GLOSSARY OF FINANCIAL DERIVATIVES TERMS

A B C D E F G H I J K L M N O P Q R S T U V W X Y Z

GAap

Generally Accepted Accounting Principles - A widely accepted set of standards, conventions, rules, and procedures that for-profit and not-for-profit entities follow in the recording and reporting of accounting and financial information as established by FASB.

GAMMA

The rate of change in the delta of an option for a small change in the underlying. The rate of change is greatest when an option is at-the-money and decreases as the price of the underlying moves further away from the strike price in either direction – gamma is therefore -shaped. A long gamma position is one in which a trader is long options. For a position that is short gamma, the opposite holds. Gamma can be hedged by mirroring the options position. Alternatively, a trader may choose to adjust the position in the underlying continually in order to maintain delta neutrality.

GAO REPORT

The colloquial name for the May 1994 report “Financial Derivatives: Actions Needed to Protect the Financial System” published by the US General Accounting Office, the investigative arm of Congress. The report made six key points:
    •     Derivatives perform a valuable function by enabling end-users to manage the financial risks associated with their business
    •     The concentration of over-the-counter (OTC) derivatives activity among 15 extensively linked major US dealers opens up the possibility of liquidity problems and systemic risk should any of these dealers fail
    •     There are no comprehensive or federal regulatory requirements to ensure that major OTC players in the US follow good practice in risk management, so newcomers could increase the systemic risk by taking on unnecessary risk
    •     Significant gaps exist in the regulation of many major OTC derivatives, most notably affiliates of securities firms and insurance companies
    •     Insufficient precision in accounting for and financial reporting of derivatives compound the difficulties faced by interested parties when trying to assess their impact
    •     Innovation and creativity are strengths of the US financial services industry which should not be shackled by over-regulation.

GARCH

Generalized ARCH.

GARMAN-KOHLHAGEN MODEL

A model developed to price European-style options on spot foreign exchange rates. The model is based upon the Black-Scholes model with the addition of an extra interest rate factor for the foreign currency.

GARMAN-KOHLHAGEN MODEL

gasb

Governmental Accounting Standards Board – A private, independent, not-for-profit organization that – through an open and thorough due process – establishes and improves standards of financial accounting and reporting for state and local government. Governments and the accounting industry recognize GASB as the official source of generally accepted accounting principles (GAAP) for state and local governments.

GEARED KNOCK-OUT/IN OPTION

See barrier option

GEARING

The price of the underlying divided by the price of the derivative contract, which can be used for crude assessments of leverage and option pricing. A more sophisticated measure is effective gearing, or elasticity, which is designated lambda. This is the traditional gearing multiplied by the derivative’s delta.

GEOMETRIC BROWNIAN MOTION

Geometric Brownian motion is a model frequently used for the diffusion process followed by asset prices. Standard Brownian motion is a random walk process with Gaussian increments; that is, changes in the asset price are normally distributed. The term geometric means it is the proportional change in the asset price (as opposed to the absolute level) that is normally distributed. This gives the model useful properties, in that the asset price cannot be negative, and that the logarithm of the asset price will be normally distributed, making the model analytically tractable.

Gic

See Guaranteed Investment Contract

GOLD FORWARD OFFERED RATE

The rates at which dealers will lend gold on swap against US dollars.

GOLD LEASE RATE

The gold lease rate is the cost to borrow gold. Similar to other commodities it is a function of supply and demand. The rate (non-credit adjusted) is determined by the difference between Libor and the gold forward rate for the specified period. Credit adjustments are subsequent to the calculation.

GOLD-LINKED NOTE

A note (or bond) with interest payments linked to the price of gold constructed by reducing the coupon (sometimes to zero) and buying (or selling) put or call options to gain exposure to an increasing (or decreasing) gold price.

GOvernmental accounting standards board (GASB)

See GASB

GROUP OF THIRTY REPORT

The colloquial name for the July 1993 report “Derivatives: Practices and Principles” of the Global Derivatives Study Group of the Group of Thirty, a private think-tank of dealers, end-users, academics, accountants and lawyers. The report made 20 recommendations on best practices for derivatives management, based on the results of a survey of banks and end-users. (A follow-up survey was conducted in 1994). The report suggested a number of operational improvements for firms using derivatives. These included: involving senior management in policy-making for derivatives, authorizing only skilled professionals to trade derivatives, and establishing autonomous market and credit risk management functions with sophisticated reporting and measurement systems.

On market risk, the report recommended marking derivatives positions to market on a regular basis, quantifying and stress-testing for market risk under extreme market events. On credit risk, it suggested comparing credit exposure with credit limits frequently and establishing legal provisions for default scenarios. It also called for market participants voluntarily to adopt standard accounting and disclosure procedures for international harmonization and greater transparency.

In addition, the report called upon regulators, legislators and supervisors to recognize close-out netting agreements and the provisions of the Basel Capital Accord when setting bank capital requirements, work with market participants to reduce legal uncertainties and improve accounting and disclosure procedures connected with derivatives, and amend tax regulations which disadvantaged the economic use of derivatives.

GUARANTEED EXCHANGE RATE OPTION

An option (also known as a quanto option) on an asset in one currency denominated in a second currency. The exchange rate at which the purchaser converts the currency is fixed at the start. Such options are increasingly popular as investors want exposure to foreign assets without the foreign exchange risk. Most of the demand is for bond and stock index options. The extra cost of the option depends on the correlation between movements in the exchange rate and movements in the underlying. The higher (more positive) the correlation between the underlying and the exchange rate (expressed as the number of units of currency two per unit of currency one) the more expensive a call option will be and the cheaper a put option will be. Quanto options can, however, look cosmetically cheaper (or more expensive) depending on the forward interest rates in the two currencies. For example, buying a call on a US asset could be “cheaper” in euros if there is a wide interest rate differential between the euro and the dollar.

GUARANTEED investment contract (GIC)

A Guaranteed Investment Contract ("GIC") is a contract between a municipal entity or 501(c)(3) organization and a financial institution (the "Provider") in which the Provider guarantees a rate of return on bond proceeds deposited under the investment contract. Guaranteed Investment Contracts have proven to satisfy the unique economic, tax and legal requirements associated with the investment of tax-exempt bond proceeds and have been used with increasing frequency among tax-exempt issuers.

  A GIC offers the preservation of principal, earns a fixed yield, and allows for access to funds with no market risk. A GIC is particularly well suited for construction funds because it allows for full flexibility of draws, thus eliminating any market and/or reinvestment risk if construction draws fluctuate for any reason. GICs can also be used for debt service reserve funds, bond funds, and escrow funds, with draws occurring semi-annually on bond payments dates or as required by the Indenture. The yield on an investment contract will generally exceed the yield on a repurchase agreement by approximately 30 basis points.

  Guaranteed investment contracts can be structured with varying degrees of security. Typically, the security is provided by requiring the Provider of the GIC to maintain a certain level of long-term credit rating by one or more of the recognized Rating Agencies. The rating requirement for the Provider is often determined by the Indenture or other bond documents. In the event the Provider is downgraded below a certain level (e.g. below the "A" category from Moody's or Standard & Poor's) while the GIC is in place, then the Provider is required to provide additional security such as posting collateral with an independent third-party or assigning the contract to a new provider that both meets the rating requirement and is acceptable to the Issuer.

  Documentation for a GIC is usually a straight forward contract between the Provider of the GIC and the Trustee and/or the Issuer.

GUARANTEED PRODUCT

See guaranteed return on investment, principal-guaranteed note

GUARANTEED RETURN ON INVESTMENT

Any instrument (usually a structured note) which guarantees investors a minimum return on their investment. This can be achieved by combining a debt issue with a structure, such as a collar or cylinder, which locks gains into a range. This means that the investor gains protection from an adverse market move by limiting participation in any favorable move.