CFM1107 - Glossary to the Corporate Finance Manual

Glossary

A B C D E F G H I L M N O P Q R S T U V W YZ

A

Acceptance credit

The use of bills of exchange by a company as an alternative to short-term bank borrowing. The company draws a bill of exchange on an accepting house (a financial institution which guarantees payment of the bill on the maturity date) and sells the bill to a bank for less than its face value. The accepting house pays the bank the face value of the bill on the maturity date; the company must fund the repayment. In effect, the company has borrowed money; the discount at which it sells the bill to the bank is equivalent to interest.

Accruals basis (accrual accounting)

Accounting basis that brings income and expenses into account in a period of account in which they are earned or incurred (even if not actually received or paid).

AFS

See available for sale.

American (or American-style) option

An option which can be exercised on any business day until the expiry date. See also European option, Bermudan option.

Amortised cost

A method of measuring a financial instrument by taking the amount at which an asset or liability is measured at initial recognition minus any repayments of principal, any reduction for impairment or uncollectability and plus or minus the cumulative amortisation of the difference between the initial amount and the maturity amount. The amortisation is calculated using the effective interest method.

Amortising swap

A swap whose underlying principal amount declines in stages through the life of the swap.

Arbitrage

Taking advantage of profitable opportunities in markets that arise from pricing anomalies. Risk-free arbitrage profits are possible if two instruments with identical characteristics are trading at different prices in different markets - the arbitrageur can simultaneously sell the higher-priced asset and buy the lower-priced asset.

ASB

Accounting Standards Board – the role of the ASB is to issue accounting standards having taken over this role from the Accounting Standards Committee (ASC) in 1990.

Asian option

An option where the amount received at settlement depends on the difference between the average price of the underlying asset over a particular period and the strike price. Also known as an average rate option.

Ask price

The price at which a trader or market maker is willing to sell. Also known as offer price.

Asset-backed security (ABS)

Tradable debt (normally issued by a company) backed by a pool of assets, such as stocks of finished goods or raw materials, trade debts, bonds, loans or mortgages. If the issuer defaults, the bondholders have first claim on the asset backing the bond.

Asset-linked security

Security whose value is linked to the value of an underlying asset, such as land or shares.

Asset swap

A swap that enables the investor to alter the characteristics of an investment, such as its interest rate characteristics or denominated currency.

Assign or assignment

A transfer of an asset or the right to receive payment from the original beneficiary (the assignor) to another (the assignee). This is different to novation.

Assignment (options)

A notice sent by the clearing house to the writer of an option telling him it has been exercised.

At-the-money (ATM) option

An option where the strike price is at the current market level of the underlying. See also in-the-money, out-of-the-money option.

Available for sale

IAS 39 categorises financial instruments into four types, which determine the presentation and measurement of the instruments in the accounts. All non-derivative financial assets that are not classified in another category are categorised as ‘available for sale’.

Average rate option

See Asian option.

B {#}

Bad and doubtful debts

Debts proved or estimated to be wholly or party irrecoverable and either written off by the lender (in the case of a debt which is wholly bad) or written down in the lender’s books to their realisable value. See also Impaired Debts.

Basis point

One hundred basis points (bp) make up one percentage point, so 1 bp is equivalent to 0.01%. For example, an interest rate cut of 15 bp might take an interest rate from 3.15% to 3%.

Basis swap

An interest rate swap where two different types of floating rate interest are exchanged, for example, 6-month LIBOR for 3-month LIBOR.

BBA

British Bankers’ Association – the leading trade association for the UK banking and financial services sector.

Bearer security

A bond or other security issued in paper rather than electronic form. Title to the bond is evidenced by possession of the physical paper, rather than by the holder of the bond being registered.

Bear market

In a bear market prices are falling. A bear strategy is based on the belief that prices will fall. For example, investors will tend to sell if losses are anticipated.

Bermudan (or Bermudan-style) option

An option which can be exercised on any one of a range of dates.

Bid

An offer or undertaking to buy something at a specific price.

Bid price

The price at which a market maker or trader is willing to buy an instrument. The opposite of ask price, or offer price.

Bid-offer spread

The difference between the bid price and the offer price of a particular asset.

Bifurcation

The process of separating, in accordance with IAS 39, an embedded derivative from its host contract.

Bill of exchange

An unconditional order written and signed by one person (the drawer) and addressed to another person (the drawee). The order instructs the drawee to pay a specified sum of money to a specified person (the payee), either on demand or at a specified future date. The drawee must ‘accept’ the bill (accept liability to pay the amount when the bill matures) by signing the face of the bill. The bill then becomes an ‘acceptance’. A bill of exchange is a negotiable instrument: the payee can turn it to account immediately by selling it, usually at a discount, to a bank or to some other person. (See acceptance credit). A cheque is a special form of bill of exchange, with a clearing bank as the drawee.

Bill of lading

A foreign trade document used to describe the full details of the goods being sent. In the UK it is a negotiable instrument which gives the holder the right to possession of the goods.

Billion

In the financial world, used exclusively in the US sense of one thousand million (1,000,000,000) rather than one million million. Traders sometimes use the term yard (from the French ‘milliard’) to avoid confusion with ‘million’.

Black-Scholes model

The classic pricing model developed by Fischer Black and Myron Scholes in 1973 for the valuation of European-style options.

Bond

A negotiable written instrument evidencing a debt. Under the terms of the contract, the issuer is obliged, among other things, to pay the holder a fixed principal amount on a specified future date, and often to also make periodic payments of interest. Companies, governments and local authorities or other public bodies usually issue bonds. Banks and investors buy and trade bonds.

Bond stripping

Separating an interest-bearing security into separate components: the right to receive the principal (called the principal strip) and the right to receive interest (a series of coupon strips). The separate components are repackaged and can be traded individually. US Treasury Bonds are widely traded in stripped form. US bond strips are called STRIPS (Separate Trading of Registered Interest and Principal of Securities). The strip market in Europe, including the UK, is less active, although there is a market in gilt strips.

Broker

An individual or firm that acts on another’s behalf and, in return for a fee, brings potential buyers and sellers into contact with each other.

Broker-dealer

Someone who buys and sells securities on his or her own account and also acts as broker for clients.

Bull market

A market in which prices are generally rising and investor confidence is high. A bull strategy is based on the belief that prices will rise.

Bundesanleihen (Bund) future

Futures contract based on a notional German Government bond with a 4% coupon and 8.5 to 10.5 year maturity.

Buoni del Tesoro Poliennali (BTP) future

Futures contract based on notional Italian Government bond with a 6% coupon and 8 to 10.5 year maturity.

C {#}

Callable

Of a bond, the issue terms are such that the issuer has an option to redeem the bond before the maturity date.

Call option

An option giving the holder the right, but not the obligation, to buy the underlying subject matter, at a pre-agreed price, on or before a specified future date.

Cap

An option product that limits the holder’s interest rate exposure but still allows the holder to profit from advantageous interest rate movements.

Capital instruments

Any instrument used by companies to raise finance, including shares, debentures and loans.

Capped floater

A floating rate note with a maximum (but no minimum) rate of interest.

Cash flow hedge

A hedge of the exposure to variability in cash flows that is attributable either to a particular risk associated with an asset or liability (such as all or some future interest payments on variable rate debt) or a highly probable future transaction, and could affect profit or loss.

Cash settlement

The settlement between the parties to a derivative contract (or other financial product) of their mutual rights and obligations by means of payment of a cash sum by one party to the other, or the exchange of cash sums.

CBOT

Chicago Board of Trade. An exchange established in 1848 for trading financial, metal and commodity futures and options.

Central Gilts Office (CGO)

The computerised settlement system for gilt transactions originally operated by the Bank of England. In July 2000 the Bank transferred the system to the CREST system and decommissioned the CGO.

Certificate of deposit (CD)

A transferable/ tradeable document normally issued by a bank, which acknowledges the deposit of a sum of money and recognises the issuer’s obligation to repay the amount to the bearer of the CD on a future date.

CFD

See contract for differences.

Clean price

The price of a bond is quoted ‘clean’, that is without taking account of accrued interest. The clean price plus accrued interest is called the dirty price.

Clearing

In the context of futures and options trading, clearing denotes all activities from the time a commitment is made for a transaction until it is settled. It involves the management of post-trading, pre-settlement credit exposures, to ensure that trades are settled in accordance with market rules, even if a buyer or seller should become insolvent prior to settlement. Clearing includes reporting/monitoring, risk margining and the netting of trades to single positions.

Clearing house

An entity (which may be part of a futures or options exchange, or an affiliate of one, or independent) that matches and guarantees the performance of trades and holds collateral lodged by participants, usually by being central counterparty as principal to every trade it guarantees.

Clearing member

A member of an exchange, of guaranteed reputation and creditworthiness, with which the clearing house will enter into contracts as principal.

Close out

When a futures or options position has been closed out, the person has no further interest in the market. Closing out a position is usually effected by entering into a transaction opposite to that by which the position was opened. Thus someone who has sold futures contracts will close out the position by buying an equal number of the same contracts, and vice versa.

CME

Chicago Mercantile Exchange. An exchange for open outcry and automated trading of financial and commodity futures and options.

Collateral

A sum of money or other assets that are transferred by one party (A) to a transaction with the other party (B), so that B will have recourse to the assets in the event of default by A.

Commercial paper (CP)

Unsecured, short-term loans (less than 1 year) issued by companies. The debt is usually sold at a discount to face value. The funds are typically used for working capital, rather than fixed assets such as a new building.

Compound interest

Interest calculated on the principal plus the interest accrued to date.

Compound option

An option over an option, which gives the owner the right to buy (or sell) an option at a set date at a set price.

Compound financial instruments

Non-derivative financial instruments which have both a liability and an equity component.

Consideration

The value given in payment for something, either in cash or another form.

Collar

A combination of an interest rate cap and floor.

Constant rate of return

The result of an arithmetical calculation which takes the total yield that a lender receives from a loan and works out what percentage of the outstanding capital they would receive each year if that yield accrued in equal amounts from year to year.

Contract for differences

Usually abbreviated to CFD or CfD. A legally enforceable arrangement between two parties to realise a profit, or avoid a loss, by reference to movements in the price or value of a financial or non-financial asset, an index or other factor. There is a statutory definition at CTA09/S582(1). Swaps and futures or options settled in cash rather than by delivery of the underlying are examples of CfDs.

Convertible (debt)

Debt that gives the holder the option of either receiving repayment of the principal at maturity, or converting the debt into shares (either in the issuing company or some other company).

Counterparty

A party in any two-way financial transaction which is undertaken.

Coupon

The nominal annual rate of interest receivable on a fixed income security expressed as a percentage of the principal value. It is generally paid to the holder of the security annually, semi-annually or quarterly, depending on the type of security. The term is sometimes used loosely to denote any income-like return on an investment. (On a security issued in bearer form, each coupon is physically detachable from the security for presentation to the issuer or his agent as evidence of entitlement to an interest payment.)

Coupon strip

See bond stripping.

Coupon swap

An interest rate swap in which a stream of fixed rate interest payments is exchanged for a stream of floating rate interest payments.

Covered call

The sale of call options while long the underlying instrument. The covered call writer gives up any potential upside beyond the strike of the calls in exchange for the premium income. The opposite of naked option.

Covered put

The sale of put options while long cash.

Credit default swap

An arrangement which allows the credit risk associated with an asset (such as a loan) to be transferred to another party, without transfer of the asset. The buyer of the swap makes periodic payments to the seller in return for protection in the event of, say, default on a loan.

Credit spread

The difference in yield between a specific asset, usually a bond issued by a company, and an agreed benchmark, which is usually a very low risk investment, such as a gilt. The less creditworthy the company issuing the bond, the greater the return which investors will expect, in order to compensate them for the increased credit risk.

CREST

CREST is the London-based electronic settlement system for dealings in shares and bonds.

Cross rate

The exchange rate between two currencies expressed in terms of their relationship with a third currency.

Cum coupon

The purchaser of a bond cum coupon is entitled to receive the next interest payment.

Cumulative preference shares

As preference shares, but with the right to receive a missed dividend in a subsequent year.

Cumulative redeemable participating preference shares

The rights and terms of the preference shares are written into the Articles of Association of the issuing company and may include the right to appoint a director to the Board, and have a variety of voting rights attached depending on the nature of the resolution and the nature of the meeting at which the resolution is to be considered. In addition to a fixed, normally annual, dividend, the shares may participate in the profits of the company via a further dividend, for example, based on the reported profits of the company or based on a proportion of the dividends declared on the ordinary or other classes of shares.

Currency forward

A forward foreign exchange contract.

Currency swap

An obligation between two parties to exchange, for a set period, interest obligations on notional principal amounts in two different currencies, and then to exchange the corresponding principal amounts at the end of the period at an exchange rate agreed at the beginning of the swap.

D

Day trade

A position opened and closed within the same trading day.

Debenture

A debenture is a loan agreement where the borrower is a company. Typically, a debenture will set out the terms of the loan, the amount borrowed, repayment terms, interest, charges securing the loan and so on, including the right of a lender to appoint a receiver should the borrower default. Debentures are usually secured by charges on the company’s property, but do not have to be. It is common for the terms of a loan to be in a separate loan agreement document, cross referred to the debenture document which constitutes the security for the loan.

Debt/equity swap

Exchange of debt for equity, often part of a company reconstruction or takeover.

Debt instrument

A legal document evidencing a debt, such as commercial paper or a bond.

Deeply discounted security

Defined under ITTOIA05/S430 as a security where the amount payable on maturity or any other occasion when the security can be redeemed will or may exceed the issue price by more than 0.5% for each year in the redemption period, up to a maximum of 30 years. The redemption period is the period between the date of issue and the date of redemption. Where certain conditions apply, the tax rules ensure that gains on such securities are taxed as income, rather than as capital gains.

Delivery month

The specified month in which an exchange traded futures or options contract is fulfilled. For contracts traded on LIFFE, and many other exchanges, delivery months are March, June, September and December. Options may also be traded on a 1-2-3 month cycle in addition to the quarterly cycle, the details are defined by each exchange.

Delta

The measure of how sensitive the value of an option is to changes in the price of the underlying. The change in the value of an option is compared with a change in the price of the underlying.

Demand loan

A loan where the lender could ask for repayment at any time ‘on demand’. Bank Overdraft facilities are provided on demand.

Depositary receipt

Document proving ownership of an asset deposited with a bank for safe keeping. Some depositary receipts are tradeable.

Derecognition

The removal of a previously recognised financial asset or financial liability from an entity’s balance sheet.

Derivative

An instrument whose value is dependent on, or derived from, the value of some underlying asset. It is defined for tax purposes at CTA09/S576.

Designated assets or liabilities

A company may designate a financial asset or liability to be measured at fair value through profit or loss upon initial recognition (subject to meeting certain criteria under FRS26/IAS39).

Direct quotation

The price of each unit of foreign currency expressed in terms of the home currency, which will be sterling in the UK, e.g. £0.6960=$1. Compare with indirect quotation.

Dirty price

The value of a bond is the dirty price - that is the clean price plus accrued interest. It is also referred to as the present value or cost.

Discount

The difference between the value of a bond or other loan relationship at any time, and its (higher) maturity or face value. Issuing a bond at a discount is a way of rewarding the investor, either instead of, or as well as, paying interest. See also market discount and issue discount.

The difference between the spot price of a foreign currency and the (lower) forward exchange rate.

The difference between the forward price or future of any financial instrument or commodity and its (higher) current value.

Discounted security

A security issued at a discount to its face value.

Discount factor

The rate used to derive the net present value of a sum of money to be received at a future date using an assumed rate of return which someone could get if they received the money today and invested it. See present value.

Disintermediation

The substitution of direct borrowing by companies, government agencies etc from the investing public, for bank intermediation between borrowers and lenders. This eliminates banks’ traditional interest turn, but creates scope for fee income in managing new issues of securities. See securitisation.

Documentary letters of credit

A Documentary Letter of Credit (‘LC’) is a written undertaking given by a bank on behalf of an importer to pay the exporter a given sum of money within a specified time, providing that the exporter presents documents which comply with the terms laid down in the LC. LCs can be for any amount, in any freely traded currency, and, subject to the presentation of compliant documents, may be payable: at sight, which means as soon as a compliant set of documents are presented to the paying bank; or, after a specified term, for example, at 30, 60, 90 or 180 days of sight or Bill of Lading date. If the documents are not presented exactly as specified in the LC, payment will not be made unless the importer gives their authority to waive or amend the specified condition. A fundamental principle of LCs is that banks deal with documents and not with the goods to which the documents refer. For example, if the importer is not happy with the quality of the goods but the documents comply with the terms and conditions of the LC, the importer’s bank is obliged to pay the exporter. See also Letter of credit.

Drawdown

The drawing of funds made available by financial institutions.

E

EDSP

Exchange Delivery Settlement Price. The price of the underlying subject matter when an exchange-traded future or option reaches expiry. This determines the price for physical delivery or cash settlement.

Effective interest method

A method of calculating the amortised cost of a financial asset or financial liability, and of allocating the interest income or expense over the relevant period

Embedded derivative

A component part of a hybrid financial instrument which also includes a non-derivative host contract with the effect that some of the cash flows of the hybrid instrument vary in a way similar to a stand alone derivative.

Entity

Any business operation that draws up accounts. The term includes not only UK and foreign companies, but also such things as joint ventures, limited liability partnerships, branches of companies and partnerships and similar associations set up under the laws of overseas countries.

Equity

The residual interest in the assets of an entity after deducting all liabilities; equivalent to shareholders’ funds or reserves.

Equity derivative

A future, option or swap whose underlying asset is, or whose underlying assets include, a specific share or shares, or a share index.

Equity instrument

A contract that evidences a residual interest in the assets of an entity after deducting all its liabilities.

Equity options

The right but not the obligation to buy (call) or sell (put) an underlying equity instrument.

Eurex

The main futures and options exchange in Germany.

Eurobond

Tradable bonds issued in a currency other than the issuer’s home currency outside the issuer’s home country. This is the general market usage and differs from the definition at ITA07/S987. The use of the prefix ‘euro’ is somewhat misleading. It is used for historical reasons. Eurocurrency deposits may be of any currency in any country. So there are euroyen, euroswiss and even euroeuro.

Eurocurrency

Eurocurrency is money in the form of bank deposits of a currency outside the country that issued the currency. The most common currency deposited as eurocurrency is the US dollar, and the term eurodollar is often used to refer to dollar deposits.

Eurodollar

Eurodollars are the most common form of eurocurrency; they are US dollar deposits held outside the US.

European (or European-style) option

An option which is only exercisable on the expiry date.

Exchange-traded

A derivative contract which is traded on a regulated futures or options exchange. See also over-the-counter.

Execution risk

The risk inherent in completing the final stages of an exchange-traded transaction.

Exercise price

Also called the strike price, this is the price at which a derivative gives the right or obligation to buy or sell the underlying asset.

Exotic derivatives

Innovative and non standard derivative products are often called ‘exotic’. The term has no precise meaning.

Expiry

The last date an option can be traded or exercised. For European options, this is the only date on which options may be exercised.

Exposure

Susceptibility to any perceived financial risk.

F

Factoring

An arrangement whereby a company sells its invoiced debts, at a discount from their face value, to a specialist debt factor. This gives the company immediate cash and transfers the credit risk from the company to the debt factor subject to the Factoring Agreement.

Fair value

The amount for which an asset could be exchanged, or a liability settled, between knowledgeable willing parties in an arm’s length transaction.

Fair value hedge

A hedge of the exposure to changes in fair value of a recognised asset or liability, or an unrecognised firm commitment.

Fair value through profit or loss

IAS 39 categorises financial instruments into four types, which determine the presentation and measurement of the instruments in the accounts. A financial asset or liability categorised FVTPL is measured at fair value, with changes going through the profit and loss account. This category includes financial assets and liabilities held for trading and all derivatives, except those designated as hedging instruments in certain types of hedge.

Financial instrument

A contract that gives rise to both a financial asset of one entity and a financial liability or equity instrument of another entity. This definition (from IAS 32) is wide and includes cash, debt and equity investments, net cash-settled commodity contracts and derivatives (including embedded derivatives).

Financial Services Authority (FSA)

An independent non-governmental body given statutory powers under the Financial Services and Markets Act 2002 accountable to Treasury Ministers and through them to Parliament. Responsible for overseeing and authorising Recognised Clearing Houses (RCHs), Recognised Investment Exchanges (RIEs) and also firms who carry out investment business. Is the licensing authority allowing Banks to take deposits. The FSA’s objectives are: maintaining market confidence; promoting public awareness of the financial system; consumer protection; and the reduction of financial crime.

Firm commitment

A binding agreement for the exchange of a specified quantity of resources at a specified price on a specified future date or dates. For example, a company that has signed a contract to buy trading stock will have a firm commitment

Fixed rate loan

A loan paying interest at a fixed rate for the duration of the loan.

Floating rate

An interest rate that is periodically varied in line with a benchmark of commercial interest rates, such as LIBOR.

Floor

An option product that guarantees a lender or depositor a minimum interest return.

Forecast transaction

An uncommitted but anticipated future transaction.

Foreign operation

An entity that is a subsidiary, associate, joint venture or branch of the reporting entity, the activities of which are based or conducted in a country or currency other than those of the reporting entity.

Forward contract

A contract to buy or sell foreign currency or another underlying subject matter at an agreed price for delivery on a specified future date.

Forward rate (or price)

The price at which a currency, or some other asset, can be purchased for delivery at a specified future date. See spot price.

Forward rate agreement (FRA)

An agreement fixing the rate of interest to be applied to a notional loan or deposit, for a specified future period.

FRED

Financial Reporting Exposure Draft - draft accounting standard published for public comment by the ASB.

Free cash flow

The cash flow of a company after all trading, investment, capital expenditure, and balance sheet movements have been accounted for, including the payment of tax, and is available to either repay debt, or fund dividend payments, or fund return of capital to the shareholders.

FRN

Floating Rate Note. See floating rate.

FRS

Financial Reporting Standard

Functional currency

The currency of the primary economic environment in which the company operates. See presentation currency.

Futures

An agreement (obligation) to buy or sell a given quantity of a particular asset, at a specified future date, at a pre-agreed price. Futures contracts have standard delivery dates, trading units, terms and conditions. For tax purposes, a future is defined at CTA09/S581(1).

FVTPL

See fair value through profit or loss.

FX

Foreign exchange or forex.

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GAAP

Generally Accepted Accounting Practice. UK GAAP is not formally defined, but would be understood to include mandatory guidance, such as Financial Reporting Standards, relevant company law, and the Listing Rules. UK GAAP also includes other guidance such as Statements of Recommended Practice, and other established practice which may not be set out in mandatory guidance, but would be generally accepted by UK accountants.

Gearing

Gearing measures the extent to which a company is funded by debt. It is commonly the ratio of the debt in a company’s balance sheet to its equity. Alternatively, it is sometimes expressed as the ratio of the debt to the balance sheet total (that is the sum of the debt and equity). Called leverage in the US and some other countries.

Gilt

Sterling denominated bond issued by the UK Treasury and backed by the credit of the UK. So called because the first certificates issued bore a gilded stripe.

Gilt strip

Security created by separating the principal and individual interest payments of a gilt.

Gold standard

Historical system under which the value of currencies was fixed in terms of the value of gold.

Guarantee

An undertaking to meet someone else’s financial obligations, such as a loan repayment, if they default.

Guarantor

Person giving a guarantee.

H

Hedge (noun)

A transaction that reduces or mitigates financial risk.

Hedge efficiency

The success of a hedging transaction in reducing financial exposure.

Hedge fund

Funds which trade capital from rich individuals and institutions aggressively in the market. They may take positions that are many times larger than their capital. Investment in hedge funds is therefore high risk.

Hedged item

An asset, liability, firm commitment, highly probable forecast transaction or net investment in a foreign operation that (a) exposes the entity to the risk of changes in fair value or future cash flows and (b) is designated as being hedged (or treated as being hedged).

Hedging

Refers to designating a derivative (or, for hedges of foreign currency risk only, a non-derivative financial instrument) as a complete or partial offset in profit and loss to the change in fair value or cash flows of a hedged item.

Hedging instrument

A designated derivative (or, for a hedge of the risk of changes in foreign currency exchange rates only, a designated non-derivative financial asset or non-derivative financial liability) whose fair value or cash flows are expected to offset changes in the fair value or cash flows of a designated hedged item.

Held for trading (HFT)

IAS 39 categorises financial instruments into four types, which determine the presentation and measurement of the instruments in the accounts. Held for trading items are either ones that are acquired or incurred principally for the purpose of selling or repurchase in the near future or derivatives (except derivatives which are designated an effective hedging instrument).

Held to maturity (HTM)

IAS 39 categorises financial instruments into four types, which determine the presentation and measurement of the instruments in the accounts. Held to maturity investments are non-derivative financial assets with fixed maturity and determined or determinable payments that an entity has the positive intention and ability to hold to maturity.

Holder

Someone who has bought or subscribed for a bond or similar debt security, and therefore has a right to receive the principal sum from the issuer when the bond matures. Also, someone who has bought an option.

Hybrid financial instrument

A financial instrument combining a non-derivative host contract with an embedded derivative, for example, a convertible bond held by a company.

I

IAS

A standard adopted by the International Accounting Standard Board’s (IASB) predecessor, the International Accounting Standards Committee (IASC). When the IASB replaced the IASC in 2001 it adopted all IAS’s then in force.

IASB

The International Accounting Standards Board (successor in 2001 to the IASC) is an independent accounting standard setter.

IASC

International Accounting Standards Committee (succeeded in 2001 by the IASB).

IBOR

Abbreviation for Inter-Bank Offered Rate. The rate of interest at which banks are prepared to lend to each other. For example LIBOR rates are interest rates in various currencies quoted in London. Banking associations (such as the BBA in London) conduct interest rate fixings which are published in the financial press. Euribor is a fixing of the cost of borrowing in euros, conducted by the European Banking Federation. The Japanese banking association produces Tibor, the cost of borrowing in Yen in Tokyo.

IFRIC

The International Financial Reporting Interpretations Committee, the International Accounting Standard Board’s (IASB) interpretative body. IFRIC issues interpretations of financial reporting issues.

IFRS

International Financial Reporting Standards – a set of accounting rules that became mandatory for the consolidated group accounts of a listed plc for accounting periods commencing on or after 1 January 2005. In the UK, the groups can choose whether to prepare individual entity accounts under UK Generally Accepted Accounting Practice (GAAP), or IFRS.

Impaired debt

Debt sold at less than face value because of doubts over whether it will be repaid in full - see market discount.

Can also refer to debt against which provisions have been raised in the accounts of the lender. A fully provided debt is written down to nil. This does not change the borrowers liability, the debt remains payable in full by the borrower. See also Bad and doubtful debts.

Implied volatility

See volatility.

Imputed interest

Interest deemed under the transfer pricing legislation to be receivable on certain transactions not at arm’s length.

Income statement

Interchangeable with profit and loss account – the primary statement giving information about the company’s performance.

Indemnity

Legal exemption from loss or damage.

Index-linked gilt (ILG)

A gilt on which both the coupon and the capital repayment on redemption are adjusted in line with inflation, as measured by the Retail Price Index, thus protecting the investor against inflation.

Indirect quotation

The price of each unit of the home currency (sterling) expressed as a value in an overseas currency, e.g. $1.4358=£1. Compare with direct quotation.

Insolvency

The Insolvency Act 1986 section 123 defines insolvency in terms of cash flow, i.e. the company is unable to pay its debts as they fall due, and in terms of its balance sheet i.e. the value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities.

Initial margin

In the context of exchange-traded futures and options, a collateral deposit placed with the clearing house when a position (whether it be buying or selling contracts) is first opened.

Interest rate guarantee/interest rate insurance

Terms used generically to denote any derivative products, such as forward rate agreements, caps, floors and collars, which limit a borrower’s or lender’s exposure to interest rate changes.

Interest rate swap

An agreement between two counterparties to exchange cash on a notional principal sum which is not exchanged. The most common structure is the fixed-for-floating swap in which one counterparty agrees to pay a rate over the term of the swap in exchange for a floating-rate payment by the other counterparty. It is possible to swap a fixed for a floating rate of interest (a coupon swap) or one type of floating rate interest for another (a basis swap).

International Petroleum Exchange (IPE)

An exchange for the trading of futures and options over oil, gas oil and other petroleum products.

In-the-money (ITM) option

An option where the strike price is more advantageous than current market value of the underlying subject matter. An in-the-money option will normally be exercised at the earliest possible date. See at-the-money, out-of-the-money options.

Intrinsic value

One of the components of the value of an option - the amount by which the option is in-the-money. See also time value.

ISDA

International Swaps and Derivatives Association. This global financial trade organisation represents participants in the privately negotiated derivatives industry. For ISDA Master Agreement, see CFM13100.

Issue discount

The difference between what someone subscribing to a new bond issue pays and the (higher) nominal value of the bond.

Issuer

Someone (a government, bank, company, local authority) who issues bonds or other debt securities as a way of raising loan finance. A UK company issuing bonds has, for tax purposes, a debtor loan relationship.

L

Letter of credit

A non-negotiable order in writing from a bank, authorising the payment of a sum of money to the person named in the letter; often required by exporters as proof that they will be paid before the goods are shipped. A Letter of Credit (‘LC’) may be Irrevocable, Confirmed, Unconfirmed, Transferable, Revolving, Back to Back, Standby, or include a Red Clause. See also Documentary letters of credit.

Leverage

A term used in the US and some other countries to refer to gearing. It is the use of debt to increase the expected return on equity. It is commonly the ratio of the debt in the company’s balance sheet to its equity. Alternatively, it is sometimes expressed as the ratio of the debt to the balance sheet total (that is the sum of the debt and equity).

LIBID

The London inter-bank bid rate. The rate of interest at which first-class banks in London will bid for deposit funds on the international interbank market. Often used as a benchmark for deposit rates. In practice LIBID is not fixed (officially) in the same way as LIBOR, but is typically one eighth of a per cent below LIBOR. The average of the two is Limean.

LIBOR

London Inter Bank Offered Rate. A benchmark interest rate fixed by the BBA at 11:00 each London business day. LIBOR is set using a daily survey of 16 banks that report the rates they pay to borrow from each other in different currencies and for varying lengths of time. It is thus a key measure of how prepared banking institutions are to lend to each other. See also IBOR.

LIFFE

London International Financial Futures and Options Exchange. It trades a wide range of financial futures and options, including equity derivatives, plus a range of agricultural commodity contracts.

Limit order

An order given to a broker by a customer specifying that the trade can only be executed if the market reaches or betters a particular price.

Liquidity

The market in a financial asset is said to be liquid if it is possible to buy or sell a large number of units in a short period without significantly affecting the price of the asset.

Liquidity also refers to the ability of a company to meet its obligations as they fall due, see Insolvency.

Loan note

Instrument giving evidence of a loan or another name for a bond.

Loan relationship

A term used for tax purposes for a money debt arising from the lending of money. Defined under CTA09/S302.

Loans and receivables

IAS 39 categorises financial instruments into four types, which determine the presentation and measurement of the instruments in the accounts. Loans and receivables must be unquoted non-derivative financial assets having fixed or determinable payments.

London Clearing House (LCH)

A Recognised Clearing House under the Financial Services and Markets Act 2000. Its primary role is to act, in relation to its members, as central counterparty for contracts traded on LIFFE, IPE and LME. When LCH has registered a trade, it becomes the buyer to every LCH member who sells and the seller to every LCH member who buys, ensuring the financial performance of trades. To protect itself against the risks assumed as central counterparty, LCH establishes margin requirements.

London Metal Exchange (LME)

An exchange for the trading of futures and options over non-ferrous metals, such as copper, aluminium, tin, and zinc.

London Stock Exchange (LSE)

The London Stock Exchange provides a market for trading in a wide range of securities, including UK and international equities, debt, covered warrants, exchange traded funds (EFTs), contracts for difference (CFDs) and depositary receipts.

Long

Someone who owns quantities of a particular financial or non-financial asset; thus someone who has bought gilts is ‘long in gilts’. Someone who has bought futures contracts might be described as ‘long the future’ or having a ‘long position’. See also short.

Lot

Standardised contract size for exchange traded futures.

M

Macro hedging

A technique whereby financial instruments with similar risks are grouped together and the risks of the portfolio as a whole are hedged.

Manufactured payment

Payment representing interest or dividends made by the interim holder of a share or security to the original holder.

Margining

The margining system is the means by which the LCH

controls the risk associated with a LIFFE clearing member’s position on a daily basis. Clearing members deposit cash or collateral with the LCH in the form of initial margin and variation margin.

Market discount

The difference between the market price of a bond or other tradable debt security and its (higher) nominal value. If the market value of the bond is higher than its nominal value, it trades at a market premium.

Market maker

A financial institution or individual who has the right to buy and sell securities on their own account, coupled with the obligation to quote buying and selling prices for those securities in the secondary market. See also broker-dealer.

Market order

An order for immediate execution given to a broker to buy or sell at the best obtainable price.

Mark-to-market

The process whereby exchange-traded futures or options are revalued on a daily basis; regular periodic revaluation of any financial asset or liability by reference to its current fair value.

Maturity

The date on which the principal or nominal value of a bond becomes due and payable in full to the holder.

Mezzanine finance

Partway between debt and equity, it has the characteristics of debt but may carry a right to shares, for example, a convertible bond.

Mirror bonds

Reset bonds issued in pairs: one loses value and the other gains in value by a corresponding amount when the terms are reset following a trigger event.

Money market

A wholesale market for the buying and selling of money. Money market paper is predominantly negotiable and traded just like any other product. Maturities are short-term (less than a year).

Multicurrency facility

A borrowing facility where advances can be drawn down in more than one currency.

N

Naked option

A short option position held by someone who does not own the underlying commodity or other asset. See also covered call and covered put.

Net investment in a foreign operation

The amount of the reporting entity’s interest in the net assets of a foreign operation. The accounting for hedges of a net investment in a foreign operation is the subject of IFRIC 16.

Nominal

The face value of a bond; the amount by reference to which the interest coupon is calculated.

Novation

The transfer of the duties under a contract from one party to another by the extinguishing the original contract and replacing it by another. This is different to assignment.

NYMEX

New York Mercantile Exchange, the world’s largest physical commodity futures exchange.

O

Off balance sheet

An asset, liability or commitment, which is not reflected in a company’s balance sheet. This treatment is commonly used to account for derivatives held for hedging purposes by entities applying UK GAAP excluding FRS 26.

Off-exchange

In relation to a transaction, entered into other than under and subject to the rules of an exchange.

Offer price

See ask price.

Offset

The presentation of a financial asset and a financial liability on a net basis in an entity’s balance sheet. FRS25/IAS32 permit such treatment only in certain limited circumstances.

On-exchange

In relation to a transaction, entered into under and subject to the rules of an exchange.

Open interest

The net (i.e. either long or short) open positions in a particular future or option contract which needs to be either traded out before expiry, or delivered at expiry.

Open outcry

A method of face-to-face trading on a futures or options exchange, where bids and offers for a particular contract are made audibly (and visibly, through the use of hand signals) to other members of the exchange. This has been largely replaced by automated trading systems.

Option

An agreement between two parties whereby the holder has the right, but not the obligation, to buy (call option) or sell (put option), a specified underlying asset at a pre-agreed price, at either a fixed point in the future (European-style) or at a time chosen by the holder up to maturity (American-style). Options are available in exchange-traded and OTC markets. A premium is usually payable for an option contract.

Out-of-the-money (OTM) option

An option that has no intrinsic value because the price of the underlying is below the strike price of a call or above the strike price of a put. An option will not normally be exercised while it is out-of-the-money.

Over-the-counter (OTC)

The market for derivatives or other investments created outside organised exchanges, by parties (such as companies, banks and dealers) entering into contracts directly with each other by telephone or screen. See off-exchange and on-exchange.

P

Paper

Generic term for any short-term negotiable debt instrument. See commercial paper, certificates of deposit, promissory note.

Participating preference shares

As preference shares but carrying a right to a profit share as well as a fixed dividend.

Participator

A person with a share of, or interest in, a company.

Pay-off profile

A diagram showing how the amount of money which the holder or writer of an option receives or pays changes as the price of the underlying asset changes.

Performance bond

An arrangement intended to ensure that a contract or arrangement is completed properly. If there is a failure, the bank issuing or guaranteeing the performance bond is liable to pay compensation.

Perpetual debt

Debt that has no maturity date. Interest coupons are paid forever (in theory). Such debt represents a very considerable credit risk to the investor, and would therefore be expected to carry a high rate of interest.

Physical (‘the physical’)

The physical commodity underlying a commodity option or future. Also referred to as ‘the actual’.

Position

An interest in the market (the balance on a running account), either long or short, in the form of open contracts, an amount of currency, purchased financial instruments, etc.

Preference shares

Shares that carry preferential rights to dividends (usually fixed) and to repayment in a winding up, but no voting rights.

Premium

The cost of an option contract.

A sum paid on maturity of a debt security, over and above the principal sum, by way of reward to the investor.

The difference between the market value or issue price of a bond and the (lower) nominal value.

In foreign exchange, the amount by which the forward price of a currency exceeds the spot price (‘forward premium’).

Present value

The current value of a future cash flow. Money receivable immediately can be invested with interest and earn more money. A future cash flow must therefore be discounted at an appropriate interest rate to arrive at its present value. See discount factor.

Presentation currency

The currency in which the financial statements are prepared. Under IAS21 and FRS23 a company can prepare its accounts in any currency. The presentation currency does not have to be the functional currency - sometimes referred to as the reporting currency.

Primary economic environment

This is usually the economic environment in which the company generates and expends cash. It is usually obvious, but where it is not, a decision is made by the company after considering all relevant economic factors.

Primary market

The market for the placement of new securities, such as international, domestic and foreign bond issues. Any subsequent resale or purchase is handled on the secondary market.

Principal value

The amount inscribed on the face of a security which is repayable when a bond or other debt matures (excluding any premium or interest). Can be referred to as the ‘face value’.

Principal strip

A zero coupon bond created when a government bond or other security is stripped. It consists of the right to receive the principal on the maturity date, but no interest coupons. See bond stripping.

Promissory note

A written promise to pay.

Prop trader

A proprietary trader, an employee of a bank or similar financial institution who uses his or her employer’s money to make more money (for the employer).

PSBR

Public Sector Borrowing Requirement – the borrowing needs of all public authorities. The UK Treasury also issues Treasury bills to control daily liquidity, which are not considered to be part of government debt issues.

Purchasing power parity

The theory that an exchange rate between two currencies is related to the purchasing power of the same goods in each currency.

Put option

An option that gives the holder the right, but not the obligation, to sell the underlying. See also call option.

Q

Quanto swap

A variation on the currency swap. Both streams of interest are calculated on principal amounts of the same currency, and the interest payments that are exchanged are all made in the same currency. This is also referred to as a differential or ‘diff’ swap.

R

Real-time prices

Up-to-date market prices for traded contracts (and other financial instruments).

Recovery

Amount of debt repaid by borrower after being written off by the lender.

Recognition

A company is required by IAS to recognise all financial assets and liabilities, including derivatives, on its balance sheet at the time when it becomes party to the contract concerned.

Red clause

A Letter of Credit (‘LC’) that contains a clause which authorises the nominated bank to advance a portion of the value to the exporter before shipping documents are presented.

Advances are made at the risk of the importer. Drawings under an LC are made against a simple receipt from the exporter that they will refund the amount if they do not ship the goods as required. The importer’s account is debited as soon as an advance has been made.

Redeemable preference shares

As preference shares, with the issuer having the right to redeem them, so they have debt characteristics.

Redemption

The repayment of shares or securities, usually at a set time for a fixed amount.

Regulatory capital

The minimum capital required to be maintained by banks and other regulated financial institutions pursuant to, amongst other things, the Basel I and Basel II accords. Regulated by the FSA in the UK.

Release

Giving up rights to repayment of a debt.

Repo

A means of providing short term finance against collateral. The ‘borrower’ agrees to sell securities (such as government bonds or shares) to the ‘lender’, with an agreement to buy them back (repurchase) at a specified later date, either at an agreed higher price or at the market price. The interest rate implied from this ‘lending’ transaction is called the repo rate. The legislation is from CTA09/S542 onwards. See also stock loan.

Repurchase agreement

See repo.

Reset bond

A medium or long-term bond issued with one or more coupons already fixed, but with later coupons remaining to be fixed at a future date according to a reference index, or some event unascertainable at the time of issue.

Revolving credit

A credit arrangement allowing the borrower some flexibility as to the scale and timing of a proposed borrowing or note issue. The borrower can usually increase or reduce his indebtedness with some freedom during an agreed period.

Rollover

The transfer of a futures or options position from one delivery month to a later month. Loans and deposits can be rolled over on agreement between the two original counterparties.

Round trip

A futures or options position plus its offsetting position. Commissions are usually quoted per round trip.

S

Secondary market

The market in which bonds or shares trade once they have been issued. See primary market.

Securitisation

The packaging of debt or other receivables into the form of a tradable security.

Senior debt

Debt which is not subordinated.

Settlement price

The price used for daily revaluation of open futures or options positions (see mark-to-market). Also known as closing price.

Short selling

Selling assets (such as bonds, shares or commodities) that one does not own in the hope of buying them more cheaply later. Also known as shorting, going short, or taking a short position. The opposite of long.

SPAN

Standard Portfolio Analysis of Risk. A method of calculating initial margin requirements by evaluating portfolio risk under a

In the foreign exchange market, the price agreed today at which a currency can be bought or sold for set

number of scenarios used by LCH, LIFFE and other exchanges or clearing houses.

Spot price

tlement in two business days’ time. More generally, spot price refers to the price payable for any asset that is to be delivered immediately, or almost immediately. ‘Asset’ in this context includes money: for example, the spot price of 3-month money is the interest rate at which money could be borrowed today, for three months. See forward price.

Spread

Bid-offer spread is the difference between quotations for selling and buying a financial asset.

The term ‘spread’ is also used to describe combinations of derivative contracts with different pay-off profiles.

SSAP

Statements of Standard Accounting Practice

Stepped interest bond

An otherwise fixed rate bond whose coupon is set to vary at prescribed intervals.

Stock loan

An arrangement between two parties whereby party A transfers securities, such as bonds or shares, to party B with an agreement that the securities will be transferred back on a specified future date. This will normally happen where B has a short position in the bond or share in question. B can use the stock loan to fulfil his obligation to sell the security to another party, and later buy the security in the market in order to transfer it back to A. There is a statutory definition of a stock loan at S263B TCGA92. See also repo.

Stop order (or stop)

An order to buy or sell at the market when and if a specified price is reached.

Straddle

An option trading strategy involving simultaneously buying a call option and a put option with the same strike price and same expiry date. This strategy is designed to benefit when a sharp price movement is expected but the direction is unknown.

Strangle

An option strategy involving one call and one put with different strike prices but the same expiry date. Like the straddle buying strategy, traders use strangle when they expect a sharp swing of the exchange rate in either direction.

STRGL

Statement of Total Recognised Gains and Losses required by FRS3. It is a primary financial statement that includes the profit or loss for the period together with all movements in reserves reflecting recognised gains and losses attributable to shareholders. Accounts prepared under IFRS may present a ‘Statement of Changes in Equity’, or similar statement.

Strike price

The pre-agreed price at which the holder of an option can buy or sell the underlying subject matter.

Strip

One of the tradable products (principal strip or coupon strip) obtained from stripping a bond. See bond stripping.

A sequential series of short-term forward contracts or options used to hedge a longer-term exposure.

Structured product

A financial product consisting of bonds or equities combined with one or more derivatives, engineered to give a particular desired pattern of cashflows.

Subordinated debt

Debt, which is issued on terms that stipulate it, will only be repaid once the claims of more senior creditors have been satisfied.

Surrender

Giving up rights.

Swap

An agreement between two parties to exchange payments over a specific period. The prices, values or levels of the asset(s) or indices underlying the swap determine the payments.

Swaption

An option to enter into an interest rate swap.

Syndicated loan

A very large loan issued by a group of lenders, usually banks or financial institutions.

Synthetic position

A position constructed in order that its cashflows and/or its risk/reward characteristics replicate those of some other financial asset or liability. For example, a synthetic floating rate note can be constructed from a fixed rate note plus a fixed/floating interest rate swap. Someone may construct a synthetic position for the purposes of arbitrage (there is a price differential between the synthetic and the straightforward asset), or because it is simpler than dealing in the asset, or because the synthetic and the asset are taxed differently.

T

Tainting

Held-to-maturity (HTM) investments become tainted if the entity sells or reclassifies more than an insignificant proportion of them before maturity. All its remaining HTM assets must then be reclassified as available for sale.

Term loan

A loan with a period left to run. Compare with a demand loan.

Tick

Usually refers to the standard minimum price movement on an exchange-traded futures or option contract.

Tier 1 capital

The core measure of a bank’s or other regulated financial institution’s financial strength from regulator’s point of view. It consists primarily of shareholders’ equity but may also include preferred stock that is irredeemable and non-cumulative and retained earnings. It forms part of a bank’s or other financial institution’s regulatory capital.

Tier 2 capital

A measure of a bank’s or other regulated financial institution’s financial strength with regard to the second most reliable form of financial capital, from a regulator’s point of view. It consists of undisclosed reserves, revaluation reserves, general provisions, hybrid instruments and subordinated term debt. It forms part of a bank’s or other financial institution’s regulatory capital.

Time value

The amount by which the premium payable for an option contract, or its fair value at any time, exceeds the intrinsic value of the option. An out-of-the-money option will only have time value.

Total return

The overall commercial return from a share or debt security, consisting of income (interest or dividends) and capital gains. A total return swap is a swap where the cashflows payable by at least one party are based on the total return from a specified security or bundle of securities.

Transparency

The degree to which a market is characterised by prompt availability of information on prices and trading volumes. Transparency gives participants the assurance that the market is fair, because everyone has access to the same information.

Treasury Bonds (T-Bonds)

A US government debt security issued by the Treasury Department. The term Treasury Bond (T-bond) is applied to such a security with a maturity of 10 years or more; shorter-term US Treasuries (USTs) are referred to as Treasury Notes.

Treasury shares

A company’s own equity instruments that it has reacquired.

U

UITF

Urgent Issues Task Force

Underlying

The asset (or index, interest rate etc) from which a derivative financial instrument derives its value. The underlying subject matter of a derivative contract is defined at CTA09/S583.

V

Vanilla (or plain vanilla)

A financial instrument, such as a bond or an interest rate swap, of a conventional, standard or well-understood type. See also exotic derivatives.

Variable rate loan

A loan paying interest that’s linked to a reference rate, such as LIBOR, that can vary.

Variation margin

Actual profits or losses arising from the mark-to-market process on open futures and options positions are posted as variation margin. If the amount of margin deposited with the clearing house falls below the minimum margin requirement, a call is made for additional funds to cover the loss. If these funds are not forthcoming, some or all of the open positions are automatically closed out. Conversely realised profits may be called from the clearing house.

Vega

The measure of change in the value of an option compared with a change in volatility.

Venture capital fund

A fund attracting third party investors that invests in and or lends on to businesses needing finance.

Vertical spreads (Bear spread)

An option strategy combining the purchase and sale of two puts (bear put spread) or two calls (bear call spread) with different strikes on the same underlying.

Volatility

Tendency of the price of a share, or other asset, to fluctuate in an unpredictable manner. The value of an option is affected by the volatility in the price of the underlying asset. Historical volatility is a figure derived mathematically from past price movements. Implied volatility is an estimate of future volatility derived from the market price of an option.

W

Waiver

Forgoing repayment of a loan, or other amount legally due to you (such as a dividend).

Warrant

A certificate giving the holder the right to subscribe for certain new shares or securities at a predetermined price. It is therefore a form of option. (See CFM13220).

Writer

The opening seller of an option; the party to an option contract who receives the premium.

Y

Yield

The internal rate of return (taking into account both interest and capital appreciation) on a bond or similar investment, usually expressed as a percentage.

Yield curve

A graph plotting the yield from bonds of differing maturities (for example, UK gilts of differing maturities) against the maturity. The ‘normal’ yield curve is upward sloping, reflecting the fact that investors will usually expect a higher rate of return if they tie up their money for longer periods, since the real value of the money is being eroded by inflation.

Z

Zero coupon bond

A bond that pays no interest. Such bonds will be issued and traded at a deep discount to the face value. The difference between the issue and the redemption prices creates a hefty gain which boosts the yield close to market levels.