Way Floater
     A One Way Floating Rate Note (q.v.).

One Way Floating Rate Note
     Definition: A Floating Rate Note whose rates can only ratchet up (usually) or
     down. Also known as One Way Collared Note, One Way Floater, Ratchet
     Floater, and Sticky Floater. (Source: Peng, Scott, and Dattatreya, Ravi, The
     Structured Note Market.)
     Example: A Floating Rate Note that pays a quarterly coupon that is at least the
     previous period‟s LIBOR, at most 50 bips (q.v.) above the previous LIBOR, and
     equals LIBOR if LIBOR falls between these bounds.
     Application: This is mainly a vehicle for speculation, because it is difficult to name
     something that it hedges.
     Pricing: The payoff is path dependent, and the most obvious way to price it is
     with Monte Carlo simulation. (See Peter Fink‟s discussion at
     http://www.sbcm.com/hot/current.htm)

On-the-run Treasury
      Definition: The most recently issued U.S. Treasury note or bond of a given initial
      Maturity. Also known as the Current Coupon issue.
      Example: For example, when the Treasury auctions a new two-year note it
      becomes the new On-the-Run two-year note.
      Risk Management: The On-the-Run issues tend to be the most liquid – i.e., they
      have the smallest bid-ask spreads. That makes them most attractive as hedging
      instruments.
      Comment: After the Treasury announces that it will auction a specific security
      (defined by maturity and coupon), but before the auction, the bond may trade in
      the When Issued Market (). After the auction, this security becomes the new On-
      the-Run Issue for its maturity. The previous On-the-Run becomes an Off-the-Run
      issue.
option
      The right but not the obligation to buy (call, q.v.) or sell (put, q.v.) an underlying
      asset at a predetermined and fixed price, enter into a long or short futures
      position, or receive a payoff that simulates a purchase or a sale.
OTM
      Out-of-the-Money. Having an Intrinsic Value of zero.
Outperformance Option
      An option on the performance of one asset in excess of the performance of
      another. Typically, one measures the outperformance by the excess of the one
      return or rate of retun over the other. One might also measure the
      outperformance as the excess of the ratio of the two final price over a benchmark
      ratio.
overnight (o/n)
      From today to "tomorrow" (i.e., the next business day).
Overnight Indexed Swaps
      Swaps with a floating rate based on Sonia (q.v.).
overnight rate
      The interest rate from today to tomorrow (i.e., the next business day). Rates for
      overnight (q.v.), tom/next (q.v.), and spot date (q.v.) satisfy the following
      equation:
      (1 + ro/n × to/n ) (1 + rt/n × tt/n ) = (1 + rspot × tspot ).
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Pack
        A Forward (q.v.) Strip (q.v.,#2), each corresponding to a particular year, of four
        consecutive, quarterly Eurodollar or Euroyen futures contracts. Markets, such as
        Simex offer a Pack as a convenient package of futures contracts, without the
        execution risk inherent in building up the Strip, contract by contract. A trader can
        use Packs and Bundles (q.v.) to implement bets on the change in shape of the
        Forward Curve.

paper
        Customer buy and sell orders coming to a trading pit.

PCS Options
     The CBOT's option contracts with the underlying Property Claims Service (PCS)
     index. Apparently, they operate more or less as a call option on the underlying
     index, which could be any one of nine indexes. (Source: Robert Clow, "Coping
     with catastrophe," Institutional Investor, December 1996, pp. 138.)


PEEQS
    Protected Exchangeable EQuity-linked Securities (q.v.).
PERCS
    Preference Equity Redemption Cumulative Stock. Preferred stock in Corporation
    A that behaves on the downside like common stock in Corporation A, but
    contains an embedded short Call Option on that stock. The PERCS is a
    descendant of the Prime of the early 1980s, which was itself a descendant of the
    hoary Buy-Write (q.v.) strategy. (See Pratt, Tom. "You can't keep a lid on public
    derivatives." IDD, Oct. 24, 1994, pp. 12-18.) The PERCS is like a ELKS (q.v.),
    except that the company that the company that issues the stock issues the
    PERCS, and another company issues the ELKS. Morgan Stanley issued the first
    PERCS in 1991.3.375

Periodic Cap
      An Interest Rate Cap (q.v.) for which the strike for each Caplet (q.v.) can differ
      from strikes on other Caplets. Typically, the strike depends on LIBOR, as in a
      Ladder Periodic Cap (q.v.) or Lookback Periodic Cap (q.v.).

PERQS
      Performance Equity-Linked Redemption Quarterly-Pay Securities (sm). Morgan
      Stanley's proprietary Equity Linked Debt Security (q.v.).
Pfandbriefe
      German asset backed bonds, backed by private mortgages or public sector
      loans. The Association of German Mortgage Banks claims that for at least 100
      years, through 1998, no investor who has held a Pfandbriefe issue to maturity
      has ever failed to receive full principal and interest. This claim suggests that
      some of the payments may not have been timely. Better late than never!
Pfandbriefe, Jumbo
      Straight bonds with face value of at least DEM 1 billion, which at least three
      market makers have pledged to quote continuous, two-way markets during
      normal market hours, for size up to DEM 25 million. Cf. Pfandbriefe.
Pfandbriefe, Public
      Bonds backed by loans to the public sector. Cf. Pfandbriefe.
Pibor
      Paris Interbank Offered Rate. The French counterpart of LIBOR.

Planned Amortization Class
     An indexed amortizing structure with an amortizing rate that is nearly flat over a
     large range of values for the underlying rate of interest.

pooling of interests
      Accounting for a merger by simply adding up the financial statements for the
      merging firms. To a first approximation, the financial statements of the merged
      firm show the same numbers as the sum of the financial statements of the
      merging firms.
purchase method
     Accounting for a merger by designating one firm the acquirer, computing
     "goodwill" as the excess of the acquired firm's purchase price over its book value,
     and amortizing the goodwill over a period, which depresses income.

price
       Clean Price = Quoted Price. What the broker or dealer tells you is the price of
      a bond = Dirty Price - Accrued Interest.
       Dirty Price = Invoice Price = Full Price. The size of the check you write to buy a
      bond = Clean Price + Accrued Interest
Principal-Only (PO) Tranche
      A CMO (q.v.) Tranche (q.v.) that receives a portion of only the CMO's underlying
      principal payments.

Preferred Share
      A share that pays a fixed dividend and has preferences over Common Stock
      (q.v.) with regard to dividends and in case of bankruptcy.

probability measure
      A measure (q.v.) that maps a set of points in a probability space into a point in
      the interval [0,1]. Example: If the probability space corresponding to two flips of a
      fair coin is  = {HH, HT, TH, TT}, and we have the set of all outcomes with tails
      once out of two flips, A = {HT, TH}, then the probability of that outcome is P(A) =
      1/2 and P(.) is the probability measure that assigns a probability of 1/4 to each of
      the points in the probability space.
project finance
      Raising money via a loan or bond issue to build a specific project (such as a
      power plant, hydroelectric dam, or airport) and having only that project as
      security for the loan or bond. Thus, a project loan is typically "without recourse"
      or "non recourse" and a project bond is typically a revenue bond.

Protected Exchangeable EQuity-linked Securities
      The Morgan Stanley Group, Inc.'s proprietary, listed (American Stock Exchange)
      equity index derivative product, which pays off at maturity (4/20/01) the greater of
      issue price ($69.55) or 10% of the S&P 500 Index value on that date. The owner
      may from 11/17/97 to seven trading days before 4/20/01) exchange 100 PEEQS
      for ten times the S&P 500 Index level. Thus, at each dividend date, the owner
      has the option to forgo the dividend in return for a compound option that
      ultimately pays off as mentioned. (Cf. SPINs.)

Putable Bond
      Definition: A Bullet Bond (q.v.) that the bondholder can force the issuer to buy
      back at a scheduled price. The Put Price as a function of calendar time is the Put
      Schedule. A Bullet Bond plus a Put Option (q.v.) on the Bond. AKA Retractable
      Bond.
     Example: A corporation might issue a ten-year Note (q.v.) with a five-year Put
     Option.
     Application: A Putable Bond is a bet on the cost of refinancing at the Put Date.
     The issuer is betting that the Put Option will expire worthless – i.e., that interest
     rates will be low at the Put Date. The bondholder is betting that interest rates will
     rise, the bond price will fall, he will be able to sell the bond back to the issuer at a
     profit, and he will be able to reinvest the proceeds of that sale in a bond with a
     higher coupon.
     Pricing: You can price it as a bond, plus a put option on the bond. For it to sell
     near par requires a low coupon.
     Risk Management: For example, suppose that a corporation issues a ten-year
     bond with an embedded five-year European Put Option. It is exposed to the
     danger of rising interest rates, in which case the bondholder will put the bond
     back to the issuer. However, if the issuer also buys a Payer Swaption, struck at
     the same coupon as the bond, then it will be able to issue floating rate debt to
     repay the principal on the bond and exercise the Swaption to continue paying the
     same fixed rate. The floating rate receipts from the Swaption will roughly cover
     the new floating rate debt interest.
     Comment: Cf. Callable Bond, Extendible Bond.
Put Option
     The right, but not not the obligation, to sell the underlying asset at the strike
     price. Cf. Call Option.

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Quanto
     Goldman Sachs's copyrighted (but not enforced) term for a "quantity-adjusting"
     option or forward. In 1986 Lee Thomas, then of Goldman Sachs, introduced the
     term. See also Quanto Forward (q.v.), Option (q.v.), and Swap (q.v.). ("Quanto
     swap challenge: the results," Euromoney, October 1994, p. 30.)

Quanto Forward
     A forward contract in which the buyer receives a random number of units of the
     underlying , and that number depends on another price. For example, consider a
     Quanto Forward contract on the Nikkei. The forward price might be a fixed
     number of dollars, while the number of units of the Nikkei would depend
     proportional to the yen/dollar exchange rate. This is equivalent to a cash-settled
     forward contract with a nominal dollar value of the Nikkei proportional to the ratio
     of its true dollar value to the dollar value of one yen.


Quanto Option
      An option in which the payoff is the greater of zero or the value of a Quanto
      Forward (q.v.) contract.

Quanto Swap
     A swap in which the underlying price is quantity adjusted, as with the Quanto
     Forward and Quanto Option.

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Rainbow Option
     Definition: An option that has several risk factors of the same type, e.g., two
     stock prices or three exchange rates.
     Examples: The earliest Rainbow Option in the derivatives literature was probably
     Margrabe‟s Option to Exchange One Asset for Another, an Outperformance
     Option (q.v.), with a payoff that depends on the difference between two prices.
     An Equity Index Option (q.v.) has a payoff that depends on the average of
     underlying share prices.
     Pricing: Margrabe (1976) published the first pricing model for a Rainbow Option,
     namely the "Margrabe Option." In some cases one can price a Rainbow Option
     with a Black-Scholes-Merton model by computing the appropriate adjusted
     volatility and dividend yield. The most common way to price a general Rainbow
     Option is with Monte Carlo pricing. Next most common is with a multinomial
     model (a generalization of the binomial model). Explicit finite difference pricing is
     easily feasible, but rarely seen.
     Risk Management: Rainbow options with n sources of risk have n Deltas, n
     Kappas, n(n+1)/2 Gammas, and sensitivity to n dividend yields and n(n-1)/2
     correlations. With large n this can get complicated.
     Comment: If the several risk factors are of two or more types, e.g., a stock price
     and an exchange rate, then the option is a Hybrid Option (q.v.).

random variable
     A variable that takes on different numerical values for different points in an
     underlying probability space (q.v.).
     Example: The number of "heads" outcomes in five coin flips.
Range Accrual Option
     An Option that accrues value for each day that the index rate remains within the
     specified range. See Range Note, Hamster Option.

Range Binary Option
     An Option that pays off a fixed amount at expiration if and only if the underlying
     price remains in the range the option's entire life. .

Range Note
      An Accrual Note (q.v.).

Ratchet Floater
       A One Way Floating Rate Note (q.v.).
real option
       Definition: An option that involves tangible objects – such as bricks and mortar,
       pipelines and equipment – rather than financial instruments and cash flows, and
       physical actions – such as excavation, construction, demolition, physical
       movement, and hard work – rather than simply tendering notice of the exercise of
       an option.
       Examples: Examples include the following decisions to:
       - build a plant today, rather than wait until next year
       - choose a more flexible and more expensive production process, rather than a
       cheaper one with fewer applications
       - decline a marriage proposal and play the field, looking for a better proposal
       - go for an MBA, rather than a law degree
       Applications: The main business application for real options seems to be capital
       budgeting, i.e., business investment. The idea is that one investment may open
       doors to other opportunities that may grow or not, and that traditional net present
       value methods are not up to the task of evaluating such investments.
       Comment: Although the real option approach is theoretically sound, the
       challenge of applying it correctly to get out a useful value is daunting. I have
       waited 30 years to see widespread use of the capital asset pricing model for
       capital budgeting. We may have to wait as long to see widespread use of real
       option theory.
Real Estate Mortgage Investment Conduit (REMIC)
       A relatively new vehicle for passing the cash flows from a portfolio of mortgages
       and MBS's through to holders of REMIC certificates. The REMIC legislation took
       effect on 1/1/87. Since REMICs appear, new issues of CMOs have nearly
       disappeared.

Red Chip Stocks
     Shares listed on the Hong Kong Stock Exchange of companies with
     headquarters and operations in the People‟s Republic of China.
Rediscount credit
     Bundesbank (Buba) credit to institutions "against the purchase of bills of
     exchange". This is typically the lowest rate at which the Buba lends, and the
     Buba‟s Central Bank Council limits the total amount of such credit.
Rembrandt market
     Holland‟s foreign market (q.v.). Example: Some Exxon debt trades in the
     Rembrandt market.

REMIC
     Real Estate Mortgage Investment Conduit (q.v.). A "pot" of real estate mortgage
     assets, sometimes homogeneous, sometimes a mischmasch, usually sliced an
     diced to sell for maximum value.
Replicating Portfolio
      A portfolio of securities (ordinarily more "basic" and from a more liquid market)
      that either (1) mimics the returns on a derivative security (static replication) or (2)
      is part of a trading strategy that mimics those returns (dynamic replication).

Residual Tranche
     The "equity" portion of a CMO (q.v.). The Tranche (q.v.) that receives what's left
     over after satisfying all other claims against the underlying cash flow.

REXâ
        A price index for all fixed-income bonds, debt obligations, and Treasury bills of
        the German federal government, Treuhandanstalt, and the German Unity Fund.
        The REX bond index is a weighted price average based on 30 synthetic,
        notional bonds with a constant integer life to maturity periods of one to 10 years
        and three different coupon types of 6, 7.5, and 9 percent. (Source:
        http://www.exchange.de/fwb/indices.html#rex).

REXPâ
     A performance index corresponding to the REX (q.v.). (Source:
     http://www.exchange.de/fwb/indices.html#rex).

Right
        A Call Warrant (q.v.) – ordinarily in the money – that a corporation grants to
        current shareholders to buy additional shares.

Roller Coaster Swap
       A Swap (q.v.) that is a hybrid of an Accreting Swap (q.v.)and an Amortizing Swap
       (q.v.). The Notional amount both increases and decreases during the Swap's life.
       (Source: http://www.snowgold.demon.co.uk/webrisk/)
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8/28/01 Samurai  bonds
        Definition: Yen-denominated bonds that foreign companies or governments issue
        in the Japanese market.
        Example: In July 2001 Brazil sold in Japan ¥200 billion of two-year Samurai
        bonds, yielding 3.75%.
        Application: Samurai bonds appeal more to Japanese investors than ordinary
        foreign bonds, denominated in the foreign currency, because the they avoid the
        possibility of loss due to devaluation or depreciation of the foreign currency
        relative to the yen.
        Comment: In July 2001 the two-year swap rate in Japan was about 0.17%.
      Consequently, the 3.75% coupon on Brazil's issue of` Samurai bonds appears to
      reflect a credit risk premium.

Samurai market
     Japan‟s foreign market (q.v.). The market in Japan for securities that non
     Japanese companies and governments issue. Example: Some shares of General
     Motors trade in the Samurai market.

scalper, scalp-beggar
      A exchange floor trader who is a market maker (q.v.). (Source: Charles di
      Francesca, as quoted by William D. Falloon in "God Doesn't Trade Bonds,"
      Derivatives Quarterly, Fall 1999.)

scalping
      Disseminating (e.g., via a newsletter, press release, web page, or “spam”) false,
      favorable information about a stock to boost its price, while unloading your
      position in it. Also known as "pumping and dumping"

SCHATZ
    German Federal Treasury Bills (BundesSCHATZanweisungen). (Source:
    http://www.exchange.de/dtb/SCHATZ-future.html)

SCHATZ Futures
      The DTB Futures contract on a notional short term (1 3/4 - 2 1/4 years) debt
      security of the German Federal Government or the Treuhandanstalt, with a
      notional interest rate of 6%. The SCHATZ (q.v.) and other instruments qualify.
      (Source: http://www.exchange.de/dtb/SCHATZ-future.html)
Section 215
      "Section 215 of the U.S. penal code says those found to have given or received
      improper financial incentives of more than $1,000 „in connection with any
      business or transaction‟ of an institution „shall be fined not more than $1 million
      or three times the value of the thing given, offered, promised, solicited,
      demanded, accepted or agreed to be accepted, whichever is greater, or
      imprisoned not more than 30 years, or both."
      (Michael Siconolfi, " „Spinning‟ Of Hot IPOs Is Probed", WSJ, 4/16/98. )
Securitization Conduit
      A Special Purpose Vehicle (SPV) (q.v.), with a remote chance of bankruptcy, that
      a bank forms. The Conduit purchases or originates loans and finances them with
      various sorts of Asset Backed Securities (q.v.). The underlying loans provide the
      collateral for the ABS's. Typically, the sponsoring bank guarantees the payments
      of the ABS's, which the security holders demand. The guarantee may come from
      a standby letter of credit or from the bank's purchase of the Conduit's junior
      securities. In return for its guarantees, the bank receives the residual coupon
      spread of the underlying securities over that of the conduit's securities.

settlement date
     The date on which the buyer pays (the seller receives) cash and the seller
     delivers (the buyer receives) property. In the Eurobond market, this is the "value
     date" (q.v.). (J.P. Morgan Glossary of terms for global sovereign bond markets.)
Sharpe ratio
     A measure of investment performance, namely, the investment's average excess
     rate of return (investment's rate of return minus riskless rate of return), divided by
     its standard deviation of rate of return. Thus, the Sharpe ratio measures how
     many standard deviations the average rate of return is from the riskless rate of
     return. If the distribution of rate of return were normal and we knew its mean and
     variance exactly, the Sharpe ratio would provide an idea of the probability that
     the risky investment would beat a riskless investment. William Sharpe, creator of
     the Sharpe model of capital market equilibrium (1964) and subsequently Nobel
     Prize Winner in Economics, devised the Sharpe ratio.

short-short rule
      A part of the U.S. federal tax code (from 1936 to 1997) that imposed corporate
      income tax (hence double taxation of income) on a mutual fund that received
      more than 30 percent of its gross income (i.e., before deducting losses) from
      gains on positions held less than three months. A mutual fund that violated the
      short-short rule would owe corporate income tax on all its income for that year.
      Also known as the 30% Rule.
      Its advocates argued that the rule would discourage funds from short-term
      trading that might destabilize the markets. Its opponents pointed out that it
      discouraged short selling and trading in derivatives.
SIRES
      Merrill Lynch's Secured Individually Repackaged Exchangeable SecuritieS),
      denominated in several currencies, for international investors. A kind of SPV
      (q.v.). Source:
      http://emwl.oyster.co.uk/contents/publications/euromoney/em.96/em.96.04/em.96
      .04.12.html)

SLOB
       Secured Lease Obligation Bond. A bond, backed by a portfolio of leases.
       (Source: Gastineau and Kritzman, Dictionary of Financial Risk Management,
       Frank J. Fabozzi Associates, 1996.)

SOES
       Small Order Execution System. NASDAQ‟s computerized way for a customer to
       enter a small order to buy or sell shares of a NASDAQ stock. Under old
       NASDAQ "order handling rules", market makers had to fill orders for up to 1000
       shares. The new (as of 1/24/97) rules – which tend to protect market makers
       from so-called "SOES Bandits" (q.v.) – reduce this size to only 100 shares. A
       trader can use SOES for a given stock once every five minutes. Source: Cory
       Johnson, "Easy Money: Is the NASD's SOES Attack a Ticking Time Bomb?"
       TheStreet.com (3/3/97).
Sonia
        Sterling Overnight Interbank Average (q.v.). An average of the rates that
        London's largest money brokers pay for overnight deposits on a given day.

Special Purpose Vehicle (SPV)
      A merger of a bond and a derivatives trade into a single contract. For example,
      one SPV might consist of a fixed rate bond plus a Swap in which the owner of the
      bond pays fixed and receives floating. Thus, the SPV is equivalent to a floating
      rate bond. Examples include the ARGO, EX, LASER, SIRES, and STEERS – all
      of which (q.v.). (Source:
      http://emwl.oyster.co.uk/contents/publications/euromoney/em.96/em.96.04/em.96
      .04.12.html)

Spiders
      Essentially, shares in a trust that owns shares of stock in the same proportion as
      the S&P 500 stock index portfolio. Spiders are a.k.a. Standard & Poor's
      Depositary Receipts (SPDRS), and have ticker symbol SPY. The Spider portfolio
      contains one-tenth of the S&P 500 index portfolio, so it sells for about a dollar
      amount equal to about one-tenth of the S&P 500 index level. Spiders trade on
      the American Stock Exchange like ordinary shares, which gives then continuous
      liquidity while the market is open, the ability to sell short, and ordinary stock
      transaction costs. Spider's distribute dividends of their underlying stocks
      quarterly, and do not reinvest them in the meantime, which costs shareholders in
      rising markets and profits them when the market tumbles.

        Spiders compete directly with S&P 500 index funds. Investors are stuck in these
        funds until after each day's market closes. However, transaction costs may be
        zero. No-load mutual funds often reinvest dividends promptly and without
        transaction costs.

        (Source: Vanessa O'Connell, "'Spiders' Offer Another Way to Scale S&P 500's
        Heights", Wall Street Journal, 3/11/95.)

SPINs
        Standard & Poor's 500 Index Notes (q.v.).

Split Fee Option
       An option on an option, in which the buyer makes from one to three payments.
       The buyer may pay a premium up front, may make a second payment (the
       second premium, hence the name Split Fee, also known as the first strike price)
       to keep the option alive, and may make a third payment (the second strike price)
       to exercise the final option. Also known as a Compound Option (q.v.). A special
       case of an Installment Option (q.v.).
SPOOs or SPUs
       S&P 500 index futures – from its ticker symbol: SPU.
spot date
      The date from which interest starts accruing in a fixed income transaction. In the
      USD swap market (1999), typically, two business days after the transaction date.
spot/next
      From the spot date to the following business day.
spot rate
      The interest rate from today to the spot date. When the spot date is two business
      days hence, rates for overnight (q.v.), tom/next (q.v.), and spot date (q.v.) satisfy
      the following equation:
      (1 + ro/n × to/n ) (1 + rt/n × tt/n ) = (1 + rspot × tspot ).
spread trade
      Definition: A trade that profits from a positive move in one risk factor and a
      negative move in another.
      Examples: Long September gold futures and short December gold futures is a
      calendar spread trade that highlights the difference between gold delivered at the
      two dates. Other spread trades include: stereo trade (q.v.) , tailed calendar
      spread (q.v.) , tandem spread (q.v.) , and turtle trade (q.v.).
      Pricing: A calendar spread trade can be the basis for cash-and-carry arbitrage,
      which establishes a relationship between two forward prices.
      Risk Management: A simple calendar spread trade cannot establish the
      relationship between two futures prices, despite the popular belief that it can.
      Comment:
      Reference: Geoffrey Poitras, "Turtles, Tails and Stereos: Arbitrage and the
      Design of Futures Spread Trade Strategies," Journal of Derivatives 5, Winter
      1997, pp. 71-87.
Standard & Poor's Index Notes (SPINs)
      One of Salomon Inc's proprietary, listed (American Stock Exchange) debt
      securities. SPINs pay no interest and settle in cash. At maturity they pay the
      maximum of par and an amount equal to K times the current value of the S&P
      500 Index level. Throughout most of a SPINs' life the owner can exchange it for
      cash equal to K times the value of the current S&P 500 Index level. (C.f.
      PEEQS.)

State and Local Government Series (SLGS or Slugs)
      Definition: Special U.S. Treasury bonds with low yields and high prices that the
      Treasury issues for municipalities to use in advanced refundings of their
      municipal securities.
      Application: The idea is to provide securities that will allow the municipalities to
      benefit from a drop in market interest rates, without giving them an excuse to
      engage in "tax arbitrage" by issuing tax-exempt debt, investing the proceeds in
      taxable debt, and keeping the spread without paying tax on it.
      Source: Charles Gasparino, "Cities Have a Headache Thanks to Wall Street: It‟s
      „Yield Burning‟," WSJ, 8/26/97.

STEERS
     Merrill Lynch's STructured Enhanced Return TrustS, originated in 1990. A kind of
     SPV (q.v.). (Source:
       http://emwl.oyster.co.uk/contents/publications/euromoney/em.96/em.96.04/em.96
       .04.12.html)

Step-Down Preferred Stock
      Corporate Preferred Stock that a REIT issues, as part of a tax avoidance plan
      that the IRS declared abusive in 2/97. The parent corporation would set up a
      REIT that issued preferred shares and lent the proceeds to the parent. The
      parent then paid tax-deductible interest on the loan to the REIT, which paid tax-
      deductible preferred dividends (unique to REITs) to its shareholders, who were
      ordinarily tax exempt. The tax treatment is similar to that of interest on debt that a
      taxable corporation pays a tax exempt investor. The preferred dividend was
      typically large, initially and for up to about ten years, then much smaller. Cf.
      MIPS.

       The arrangement exploded in popularity during February 1997, with Freddie Mac
       the most prolific issuer. Morgan Stanley and Bear, Stearns were major
       underwriters of such issues. The IRS responded to this growth by shutting down
       this type of security, claiming that it abused the federal tax system.

       (Robert D. Hershey, Jr., "Newly Popular Corporate Investment Banned as Tax
       Dodge," New York Times, pp. D1 et seq.)

Step-Payment Option
      A "free" ordinary European Option, minus a portfolio of Binary Options with
      successively higher or lower Strikes. For example, for no premium paid up front,
      party A receives a European Call Option struck at 100 in return for making one
      payment if the underlying price goes to 98, another if the price goes to 96, etc.

Step Up Bond
      Definition: A bond with a coupon that increases over time on schedule – unless
      the issuers call it. Ordinarily, the coupon begins slightly above the going rate for
      short-term bonds and the bond is callable at par on each coupon reset date.
      Example: FHLBB issued in December 1997 a bond that matures in 1/03. Its first
      coupon is 6%, and the coupon increases to 6 3/8 % in 1/99, 6.5% in 1/00, 7% in
      1/01, then 8% in 1/02 through maturity.
      Application: At the start of each coupon accrual period, the investor bets that the
      next oversize coupon compensates for the possibility that the issuer may call the
      bond.
      Pricing: At the last reset date, the issuer has an option to call the bond. At each
      previous reset date, the issuer can either call the bond or pay a forward premium
      (the excess of the next coupon(s) over the going market coupon) for the current
      installment of a compound option. Thus, the Step Up Bond has a sort of
      embedded Chooser Option (q.v.).
      Risk Management: The Step Up Bond embodies two kinds of market risk
      (interest rate risk and exposure to the volatility of the rates), and may embody
      credit risk.
        Comment: Step Up Bonds are available with different credit qualities. Issuers
        include federal agencies, blue chip corporations, and lesser corporations. Credit
        risk can be a significant issue.
        Source: For a thorough, nontechnical description and analysis, see Marilyn
        Cohen, "Step up to the plate," Forbes, 1/26/98, p. 112.

Sterling Overnight Average
       An index of overnight GBP interest rates that weights its components by volume.
       (Source: IFR's online version of "Derivatives: Action in Japan," IFR, 5/3/97,
       http://www.ifrpub.com/ifrstart.htm)

stereo trade
      A tailed tandem trade (q.v.), with tails designed to produce calendar spread
      payoffs that depend on the implied repo rates.

Sticky Floater
      A One Way Floating Rate Note (q.v.).

Stock Market CD
      A CD (q.v.) that pays a rate of interest that depends on the rate of return on an
      underlying equity instrument.

Stock Upside Note Securtiies
      Lehman Brothers' listed, senior debt securities that offer upside participation in
      the value of a basket of shares, with limited downside risk. The SUNS is
      equivalent to a position in the underlying basket, plus a protective put.

        For example, Lehman offered SUNS with an underlying basket of 20 regional
        bank stocks, and offers SUNS with an underlying basket of 24 international
        telecommunication stocks.

Straddle
      An option portfolio consisting of one Call Option and one Put Option, both with
      the same underlying, direction (long or short), strike, and expiration date.

Strap
      A Straddle (q.v.) plus another one of the Call Options.
stress test
        Definition: A test of a model for pricing or risk management, using an extreme scenario or family
        of scenarios.
        Example: For example, you might price your portfolio, using market conditions at the time of the
        crash of 1987, or assuming a three-standard-deviation move in prices, or a 100-year move in the
        forward curve.
        Application: You can use a stress test to find out a model‟s breaking point.
        Pricing: As you move a European barrier call option‟s barrier away from the spot price, the
        option‟s value approaches that of an ordinary European call.
        Risk Management: Stress-testing of VaR systems is commonplace.
        Comment:
strip
   1. A Straddle (q.v.) plus another one of the Put Options.
   2. A portfolio of similar options, but with different expiration dates and each with an
      underlying that depends on the expiration date. E.g., an Interest Rate Cap is a
      Strip of Call Options on LIBOR for consecutive, nonoverlapping accrual periods.
   3. A cash flow at a single date, stripped from a note or bond. The Strip could be all
      or part of either a coupon payment or a principal payment.
structured product
      Essentially a portfolio of securities and other (often, Vanilla) Derivative Products,
      although the dealer that creates it hopes the customer doesn't realize this. A
      Financial Engineer assembles a Structured Product from readily available
      Swaps, Options, etc., much the way a designer might assemble a prototype PC
      from components imported from all over the world.

STRYPES (sm)
    Structured Yield Product Exchangeable for Stock (sm) (q.v.). A debt product that
       Merrill Lynch and DLJ underwrote,
       is listed on the American Stock Exchange,
       pays a quarterly interest payment, and
       converts at maturity into a number of shares (between 0.8403 and one) that a
        mathematical formula defines.
For example, let the initial price be X(0)=$14.00 and the "Threshold Appreciation Price"
equal $16.66. Then the number of shares upon conversion is
                      Terminal Price X(T)   # of Shares upon Conversion
                      X(T)<$14.00           1.0000
                      $14.00<X(T)<$16.66 14.00/X(T)
                      $16.66<X(T)           0.8403
(Source: American Stock Exchange Press release.)
stub Risk
      "[T]he risk that interest rate outlooks based on the performance of the front
      contract in any given futures strip will prove premature." (Source: IFR's online
      version of "Derivatives: Action in Japan," IFR, 5/3/97,
      http://www.ifrpub.com/ifrstart.htm)

SUNS
        Stock Upside Note Securities (q.v.).

4/28/00 super   replication
       Producing returns from a portfolio of financial instruments that precisely match or
       exceed the returns from another instrument.

swap
       The exchange of a sequence of cash flows that derive from two difference
       financial instruments. For example, the party receiving fixed in an ordinary
       Interest Rate Swap receives the excess of the fixed coupon payment over the
       floating rate payment. Of course, each payment depends on the rate, the
       relevant day count convention, the length of the accrual period, and the notional
       amount.

synthetic IO-ette
      A REMIC (q.v.) bond with a small principal amount and a huge coupon rate. It
      absorbs some of the interest payment when market conditions demand that most
      REMIC bonds have a lower coupon than the collateral. (Its coupon must be less
      than 1200% for an Agency IO-ette, because of limitations of the Fed's Book Entry
      system).

       (Source: "Derivative Mortgage Securities Glossary," Dean Witter, Mortgage
       Backed Securities Department, Derivative Products Group, January 1995.)

swaplet
     A Swap (q.v.) that has a single payment.

swaption
      An option on a Swap (q.v.).
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-T-
tailed calendar spread
       A calendar spread trade (q.v.) involving one long position and one short position
       of different sizes (in contracts).

tandem spread
     A spread (q.v.) consisting of calendar spreads in two commodities.

Tanker Freight Swap
     A Swap (q.v.) with payoffs that depend on an average of tanker shipping rates.
     Citibank and Mallory Jones introduced the OTC product ca. 1996 November.
     (Source: Hampton, Michael. "The shipping forecast." FOW (November 1996): 12-
     13.)
TED Spread
     Definition: The U.S. T-Bill futures price minus the Eurodollar futures price, the
     premium that lenders require hold Eurodollar deposits, rather than Treasury bills.
      Example: For example, if the T-bill futures price is 93.60 (corresponding to a T-
      bill yield of 6.40%) and the Eurodollar futures price is 92.80 (corresponding to a
      Eurodollar deposit rate of 7.20%), then the TED Spread is 93.60 - 92.80 = 0.80.
      One would say that the TED Spread is 80.
      Application: If you think the Eurodollar credit quality will improve, hence the TED
      Spread will narrow, then you would sell the spread, going short T-Bill futures and
      long ED futures.
termination structure
      A design for a DPC (q.v.) that liquidates when the related name defaults. Cf.
      continuation structure.
tom/next (t/n)
      From tomorrow to the following business day.
tom/next rate
      The interest rate from tomorrow to the following business day. When the spot
      date is two business days hence, rates for overnight (q.v.), tom/next (q.v.), and
      spot date (q.v.) satisfy the following equation:
      (1 + ro/n × to/n ) (1 + rt/n × tt/n ) = (1 + rspot × tspot ).
Total Return Swap
      Definition: The synthetic purchase of risky debt with 100% leverage. One of the
      counterparties receives (and the other pays) the excess of the risky debt‟s total
      rate of return (interest plus capital gain) over LIBOR. A swap that has a floating
      payment that depends on the value of the remaining payments, hence depends
      on how likely it appears that the payer will make good its promise to pay.
      Examples:
      A counterparty in a junk bond swap receives the total rate of return on a portfolio
       of junk bonds and pay LIBOR.
      A bank loan swap might pay the total rate of return on a risky bank loan and
       receive LIBOR. In particular, Bankers Trust has offered swaps that pay the return
       on loans that fund the merger of Ralph‟s Supermarkets and Yucaipa Companies‟
       Food 4 Less (Derivatives Week, 11/7/94).
      A counterparty might receive the total return on some risky corporate bond and
       pay LIBOR minus a fixed spread.
       Application: See Credit Derivatives.
       Pricing and Risk Management: The replicating portfolio for Total Return Swap is
       the levered purchase or sale. Consequently, its value is the value of the
       replicating portfolio, and its hedge is the sale of the replicating portfolio. Thus, the
       dealer providing this swap could hedge his position by buying the risky corporate
       bond and financing the purchase with a floating-rate loan.
       Comment: Why doesn‟t the customer just do this, directly? The customer may
       not be able to deal with counterparties with low credit ratings. The dealer might
       have a higher credit rating. Of course, this looks like a way around regulations.

Total Return Option
      Definition: A Put Option (q.v.) on debt with credit risk.
      Example: A customer fearing a default on his debt could pay a premium for a put
      option that allows him to sell a risky corporate bond at par if the corporation
      defaults on any of its debt.
      Application: See Credit Derivatives.
      Pricing: A standard model for pricing equity options would be a good starting
      place for pricing a Total Return Option.
      Risk Management: One might try to hedge this dynamically with the underlying
      risky debt.
      Comment: Pricing and hedging might be difficult, and market manipulation may
      be an issue for a thinly traded underlying instrument.
trading post
      A location on the floor of a stock exchange where market makers (such as
      "specialists") and traders come together to determine value for shares in a
      number of corporations.

tranche
      One of the classes of claims making up a CMO (q.v.).
TruPS Units
      Trust Preferred Stock Units (q.v.).
Trust Preferred Stock Units
      Each unit of Salomon's TruPS issue of 7/3/96 consists of a 9.25%, mandatorily
      redeemable preferred security of the SI Financing Trust I ("the Trust") and a
      contract requiring the holder to purchase in 2021 (or earlier, at Salomon's option)
      1/20 of a share of Salomon's 9.5% Series F Preferred Stock.

        Salomon set up the Trust to issues the TruPS and common shares and invest
        the proceeds in Salomon's 9.25% secured debt. Also, Salomon contributes
        0.25% each year under the terms of the purchase contract. This structure allows
        Salomon to deduct interest coupon payments to the trust, which pays preferred
        dividends to investors who would prefer dividends to coupons.
turtle trade
        A tailed spread (q.v.) in a commodity, plus a position in interest rate futures.
T+1
        Next day, the business day after trade date. The SEC wants firms involved
        directly in securities trades – shares, bonds, and futures – to settle by T+1. This
        is supposed to happen by 2002. The current system (since 1995) calls for
        settlement by T+3, three business days after trade date. T+5 was the old method
        of settling trades in five business days, typically a calendar week. T+0 means
        same-day settlement.
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Derivatives Dictionary (U-Z,#)                   TM
                                                                    Lasted updated:


               ABCDEFGHIJKLMNOPQRSTUVWXYZ#
-U-
U.K. Mips
      Goldman, Sachs's variation on its Mips (q.v.) structure, tailored to maximize its
      advantages for the UK market in ways that the U.S. government wouldn't allow.
      Grand Metropolitan Delaware (limited partnership) issued 20 million "preferred
      securities" paying quarterly dividends at $25, lending the proceeds to Grand
      Metropolitan plc via a perpetual, subordinated loan with the seniority of preferred
      stock. (Source: Pratt, Tom. "Goldman modifies 'Mips' to land Grant Met deal."
      IDD, Nov. 7, 1994, p. 11.)

Up-and-in Option
     An option that pays off nothing, unless the underlying price rises to an upper
     barrier. Cf. Up-and-out Option.

Up-and-out Option
     An option that pays off as the corresponding ordinary option, unless the
     underlying price rises to an upper barrier. Cf. Up-and-in Option.
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-V-
value date
      1. In the Eurodeposit and FX markets, the delivery date for funds traded. For the
      spot market it would be the spot date, ordinarily two business days after the
      transaction. For the forward market it would be a future delivery date. In the bond
      market (usually), the date on which the buyer begins to earn interest.
      2. The date on which a bond buyer begins accruing interest on the bond. This
      may be the same as the settlement date (q.v.). (J.P. Morgan Glossary of terms
      for global sovereign bond markets.
vanna
      The sensitivity of vega (also known as kappa) to a change in the underlying
      price. Hence, (a) the first derivative of vega (kappa) with respect to a change in
      the underlying, (b) the first derivative of delta with respect to a change in
      volatility, and (c) the second derivative of option value with respect to a changes
      in volatility and underlying.

Variable Common Right
      Viacom issued VCRs in connection with its takeover of Blockbuster. (Source:
      Falloon, William. "The $48 and $52 Questons." Risk 8 (April 1995), pp. 48 ff.)

      Such a VCR is basically equivalent to a bearish Put Spread (long a Put struck at
      52, short a Put struck at 48). The underlying price is the highest of four 30-day
      Arithmetic Averages for the price of Viacom Class B shares. The four 30-day
      averaging periods are distinct periods during the pricing period, May 23 - Sep.
        28, 1995. To make manipulation more difficult, Viacom agreed not to buy its
        Class B shares during the pricing period. (Source: Bary, Andrew. "Drama at
        Viacom." Barron's, August 21, 1995, p. MW10.)

variance swap
       Definition: A contract that pays off an amount proportional to the difference between the realized
       variance over a specific period of time and the contractual variance.
       Example: If the realized, annualized standard deviation of the rate of return on the S&P 500 is
       40% and the contractual variance is 9%, then the net payoff on the side receiving the realized
                                                                                                     2
       variance on $100 million notional value for half a year is $3,500,000 = $100,000,000 x (0.4 -0.09)
       x 0.5.
       Application: The variance swap is a potential tool for managing the sensitivity of an option book to
       volatility risk.

VDAXâ
    The DAX (q.v.) volatility index, which measures the Black-Scholes implied
    volatility of a basket of DAX options. The Deutsche Börse has published it since
    7/97. (Source: http://www.exchange.de/fwb/indices.html#volind).

VIX
      The ticker symbol for the Chicago Board Options Exchange Volatility Index.
Vol-Vol
      The volatility of volatility. This presupposes that volatility is a random market risk
      factor, which is a lot more reasonable than the original assumption of the
      incredibly robust Black-Scholes model, that it is known and constant.

Volatility
       The annualized standard deviation of the percentage change in a risk factor.

volatility convexity
         Definition: The sensitivity of vega = dvalue/dvol (a.k.a. kappa) as a function of volatility to a
                                                                                  2          2
         change in volatility, also known as "dvega/dvol", where dvega/dvol = d value/dvol . Volatility
         convexity is to vega (kappa) as gamma is to delta and convexity is to duration. Also known as
         "vomma" (q.v.).
         Application: The volatility convexity shows the deviation from a vega (kappa) neutral hedge when
         the volatility moves, just as the gamma or convexity shows the deviation from a delta or duration
         neutral hedge when the underlying price or yield moves.
         Source: Howard Savery, "Quantifying Volatility Convexity," Derivatives Strategy, 2/2000, pp. 54-
         55.

VOLAX Future
    A futures contract based on the VDAX (q.v.) volatility index for the DAX stock
    index.

vomma
    The sensitivity of vega (also known as kappa) to a change in volatility. Hence, the
    second derivative of option value with respect to a change in volatility.

vulnerable option
        1. "[An option] on a defaultable instrument, subject also to their issuer's default
        risk. Ex: A put issued by a shaky bank on a corporate bond issued by a third
        party."
        (Giovanni Barone-Adesi, private email correspondence, 9/10/98.)
        2. An option "subject to the additional risk that the writer of the [option] might
        default."
        (Robert J. Jarrow and Stuart Turnbull, Derivative Securities, Cincinnatti, South-
        Western, 1996, p. 575.)
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-W-
Warrant
     An option that a corporation issues, with its own shares as the underlying asset.
     The crucial implication is that exercise of the option changes the number of
     claims against the corporation's assets. Thus, the pricing equations for Call (Put)
     Warrants and ordinary Call (Put) Options differ by the dilution (antidilution) effect.
     Empirically, warrants are options with a long time to expiration, which may be
     several or many years, or even decades or an infinite time. An option on asset A
     that party B issues and lists on an exchange. Party B might a corporation, a
     government, etc. Endowment Warrants (q.v.). Installment Warrants (q.v.).

weather derivatives
        Definition: Derivative products whose values depend on risky weather variables, such as
        temperature, precipitation, or dollar damage from extreme weather.
        Example: Options on heating or cooling degree days, hurricane-based catastrophe bonds.
        Application: An insurer or reinsurer who wanted to lay of f some risk in the capital markets might
        issue a bond that repaid principal as a function of the loss rate for Florida East Gulf Coast
        property casualty rates.
        Pricing: The pricing models are sensitive to assumptions, as usual. Historical results depend on
        the historical period. With global warming and El Nino, pricing isn't simple.
        Risk Management: Catastrophe contracts are simple ways of laying off weather risk.

WEBS
        World Equity Benchmark Shares (q.v.).

When Issued Market
     The market for forthcoming On-the-Run (q.v.) securities.

widget
     A brand of listed security representing a claim against a share or basket of
     shares. A widget with an underlying index or basket is comparable to SPDRS
     (q.v.) or WEBS (q.v.) listed on the American Stock Exchange, but can have a
     different underlying portfolio. A widget with an underlying share is comparable to
     an ADR (q.v.). W.I. Carr Indosuez of Hong Kong created and listed widgets on
     the Luxembourg Stock Exchange. (Rachel Horsewood, "What's in a Name –
      Introducing the Widget," AsiaRisk, August 1997.) The main advantage is
      reducing the transaction cost for investing in a basket of shares.

World Equity Benchmark Shares
      Each WEBS share is a claim on a portfolio of publicly traded shares in a
      particular country. That portfolio corresponds more or less to the MSCI portfolio
      for that country. All WEBS shares are listed on the American Stock Exchange
      and trade in dollars. Roughly speaking, each WEBS is to an MSCI Indexes of
      foreign stocks what Spiders (q.v.) are to the S&P 500 Index of U.S. stocks.

      Foreign Fund, Inc. issues all WEBS shares. Any investor can create (redeem) a
      "Creation Unit" – i.e., a fixed number – of WEBS shares by depositing the
      appropriate underlying shares, plus cash expenses (WEBS shares) with an
      "Authorized Participant" in exchange for WEBS shares (underlying shares, less
      cash expenses). That makes a WEBS share like a share in an open end
      investment company (mutual fund).

      WEBS are listed and trade exactly like shares in a closed end fund and other
      ordinary shares. A trader can sell them whenever the American Exchange is
      open, and can sell them short. However, it is possible to create or redeem shares
      continuously, as with mutual fund shares.

      Any of the underlying shares may pay a dividend. The country that is the source
      of dividends for the underlying shares of WEBS may withhhold dividend income.
      Foreign Fund, Inc. retains dividend income temporarily, deducts expenses, and
      distributes the remainder at least each year.

      The I.R.S. treats dividends and capital gains in a manner similar to the way it
      treats them for a mutual fund holding foreign shares.

      (Funds Distributor, Inc. World Equity Benchmark Shares; Questions and
      Answsers. 1996.)

      WEBS and a competitive family of international mutual funds, CountryBaskets hit
      the market in the first half of March, 1996. (Peter C. Du Boi, "Deutsche Bank,
      Morgan Stanley Offer Ways to Play Foreign Indexes on U.S. Exchanges,"
      Barron's, 3/11/96.) Apparently, WEBS won the battle in the marketplace, and
      Deutsche Morgan Grenfell plans to dissolve the CountryBasket funds in March,
      1997. (Maureen Nevin Duffy, "Deutsche MG Dumps Baskets," Financial Trader,
      3/97.)

Worst-of-Two Option
      A payoff which equals the minimum of two option payoffs, such as the minimum
      of a call on asset 1 and a put on asset two. Cf. Best-of-Two Option.
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-X-
Xerxes
      The sensitivity of Convexity (q.v.) to a change in yield.
      The "Convexity" of Modified Duration (q.v.).
      The third derivative of a financial instrument's value with respect to its yield.
       (Source: "Derivative Mortgage Securities Glossary," Dean Witter, Mortgage
       Backed Securities Department, Derivative Products Group, January 1995.)

       Hedging so that Xerxes equals zero is one step beyond Convexity hedging,
       which is itself one step beyond matching durations of one's investment and
       (short) hedge portfolio. In theory, such a hedge would require relatively little
       rebalancing.
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-Y-
Yankee market
     The U.S. foreign market (q.v.). The market in the U.S. for securities that non U.S
     . companies and governments issue. Example: Some shares of Nomura
     Securities trade in New York in the Yankee market.
yard
       Definition: One billion units of a currency.
       Usage: "I‟ve got a customer who wants to buy a yard of Mexican pesos. Price, please." The
       customer wants to buy a billion pesos.
YEELDS
     Yield Enhanced Equity Linked Debt Securities (sm). Lehman Brothers'
     proprietary synthetic Equity Linked Debt Security (q.v.). Lehman issues the
     security, which pays a high coupon until maturity, then pays the value of the
     underlying common stock (not Lehman's) – up to a cap, such as 150% of the
     issue price. (Pratt, Tom. "Lehman's new 'Yeelds' trade on the Amex – or do
     they?" IDD, Aug. 22, 1994, p. 10.)

Yield Burning
      Definition: The IRS's name for the dealer's crime of overcharging state and local
      governments and authorities for Treasury securities that they use in "advanced
      refunding" of old, high-yielding municipal bond issues with new, low-yielding
      ones.
      Application: After interest rates decline, the tax-exempt entities issue new bonds
      with low coupons and use the proceeds to buy just enough Treasury bonds to
      cover the higher coupons on the old bonds. If the entity is able to use less than
      the full proceeds of the new bond issue to buy the Treasuries, thus, turning a
       profit, the IRS taxes this profit. If the bond dealer marks up the Treasuries above
       market to reduce the profit, this reduces the IRS take. "Michael Lissack, a former
       managing director of Smith Barney who identified the arcane and complex
       practice [of yield burning], originally filed the suit [against various bond dealers].
       ...
       "As recently as 1996, the Department of Justice had not definitively decided that
       yield burning falls under the federal False Claims Act.
       ...
       "The government's had difficulty pursuing allegations of yield burning because
       the bond issuers are often unaware of the price gouging, as it can be done
       without affecting the issuer's savings on the refunding."
       (Michael Brick, "Deutsche Bank Alex. Brown to Pay Over $15 Million to Settle
       Yield-Burning Suit," NYTimes.com/TheStreet.com,
       http://www.nytimes.com/yr/mo/day/news/financial/17alex.html, 11/17/99.)
        Example: "For example, the lawsuit alleges that Alex. Brown secretly charged
       the state of Pennsylvania a markup of 4.5 basis points instead of 0.45 basis
       points in a $494 million bond offering in March 1994. The federal government
       was defrauded, according to the I.R.S., because it could have collected taxes on
       the profits if the lower amount was charged."
       (Brick, op.cit.)
       Comment: While charging what the market will bear may come naturally to a
       competent dealer, it is against the law in many cases. Woe be to the dealer who
       charges an excessive markup in the OTC stock market or to municipal refunders
       in the market for Treasury securities.
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-Z-
Z-Bond
     A CMO (q.v.) tranche (q.v.) that resembles a Zero Coupon Bond (q.v.) and
     ordinarily has neither the first, nor the last claim on the CMO‟s underlying cash
     flows and asset value. Hence, the Z-Bond has significant Credit Risk (q.v.) and
     Market Risk (q.v.).

ZENS
       Zero-coupon exchangeable notes. Equity-linked notes that pay at maturity the
       greater of 100% of the appreciated value of original principal invested in stock or
       the original principal amount. Any time before maturity, the bondholders can
       exchange the bonds for 95% of the appreciated value of the corresponding stock.
       The bondholders pay for their embedded options by accepting a lower coupon
       plus quarterly dividend payments. ("RELIANT ISSUES $1b IN EQUITY-LINKED
       NOTES," Power Finance & Risk, 9/27/99.)

ZEPO
       A Zero Exercise Price Option (q.v.).
Zero Cost Collar
      Aka "Costless Collar". A howlingly funny misnomer. "Hidden-cost Collar" would
      be more accurate. Think about it. A dealer won't do a transaction for you if it
      doesn't cost you something, because his revenue is your transaction cost. The
      purchase of a put option financed by the sale of a call.

Zero Coupon Bond
      A bond that pays no coupon, just par at maturity.

Zero Exercise Price Option
      A European Call Option with strike price of zero. The owner will certainly exercise
      it, so it is equivalent to owning the underlying asset without receiving the cash
      flow (dividends or interest) through expiration. (Source: Australian Financial
      Review Dictionary of Investment Terms.)

Zero Gain Collar
      A Costless Collar (q.v.) consisting of a short Call (q.v.) and long Put (q.v.), where
      the short Call's strike is ATM (q.v.). Hence, when owned in combination with a
      long position in the underlying, the Zero Gain Collar gives up all the underlying's
      upside gain, and the combined position can never show a profit.
4/28/00 zeta
         Definition: The market value of an option, less its model value, using the ATM implied vol for the
         same expiration.
         Application: Zeta is a measure of the importance of using the volatility smile, rather than only the
         ATM volatility.
         Source: Howard Savery, "Quantifying Volatility Convexity," Derivatives Strategy, 2/2000, pp. 54-
         55.


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-#-
1M, 2M, 3M, 6M, 12M
      Refers to a loan or swap with initial cash flows on spot date (ordinarily, two
      business days) and cash flows in the opposite direction one, two, three, six, or
      twelve months later. In the Eurodeposit and FX markets, the delivery date for
      funds traded. For the spot market it would be the spot date, ordinarily two
      business days after the transaction. For the forward market it would be a future
      delivery date. In the bond market (usually), the date on which the buyer begins to
      earn interest.

1978 International Banking Act
      The U.S. law that instructs the Fed to delete any regulations that put U.S. banks
      at a disadvantage, relative to U.S. branches of foreign banks.
3-1 ARM
       An adjustable-rate mortgage loan that has a fixed rate for three years, then
       adjusts to market conditions each year.
50 at 7
       Floor trader language meaning that the trader is offering 50 contracts at 7 (or
       7/32nds, etc.) per contract. (Source: Charles di Francesca, as quoted by William
       D. Falloon in "God Doesn't Trade Bonds," Derivatives Quarterly, Fall 1999.)

6 bid at 7
       Floor trader language meaning that the trader is making a market, bidding 6 and
       offering at 7 or 6/32nds and 7/32nds, etc. (Source: Charles di Francesca, as
       quoted by William D. Falloon in "God Doesn't Trade Bonds," Derivatives
       Quarterly, Fall 1999.)

6 for 50
       Floor trader language meaning that the trader is bidding 6 (or 6/32nds, etc.) per
       contract on 50 contracts. (Source: Charles di Francesca, as quoted by William D.
       Falloon in "God Doesn't Trade Bonds," Derivatives Quarterly, Fall 1999.)

88888
        The number of the account that Nick Leeson of Barings allegedly opened in July
        1992 and used to hide trading losses that accumulated to GBP 830 million by
        February, 1995.

				
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