ACCELERATED SUPPLY
Gold that reaches the market through leasing, lending, or the derivative market before it is physically produced. Commonly used to describe the effect of a gold producer hedging on the short-term market. This term is sometimes used in other commodity markets as well.
ACCRETING
A description, applicable to a variety of instruments, denoting that the notional principal increases successively over the life of the instrument, e.g., caps, collars, swaps and swaptions. If the increase takes place in increments, the instrument may be known as a step-up.
See also
amortizing
ACCRUAL ACCOUNTING
When swaps are used for asset/liability hedging purposes, that is, to hedge specific on-balance sheet exposures, they are often accounted for on an accrual basis. Under the accrual method, the net payment or receipt each period is accrued and recorded as an adjustment of income or expense.
See also
hedge accounting,
mark to market
ACCRUAL CORRIDOR
The range within which an underlying reference rate must trade for coupon payments to accrue in a range note or corridor option.
ACCRUAL NOTE
See
range note
ACCRUAL PERIOD
Period over which net payment or receipt pertaining to swaps is accrued. It is inclusive of the start date and runs to the end date without including the end date.
ADVANCE PREMIUM FORWARD
A forward contract in which the contango is partly payable in advance. This transaction is also known as a flat rate forward or stabilized contango. An advanced premium forward is particularly useful during the early years of a project when the greater contango can provide greater cash flow. The conversion of a standard forward into an advanced premium forward allows for the early realization of hedging values. In this case, the early payment of the contango is at the expense of yield in the later years in a strip of forwards.
ALL-OR-NOTHING OPTION
See
binary option
ALTERNATIVE RISK TRANSFER
An approach to risk management combining capital markets, reinsurance and investment banking techniques that allows a party to either free itself from risks not easily transferred via traditional insurance, or alternatively cover such risks in a non-traditional way – by using the capital markets for example.
AMERICAN-STYLE OPTION
The holder of an American-style option has the right to exercise the option at any time during the life of the option, up to and including the expiry date.
See also
option styles
AMORTISING
A description, applicable to a variety of instruments, denoting that the notional principal decreases successively over the life of an instrument, e.g., amortizing swap, index amortizing rate swap, amortizing cap, amortizing collar, amortizing swaption. If the decrease takes place in increments, the instrument may be known as a step-down. Mortgage-style amortization refers to an amortizing swap such that the principal amortization plus interest is the same amount in each interest period.
See also
accreting
ANNUITY SWAP
An interest rate swap in which a series of irregular cashflows are exchanged for a stream of regular cashflows of equivalent present value.
ARBITRAGE
A guaranteed or riskless profit from simultaneously buying and selling instruments that are perfect equivalents, the first being cheaper than the second.
ARBITRAGE-FREE MODEL
Any model that does not allow arbitrage on the underlying variable. Some simple early models assumed parallel shifts in the yield curve, but the varying yields of different duration bonds could be arbitraged using butterfly strategies.
ARCH
(AutoRegressive Conditional Heteroscedasticity.) A discrete time model for a random variable. It assumes that variance is stochastic and is a function of the variance of previous time steps and the level of the underlying.
See also
GARCH
ARS
See auction rate securities
ASIAN OPTION
See average option
ASSET ALLOCATION
The distribution of investment funds within a single asset class or across a number of asset classes (such as equities, bonds and commodities) with the aim of diversifying risk or adding value to a portfolio.
See also
portfolio insurance,
overlay
ASSET SWAP
A package of a cash credit instrument and a corresponding swap that transforms the cash flows of the non-par instrument (bond or loan), into a par (floating interest rate) structure. Asset swaps typically transform fixed-rate bonds into par floaters, bearing a net coupon of Libor plus a spread, although cross-currency asset swaps, transforming cashflows from one currency to another are also common.
ASSET/LIABILITY MANAGEMENT
The practice of matching the term structure and cashflows of an organization’s asset and liability portfolios in order to maximize returns and minimize interest rate risk. An institutional example of this would be a bank converting a fixed-rate loan (asset) by utilizing a fixed-for-floating interest rate swap to match its floating rate funding (deposits).
ASSET-BACKED SECURITY
A financial instrument which is collateralized by bundled assets such as mortgages, real estate, credit card repayments or other receivables. This class of securities includes collateralized mortgage obligations and mortgage-backed securities, which are debt instruments collateralized with pooled real-estate mortgages.
AT MATURITY TRIGGER FORWARD
See trigger forward
AT-THE-MONEY
1. At-the-money forward: An option whose strike is set at the same level as the prevailing market price of the underlying forward contract. With a Black-Scholes model , the delta of a European-style, at-the-money forward option will be close to 50%.
2. At-the-money spot: An option whose strike is set the same as the prevailing market price of the underlying. Because forwards commonly trade at a premium or discount to the spot, the delta may not be close to 50%.
AUction rate securities
A debt instrument used by tax-exempt and corporate issuers with a long term maturity for which the interest rate is adjusted either daily, or every seven, 28 or 35 days. The interest rate adjustments are determined by an auction, in which the remarketing agent (typically a securities dealer) takes bids from investors in the form of a yield and amount. The remarketing agent then determines the lowest rate to clear the outstanding amount of auction rate securities (ARS).
In early 2008, as the credit crunch continued, Wall Street firms which served as the remarketing agent for the auctions stopped bidding on the auctions themselves, and the auctions failed. A failed auction simply means that there were not enough ‘buy’ orders to fill the number of ‘sell’ orders. In the relatively opaque bidding process, many dealers were supporting auctions by bidding on the ARS to prevent the auction from failing. The result was that many investors who held this paper were not able to sell it, and the investments became illiquid. Because ARS have no bank liquidity facility, there is no put option available for the investor. In the event of a failed auction, the interest rates jump to a pre-determined max rate. The max rates can be absolute, such as 12%, or formulaic, such as 6-month commercial paper + 100 basis points, for example. In the spring of 2008, there were widespread auction failures in the $165 billion municipal ARS market. Many issuers were experiencing borrowing costs that greatly exceeded their budget, and by the summer of 2008, over half of the outstanding municipal ARS had been converted to another debt mode, such as fixed rate, or variable rate bonds.
AUTOCAP
A standard cap consists of a series of caplets hedging future floating rate payments. However, autocaps only provide a hedge for the first pre-specified number of in-the-money caplets after which the option expires, and so are a cheaper alternative to caps.
AUTOCORRELATION
A time series is autocorrelated if future returns are correlated with past returns. If a financial time series such as a record of stock prices, for example, exhibits autocorrelation, then it may be possible to use historical data to predict future price changes.
AVERAGE OPTION
A plain vanilla option pays out the difference between its predetermined strike price and the spot rate (or price) of the underlying at the time of expiry. The purchaser of an average option (average price, average strike, average hybrid, average ratio), on the other hand, will receive a pay-out which depends on the average value of the underlying. The average can be calculated in a number of ways (arithmetic or geometric, weighted or simple) from the spot rate on a predetermined series of dates (usually official fixing rates). An average rate (also known as average price) option is a cash-settled option with a predetermined (i.e., fixed) strike which is exercised at expiry against the average value of the underlying over the option’s life. In general, hedging with an average option is cheaper than using a portfolio of vanilla options, since the averaging process offsets high values with low ones and therefore lowers volatility and premium. Average rate options, also known as Asian options, are particularly popular in the currency and commodity markets.
In contrast, the strike for an average strike option is not fixed until the end of the averaging period which is typically much before the expiry. When the strike is set, the option is exercised against the prevailing spot rate. Unlike average price options, average strike options may be either cash or physically settled. In the case of an average hybrid option (also known as an average-in/average-out option), both the strike and settlement price of the option are determined using the average, where the strike averaging period typically precedes the settlement price averaging period. For the average ratio option, both the strike and settlement price of the option are determined using the average as in the hybrid case. The final payoff is determined by comparing the ratio of settlement price to strike and a fixed percent strike.
AVERAGE PRICE OPTION
See
average option
AVERAGE RATE OPTION
See
average option
AVERAGE STRIKE OPTION
See
average option