Glossary of
derivatives terms
Accrued Interest Interest due on a bond or other fixed income
security that must be paid by the buyer of a secur-
ity to its seller. Usual compensation: coupon rate
of interest times elapsed days from prior interest
payment date (i.e. Coupon date) up to but not
including settlement date. Is used in the calcula-
tion of the invoice amount for bond futures being
delivered.
Actuals An actual physical commodity someone is buying
or selling, for example, soybeans, corn, gold, silver,
Treasury bonds, etc.
Against Actuals A transaction generally used by two hedgers who
want to exchange futures for cash positions. Also
referred to as ‘versus cash’.
AEX Amsterdam Exchanges now part of EURONEXT.
Agent Bank A commercial bank that provides services as per
their client’s instructions.
Agent One who executes orders for or otherwise acts on
behalf of another (the principal) and is subject to its
control and authority. The agent takes no financial
risk and may receive a fee or commission.
All or None (AON) Instruction to buy or sell the entire order in a single
transaction, i.e. not to execute a partial transac-
tion. The AON restricts the size but not necessarily
the time of the transaction.
Allocation (Give Up) The process of moving the trade from the executing
broker to the clearing broker in exchange-traded
derivatives.
American Style Option The holder of the long position can choose to
exercise the position into the underlying instru-
ment until the expiry day.
Arbitrage The simultaneous buying and selling of two dif-
ferent derivatives, or a derivative and its under-
lying where the fair value prices are different.
The arbitrageur has a risk-less trade as the
exposure is flat and the profit is the difference
between the two prices traded.
Asian Option See average rate option.
Asset Allocation The use of derivatives by a fund manager to
immediately gain or reduce exposure to different
markets or asset classes.
Assignment The process by which the holder of a short option
position is matched against a holder of a similar
long option position who has exercised his right.
ASX Australian Stock Exchange.
At-the-Money An option whose exercise price is equal, or very
close, to the current market price of the underly-
ing share. This option has no intrinsic value when
the strike and the underlying price are equal.
ATM See At-the-money.
At-the-Money An option where the strike is the same as the
(currency option) current spot or forward market rate.
Authorised Unit Trust Unit trust that meets the requirements of the
Financial Services Authority to allow it to be
freely marketable. Permitted to use derivatives
for some strategies subject to Trustee’s approval.
Average Rate Option An option where the settlement is based on the
difference between the strike and the average
price of the underlying over a predetermined
period. Also known as Asian option.
Average Strike Option An option that pays the difference between the
average rate of the underlying over the life of the
option and the rate at expiry.
Bargain Another word for a transaction or deal. It does
not imply that a particularly favourable price was
obtained.
Base Currency Currency chosen for reporting purposes.
Base Rate The rate of interest set by the banks as a basis
for the rate on loans and deposits. Can be used
as a reference value for certain derivatives.
168 Glossary of derivatives terms
Basis (Gross) The difference between the relevant cash instru-
ment price and the futures price. Often used in the
context of hedging the cash instrument.
Basis (Value or Net) The difference between the gross basis and the
carry.
Basis Point (B.P.) A change in the interest rate of one hundredth of
one per cent (0.01 per cent). One basis point is writ-
ten as 0.01 when 1.0 represents 1 per cent.
Basis Risk The risk that the price or rate of one instrument or
position might not move exactly in line with the
price or rate of another instrument or position
which is being used to hedge it.
Basis Trade A trade simultaneously of a future and the underly-
ing; a facility offered by some exchanges.
Bear Investor who believes prices will fall.
Bear Market A market in which prices are falling, and sellers are
more predominant than buyers. Usually refers to
equity markets.
Benchmark Bond The most recently issued and most liquid govern-
ment bond.
Bermudan Option An option where the holder can choose to exercise
on any of a series of predetermined dates between
the purchase of the option and expiry. See American
option, European option.
Best Execution The requirement for a broker to obtain the best
market price when buying or selling a marketable
investment on behalf of the client.
Bid (a) The price or yield at which a purchaser is will-
ing to buy a given security.
(b) To quote a price or yield at which a purchaser
is able to buy a given security.
(c) The investor’s selling price of units in a unit-
linked policy.
BIFFEX The Baltic International Freight Futures Exchange.
Bilateral Netting A netting system in which all trades executed on the
same date in the same security between the same
counterparties are grouped and netted to one final
delivery versus payment.
Block Trade A purchase or sale of a large number of futures or
options normally much larger than what constitutes
a ‘normal’ size trade in the market in question. Not
all exchanges permit block trades.
Glossary of derivatives terms 169
Bond A certificate of debt, generally long term,
under the terms of which an issuer contracts,
inter alia, to pay the holder a fixed principal
amount on a stated future date and, usually,
a series of interest payments during its life.
Bonus Issue A free issue of shares to a company’s existing
shareholders. No money changes hands and
the share price falls pro rata. It is a cosmetic
exercise to make the shares more market-
able. Also known as a capitalisation or scrip
issue. Affects the specification of derivatives
based on the underlying share.
Bretton Woods Agreement An agreement that set a system of exchange
rate stability after the Second World War, with
all member currencies having a par value
pegged to the US$, allowing a 1 per cent
variance. This was agreed by major econo-
mists from 44 countries. The International
Monetary Fund and the World Bank were
set up at this conference. The dismantling
of the Agreement led to the launch of the first
financial futures contracts in 1975.
Brokers Agents, often members of a stock exchange
firm or exchange members themselves, who act
as an intermediary between buyer and seller.
A commission is charged for this service.
Broker/Dealer Firm that operates in dual capacity in the
securities marketplace: as principal trading
for its own account and as broker represent-
ing clients on the market.
Broking The activity of representing a client as agent
and charging commission for doing so.
Building Societies Institutions that provide a safe haven for
investor’s deposits and who charge interest
on long-term mortgages and loans on prop-
erty. Since the 1986 Building Societies Act,
the services societies are able to provide have
widened to include those traditionally offered
by banks and insurance companies. Many
have indeed converted into banks as a result.
Bull Investor who believes prices will rise.
Bull Market A market in which prices are rising, and
buyers are more predominant than sellers.
Usually refers to equity markets.
170 Glossary of derivatives terms
CAC 40 French Equity Index on which futures and options
are traded on Euronext.
Calendar Spread The simultaneous purchase (or sale) of a futures
or an option contract for one date and the sale (or
purchase) of a similar futures contract for a different
date. See spread.
Call Option An option that gives the seller the right, but not the
obligation, to buy a specified quantity of the underlying
asset at a fixed price on or before a specified date. The
buyer of a call option has the obligation (because they
have bought the right) to make delivery of the underly-
ing asset if the option is exercised by the seller.
Call Spread The purchase of a call option coupled with the sale of
another call option at a different strike, expecting a
limited rise or fall in the value of the underlying. The
sale reduces the cost of the purchase.
Capital Markets A term used to describe the means by which large
amounts of money (capital) are raised by companies,
governments and other organisations for long-term
use and the subsequent trading of the instruments
issued in recognition of such capital.
Cash Market Traditionally, this term has been used to denote the
market in which commodities were traded for immedi-
ate delivery against cash. Since the inception of futures
markets for T-bills and other debt securities, a distinc-
tion has been made between the cash markets in which
these securities trade for immediate delivery and the
futures markets in which they trade for future delivery.
Cash Settlement The settlement in cash rather than a physical asset
of a derivative, for example index and interest rate
futures and options.
CBOE Abbreviation for the Chicago Board Options Exchange.
CBOT Abbreviation for the Chicago Board of Trade. Term
‘Board’ is also used.
Central Securities An organisation that holds securities in either
Depository (CSD) immobilised or dematerialised form thereby enabling
transactions to be processed by book entry transfer.
Also provides securities administration services.
Certificate Paper form of shares (or bonds), representing owner-
ship of a company (or its debt).
Certificate of A money market instrument in bearer form issued by
Deposit a bank certifying a deposit made at the bank. Usually
acceptable as collateral against margin calls.
Glossary of derivatives terms 171
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