See Absolute Prepayment Speed and/or Asset Backed Security.

Absolute advantage

The ability of one country to produce more of a given good with its endowed resources. In the context of swaps, the ability of one party to borrow at a lower rate of interest in a given currency than another party.

Absolute Prepayment Speed (ABS)

Prepayment measure applied to securities backed by auto loans, truck loans, RV loans and auto leases. Unlike CPR, which measures prepayments as a percentage of the current outstanding loan balance, the ABS calculates them as a monthly percentage of the original loan balance.

Accreting Swap

Any swap in which the notional principal increases over the tenor of the swap. Thus, interest exchanges are made on a progressively larger notional principal.

Active management

The management of a portfolio based on the judgment of the portfolio manager. Active management seeks to outperform an index or a benchmark. It involves active trading to take advantage of opportunities based on relative valuations across securities within the investment universe.

Agency Bonds

Bonds issued by an entity of the U.S. government, such as Ginnie Mae, or by a Government Sponsored Enterprise (GSE), such as Fannie Mae, Freddie Mac, Federal Home Loan Bank System and Sallie Mae.


See Algorithmic Trading.

Algorithmic Trading (Algo)

Automated trading whereby trades are executed using a set of pre-defined instructions or rules via computer programs. Trading is automated through one or more stages of the trading process – pre-trade or data analysis, trading signal generation or what to trade, and trade execution, i.e., when and how to trade.

All-in cost

Also called effective annual percentage cost (the latter term is often applied to component costs individually). An important measure of the total cost of a financing that expresses the cost on an annual percentage basis. This measure is very useful for comparing alternative financing opportunities.

All-to-all platform

Multiple parties on the same platform can trade with each other. So, dealer to dealer, dealer to investor and investor to investor can all trade directly with each other. This is in contrast to the traditional model where a dealer supplies the price.


See Asset/Liability Management.


The unsystematic or non-market risk in a portfolio. Alpha is the risk specific to an asset and can be eliminated in a diversified portfolio of assets.

Alternative Trading System (ATS)

Electronic trading system that is an alternative to an organized exchange which matches orders for buyers and sellers of securities.

American Option

An option that allows the buyer of the option the right to exercise the option at any time during the life of the option.

Amortization schedule

A loan repayment schedule, which describes the payment process by which the principal on a loan will be amortized. Such schedules usually also depict the interest payments and the total payments (principal and interest combined).

Amortizing debt

Any form of debt in which the principal balance is repaid gradually over the term of the loan.

Annual Yield

A yield that is expressed on an annualized basis regardless of the number of payments per year.


A series of fixed payments made at equal intervals in time.


See Authorized Participant.


See Arbitrage Pricing Theory.


The simultaneous transacting in two or more markets to exploit a price discrepancy. As generally understood, arbitrage involves little risk and little investment.

Arbitrage Pricing Theory (APT)

A multi-factor model whose theory states that the excess return on any security or portfolio should be proportional to its systematic risk, as measured by beta.

Arithmetic Return

The average return from any investment, calculated by summing up the returns of all the periods and then dividing this sum by the number of periods.

Artificial Intelligence

A branch of computer science that is concerned with the automation of intelligent behavior. To be considered “intelligent”, should respond to situations flexibly, make sense of ambiguous or contradictory messages, recognize the different elements of a situation, find similarities between situations despite differences which may separate them and draw distinctions between situations despite similarities which may link them. See http://www.kanneganti.com/technical/become-intelligent-and-successful-in-30-days-or-years/

Ask Price

Sometimes referred to as the offered price and part of a two way price quote, known as the bid-ask spread. In regard to the bid-ask spread, it is the right side of the quote and is the price at which the seller of the security is offering to sell.

Asset Allocation

The process of distributing investment funds among various investment avenues such as stocks, bonds, money market instruments, cash equivalents, precious metals, real estate etc. This distribution enables diversification of funds among various sectors and asset classes. It helps in gaining a balance between an investors return objectives and his risk appetite, as the risks and returns are not the same for all asset categories.

Asset Backed Security (ABS)

A fixed income security that is collateralized or securitized by the cash flows from other assets, usually smaller, illiquid assets that are pooled together. Examples of ABS collateral are credit cards, home equity loans, auto loans and student loans. Other names for ABS are Securitization and Structured Finance.

Asset-based swaps

Any swap written to transform the cash flow characteristics of an asset in order to replicate the cash flows characteristics of another asset. The combination of the original asset together with the swap often constitutes a synthetic instrument.

Asset/Liability Management (ALM)

Simply known as ALM. 1) In a portfolio management context, it is the management of assets and/or liabilities in such a way as to match cash flows, durations, or maturities of assets and liabilities. 2) In commercial banking, it is the management of the balance sheet including interest rate, prepayment, credit and liquidity risks. There are some institutions that refer to ALM as risk management. Using this title all risks, including operational risk, would fall under this umbrella.


See Automated Trading.


A situation in which an option’s strike price and the current market price of the underlying asset are the same.


See Alternative Trading System.

Attribution analysis

1). A process used to analyze the sources of excess returns from a portfolio against its benchmark into the active decisions of the investment management process. This process helps to separate investment management skills from performance by luck. 2). The process of identifying the source of excess returns from a portfolio over its benchmark wherein a fund manager’s performance is evaluated based on returns due to style allocation, sector allocation, stock selection and activity.

Authorized Participant (AP)

Pre-approved group of institutional firms who enter into an agreement with the ETF sponsor such as Blackrock/iShares. APs offer a basket of securities (or receive a basket of securities) from the ETF sponsor in exchange for ETF shares. APs may create or redeem (buy or sell) ETFs on behalf of their clients, use them for internal use or arbitrage the price of the ETF against the value of the basket of shares that is being created/redeemed. When the AP creates/redeems ETF shares with the ETF sponsor, it is considered the primary market.

Automated Trading (AT)

Automated Trading or AT is part of the electronic trading universe. Automated Trading refers to executing trades based on algorithms, or ALGOS, which are based on a set of pre-defined rules e.g., price, time, and volume among others. Market making and High Frequency Trading (HFT) may also be considered automated trading.

Average Life

A maturity measurement indicating the average amount of time that principal and interest will be received. It is calculated by weighting the future cash flows by the time period they are received divided by the original principal. Used in the U.S. mortgage markets to approximate the maturity of the security, the yield of the mortgage backed security is compared to the yield of the Treasury security whose maturity most closely matches the average life of the mortgage.


Bank Discount

Also known as discount basis. A yield measure used to express the yield on certain non-coupon bearing securities, such as T-bills, that always sell at a discount from face value.

Bank Reserve Requirements

The Federal Reserve requires banks to put “in reserve” a certain portion of their deposits.


A bond portfolio structuring technique where investments are made primarily in securities with only short term and long-term maturities. Such a strategy helps in achieving a targeted average maturity or duration and the price volatility of an intermediate bond. This strategy allows one portion of the portfolio to take advantage of high yields, while the other portion controls risk. When compared to an intermediate bond a barbell has an advantage of higher convexity.

Barrier Option

A type of exotic option that provides a payoff if the value of the underlying reaches (or does not reach) a predetermined price or “barrier level”. Barrier options are called “knock in” if the right to exercise the option is met, or “knock out” if the right is not met. It is characterized as “up” if the price of the underlying is above the barrier, and as “down” if the price is below the barrier.


1) Generally refers to the differences in two prices. 2) Also can refer to the day count convention uses in fixed income securities. For example, in the United States, money market instruments pay interest on an actual over 360 days basis or day count convention. The basis is 360 days. (The United Kingdom pays actual over 365).

Basis point

An interest rate equal to one one-hundredth of 1 percentage point, that is, 0.01 percent. The term “basis points” is often abbreviated in the text as “bps.”

Basis risk

1) The degree to which the difference between two prices fluctuates. 2) The residual risk that remains after a hedge has been placed.

Basis swap

A swap in which both counter-parties pay a floating rate of interest but these are tied to different reference rates. Also called floating-for-floating interest rate swaps.


See British Bankers’ Association.

Bearer securities

Securities which are physically held by investors. To receive interest payments, the holder actually clips the coupon and sends it to the obligor.


A standard that works as a reference point for performance measurement. A benchmark is usually an index comprised of securities from various asset classes such as stocks, bonds etc. The Benchmark selected has characteristics similar to that of the investment strategy for which the benchmark is applied.

Benchmark Error

Arises from using an incorrect or inappropriate benchmark to compare and assess portfolio returns and management.

Bermudan Option

An option which can be exercised only on certain discreet dates after the premium is paid and up to expiration.

Best Execution

SEC requirement that brokers show investors the best bid and offer price for a stock at any given time.


Measures the price/yield sensitivity of a security versus the market as a whole. A beta of 1 means the security has the same degree of price sensitivity or price risk as the general market. A beta < 1 means the security is less sensitive and a beta > 1 means the security is more sensitive than the general market.


See Bond Equivalent Yield.


The price that a buyer is willing to pay for a security. In regard to the bid-ask spread, it is the left side of the quote and is the price at which the buyer of the security is offering to buy.

Bid-ask spread

Also called bid-asked spread. The difference between the bid price and the asked price for any marketed instrument. In dealer markets, the bid-asked spread is one source of the dealer’s income.


Treasury bills or T-bills as they are known in the market, are short-term, discounted government securities issued for one year or less. T-bills are extremely liquid.

Binary Options

Also known as all-or-nothing options, digital options and Bet options. Options that pay a fixed amount of cash if they expire in the money, no matter how deeply, otherwise nothing.

Block Trades

Large size trades executed in the market place. For example, in the equity markets, a trade containing 10,000 shares or greater is considered a block trade. If executed in one trade, then the execution of the trade can impact the market price of the security. The blocks can be divided into multiple orders or can be traded bilaterally so as to reduce price volatility.

Board of Governors of the Federal Reserve

The Federal Reserve’s governing body.


A marketable debt obligation of an issuer. Issuers are governments, agencies and corporates.

Bond Anticipation Notes

When a municipality or local government requires short term funding in anticipation of issuing longer dated notes/bonds.

Bond equivalent yield (BEY)

Also known as the coupon equivalent yield. A method of calculating and stating the yield on a coupon bearing instrument. Most often assumes semiannual compounding.


1) Market slang that means that a transaction giving rise to a position is recorded among the institution’s assets and/or liabilities. 2) Market slang that refers to an institution’s portfolio of some specific asset type such as a “swap book,” a “foreign exchange book,” and an “options book.”


As the term is used in swap finance, an iterative numerical procedure to determine the implied spot yield curve from the conventional yield curve.

British Bankers’ Association (BBA)

A London-based trade association that deals with matters of common interest to member banks. The BBA documentation can be used for swaps and forward rate agreements.


See Broad Treasury Financing Rate.


A banking term that describes a loan in which the principal is repaid in a single transaction upon maturity of the instrument.

Business Cycle

The ups and downs of the economy measured by four phases: peak, recession, trough and recovery and expansion.

Buy and hold strategy

A passive portfolio management strategy in which stocks or bonds are purchased and held for several years or up to maturity regardless of the market’s fluctuations. Such a strategy enables investors to minimize the cost of transactions and tax obligations from capital gains.


Calculation date

The date specified as such for the calculation of the cash settlement amount on an interest-rate or exchange-rate contract. If the calculation and settlement dates differ, the calculation date will precede the settlement date.


1). An option that grants the holder the right to buy the underlying asset from the option writer. 2). The act of redeeming an instrument prior to its scheduled maturity.

Callable Bond

A feature on a bond allowing the issuer to buy back or call the bond at a specific price and on a specific date.

Callable swap

A swap that may be terminated prior to its scheduled maturity at the discretion of the fixed-rate payer.


The difference between market value of a bank’s/financial institution’s assets and liabilities. The primary purpose is to protect against large unexpected losses. As seen in the ‘credit crisis’ it is also meant to instill confidence to external investors and protect the firm’s credit rating.

Capital Adequacy

Refers to a desired level of capital maintained by a financial institution to cover losses. It is an indication of the firm’s ability to remain a viable concern.

Capital Adequacy Ratio (CAR)

See capital ratio.

Capital Appreciation

An increase in the value of a portfolio or a particular security due to a rise in the market price from the time of purchase to the time of sale.

Capital Asset Pricing Model (CAPM)

CAPM explains the relationship that should exist between the expected return and the risk, of a security or a portfolio. This theory is concerned with deriving the expected or required rates of return on a risky asset based on the asset’s systematic risk level measured by beta. In this financial model, the cost of capital for any security or portfolio of securities equals a risk-free rate plus a risk premium that is proportionate to the systematic risk of the security or portfolio.

Capital Market Line

A straight line in a risk-return map showing all the combinations of total return and market risk that are possible by allocating capital between an optimal portfolio of risky assets and a risk-free investment.

Capital Markets

Markets that bring issuers of debt and equity together with investors.

Capital Ratio

Also known as capital adequacy ratio (CAR) and risk based capital ratio. It is a measure, specifically a ratio, of a financial institution’s capital position. In general, it is the amount of capital held by the firm divided by the amount of assets adjusted for risk:capital-ratio


See Capital Asset Pricing Model.


Multi- period cash settled options on interest-rates. The cap purchaser receives a cash payment whenever the reference rate exceeds the ceiling rate (also called the cap and sometimes called the contract rate) on a fixing date.


See Capital Adequacy Ratio.

Cash flow stream

The series of cash flows associated with a debt instrument, swap, or other derivative instrument.

Cash flows

The payments made by one party to a contract to another party to the contract.

Cash settlement

1) A transaction made for immediate settlement. 2) In futures trading, refers to contracts that do not provide for physical delivery of the underlying asset. Instead, contracts are settled in cash on a final settlement date using a mark-to-market procedure.


See Collateralized Bond Obligation.


See Constant (Conditional) Default Rate.

Central Limit Order Book (CLOB)

Electronic trading platform using a centralized engine to match all bids and offers according to price and time priority. Allows users to trade with each other and not have to go through an intermediary. Trade orders are seen in real time.

Circus swap

A combination involving a fixed-for-floating interest rate swap and a fixed-for-floating currency swap in which both floating rate sides are LIBOR based in the same currency. Allows for the creation of a fixed-for-fixed or floating-for-floating currency swap.

Clearing Corporation/Organizations

Exchange affiliated organizations that handle the clearing, settling, matching of trades.

Click-to-Trade (CTT)

Ability to immediately trade on prices that are streamed by dealers.


See Collateralized Loan Obligation.


See Central Limit Order Book.

Closing trade

Also called an offsetting trade. A trade that closes an existing position by taking an offsetting position equal and opposite to that of the existing position.


1) An interest rate collar or simply collar, is the purchase of a cap and the sale of a floor. A collar is constructed to reduce the cost of the cap. 2) The term collar can also be used to purchase a put and sell a call.

Collateralized Bond Obligation (CBO)

Securitized product that is backed by low quality, or junk bonds. The cash flows are divided, or tranched into different risk exposures. CBOs are issued as investment grade bonds even though they are backed by junk bonds because the credit diversification within the structure increases the credit quality of the bond.

Collateralized Debt Obligations

Known as CDO’s, the pooling of bonds (CBO’s) or loans (CLO’s) that are transferred to a trust and the claims to these assets are subsequently sold to investors in different classes or tranches. Each tranche has different credit and investment characteristics.

Collateralized Loan Obligation (CLO)

Securitized product that is backed by bank loans. The cash flows are divided, or tranched into different risk exposures. The sale of the loans allows the financial institution to reduce regulatory capital requirements.

Collateralized Mortgage Obligation

Known as a CMO or REMIC (Real Estate Mortgage Investment Conduit). A structure which allows issuers to carve the cash flows of the underlying pass-through securities into various classes or tranches having different investment characteristics.

Commercial paper

Short-term corporate IOUs often used as part of a rollover strategy to obtain long-term financing at lower cost. Often called paper and sometimes denoted CP. May be placed directly or through commercial paper dealers. May be used as an index for leg of a swap.

Commodity swaps

Swaps that are structured to convert floating-prices paid (or received) for commodities to fixed prices, or vice versa. These swaps have a similar structure to interest-rate swaps.

Companion classes

A tranche of a CMO, companion classes absorb the excess cash flow generated by faster prepayments so that the other tranches in the structure, such as PACs and TACs have more stable cash flows. Further, when prepayments are slow, the companion classes will extend so that the PACs and TACs in the structure can receive the required cash flows. Companion classes have the most volatile cash flows in a CMO structure, even more so than the underlying collateral.

Comparative advantage

A situation in which one country (or firm) can produced a good (or engage in a borrowing) at less cost than another country (or firm) in the special sense that it must sacrifice less of an alternative good to achieve production. The term is associated with the Theory of Comparative Advantage used to explain trade between nations.

Compounded rate

The rate of return earned on an investment when all of the cash flows received over a given time period are reinvested. The rate takes into account earning interest on interest.


When an initial investment earns interest, the newly earned interest also begins to earn interest. It may be thought of as earning interest on interest. May also be referred to as the effective rate.

Conditional Prepayment Rate (CPR)

Sometimes referred to as Constant Prepayment Rate. Describes the percentage of the remaining loan balance which is expected to prepay (or has prepaid) above and beyond the scheduled amortization of principal. CPR assumes the unscheduled amount of principal repays at a rate of .2% in the first month, increasing by .2% each month for 30 months, at which point prepayments level off and stay constant at 6% (.2 x 30) CPR for the remainder of the life of the mortgage.

Conforming Loans

Conforming loans meet FNMA and FHLMC eligibility requirements. Among the requirements that are necessary to qualify as a conforming loan, the two most important are: maximum loan size, which changes every year and minimum loan to value ratio, also subject to change. Use of property and payment to income ratio are also analyzed.

Constant (Conditional) Default Rate (CDR)

Similar concept to CPR for prepayments CDR measures the percentage of mortgage loans that default in a pool of mortgages on an annualized basis. However, the actual losses are based on the Loss Severity which estimates the loan principal lost each month to default.

Constant Prepayment Yield (CPY)

A measure of prepayment speed in CMBS. A 100% CPY is the equivalent of 0% CPR up to the end of the yield maintenance (YM) period and 100% CPR thereafter.

Contingent Capital

Arrangement entered into, before an event occurs which would trigger losses exceeding a certain threshold, giving the company the flexibility to raise capital by issuing securities or borrowing money to cover those losses. Generally a fee is paid by the company to the party who agrees to advance the funds.

Contract rate

The rate of interest (or exchange) to serve as the basis of a cash settlement on a forward contract or an option contract. More precisely, the difference between the contract rate and the reference rate serves as the basis of the cash settlement.

Conventional Mortgage

Conventional Mortgages are non-government guaranteed mortgages.

Convertible bonds

A bond with an added feature where the holder/owner of the bond has the option to exchange the bond for a specific number of shares of the company’s common stock at a future date. The price at which the bond will be converted and the conversion ratio is determined at the time the bond is issued.


A measure of price sensitivity for fixed income securities. Duration measures the linear change in price for a change in yield; convexity is the second derivative of a bond’s price relative to its yield.  Convexity explains the price change that is not explained by duration.

Core Capital

Generally speaking, regulators break down capital into tier 1 and tier 2 capital. Tier 1 is considered core capital and generally contains items such as equity and retained earnings and other qualifying items. Tier 2 is referred to as supplemental capital (see supplemental capital).

Corporate Debt

Debt issued by a corporation. Can be money markets such as commercial paper or note or bonds.


The degree to which the price of one or more securities correspond to each other. Perfect positive correlation, or +1, means that the prices will move 100% in the same direction. Perfect negative correlation, or -1, means that the prices will move 100% in the opposite direction. Zero correlation means that the prices move independently of each other with no distinct relationship.


A principal to a swap or other derivative instrument, as opposed to an agent such as a broker.

Counterparty Credit Risk

A term used in derivatives to define the risk that a counterparty will not meet their obligations under the terms of a derivatives contract. This can be further broken down into pre-settlement and settlement risk. In pre-settlement risk the counterparty defaults prior to maturity. Settlement risk refers to the risk that the counterparty defaults on the day the transaction is to be paid for or settled


(1) The periodic interest payment on a debt instrument. (2) The periodic interest payment on the fixed-rate side of an interest rate or currency swap.

Coupon bonds

Bonds that pay periodic interest. The periodic payment is called the coupon.

Coupon dates

The dates that the coupons are paid and can be annual, quarterly, semi-annual or monthly.

Coupon rate

(1) The fixed rate of interest on a debt instrument. (2) The fixed rate of interest on the fixed-rate side of a swap.

Covenant-Lite Loans (Cov-Lite)

Traditional bank loans incorporate financial (maintenance) covenants, which are designed to give the lender warning signs of a borrower’s negative financial changes when they are breached and allow lenders to either amend the covenant for a period of time or restructure the deal to allow the borrower additional time to strengthen their finances. Cov-lite loans eliminate or reduce maintenance covenants that can result in the lender having little recourse in the event the borrower gets into financial trouble.


Covenants, in the financial context, are found in debt agreements, e.g., loans or bonds. These covenants are promises agreed to by the borrower in a bond/loan documentation/agreement. Covenants are put in place to protect the lender from the borrower going bankrupt or to help ensure the borrower will pay back their loan in a timely manner. Most financial covenants are found in the form of financial ratios that the borrower has to maintain, e.g., total assets to debt, interest coverage ratio or a debt to equity ratio, to name a few.


See Conditional Prepayment Rate.


See Constant Prepayment Yield.

Credit analysis

The process of analyzing financial and non-financial information on companies, individuals, sovereign states, local bodies or any other obligation seeker in order to estimate the ability of the obligation seeker to live up to its future contractual obligations. The inputs to credit analysis are from many sources, some of which include: detailed financial analysis, industry analysis, economic analysis, and views of the experts. The output of a credit analysis process is usually a subjective judgment on the credit quality (rating) of the obligation seeker.

Credit Default Swaps

A financial contract where the protection buyer (PB) pays a premium commonly referred to as a spread, to the protection seller (PS). The amount paid will be based on the percentage (basis points) of a notional principal. The notional is agreed up front between the PB and PS. The premium is broken down into two parts. First a fixed coupon is paid by the protection buyer to the protection seller for the life of the contract. It is generally paid quarterly and in arrears. Second the difference between the fixed coupon and the current market spread will be present valued and settled up front. If the current spread is higher than the fixed coupon, the PB pays the PS. If the current spread is lower than the fixed coupon the PS pays the PB. In return the PS agrees to make a payment to the PB, contingent on a credit event.

Credit Event

Payment trigger in a credit derivative, resulting from bankruptcy, failure to pay or restructuring.

Credit risk

The risk that a counterparty to a contract will be unable to fulfill its obligations due to bankruptcy or other cause.


A reference to the likelihood that a party to a contract will default on its obligations. The greater the likelihood of default the less creditworthy is the party.


Alternative source of funding, through the internet, by raising small amounts of money from many individuals or organizations.


See Click-to-Trade.

Cumulative Default Rate

Annualized rate of default on a group of mortgages, usually within a collateralized product such as an MBS. The CDR represents the percentage of the outstanding principal balances in the pool that are in default (usually 60 to 90 days past due and in foreclosure process). CDR is used to determine current market value of an MBS.

Currency markets

Also known as foreign exchange markets, FOREX markets, and FX markets. These are the markets in which the world’s currencies are exchanged.

Currency swap

An agreement between two parties providing for the exchange of a future series of interest and principal payments in which one party pays in one currency and the other party pays in a different currency. The exchange rate is fixed over the life of the swap.

Current Coupon

Newly originated mortgages represent the current coupon in mortgage issuance. In the MBS market, practitioners refer to the current coupon as the coupon trading at or near par.

Current income

Cash received on a regular basis in the form of interest, dividend etc. from investments such as stocks, fixed income securities, or mutual funds.


A financial institution with the legal responsibility for safekeeping, administering and servicing customers’ assets.

Cyclical Sector

Industries with high betas, specifically, consumer durables, properties, capital equipment.


Dark Pool

Private Automated Trading Systems which execute large orders so as to not move market prices. Dark pools do not show their liquidity to the general public. Block trades are often executed in dark pools.

Day-count convention

Various fixed income instruments follow set conventions to calculate interest. In the United States, money market instruments calculate interest using the actual number of days over a 360-day basis (act/360). Many U.K. commonwealth countries use an act/365 and not act/360. (U.S. credit unions also follow this act/365 day convention). U.S. Treasuries calculate accrued interest on an actual number of days over actual number of days (act/act). U.S. corporate bonds calculate accrued interest assuming there is 30 days in every month and a 360-day basis (30/360).

Dedicated Cash Flow Matching

One of the methods of constructing a dedicated portfolio. It involves developing a portfolio of bonds that will provide an income stream by way of coupon payments, and principal payments at maturity, which will exactly offset a specific set of liabilities over a given time period.


A bond portfolio management strategy in which cash flows from specific assets are earmarked to retire a specified set of liabilities over a period of time. Dedicated portfolios are normally immunized against interest rate risk. Dedication can either be “Cash Flow Matched” or with “Reinvestment”.

Default risk

1) The risk that a party to a contract will fail to make a payment when required to do so. Usually associated with an inability to make the payment due to insolvency or bankruptcy. When used in this way, the term is synonymous with credit risk. 2) In swap markets, the term is used more broadly to describe the risk of an “event of default.” 3) In swap markets the term is sometimes used to describe a swap bank’s exposure from the combination of credit risk and market risk.

Defaulting party

Counterparty to a derivative transaction that has committed an event of default.

Defensive Stocks

Non-cyclical stocks having low betas in industries such as food retailers and public utilities.

Deferred delivery

A contract delivery schedule that involves a period of time longer than that customary for cash transactions, implying immediate delivery. Both futures and forward contracts involve deferred delivery.

Delayed rate setting swap

Also called a deferred rate-setting swap. A fixed-for-floating interest rate swap in which the swap commences immediately but the swap coupon is not set until later.

Deliverable Obligation (DO)

Obligation/security that will be delivered if a credit event is triggered.

Delivery risk

Also called settlement risk. The risk that differences between market settlement hours may result in exchanges of interest and/or principals at different times or even on different days. The first paying party is exposed to the risk that the later paying party will default after the first paying party has made its required payment but before the later paying party has made its payment.


Delta shows the relationship between the price of an option and the asset underlying the option. It is the ratio of the change in the price of an option to the change in the price of the underlying asset. It shows the amount by which an option’s price will change for every one-unit change in price of the underlying asset.

Delta Neutral

The buying or selling of the underlying instrument in order to eliminate the exposure of the underlying price movement found in the price of an option.

Derivative instruments

An instrument that is defined on, and whose value is a function of, some other instrument or asset. Examples include futures, options, and swaps.

Digital FX linked note

A plain vanilla FX linked note combined with a digital option. Coupon payment is determined by the strike rate (pre-determined exchange rate) of the embedded option.

Digital Option

See binary option.


When the price of a security is below par (100.00), the bond is said to be trading at a discount and when it is trading above par it is trading at a premium.

Discount rate

1) The rate that banks can borrow money from the Federal Reserve. 2) The rate used to discount future cash flows to determine the current value of the instrument. 3) The rate used in certain money market instruments e.g. U.S. Treasury Bills, when there is no coupon. The interest is said to be paid up front i.e. the interest amount is calculated first using the discount rate and the appropriate conventions and then subtracted from the principal. Therefore the equivalent yield will always be higher than the discount rate.


The act of taking a future cash flow(s) and present valuing them to determine the current market value.

Diversifiable Risk

Risk on an individual security that can be eliminated by owning that security in a well-diversified portfolio of assets. Also known as non-systematic risk, specific risk.


See Deliverable Obligation.

Dollar Duration

The product of the modified duration and the market value of the bond. Dollar duration expresses the price volatility of an asset or portfolio of assets in absolute dollar amounts as opposed to modified duration which shows the price volatility in terms of percentage changes in price.

Dollar Value of a Basis Point (DVBP, DV01)

The dollar value change that would result from a 1 basis point change in an instrument’s yield. In order to make the definition usable, the DVBP must be stated per some amount of face value.

Dual currency note

A dual currency note (DC) pays coupons in the investors’ domestic currency with the notional in the issuers’ domestic currency.


A measure developed by Frederick Macaulay that allows for accurate measurement of a debt instrument’s price sensitivity to yield changes. Duration is the instrument’s weighted average time to maturity.


See Dollar Value of a Basis Point.



Earnings Before Interest and Taxes. EBIT measures a company’s operating profit.


Earnings before Interest, Taxes, Depreciation, and Amortization. Used to measure company’s operating profitability before non-operating expenses. Used as a proxy for cash flow.


EBITDA PLUS change in acquisition costs.


EBITDA PLUS option expenses.


EBITDA PLUS pension expenses.


EBITDA PLUS lease/rental expenses.


EBITDA PLUS losses, gains, and other adjustments on real estate.


EBITDA PLUS stock-based compensation.


See Electronic Communications Network.

Effective duration

A measure of price sensitivity for fixed income securities having embedded options, such as callable bonds and mortgage backed securities. Changes in cash flow due to changes in interest rates are taken into account such that the effective duration estimates the change in the price of the security for a 100 basis point change in yield.

Effective rate

The rate of return earned on an investment when all of the cash flows received over a given time period are reinvested. The rate takes into account earning interest on interest. May also be referred to as the compounded rate.

Electronic Communications Network (ECN)

Computerized trading system bringing buyers and sellers together, eliminating the traditional middleman. ECNs are a type of ATS and show best-priced orders in the consolidated quote stream, not just the best bid/offer available. In the U.S., ECNs are registered with the SEC as broker-dealers.

End User

Market participant that uses the market makers price.


See European Short-Term Rate.


See Exchange Traded Funds.


A debt instrument issued in the Euromarkets (excluding money market instruments).

Eurobond market

Any Euro market for longer-term debt instruments (specifically excludes the money markets). Examples include Euro sterling and Euro yen.

Eurodollar bonds

Dollar-denominated bonds and bond-like instruments sold outside the United States

European option

An option that can only be exercised during a limited exercise period at the very end of the option’s life.

European Short-Term Rate (ESTR, €STR)

A transaction-based overnight interest rate that is based on wholesale unsecured overnight borrowing costs and will be used as the preferred risk-free reference rate in Europe. The official start date will be October 1, 2019.

Exchange rate

Also called foreign exchange rate. The price of one unit of one currency stated in terms of units of another currency.

Exchange Traded Funds (ETF)

Known as ETFs, a subset of Exchange Traded Products (ETPs), they are registered investment funds, regulated by the SEC, and like stocks, they trade on an exchange. ETFs are comprised of a basket of securities such as stocks, bonds, or commodities and track a specific index for performance. The concept is similar to Mutual Funds but ETFs can trade during the day, unlike Mutual Funds which are priced at the end of each day.

Exchange-rate risk

The risk that on closing a position, the current exchange rate will be different then the original contract rate.

Exercise Price

Also known as strike price. The amount that must be paid (or the price that will be received) by an option owner to buy (or sell) the underlying asset from the option writer.


The final maturity of an option contract.


Face value

The redemption value of a bond. Also known as par value.

Fannie Mae


Fannie Mae



Federal Housing Administration is responsible for the various mortgage insurance programs for the U.S. Department of Housing and Urban Development.


Federal Home Loan Mortgage Corporation, or Freddie Mac, is a government sponsored enterprise or GSE. FHLMC is a public, shareholder owned company trading on the New York Stock Exchange. FHLMC provides low-cost funds to mortgage lenders, which in turn lend to home buyers throughout the United States. FHLMC supports the secondary mortgage market for conventional mortgages. Put into conservatorship September 2008.


A person who is legally authorized to supervise the investment portfolio of a third party and make investment decisions in accordance with the wishes of the beneficiary. Examples of fiduciaries include executors of wills and estates, trustees, and those who administer the assets of the underage or incompetent beneficiaries.


Fintech is short for financial technology. It is technology-driven innovation in the design and delivery of banking, lending and capital markets financial services and products. Examples would be mobile payment systems, cryptocurrencies, the use of blockchain, peer to peer lending, and robo-advisors.

Fixed Income Security

A marketable debt obligation where an issuer agrees to pay a certain amount of interest over the life of the security.

Fixed-for-floating rate swap

A swap in which one counterparty pays a floating rate of interest while the other counterparty pays a fixed rate of interest. This is the most common type of swap.

Floating rate notes

Notes issued with a floating rate of interest that is tied to a specified index, such as LIBOR.


Also referred to as an interest rate floor. A multi-period interest-rate option that provides a cash payment to the holder of the option whenever the reference rate is below the floor rate (also called the “floor” and sometimes the contract rate”) on a fixing date.


Federal National Mortgage Association, pronounced Fannie Mae, is a government sponsored enterprise or GSE. FNMA is a public, shareholder owned company trading on the New York Stock Exchange. FNMA provides low-cost funds to mortgage lenders, which in turn lend to home buyers throughout the United States. FNMA supports the secondary mortgage market for both government insured and conventional mortgages. Put into conservatorship September 2008.

Forward contract

Also called a forward. A contract for deferred delivery traded in over-the-counter dealer-type markets. Less standardized than a futures contract but more easily tailored to commercial users’ idiosyncratic needs than futures.

Forward exchange rate

Current rate of exchange for a foreign exchange transaction scheduled to take place at a later date. Also called a forward rate, but the latter term can also refer to a forward interest rate.

Forward rate agreement (FRA)

An interest-rate forward contract written on a notional principal and cash settled on the basis of the difference between the contract rate and the prevailing reference rate on the settlement date. The resultant settlement value is discounted to adjust for an up-front settlement.

Forward swap

Also called a deferred swap. A fixed-for-floating interest rate swap in which the swap coupon is set at the outset but the start of the swap is delayed.

Forward yield curve

A yield curve currently expected to prevail at some later date. For example, a three-month forward yield curve graphically shows a series of 3 month forward rates.


See Forward Rate Agreement.

Freddie Mac


Freddie Mac


Future Value

The amount that a sum of money invested today, earning a simple or compounded interest, will be worth at a future date

Futures contract

Also known as futures. Standardized contracts for deferred delivery (or cash settlement) of commodities and financial instruments. Always traded on a designated futures exchange and regulated by the Commodity Futures Trading Commission.

Futures Exchange

An exchange is a central meeting place where buyers and seller come together to exchange goods and services. A futures exchange is where buyers and sellers meet to buy and sell futures and options contracts. Must be designated a futures exchange by the Commodities Futures Trading Commission (CFTC).

Futures series

All futures contracts having identical terms (including the same delivery month) and trading on the same exchange constitute a series.

Futures strip

A series of futures contracts with successive delivery (settlement) months. Most often used to refer to a series of interest-rate futures such as Eurodollars.


Geometric Return

A measure of the compounded rate of return of the market value of the initial portfolio during the evaluation period, assuming that all cash distributions are reinvested in the portfolio. Geometric Return is given by the nth root of the product of the returns for n number of years.


Government National Mortgage Association, pronounced Ginnie Mae, is a wholly owned U.S. government agency guaranteeing government issued or guaranteed mortgages.



A position taken in order to offset the risk associated with some other position. Most often, the initial position is a cash position and the hedge position involves a risk-management instrument such as a swap or a futures contract.

Hedge Fund

Pooled investor funds that are aggressively managed by professionals with the goal of generating high returns. Hedge funds use leverage and derivative instruments to aid in generating high returns and attract a more sophisticated type of investor, ie, requiring minimum amounts of income and money to invest, to be eligible.

Hedge ratio

The number of units of a hedging instrument that must be held to minimize the overall portfolio variance (cash position and hedge combined) of a portfolio or individual instrument.


See Home-Equity Prepayment Curve.


See High-Frequency Trading.

High Yield Bond

Also called junk bonds, these bonds have a credit rating of BB or lower. A high yield bond is considered a speculative grade bond or below investment grade bond and is issued by companies with a higher credit risk. As the name suggests, a high yield bond earns high gross income, to compensate for the high credit risk.

High-Frequency Trading (HFT)

HFT is a form of automated trading. These automated strategies try to find market liquidity imbalances or short-term pricing inefficiencies leaving no positions at the end of the day. HFT produces large-scale turnover of many positions, making small returns on each position.

Historical volatility

A measure of the actual volatility (a statistical measure of dispersion) observed in the marketplace.

Home-Equity Prepayment Curve (HEP)

A prepayment scale (ranging from 0% - 100%) for HELs. The HEP takes into account the faster plateau for HEL prepayments vs. that of traditional mortgages. HEP assumes a 10-month seasoning ramp, with even step-ups, ending at the final HEP percentage in the 10thmonth. The standard HEP is 20% and assumes the following prepayment curve; 2% CPR in first month, 4% in second month, 6% in third month continuing this pattern until leveling off at 20% CPR in the tenth month.

Horizon Matching

A variant of immunization strategy, in which the cash flows due up to a certain intermediate horizon are matched on a cash flow basis, and the cash flows due after this intermediate horizon are matched on a duration basis.

Hybrid Capital

A hybrid security that the issuer classifies or structures as capital. Generally between debt and equity in regard to subordination.

Hybrid Security

A security that has features of both equity and fixed income securities.


IMM settlement dates

The settlement dates of IMM Eurodollar futures contracts. These dates are often used as settlement dates on forward rate agreements, and swap contracts

IMM swaps

Short-dated swaps that are priced off the IMM’s Eurodollar futures strip.


A bond portfolio strategy of matching the modified duration of the assets in a portfolio to the liability it is intended to pay off through portfolio rebalancing. The term of the liability represents the investment horizon of the investor. This strategy helps to eliminate interest rate risk, as interest rate changes will have equal and offsetting effects on the investor’s portfolio of assets and liabilities.

Implied volatility

Inferred from option pricing model (typically Black-Scholes) using the market value of an option and solving for the value of volatility consistent with the observed value of the option. Inputs include price of underlying, strike price of option, interest rates, time to expiration, volatility and type of option.


In the case of a call option, a situation in which the price of the underlying asset exceeds the strike price of the option. In the case of a put option, a situation in which the price of the underlying asset is below the strike price of the option.

Incurrence Covenants

Covenants that are tested for specific events such as incurring additional indebtedness, paying dividends and acquiring new businesses


A statistical measure of the weighted value of a group of securities used as a performance indicator. Example: S&P 500, Dow Jones, FTSE Indices etc. Indices act as mirrors of any given market (stock market or bond market), industry or economy and as benchmarks against which the performance of individual securities or portfolios is measured.


A passive portfolio management strategy, which aims to replicate the performance of a select index such as, the S&P 500, Dow Jones, and FTSE Indices etc, by investing in companies that make up the index.


The increase of prices within the economy.

Inflation Linked Notes

Corporations and Government Sponsored Enterprises issue inflation-linked structures as part of their overall funding program. The notes are typically issued with a “floating coupon” structure based on the change in the Consumer Price Index for All Urban Consumers (CPI) over the previous year. The inflation component is added to the fixed rate coupon and paid to the investor. At maturity, the initial investment is returned to the investor without any inflation adjustment. Therefore, a portion of each interest payment is meant to offset inflation, and the remainder is the real return.

Interest differential

The rate differential between instruments of the same maturity but denominated in different currencies.

Interest rate anticipation swaps

A portfolio immunization strategy where bonds in a portfolio are exchanged for new bonds in order to achieve the target portfolio duration, given the investor’s expectations about changes in interest rates.

Interest rate option

Generic term used to imply inters rate caps, inters rate floors or inter rate collars. See caps, floors and collars.

Interest-rate collar

A combination of an interest-rate cap and an interest-rate floor such that a cap is purchased and a floor is sold. The effect is to place upper and lower bounds on the cost of funds.

Interest-rate futures

Futures on debt instruments or debt indexes. Known as bond futures or short term interest rate futures (STIRs) depending on the underlying asset.

Interest-rate risk

1) The risk that on closing a position, the current interest rate will be different then the original contract rate. 2) The price risk associated with holding a fixed-rate debt/derivative instrument as a result of fluctuations in the instrument’s yield.

Interest-rate swap

An agreement between two parties to engage in a series of exchange of interest payments on the same notional principal denominated in the same currency.

Internal rate of return (IRR)

The discount rate that equates the sum of the present values of the cash flows associated with an investment with the initial cost of the investment.

International Swap and Derivatives Association (ISDA®)

A New York-based trade association that deals with matters of common interest to member swap dealers.

Intrinsic value

A major component of an option’s value. It is the greater of the amount by which an option is in-the-money or zero.

Inverse Floater

Bonds whose coupon rates increase as rates decline and decrease as rates rise. The coupon rate is based on a formula using an index and moves in the opposite direction of changes in that index. Some inverse floaters may be a type of structured note. Other inverse floaters, such as interest-only (I/O) and principal-only (P/O) strips are types of collateralized mortgage obligations (CMOs).

Investment grade bond

Any bond that has been rated as such by a rating agency. In the case of Moody’s, Standard & Poor’s and Fitchratings, these would be ratings of Baa or better and BBB or better, respectively.

Investment Horizon

The time period over which an investor wishes to keep his money invested. Investment horizon varies from one investor to another depending on their investment objectives in terms of risk, return, market conditions and most importantly their liability profiles.

Investment Policy Statement (IPS)

A formal written plan, which communicates the long-term investment objectives, constraints and guidelines to be followed for achieving investors’ objectives. It lays down the possible courses of action that have to be followed to achieve the investment objectives.


See Investment Policy Statement.


See Internal Rate of Return.


See International Swap and Derivatives Association.


Jensen Measure

A measure of risk-adjusted performance that is the average return on a portfolio over and above that predicted by CAPM, given the portfolio’s beta and the average market return. Also known as Jensen’s alpha, measures the excess return above the market return based on the portfolio’s beta.

Junk Bond

See High Yield Bond.


Knock-In Option

See Barrier Option.

Knock-Out Option

See Barrier Option.



A bond portfolio construction strategy in which equal amounts are invested in every maturity within a given range.


Delays that can be incurred in the processing of network data. Low latency network connections generally experience small delay times while high latency connections generally suffer from long delays.

Lead Market Maker (LMM)

The LMM provides defined market quotes for listed Exchange Traded Products on the NYSE Arca exchange. LMMs must maintain continuous, two-sided quotes for each security in which the firm is registered as set forth by the parameters in NYSE Arca Rule 7.23. LMM must meet minimum performance requirements which include a BBO (Best Bid Offer) requirement, minimum displayed size, minimum quoted spread and participation requirements for opening and closing auctions. Performance requirements will be determined by NYSE Arca and detailed in the LMM Requirements document. See https://www.nyse.com/publicdocs/nyse/markets/liquidity-programs/arca_lmm_fact_sheet.pdf


An acronym for London Interbank Offered Rate. This interest rate is the standard rate for quoting interbank lendings of Eurocurrency deposits.

LIBOR flat

LIBOR quoted without any premium or discount.

Limit Order

An order to buy or sell a security at a specified price or better.


See Lead Market Maker.

Loan Loss Reserves

Reserves which are intended to absorb anticipated, or expected, losses. Provision for loan losses is an expense item in the income statement.


A party is said to be long an instrument when he or she owns the instrument.


Macaulay duration

A measurement of the price sensitivity of a fixed income security to changes in interest rates. Macaulay duration is measured in years and is the weighted average of the security’s cash flows.


The study of the entire economy in terms of total goods and services produced, total income earned, the level of employment and the general behavior of prices.

Maintenance Covenants

Financial tests which are performed regularly (e.g., every 3 months) and can include tests such as maintaining a minimum net worth, debt/EBITDA not to exceed a certain amount, capping capital expenditures, and requiring minimum interest coverage.

Management Fee

The compensation paid to the investment advisor / manager by a mutual fund or Investment Company or investors for the services rendered.

Manufactured-Housing Prepayment Curve (MHP)

Used to denote prepayments on manufactured housing, this prepayment scale has a 24-month seasoning ramp. 100% MHP equals a starting rate of 3.7% CPR, stepping up 0.1% per month, until the 24thmonth where it remains constant at 6% CPR. Similar to PSA, MHP is used in multiples of 100 so that 150% MHP equates to 5.6% prepayment in the first month, leveling off to 9% in month 24.


1) In futures trading refers to a required performance bond tendered by a party to a futures contract. 2) Buying on margin refers to borrowing money, generally from a broker, to buy securities.

Market maker

Also known as a dealer. A party that makes a market in an instrument by offering to both buy and sell the instrument. The market maker profits from the difference between its bid and ask prices.

Market risk

The risk that current market prices will deviate from the contracted rate. Refers to equity, foreign exchange, interest rate and commodity risk.


1) The practice of periodically adjusting a margin account by adding or subtracting funds based on changes in market value. The practice has long been employed in futures trading and for writers of options. 2) The revaluation of a financial instrument or portfolio based on current market rate(s) and the current make up of the portfolio.

Maturity date

1) The date a fixed income security matures and the issuer repays the principal to the investor. 2) In options, the maturity refers to the expiration date of the contract.

Medium term notes

Fixed income securities that are not traditionally underwritten but offered through a shelf registration that is filed with the SEC. After SEC approval, the company can issue notes of any size and with any coupon or maturity, for up to two years after the filing.


See Manufactured-Housing Prepayment Curve.


The study of total goods and services produced, total income earned, the level of employment and the general behavior of prices on the level of individuals and firms within the economy.

Mismatch risk

The risk to a portfolio from failing to precisely match the risks associated with the underlying portfolio. For example, a swap book may mismatch maturities or notional principals and will be exposed to the respective risks.

Modified duration

A modified form of duration obtained by dividing the duration measure developed by Macaulay by 1 plus the yield divided by the frequency of the coupon payments. Measures the percentage price change of a fixed income security given a change in yield.

Monetary Policy

Refers to the amount of money circulating within the economy. Monetary policy is used by central banks or other monetary authorities to impact economic performance by controlling the money supply.

Money market instruments

Debt instruments having a maturity of less than one year.

Money market yield

Also known as money market basis. A method of calculating the yield on certain money market instruments. The method assumes the payment frequency is annual and uses an actual over 360 day count convention in the yield calculation. Some countries use a 365-day basis for their money market calculations. U.S. credit unions use an actual over 365-day basis.

Monte Carlo Simulation

A simulation that attempts to simulate the future using an uncertain variable. For example, to simulate the future stock price, a simulation may use an algorithm using the current price, mean/average of the stock and volatility/standard deviation. The simulation will randomly generate a term that will change the volatility resulting in a single simulated future price. However, the Monte Carlo method refers to the simulation being run hundreds if not thousands of times with each simulation referred to as a path. In this simplistic example, the future price is determined by taking the average of all of the prices. Customary way to value MBS and other securities with embedded options. Monte Carlo simulations generate numerous random interest rate paths, present valuing the cash flows of the security under each path while taking the option into account, to derive the value of the security.

Monthly Payment Rate (MPR)

A repayment measure used with non-amortizing assets, such as credit cards and dealer floor-plan receivables which are not subject to prepayments. MPR is calculated by dividing the sum of the interest and principal payments received in a month by the outstanding balance. Rating agencies require every non-amortizing ABS issue to establish a minimum MPR as an early-amortization trigger event.

Mortgage-Backed Securities

Known by the acronym MBS. Securities backed by whole mortgages or by mortgage pass-through certificates. Mortgage pass-through certificates are themselves mortgage-backed securities.


See Monthly Payment Rate.

Multi-dealer Platform

Electronic execution of trades offered in competition between different dealers and their clients.

Municipal Bonds

Bonds issued by state and local governments, often known as general obligation bonds. The credit worthiness is based on the credit of the municipality. Special Revenue bonds are issued by agencies or authorities of state and local governments for specific public work projects, the cash flows of these projects secure the bond. The coupons paid to investors are tax-exempt from Federal taxes and often tax-exempt from the issuing State’s income taxes.

Mutual Fund

A type of investment fund which pools investors’ monies together, targeting a specific market and/or sector, which is managed by professional asset managers. Mutual funds offer the individual investor diversification that they generally cannot get on their own. The investor buys shares in the fund and participates in the fund’s gain or loss on a pro-rata basis.


Nationally Recognized Statistically Rating Organization (NRSRO)

Moody’s, Standard and Poor’s, FitchRatings and Egan-Jones are the most well-known of the 10 NRSRO’s.

Negative convexity

Convexity is defined as the property of a financial instrument that dictates the amount by which its value changes with changes in market rates. For example, a MBS is said to have negative convexity if its price rises by an amount p1 when yields fall, and its price falls by an amount p2 when yields rise, and if p1<p2. Negative convexity is undesirable for the investor. Graphically, the curve of the instrument’s price against its yield will be a concave curve.

Negative Correlation

Assets will move in the opposite direction. Benefits of diversification are greater when assets are negatively correlated.


1) The standard practice in swap documentation requiring that only the interest differential on interest-rate swaps be exchanged with the higher paying party making payment of this difference to the lower paying party. 2) The reduction of risk exposures by netting payments under a master swap agreement. This includes other derivative instruments such as caps, floors etc.

Nominal Spread

The spread, in basis points, that a security is trading over the appropriate maturity Treasury security.

Nominal yield

The rate of return over a given time period, e.g., quarterly or semi-annually, without taking compounding into account.

Non-amortizing debt

A debt obligation in which the full principal is repaid in a single transaction upon maturity of the debt with no repayments of principal prior to maturity. See also bullet transaction.

Nonparallel shift

A shift in the yield curve where the short end of the curve doesn’t move by the same number of basis points as the long end of the curve. Can result in a widening, flattening and inversion of the yield curve.

Notional principal

The amount of principal on which the interest is calculated on a swap or related instrument including FRAs and interest rate options. In the case of interest rate swaps, FRAs, and interest-rate options, the principal is purely “notional” in that no exchange of principal ever takes place.


See Nationally Recognized Statistically Rating Organization.



See Option Adjusted Spread.


1) The outcomes expected of a particular strategy or course of action within a given time frame. 2) Investment objectives refer to the investor’s goals expressed in terms of risk and return profiles, acceptable asset classes, and acceptable trading strategies and are included in the policy investment statement.

Off market

Whenever a swap or other instrument must be priced with a coupon or floating rate that deviates from currently prevailing market conditions.

Off-balance sheet

A position with potential financial consequence that does not appear on either the asset side or the liabilities side of a balance sheet. The advent of recent accounting changes such as FAS 133 and IAS 39 require these instruments to be accounted/recognized on the balance sheet. However, the term OBS still tends to be used in the marketplace.


Those U.S. Treasury securities that are not the most recent issues for their respective maturities.


Those U.S. Treasury securities that are the most recent issues for their respective maturities.

Open market Operations

The buying and selling of securities in the “open market” by central banks. Purchasing securities by central banks adds money to the banking system and selling securities by central banks drains money from the banking system.

Optimal Portfolio

A portfolio of risky assets that maximizes the Sharpe ratio or the Treynor ratio.

Option adjusted spread (OAS)

Refers to the spread over Treasuries after an adjustment is made for the value of the embedded call option. OAS present values the future cash flows by using some constant spread over the Treasury spot curve such that it takes into account any potential exercise of embedded options. Also known as an effective spread.

Option Contract

A contract giving the owner the right, but not the obligation to purchase or sell the underlying asset. A call option gives the owner the right to buy the underlying asset at the strike price and a put option gives the owner the right to sell the underlying asset at the strike price. Option contracts have set maturities, e.g., 30 days.

Option premium

The name given to the price paid for an option or an option-like feature. The premium is determined by two types of value called intrinsic value and time value.


In the case of a call option, the price of the underlying asset is below the strike price of the option. In the case of a put option, the price of the underlying asset is above the strike price of the option.


Known more commonly by the acronym OTC. A dealer market in which transactions take place via telephone, Reuters, Bloomberg and other electronic forms of communication as opposed to trading on the floor of an exchange. Such markets allow for great flexibility in product design.

Overnight repo

A repurchase agreement that provides for a secured lending for a period of one business day.



See Peer-to-Peer Lending.


See Planned Amortization Class.

Par value

The redemption value of a bond. Also known as face value.

Parallel shift

With reference to yield curve movements, a parallel shift is an equal shift of the whole curve; either upwards or downwards. A parallel shift in the yield curve occurs when the interest rate on all maturities increases or decreases by the same number of basis points.

Pass-through security

A security backed by mortgages where the interest and principal paid on the underlying mortgages is passed through to the holders of the pass-through security on a pro-rata basis, less any servicing and guaranty fees.

Passive Management

An investment strategy which aims to track the performance of an index but not to beat it. Buy and hold strategy and indexing are passive management strategies.

Peer-to-Peer Lending (P2P)

Lending from one individual to another and not involving a bank as the traditional lender.

Performance Evaluation

Compares the actual performance of the portfolio with the desired performance, on the parameters of returns and risks. It also includes attributing the reasons for the variances.

Performance Measurement

The process of quantifying the performance of a security/portfolio by calculating returns generated and the risks faced by the portfolio over the measurement period.

Performance Risk

The risk that the performance of a portfolio / manager may not track the appropriate benchmark over the next measurement period. Investors try to minimize this risk by allocating the investments to two or more investment managers.

Plain vanilla

The simplest form of a financial instrument. Often associated with the first manifestation of an instrument, e.g. a “plain vanilla swap”.

Planned Amortization Class (PAC)

A structure to give the investor more stable cash flow by channeling prepayments from the underlying mortgage pass-throughs to companion or support classes.


See Principal Only.


A set of investments made by an investor in assets such as stocks, bonds, money market instruments, mutual funds, precious metals, real estate etc. with different risk/return characteristics and maturities. A well structured portfolio offers an investor the benefit of diversification which an individual security, asset class or investment sector may not offer.

Portfolio duration

The weighted average duration of a bond portfolio. The modified duration of each bond is multiplied by the market value weight of that bond to the entire portfolio; this product is then summed over all the bonds in the portfolio to get the portfolio duration. This is a measure of the interest rate risk of the portfolio.

Portfolio Frontier

The risk and return characteristics of all possible combinations of two assets in a portfolio plotted on a risk-return graph to sketch out a curve whose shape depends on the correlation of the assets.

Positioning a swap

Also called booking a swap. The taking of a position in a swap by a swap dealer. This contrasts with a broker in which the swap facilitator acts as an agent in a swap and does not take the swap on its own books.

Positive convexity

Convexity is defined as the property of a financial instrument that dictates the amount by which its value changes with changes in market rates. For example, a straight bond is said to have positive convexity if its price rises by an amount p1 when yields fall, and its price falls by an amount p2 when yields rise, and if p1>p2. Graphically, the curve of the instrument’s price against its yield will be a convex curve.

Positive Correlation

Assets will move in the same direction. Benefits of diversification are limited when assets are positively correlated.

Power Reverse Dual Currency Notes

A power reverse dual currency note (PRDN) or power reverse dual currency bond (PRDB) is an exotic financial structured product where an investor is seeking a better return and a borrower a lower rate by taking advantage of the interest rate differential between two countries. The power component of the name denotes higher initial coupons and the fact that coupons rises as the domestic/foreign exchange rate depreciates. The power feature comes with a higher risk for the investor. Cash flows may have a digital cap feature where the rate gets locked once it reaches a certain threshold. Other add-on features are barriers such as knockouts and cancel provision for the issuer.


See Pricing or Prospectus Prepayment Curve.


When the price of a security is above par (100.00), the bond is said to be trading at a premium and when it is trading below par it is trading at a discount.

Prepayment Risk

Usually referred to in the ABS and MBS markets, this is the risk that borrowers prepay their loan early. In the mortgage market, homeowners will prepay their mortgage when interest rates decline. As rates decline, the MBS investor will receive their principal back sooner than expected and will have to reinvest the proceeds at lower interest rates, thus exposing them their portfolios to lower returns than originally expected.

Prepayment Speed Assumptions (PSA)

The Public Securities Association originally developed PSA and hence the acronym is sometimes referred to as its namesake. (The Public Securities Association became the Bond Market Association and is now known as the Securities Industry Financial Market Association or SIFMA). PSA is a prepayment benchmark based on CPR (Conditional Prepayment Rate). It is used as a measure of relative prepayment speeds. 100% PSA equals a starting rate of .2% each month for 30 months, at which point prepayments level off and stay constant at 6% CPR for the remainder of the life of the mortgage. Similar to CPR, PSA is used in multiples of 100 so that 200% PSA equates to .4% prepayment in the first month, leveling off to 12% in month 30.

Present value

The current value of a sum of money that is to be received at some later date.

Pricing or Prospectus Prepayment Curve (PPC)

This prepayment measure is used mainly with HELs and is indicative of the level of prepayments (anticipated or historical) designated in the deal prospectus. PPC is deal-specific, and deals are normally priced at 100% PPC, with prepayment forecasts expressed as some multiple of 100%. Comparisons among deals can be tricky because each PPC is defined differently in each security’s prospectus.

Primary Dealer

Firms that buy government securities directly from a government when they are issued and then resells them to other parties. Generally, primary dealers are obligated to offer liquidity in the government debt markets.

Primary market

The market for raising capital by issuing securities, debt or equity, either to the general investing public or to a special class of investors.

Primary market

The market for raising capital by issuing securities, debt or equity, either to the general investing public or to a special class of investors.

Principal Only (PO)

The principal only cash flows of a mortgage pass-through.

Principal Trading Firm (PTF)

Investors that trade for their own account and do not have traditional customers. PTFs employ algorithmic and high frequency trading strategies, generally do not hold overnight positions, trade large total volumes in small individual trade sizes, and may or may not be part of FINRA. PTFs play a major role in the liquidity of the US Treasury markets.

Private Placement

Bonds that are directly placed with investors rather than underwritten and sold to the general public. The issuer doesn’t have to register with the SEC and investors are able to write stronger covenants into the deal. Private placements are less liquid but offer higher yield versus comparable credit/maturity public issues.

Protective Put

The purchase of a put option to hedge an asset or a portfolio from a decrease in price of the underlying asset or assets.


Public Securities Association (now known as the SIFMA) developed a prepayment benchmark based on CPR (conditional prepayment rate). PSA is used as a measure of relative prepayment speeds.


The change in an option’s premium for a given increase in the yield of the underlying instrument. Has the opposite effect of Rho.


See Principal Trading Firm.

Put option

An option that grants its holder the right to sell the underlying asset to the option writer at the option’s strike price within a given time frame.

Puttable bond

A bond that allows the owner to terminate or redeem the bond prior to its scheduled maturity date.

Puttable swap

A fixed-for-floating interest rate swap in which the floating ratepayer has the right to terminate the swap prior to its scheduled maturity date.



Refers to predetermined increase in interest rates over a set period of time. For example, increase the yield curve by 100 bps every six months. Generally used in Asset Liability Management to determine “what if” scenarios on the institutions’ income.


See Risk Adjusted Return on Capital.

Rate-capped swap

A fixed-for-floating interest-rate swap in which the floating rate side is capped. Can be created as a unit or by combining an interest-rate swap with a separate interest-rate cap.


See Risk Based Capital.

Real Estate Mortgage Investment Conduit (REMIC)

A structure which allows issuers to carve the cash flows of the underlying pass-through securities into various classes or tranches having different investment characteristics. REMIC is the legal term but market practitioners simply refer to them as CMO’s or Collateralized Mortgage Obligations.


The repayment of a debt obligation.

Reference rate

An index (such as LIBOR, EurIbor or three-month T-bill) designated to determine the interest rate payable on floating rate cash/derivative instruments.

Regulatory Capital

The amount of capital a bank is required to maintain as dictated by regulators.

Reinvestment Risk

1) Risk that arises when the cash flows from assets precedes the cash requirements for meeting the liabilities of a portfolio. These early cash inflows need to be reinvested at the future dates, at rates largely unknown today. 2) The risk of reinvesting the incomes or other cash flows at rates other than those envisaged today.

Relative Return Strategy

The measurement of the comparative attractiveness of a security with respect to the associated risks, the liquidity and the return on the security relative to another security.

Relative Value

The measurement of the comparative attractiveness of a security with respect to the associated risks, the liquidity and the return on the security relative to another security.


See Real Estate Mortgage Investment Conduit.

Replacement swap

A swap that is entered to replace a swap that is terminated prematurely. This most often becomes necessary when a one of a pair of matched swaps is terminated early.

Repurchase agreement

Also known as a repo and an RP. A method of borrowing that involves the sale of a security with the simultaneous agreement to buy it back at a specific later date and at a specific price. These agreements are widely used in the securities industry as a means of obtaining relatively inexpensive short term financing.

Request for Quote (RFQ)

An electronic trading platform where users submit a query, or request, for a price on a specific security/instrument, for a set amount/size, to different dealers/counterparties. Once prices have been sent by the dealers, and the dealers respond, the sender will evaluate them.

Required rate of return

Return required by investors to invest in a security that has a specific amount of risk. Also refers to the return required to meet a specific set of liabilities.


An adjustment in a floating rate of interest that marks the rate to that prevailing in the market.

Reset dates

The scheduled dates for the resets of the floating rate of interest on rate swaps.

Reverse Dual Currency Note

A dual currency note (DC) pays coupons in the investors’ domestic currency with the notional in the issuers’ domestic currency. A reverse dual currency note (RDC) is the reverse.

Reverse repurchase agreement

Also known as a reverse and a reverse repo. The opposite of a repurchase agreement. The purchase of a security with the simultaneous agreement to sell it back at a specific later date and at a specific price.


See Request for Quote.


The change in an option’s premium for a change in interest rates.


A measure of uncertainty. Risk measures the extent of uncertainty attached to the realization of the expected return on any asset. It is generally measured through the standard deviation of returns.

Risk Adjusted Return on Capital (RAROC)

The return on an investment after taking into account the revenue and cost, both external and internal, divided by the amount of capital that is first adjusted for the riskiness of the investment. Technically speaking, it is the risk-adjusted return divided by the risk-adjusted capital.

Risk Based Capital (RBC)

The amount of capital required to be held to absorb unexpected losses when taking into account the riskiness of assets/businesses in order to protect customers, depositors and investors.

Risk Based Capital Ratio

See Capital Ratio.

Risk free rate

The return on a risk free asset. This is the guaranteed rate of return earned, when the money is invested in a security with no risk of losing capital and facing no uncertainty in realizing the returns.

Risk premium

Investors or lenders undertake risk while making an investment or lending money to borrowers. A risk premium is the additional rate expected or charged over and above the risk free rate in order to compensate them for accepting or undertaking the risk. The risk premium is expected or charged for various risks such as market risk, credit risk or liquidity risk.


Automated and digital techniques are used to build and manage investment portfolios for investors.

Roller coaster swap

Any swap in which the notional principal increases for a time and then amortizes to zero over the remainder of its tenor.



See Swiss Average Overnight Rate.


See Standard Default Assumption.


A seasoned pool of mortgages is one that is outstanding for a while, generally more than 30 months, and experiences faster prepayment levels. This can be due to increased housing turnover coming from homeowners relocating due to trading up, realizing equity gains in real estate value, improved financial situation, etc.

Secondary market

Market where participants buy and sell securities directly with one another without dealing with the issuing company.

Sector Valuation

The process of measuring the relative investment attractiveness of one sector as compared to another. Various valuation techniques are employed to infer the relative attractiveness of the sectors. The valuation techniques depend on the way the sector is defined, for example, industry sector or yield-curve segment or credit class. Sector valuation plays a major role in the top-down approach for investment management.

Secured Overnight Financing Rate (SOFR)

The rate that will be replacing US Dollar LIBOR. SOFR is based on the U.S. repo market and is considered broad based. This is because the rate is determined from the tri-party repo market, the general collateral financing (GCF) repo market and the bilateral repo market (For more specifics about this rate, calculations and its features go to https://www.gfmi.com/articles/libor-schmibor-whats-next-sofr-part/. It is intended to be used as the risk-free reference rate for U.S. cash and derivative money market instruments.


Also known as Structured Finance, securitization refers to the combination or pooling of cash flows from various underlying collateral (such as mortgages, credit cards, home equity loans, commercial mortgages, bank loans), then repackaging these cash flows to create securities that are then sold to investors.

Security Market Line (SML)

SML shows the relationship between the expected returns and market risk. According to SML, at equilibrium, the return on a security is equal to the risk free return plus the excess return (over the risk free return) on the market portfolio times the beta of the security.


See Swap Execution Facility.

Semi-annual rate

An annual rate of interest that is paid in two semiannual installments. Not to be confused with a “half-year rate” which is a rate of interest stated on a six-month basis.


With respect to futures, all futures listed on the same exchange and having the same terms, including the same delivery month.

Settlement date

1) In securities trading, the date a transaction is cleared. 2) In futures trading, the date a cash settled contract is marked to the spot price or index. 3) The date that the cash settlement is due on an interest rate contract. This may or may not coincide with the calculation date.

Settlement price

The price established by the clearinghouse of a futures exchange to be used as the basis of the daily marking-to-market of margin accounts

Settlement Risk

The risk that differences between market settlement hours may result in exchanges of interest and/or principals at different times or even on different days. The first paying party is exposed to the risk that the later paying party will default after the first paying party has made its required payment but before the later paying party has made its payment.

Sharpe Ratio

The ratio of the excess total return on a portfolio (over-and-above the risk-free rate) relative to its market risk on the portfolio.


1) A party is said to be short securities if he or she has borrowed the securities (usually for purposes of a short sale). 2) A party is said to be short futures and options if he or she has sold the contracts.


The Securities Industry and Financial Market Association, SIFMA is the combination of the Securities Industry Association (SIA) and the Bond Markets Association (BMA) and represents over 600 member firms in all financial markets in the U.S. and worldwide. SIFMA is committed to enhancing the public’s trust and confidence in the markets, offering forward-looking services and educational resources to financial professionals.

Simple rate of interest

The rate of return over a given time period, e.g., quarterly or semi-annually, without taking compounding into account.

Single Monthly Mortality (SMM)

A prepayment measure which reflects the percentage of the outstanding mortgage loan that prepays in one month.

Single-Dealer Platform

Proprietary trading platform connecting one dealer with its clients to offer trading execution.


See Security Market Line.


See Single Monthly Mortality.


See Secured Overnight Financing Rate.


See Sterling Overnight Index Average.

Sovereign risk

The risk that an issuer may be barred by its government from making interest and principal payments on its debt. In the context of derivative instruments, it is the risk that a counterparty will be barred by its government from fulfilling its derivative obligations.

Special Purpose Vehicle (SPV)

Legal entity created for the sole purpose of issuing securities to investors. In a mortgage backed pass-through, the cash flows of the underlying mortgages are used to satisfy the investor’s interest and principal payments.

Spot Date

Trade date plus two business days.

Spot exchange rate

Also known as a spot rate. The exchange rate quoted for immediate deliver of a currency. As a practical matter, immediate delivery is understood to be two business days. See also exchange rate

Spot rate

1) See spot exchange rate. 2) Refers to a spot interest rate. This is also a zero coupon yield. An interest rate that represents a yield to maturity when there are no interim coupons paid between the initial payment for the instrument and the final redemption.


The amount a security is trading above a specific benchmark. Important measurement to determine bond values.


See Special Purpose Vehicle.

Standard Default Assumption (SDA)

Similar to PSA the SDA measurement for defaults on mortgage loans is dependent on the age of the mortgage. Historically, default rates tend to be low early on in a pool of mortgages, gradually ramping up before peaking two to five years after origination. The SDA curve captures this default experience providing a standard for the market similar to the PSA prepayment curve. 100% SDA begins with .02% CPR of defaults in the first month, increasing by .02% CPR each month for 30 months, where it levels off to .6%. This rate is held for the next 30 months and in month 61, defaults decrease until month 120, where the tail value of .03% is reached and stays for the life of the security.

Standard deviation

A statistical measure of dispersion around some central (mean) value. Obtained by taking the square root of the variance.

Static yield spread

See Z-spread.

Statutory Capital

The minimum amount of capital required by state regulators to conduct business within the respective state.

Sterling Overnight Index Average (SONIA)

A transaction-based overnight interest rate that is unsecured and reflects banks’ cost of borrowing from other financial institutions. It will be used as the preferred risk-free reference rate for sterling Overnight Index Swaps (OIS) and will replace GBP LIBOR.


See Straight Through Processing.

Straight Through Processing (STP)

Complete electronic execution of a transaction from the confirmation of an order through clearing, payment, and settlement.

Strategic Asset Allocation

Long term strategy for allocating investment capital among various asset classes based on economic conditions and investor risk/return parameters and constraints. Not a trading strategy but a long term, big picture asset allocation strategy.


A dealer or market maker will continuously show or “stream” firm prices with the corresponding size so that clients can trade on these prices. Clients will “click to trade”.

Strike price

Also known as exercise price. The amount that must be paid (or the price that will be received) by an option owner to buy (or sell) the underlying asset from the option writer.


Stands for “Separate Trading of Registered Interest and Principle of Securities” and refers to breaking down a coupon bearing bond into its constituent parts of interest and principle payments which can be held /traded separately. These individual cash flows can be traded as zero coupon bonds.

Supplemental Capital

Generally speaking regulators breakdown capital into tier 1 and tier 2 capital. Tier one is considered core capital and generally contains items such as equity and retained earnings. Tier 2 is referred to as supplemental capital and generally contains items such as allowance for loan and lease losses (limited), non-qualifying perpetual preferred stock, certain hybrid capital instruments, mandatory convertible securities, long-term preferred stock and other qualifying items.


A contractual agreement providing for a series of exchanges of principals and/or interest in the same or different currencies. At a more general level, the term includes the exchange of fixed for floating payments on a given quantity of commodity, i.e., commodity swap. See also interest-rate swaps and currency swaps.

Swap broker

An agent, acting on behalf of one or more principals, that finds parties with matching swap needs in exchange for a commission.

Swap coupon

The fixed rate of interest on the fixed-rate side of a swap

Swap dealer

Also known as a market maker. A financial intermediary that makes a market in swaps and that profits from its bid-ask spread. Unlike a swap broker, the swap dealer becomes a counterparty to each swap.

Swap driven

A term loosely used to describe pricing behaviors in non-swap instruments that are brought about through a linkage to the swap market. Examples include price movements in the futures and forward markets.

Swap Execution Facility (SEF)

Trading facilities, operating under the oversight of the CFTC, for the trading and processing of swaps. SEFs were created under the Dodd-Frank Act to promote pre-trade price transparency in the swaps market.


An option on a swap. The swaption purchaser has the right to enter a specific swap for a defined period of time.

Swiss Average Overnight Rate (SARON®)

A transaction-based overnight interest rate that is secured and calculated from the swiss repo market. According to the six-group website “The point of departure of Switzerland’s yield curve is the SARON®, an overnight reference rate based on data from the Swiss franc repo market.”

Synthetic instruments

A basket or combination of instruments that behaves, in terms of its cash flow stream, like some real instrument not included in the original basket.

Systematic Risk

The degree to which the fluctuations in the value of a financial instrument are associated with fluctuations in the value of the underlying market.



See Targeted Amortization Class.

Targeted Amortization Class (TAC)

A tranche in a CMO that is similar to PACs but have a single PSA rate (not a band of PSA rates like the PAC) that protects it from fluctuations in prepayment speeds. TACs are protected against higher than expected prepayment rates but not against extension risk. If prepayments are slower than the pricing speed, then TACs have the same prepayment risk as the underlying collateral.

Tax driven swaps

Asset-based swaps that are used to alter the tax character of a cash flow stream.

TED spread

The difference between the interest rate on Treasury bills and the interest rate on Eurodollar deposits of similar maturities. The definition applies to both cash instruments and futures contracts.


The length of the life (term to maturity) of a multi-period derivative instrument such as a rate cap, a rate floor, or a swap.

Term repo

A repurchase agreement having a maturity more than one day.

Term structure of interest rates

Shows the relationship between interest rates on bonds of different maturities, usually depicted in the form of a graph called a yield curve.

Term to maturity

Also referred to as term. The length of time from the present until the maturity of an instrument.


Theta measures the rate of change or “time decay” in the option premium given a change in time i.e. a change in the option’s maturity.

Time Value

In terms of an option contracts value, the price of the option attributable to the time remaining until expiry, volatility and interest rates. Intrinsic value + time value = premium.

Time value of money

The value of one dollar is worth more in the future than it is worth today since the money can be placed in an interest bearing instrument or deposit and earn interest. Generally refers to future value and present value.

Tokyo Overnight Average Rate (TONAR)

A transaction-based overnight interest rate that is unsecured. The rate will serve as the risk-free reference rate in Japan. TONAR is used in the overnight index swap (OIS) market as a reference rate.


See Tokyo Overnight Average Rate.

Total Adjusted Capital

An insurance industry term that in general means the statutory capital and surplus, plus any other adjustments for risk based capital requirements or other adjustments, such as affiliates asset value reserve (AVR). It forms the numerator in the risk based capital ratio.

Total Return

A tool of performance measurement defined as the change in value of an investment over a given period, taking into consideration reinvestment of dividends, interest received and capital gain distributions, expressed as a percentage of the initial investment.

Total Return Swaps

A financial contract where two parties agree to:

  • Exchange predetermined cash flows over the life of the contract
  • One counterparty agrees to pay on a referenced loan/bond/index/stock while the other
  • One counterparty agrees to pay on a floating rate, generally LIBOR +/- spread
There is a final or intermittent settlement, based on cash, or delivery of securities/loans.

Tracking error

Returns are generally measured and benchmarked to a particular index. Tracking error is the difference between the performance of a particular portfolio and the benchmark.

Transaction costs

The costs associated with engaging in a financial transaction. These include such explicit costs as commissions and front-end fees and indirect costs such as a bid-ask spread.

Treasury bills

Also known as T-bills. Short-term securities sold at a discount from face value by the United States Treasury as part of its ongoing funding operation. Offered in maturities of 13 weeks, 26 weeks, and 52 weeks.

Treasury bonds

Also known as T-bonds. Long-term coupon-bearing securities issued by the United States government.

Treasury notes

Also known as T-notes. Intermediate-term coupon-bearing securities sold at periodic auctions by the United States Treasury to fund its ongoing operations.

Treynor Ratio

The excess total return on an asset or portfolio, over-and-above the risk-free rate, relative to its beta. treynor-ratio


U.S. Treasury Securities

Also called Treasuries, sometimes called Governments. Debt issues of the United States Treasury consist primarily of Treasury bills (T-bills), Treasury notes (T-notes), and Treasury bonds (T-bonds).


Refers to the asset/instrument that the derivative contract derives its value from.

Unsystematic risk

Diversifiable risk or residual risk, which is specific to a security and can be removed through diversification. It is the variability of a security’s total returns, which is not related to the overall market variability.

Upward sloping yield curve

Also called an ascending yield curve. The normal shape of the yield curve when short maturity instruments have lower yields than long maturity instruments.


Value at Risk (VaR)

A tool for assessing market risk. VAR measures the expected maximum loss at a given confidence interval over the holding period.


See Value at Risk.


Measures the change in the option’s premium for each 1% change in the underlying instrument’s volatility.


1) Refers to the price or yield of a security or market to rise or fall. Measured by the variance and standard deviation of the security. 2) Bond price volatility refers to the change in the bond price given a change in yields. See: Dollar value of a basis point.

Volatility curve

A curve depicting the relationship between implied volatility and time to expiration.

Volatility skew

A graph that depicts the relationship between implied volatility and the strike prices of options with the same expiration dates. Implied volatility is on the Y-axis and the options’ strike prices are on the X-axis and the resulting curve is skewed. Different markets exhibit curves of different shapes.

Volatility smile

A graph that depicts the relationship between implied volatility and the strike prices of options with the same expiration dates. Implied volatility is on the Y-axis and the options’ strike price is on the X-axis and the resulting curve is in the shape of a smile.


Yankee bond

A foreign bond issued in the United States.

Yield curve

A graphic portrayal of the relationship between the yields to maturity of instruments of a given class and the terms to maturity of those instruments. See also term structure of interest rates.

Yield Curve Shifts

Changes in the shape of the yield curve. See parallel shifts and non-parallel shifts.

Yield Spread

The difference of yield between various securities, of similar maturity and other features, but with different credit qualities (ratings).

Yield to call

In callable bonds, the yield calculated to the next call date. It assumes the callable bond will be called on this call date thereby contractually canceling all coupon payments past the respective call date and altering the yield earned by the investor.

Yield to maturity

Also called yield. The discount rate that equates the present value of the cash flow stream associated with an instrument and the current price of that instrument. This calculation assumes that cash flows can be reinvested to earn the same rate.


This is used in callable bonds to compare the yield to call and the yield to maturity. Whichever yield is lower is considered the yield-to-worst. (It is also used with other bonds with special features such as puttable bonds but is most frequently associated with callable bonds)


Z bond

Z bond or accrual tranche, is often the last tranche in a CMO structure and receives no interest payments until the other tranches are paid off. The interest used to pay down the earlier tranches accrues to the Z bond and is added to the principal amount.


The zero-volatility spread or static yield spread. By keeping interest rate volatility at zero, the investor can use this spread to quantify other factors, such as credit risk and liquidity risk, when comparing and valuing different bonds. Uses zero rates, so no reinvestment risk and is calculated by using the entire yield curve, thus, capturing yield curve risk. Disadvantage—doesn’t take into account changes in prepayments and the optionality of the security.

Zero Correlation

A zero correlation indicates that the securities’ returns are independent of each other.

Zero coupon bond

Also called a zero. A bond that does not pay periodic coupons. In lieu of periodic coupons such bonds are sold at a steep discount from par and redeemed at par.

Zero coupon-for- floating swap

A variant of the fixed-for-floating interest rate swap in which the fixed-rate paying party pays all interest upon the termination of the swap.

Zero Rate

Also called spot rate. An interest rate that represents a yield to maturity when there are no interim coupons paid between the initial payment for the instrument and the final redemption.

Zero Volatility Spread

See Z-spread.

Zero-coupon yield curve

A graphic portrayal of the relationship between yield and maturity when the instruments involved are zero-coupon bonds. Usually drawn for Treasury-based zeros.