The following are terms that I use on this site. The definitions are my
own. Note that definitions of financial terms are not
standardized. That is one of the reasons why financial legal
documentation is so dense -- each term has to be redefined in the
document! Useful financial glossaries are sprouting up all over the Web (See
for example the Nasdaq's
Glossary, Business
Glossary Index of
the Washington Post and The Glossary of
Frequently Used Terms by Finance Canada).
Please let me know about any problems you find with my definitions.
| Term |
Definition |
| A |
|
| ABS |
See asset backed securities |
| Acceptance |
Acceptance is the legal recognition by a drawee that it has
an obligation to make payment on a draft according to its terms |
| Acceptance Company |
A finance company that purchases at a discount extended
payment purchase contracts or receivables from sales companies |
| Account
Party |
The FI's customer. In a letter
of credit, the FI guarantees payment to the beneficiary on behalf of
the account party. The account party also undertakes a contingent
obligation to the FI in the event that the letter of credit is negotiated. |
| ACSS |
The Automated Clearing Settlement System
operated by the CPA to aggregate all payments
information to determine FIs' daily net settlement to the Bank of Canada. |
| Actuarial
Liabilities |
Actuarial liabilities are the expected present
values of insurance policy payouts recorded as liabilities on balance
sheets of FIs. They are also known as policy reserves or actuarial
reserves . |
| Actuarial
model |
An actuarial model is an insurance model. An actuarial model
consists of a stationary population
is assumed that neither grows nor shrinks in any of its age groups, but
stays the same forever as entrants to the age group exactly equal deaths
plus those who grow out of the category. Actuarial models of stationary
populations are the basis for calculating pricing of insurance contracts. |
| Actuarial
Reserves |
see actuarial liabilities |
| Actuarial
Risk |
Actuarial risk is the risk borne by an insurer that the
critical assumptions of the expected net present value model used to
price the insurance contract are substantially incorrect. Actuarial
risk is a form of model risk. |
| Actuarially
Fair Premium
|
The premium in an insurance policy that when
discounted to present value equals the expected present value of the cash
outflows of a policy (claims and expenses). |
| Add-On Factor |
Concerning capital adequacy, the amount determined by the BIS
to approximate the future potential credit risk
of the counterparty in
a derivative contract. |
| Adjustment |
in P&C insurance, the process of
arriving at a claim settlement amount. In determining the amount of the
loss, external consultant expenses -- adjustment expenses on the balance
sheet -- are regularly incurred. |
| Adverse
Selection |
The tendency of those most at risk in a group to take out insurance so
that the insuring FI that priced the contract with respect to the average
in the group is faced with losses. |
| Agency Fee |
In a syndicated loan, the fee payable to
an FI that serves as the agent for the syndicate banks in dealing with the
borrower during the course of a syndicated loan |
| Agency Costs |
Costs relating to the risk (and the monitoring of that risk) that an
agent will pursue his personal interests rather than the principal's
interests. Agency costs can arise whenever the agent's actions or
the outcomes of those actions can not be accurately fully known to the
principal. |
| Agent
bank |
An agent bank in a syndicated
loan is the agent for the lending banks. It reviews conditions
precedent to drawdown, receives drawdown instructions from the
borrower and passes them to the lenders, receives lenders remittances and
transfers them to the borrower and receives borrower payments and
allocates them to the lenders. It also serves as the nexus for flows of
information between lenders and the borrower. |
| All Risk Policy |
A P&C insurance policy that covers
against the loss caused by all perils except those specifically excluded
from the terms of the policy (also called an all risk loading policy) |
| Allowance
for loan losses |
A contra account on the balance sheet of a
credit granting FI that should be an estimate of the amount by which,
because of credit risk, realized
cashflows on outstanding loans will be less than contracted cash
flows. Allowances may be general
or specific. Loan
loss allowances are often referred to as loan loss reserves. Note
that the word "provision" is used by some finance professionals
to mean what we define here as an "allowance." |
| Angel Capital |
Informal start-up capital provided to entrepreneurs who are starting
companies by investors other than family members or close friends. |
| Annuitant |
The holder of an annuity. In life insurance, a person during whose life
a life annuity is payable. Usually the annuitant receives the annuity
payments. |
| Appropriated
Surplus |
In insurance accounting, amounts associated with certain policies in
excess of the difference between expected net present values of future
claims and premiums. |
| Arbitrage |
The making of riskless profits by the simultaneous purchase and sale of
securities (including synthetic securities) with identical payoffs. In
finance, the "no arbitrage condition" states that two securities (or two
groups of securities) that have the same payoffs must have the same price.
In other words, in efficient markets, opportunities to generate riskless
profits can not be sustained. |
| Asset Backed Security |
A public security whose value derives from a structured pool of legally
bankruptcy-remote assets, administered by an independent asset manager,
rather than claims over the cash flows and assets of a corporation that
manages the assets. |
| Asset Based
Finance |
Provision of credit for and secured by specific machinery and equipment,
inventories and/or receivables. |
| Assignment |
In a loan sale transaction, the buyer fully replaces the seller, because
all rights and obligations under the loan are assigned from the original
lender (seller) to the new lender (buyer). For
assignment to occur, the borrower must agree (or have set up the original
loan contemplating and pre-authorizing assignment. |
| Assumable
Mortgage |
A mortgage contract that is transferable from the seller to the buyer of
a house |
| At the Money |
Concerning the price of a put or call
option, the condition when the option's
strike price equals the current market price of the underlying instrument. |
| Authorized
Credits |
In credit risk management, concerning a
credit granting FI's exposure to a borrower, the sum of outstanding
credits plus amounts that are undrawn but committed to the client (off-balance
sheet commitments). |
| Average Life |
The weighted-average times of payments on a loan, security or portfolio
with the proportions of each payment in the aggregate payment being the
weights. |
| B |
|
| Back to Back LC |
A trade letter of credit (LC) issued on
behalf of an account party who is the
beneficiary under a separate LC (assigned to the FI) whose terms of
payment are substantially identical. |
| Backtesting |
The comparison of actual trading results with VAR
model-generated risk measures. |
| Balance
Sheet Identity |
Equity = Assets - Liabilities. See (Debits
and Credits: A Few Principles of Accounting) |
| Bank for International
Settlements |
The BIS
is the central bank for central banks, facilitating inter-central bank
payments and serving as a forum for bank regulatory harmonization. |
| Bank Rate |
In Canada, the bank rate is the rate of interest that the central bank
charges clearing banks on overnight overdraft loans. |
| Bankers Acceptance |
a commercial draft drawn on a bank client that has
been accepted for payment by the bank.
BAs are highly liquid money market securities. |
| Bankruptcy |
The status of a legal person (either an individual or a company) who is
unable to service its debts and petitions (or is petitioned by its
creditors) to become a bankrupt. During the bankruptcy process,
creditors may entertain plans for reorganization of the bankrupt to
preserve value in operation. During this time the bankrupt's assets
are held by a bankruptcy trustee. If no plan is approved by the
creditors, the assets are sold; the proceeds are distributed among the
unsecured creditors, and in the case of a personal bankruptcy, the
person's remaining unpaid portions of those debts are forgiven. See receivership
and Chapter 11. |
| Bankruptcy-Remote |
The characteristic of a holder of assets that makes its value from the
point of view of its claimants independent of the bankruptcy
of a related third party. In a securitization
the SPV that purchases the assets
with the new securities' proceeds is bankruptcy-remote from the asset
seller, such that, in the event of the seller's bankruptcy, the claimants
of the seller would have no recourse to the assets sold to the SPV. |
| Basis Risk |
The risk that the price movement of a hedge will differ from the price
movement of the hedged position. For example, in a deposit-taking,
credit-granting FI, the variable spread between a lending rate and a
borrowing rate. In derivatives hedging, a
residual risk that arises because the movement in a spot (cash) asset's
price is not perfectly correlated with the movement in the price of the
asset delivered under a forward, futures or option contract. |
| Basis
Point |
In quotes of interest rates, one basis point is one percent
of one percent. If interest rates rise from 4.50% to 4.55% they have
risen by 5 basis points. In quotes of foreign exchange and commodity
price rates, a basis point is often used to mean the smallest change in
the price of foreign exchange quoted. |
| Basis Point
Swap |
The simplest currency swap, being a
floating versus floating swap in which interest in each leg (i.e., each
currency) is calculated using the appropriate interbank offer rate.
Note that US usage of the term "basis point swap" may differ
from the above. Some professionals use the term to describe swaps that are
used to hedge basis risk in interest rates
within a single currency (eg a prime-LIBOR
swap). |
| BAX |
Three month Canadian Bankers' Acceptance futures
contracts traded on the Montreal Exchange |
| Bearer
Securities |
Public securities, the simple possession of which constitutes proof of
ownership. Electronic depositories and securities issues where no
individual securities are actually printed has eroded the importance of
bearer securities. See book entry
securities and registered
securities. |
| Benchmark bond |
A bond that is frequently quoted as a reference bond in analyzing yield
curves. Specific benchmark bonds are often used as the
underlying security in interest rate futures. |
| Best efforts
basis |
Concerning the primary issue of securities,
an FI's commitment to place the securities in the market, but not to underwrite
the issue, such that, if market demand for the securities was less than
anticipated, the FI would be under no obligation to purchase the unplaced
securities. |
| Bid-Ask
Spread |
The difference between the price at which the market maker is willing to
sell the security (the ask price) and the lower price at which the market
maker is bidding to buy the security (the bid price). If the
market's demand for the security at the ask equals supply of the security
at the bid over an appropriately small period of time (eg one day) then
the market maker on each trade can expect to make half the bid-ask
spread. See the traders' rule. |
| Bill of
Exchange |
see draft
|
| BIS |
See Bank for International Settlements |
| BIS Capital Accord |
The set of agreements starting in 1988 between the G-10
central banks, plus Luxembourg and Switzerland, and now adhered to by most
countries of the world, setting minimum levels of regulatory capital
between for banks. The Accord includes provisions of capital for credit
and market risk and is subject to ongoing
updating. The original 1988 Accord is also known as the Basle
Capital Accord. |
| Book Entry
Securities |
Public securities where ownership is evidenced only by recording the
owner's name in a central registry, usually held in computerized account
form. With book entry securities, no individual securities are ever
printed for distribution to securities holders. |
| Booking |
An action by an FI of purchasing an asset (or taking an off-balance
sheet position), thereby showing it as an asset on the books of the FI
(or as a risk position in the notes of the FI). |
| Bought Deal |
In Canadian investment banking parlance, an underwriting using the
prompt
offer prospectus (POP) system. The rapidity with which a bought deal
can be brought to market has made it the preferred route for listed firms.
Reduced risk for the underwriter allows it to quote firm prices at reduced
fees, achieving the same effect as a shelf
registration in the US capital markets. |
| Brady Bond |
A bond that was originally issued in exchange for outstanding
principal under loans to a country experiencing difficulty in servicing
its international sovereign debt. The program was initiated by
Nicholas Brady, secretary of the Treasury of the U.S. government in 1989. |
| Bridge
Financing |
Short term financing arranged to bridge a temporary cash shortage
between the need for a expenditure (eg. to finance the purchase of a
company, a share repurchase or the maturity of a debt financing) and the
receipt of proceeds (eg. from permanent financing or asset sales). |
| Bucket |
An aggregation of risks and/or cash flows into a single risk point
(often called a risk vertex) for analytical
purposes (for example in an interest rate
gapping model or a VAR model). |
| Bulldog Bonds |
See foreign bonds |
| Buyer Credit |
A medium or long term export credit loan
to the importer granted at the request of the exporter to finance the
purchase of capital equipment or services. |
| C |
|
| Call Option |
A derivative security that gives the
purchaser the right, but not the obligation, to buy the underlying
security from the writer of the option at a specified exercise price. |
| Canada Bond |
A bond issued by the Government of Canada. |
| CAPM |
The capital asset pricing model is an economic model that shows that, in
equilibrium, risk averse investors in an otherwise perfect economy will
price only the systematic risk of a security, (i.e., the covariance of a
security with the market portfolio) or
Where Ri is the return on the ith security, ßi
is the covariance of the ith security's returns with the market
returns over the variance of the market returns and Rm
is the market return and Rf is the risk free
rate. The higher is the beta, the greater the cost of equity.
Implementation of CAPM difficulties include estimates of the risk premium (Rm
- Rf), with ranges of 3% to 8% commonly used and
difficulties in estimating beta using historical data. |
| Capital
Accord |
See BIS capital accord |
| Capital
At Risk |
see risk capital |
| Capital
Forbearance |
A policy by a deposit insurer or FI regulator, allowing an FI to
continue operating even when its equity capital funds are fully depleted. |
| Capital
Structure |
The proportions values of the various liabilities and shareholders
equity accounts that make up the funding sources of the FI (or other
corporation). At it's simplest, the capital structure is the equity
to assets ratio or the FI's leverage |
| Capital Taxes |
Capital Taxes are taxes charged by the Canadian federal and some
provincial governments on a company's "capital" which includes
equity and long term debt financing. |
| Capricious Run |
A run on an FI not justified by the financial condition of the
FI. In the absence of the run, the FI would have no problems with
its solvency. If however, the solvent FI is
subject to a capricious run and has insufficient liquidity
to make immediate payment, it may be forced to liquidate assets at
below their fair market price which could then impair solvency. |
| Central Bank |
The central bank of a currency area is the FI on whose books final
clearing and settlement of payments is made. Deposits of FIs with it
are the most liquid assets in the economy. By creating more deposits
(eg in payment for purchase of government obligations) it can increase the
money supply. As the ultimate provider of liquidity it can
immediately and directly affect interest rates. It is the government
vehicle for conducting monetary policy. Central banks may also be
the governments fiscal agent, the issuer of notes and coins and/or a major
FI supervisor. |
| Certificate of Deposit (CD) |
A money-market security, issued by a bank or
other deposit taking FI, evidencing a deposit. If the CD may be
legally sold to a third party in the secondary
markets, it is known as a negotiable
CD. |
| Chapter 11
Bankruptcy |
The U.S. law that protects borrowers unable to pay their debts from
liquidation by their creditors while proposals for solutions allowing the
bankrupt to remain in business are being considered. |
| Chattel
Mortgage |
A mortgage over movable property, for example over a vehicle. |
| Chinese Wall |
An internally imposed barrier within an FI that limits the flow of
confidential information |
| Clearing |
Exchange of drafts and payment instructions between negotiating
and payer FIs. |
| Clearing
Account |
A demand deposit account
maintained by an FI with the clearing and settlement
authority -- typically the central bank.
The clearing account allows the FI to make final payment in the currency
of the central bank in which the clearing account is
held. |
| Clearing
Bank |
A bank with a clearing account.
Clearing banks are direct clearers. |
| Closed Pools |
MBS pools where the mortgages in the pools are not
allowed to be prepaid. |
| Closed Ended
Mutual Fund |
A closed ended mutual fund is a publicly listed investment fund that
issues a fixed number of shares to outside investors in the same manner as
a regular publicly listed corporation. See Open
End Fund. |
| Co-financing |
A large financing (bank and/or capital market) where both private sector
and government owned FIs combine forces to meet the financing needs of
a borrower. |
| Coincident
to when issued t-bill |
The seasoned T-bill whose maturity coincides with the maturity of the
T-bill to be issued and currently traded in the when issued market. For
example, the when issued one month T-bill will have coincident to when
issued T-bills whose original maturities were three months and six months. |
| Co-Insurance |
An insurance contract design where the insurer only covers a set
proportion of the losses, with the insured bearing the remainder. |
| Collateral |
Assets pledged by a borrower to a secured lender in support of a credit
facility which give the secured lender priority in repayment over
unsecured lenders up to the value of the collateral. Collateral
is used to reduce the credit risk of a
facility. |
| Collar |
For the holder of an underlying security, the hedging strategy of
issuing a call and purchasing a put
of identical maturities where, typically, the cost of the put is
substantially offset by the fee income from the issued call. |
| Combined Ratio |
In P&C insurance, a measure of the
underwriting profitability of the P&C insurer. The sum of the loss
ratio and the expense ratio. |
| Commercial Paper |
Short term unsecured money market
obligations issued directly by a non-FI. |
| Commitment Fee |
A periodic fee payable to the credit-granting FI on the undrawn balance
of the credit facility. |
| CompCorp |
CompCorp is the Canadian Life and
Health Insurance Compensation Corporation, the industry-owned,
mandatory liability guarantor for Canadian life and health insurance. |
| Compensating
Balances |
Compensating balances refer to a partial cash collateral
requirement in a credit relationship whereby a proportion of a loan that a
borrower draws is required to be held on deposit at the lending FI
(typically in a zero or low interest account). The effect is to
lower the total amount at risk to the FI while raising the effective
interest rate. |
| Concentration
Limit |
A prudential guideline that an FI implements specifying the maximum
amount of a certain type of exposure that the FI can book,
often expressed as a proportion of assets or capital |
| Conditions
Precedent |
Those conditions, specified in the credit agreement or terms sheet for a
credit, that must be fulfilled prior to drawings being permitted under the
agreement. Typical conditions precedent include legally proving the
authority to borrow, registration of collateral,
government approvals and favorable opinions of legal council. |
| Confidence
Interval |
A statistical range that a random variable will lie within a known
percentage of the time, under specified assumptions about the distribution
of a random variable. Confidence intervals are the basis of VAR
analysis. |
| Confirming a
Letter of Credit |
The guaranteeing of a letter of credit
(LC) by a bank other than the LC opening bank, typically at the request of
the beneficiary who may not be comfortable bearing the risk of the LC
opening bank. |
| Conflict
of Interest |
A
conflict of interest between an FI and its client occurs when the
FI's actions to further its own objectives conflict with the best
interests of the client, and where the FI has been employed to further
that client's best interests. Conflicts of interest are of particular
concern in FI activities where the FI has a
fiduciary responsibility to the client. |
| Consol Bond |
A perpetual bond with a fixed rate of interest. |
| Contingent
Claim |
An security that makes payment under specified circumstances
and no others. Contingent claims include lines
of credit, guarantees, insurance contracts, derivatives,
etc. |
| Contra Account |
An account that reduces the balance of an asset account, for example, on
and FI's balance sheet the allowance
for loan losses. |
| Contributory
Pension Plan |
A pension plan under which employees (and not just employers) are
required to contribute during their years of employment to the fund the
amortization of which will be their pension. |
| Core Deposits |
Deposits (excluding those purchased on wholesale markets or from retail
deposit brokers) that on average remain in a deposit-taking FI for
relatively long periods and so constitute a statistically reliable source
of funding. |
| Core Funds |
With respect to the liquidity risk faced
by an FI and a specific horizon over which the liquidity risk is being
assessed, the sum of the FI's core deposits,
term wholesale financing with maturities longer than the horizon and
equity capital. |
| Correlation
of defaults |
One of the three key factors in quantifying the credit
risk of a portfolio. If the correlation of defaults is low, then the
percent value at risk of a portfolio of loans can be
made small by increasing the number of uncorrelated loans. On the other
hand, if the correlation is very high, then the portfolio acts much like a
single loan, with correspondingly higher value at risk. |
| Correspondent
Banking |
The provision of banking services from one FI to another. Services may
include deposits, loans, LC advising and confirming
and foreign currency clearing and settlement. Profitable
correspondent banking is carried out often between FIs based in separate
countries. |
| Cost of Equity |
The cost of equity is the expected rate of return that equity holders
require. It is not directly observable but is implied by the
price of the shares of the FI and expectations of risks and returns to
those shares. See dividend
discount model and CAPM |
|
Coupon Rate |
The periodic payment on a bond (typically semi-annual or annual)
expressed as a percent per annum of the principal of the bond. It's
called the coupon rate because, in a bearer
bond, the payment is evidenced by a separate coupon that has to be cut
from the bond to be negotiated . |
| Counterparty |
The party with whom one contracts, used especially in over-the-counter
derivatives transactions. |
| Covenant |
Legal clauses in a legal agreement (eg a loan agreement or the trust
indenture of a bond) that require the signatory take or avoid
certain actions. For example, a common covenant in a loan agreement
is to maintain a minimum debt to equity ratio. |
| Covered
Interest Rate Parity |
See interest rate parity |
| CPA |
The CPA is the Canadian
Payments Association, the organization responsible for inter-FI
clearings and settlements of final payment in Canadian dollars. |
| Credit
Equivalent Amount |
A term used in the calculation of regulatory
capital for credit risk according to the
BIS Capital Accord. Off-balance
sheet items involving credit exposures are converted into credit
equivalent amounts by multiplying them by specific weighting
factors. The credit equivalent amounts are then weighted again to
convert them into risk assets. |
| Credit Facility |
A service (which may a loan, a line of credit,
a guarantee, pre-approval of LCs and/or derivatives,
or any combination of these) packaged, priced, approved and possibly
sold as a single service extended by a credit-granting FI or syndicate
of FIs or placed in financial markets. |
| Credit
Rationing |
A restriction in the supply of a loan so that excess demand for credit
exists at the market price. In perfect market economics, supply and
demand schedules intersect at a price that clears the market. If
rationing prevails, the price in such perfect economics must be below that
which equilibrates supply and demand. In the credit markets, agency
conflicts lead to credit rationing so that price adjustment does not
clear the markets. |
| Credit Risk |
Credit risk is the risk that an obligor (eg., a borrower,
derivative counterparty, or supplier of a credit
substitute) will not make timely payment when contractually obliged to
do so. "Credit" comes from the latin credo and
means to believe in. |
| Credit
scoring model |
A model that uses quantitative information about large
numbers of borrowers in homogeneous portfolios in order to make pricing
and lending acceptance decisions. Such models reduce the cost and improve
the accuracy of credit risk management. |
| Credit
Substitute |
A credit substitute is an off-balance
sheet instrument where the FI is at risk for the entire notional
value. Examples of credit substitutes include undrawn but
committed lines of credit, guarantees, letters
of credit, standby letters of
credit and underwriting of
securities. See direct credit
substitutes. |
| Cs of
credit analysis |
Variously referred to as "the four Cs", "the Five
Cs" and "the six Cs", these refer to several aspects of
analysis of credit risk that the FI credit
officer should consider in her analysis. The list may include Character
(i.e. reputation and honesty), Capital (i.e. leverage), Cash
Flow (you lend cash, cash has to repay the loan), Collateral,
Capacity (i.e., the ability of the borrower to do that which is in
the business plan to be financed), Conditions (i.e., market
specific conditions such as the business cycle and interest rates or the
conditions that should be written into the credit agreement) and Common
Sense (don't make dumb loans). I know, that makes seven, but
I've never heard the "Seven Cs" applied to credit analysis. |
| Currency Swap |
A swap where the two counterparties agree to make
payments to each other in different currencies. Unlike an interest
rate swap a currency swap involves exchanging the gross principal
amounts in the two currencies at both the beginning and the end of the
swap and gross interest payments on each interest payment date. A currency
swap is like a complex foreign exchange
swap. |
| D |
|
| Daily Earnings at Risk |
DEaR is JP Morgan's original name
for value at risk. |
| Data Envelope Analysis (DEA) |
A linear programming-based technique for calculating the production
frontier for a population of producers (such as bank branches) in order to
draw conclusions concerning relative efficiency of the producers. |
| Daylight
overdraft |
A condition in a daily settlement system whereby a payments system user
maintains a overdraft during the day that is expected to be resolved by
the end of the day. For example, in the U.S., where the Federal
Reserve guarantees direct clearers' payments during the day, banks'
reserve accounts at the U.S. Federal Reserve Bank often becomes negative
within the banking day. |
| DEA |
see Data Envelope Analysis |
| Debentures |
A debenture is a bond that is not secured with any collateral. In
general, FI regulators prohibit FIs from issuing secured bonds because
they would give priority of payment over the depositors, policy holders
and liability guarantors. |
| Debt Service
Ratio |
The ratio of a borrower's interest and principal amortization payments
to the funds available for making payment. In sovereign risk
assessment, a ratio of a country's interest and debt amortization
obligations to the value of its exports. |
| Deductible
Policy |
An insurance contract design whereby the insurer covers the full
amount of insured losses above a minimum amount, which must be born by the
insured. |
| Deep
Discount Bond |
A bond with a low coupon rate relative to
the current yield. |
| Defined
Contribution Pension Plan |
A pension plan where each employee has a separate account into which the
employer and/or employee contributes a defined amount (usually a function
of salary, but possibly also a function of profits); the funds in the
account are invested by the asset manager and the pension is calculated on
the value in the account upon employee retirement. See defined
benefit plan. |
| Defined
Benefit Pension Plan |
A pension plan which defines the benefits to be paid to the employee by
a formula stipulated in the pension plan agreement. Unlike the defined
contribution plan, employer and employee contributions are not
pre-determined but are functions of actuarial calculations based on costs,
investment returns, mortality, etc. |
| Delegated
Monitor |
An economic agent appointed to act on behalf of other agents in
collecting information and/or investing funds on their behalf. The
term was coined by Doug
Diamond to describe deposit taking FIs in his 1984 Review of
Financial Studies paper. |
| Delta of an Option |
The change in value of an option resulting from a change in price of the
underlying instrument. |
| Demand Deposits |
Low or no-interest bearing, chequing deposits held by a deposit taking
FI that can be withdrawn at any time by the depositor. |
| Deposit and
other liability insurers |
In most developed countries, government or industry sponsored insurers
explicitly guarantee that retail deposits will be honored, retail insurance policies
will be honored, and the ownership of securities held in trust will be
maintained even in the event of the deposit taker, insurance writer or
securities custodian's bankruptcy. (see
implicit deposit insurance). |
| Deposit Drain |
In liquidity risk management of
deposit-taking FIs, the amount by which cash withdrawals from deposit
accounts exceed cash inflows to deposit accounts. |
| Deposit
Run |
The rapid withdrawal of a substantial portion of an FI's
deposit base. If the FI has insufficient liquidity
to make immediate payment to meet the withdrawals, it may be forced to
liquidate assets at fire-sale prices, with
a consequential deterioration in FI solvency.
Deposit runs can be either informed or capricious
or informed |
| Derivatives |
A derivative or derivative security is a security whose prices are based
on one or more underlying securities. Examples of derivatives
contracts include a stock index futures contract, a foreign exchange
forward contract, an interest rate swap and a commodity call option.
These are based on an index of share prices, delivery of foreign exchange,
exchange of net interest payments calculated on different bases on single
notional principal of debt, and a the right but not the obligation to
purchase the commodity respectively. Derivatives are not shown at
their notional
value on the accounts of the FI and so are called off-balance
sheet accounts. |
| Designated
Jobber |
In Canada, the core group of market makers in the secondary
market for treasury bills and Canada bonds
are designated by the Bank of Canada as jobbers. |
| Direct Clearer |
An FI with an account at the central bank
through which final clearings may be made.
Also called a clearing bank |
| Direct
Credit Substitute |
A term used in computing regulatory
capital under the BIS Capital
Accord, a direct credit substitute is a credit
substitute that is effectively the same as a loan from a credit
risk standpoint. Direct credit subsguarantees include guarantees
of financial obligations, SBLCs
that serve as financial guarantees (eg backing CP), risk
participations in BAs, and securities lending where the
FI faces the credit risk of the borrower. |
| Direct Quote |
In foreign exchange markets, the price of foreign exchange quoted as a
number of units of domestic currency. |
| Discount Broker |
A stockbroker that conducts trades for customers but does not offer
investment advice or asset management services on those trades . |
| Discount
window |
A borrowing arrangement for the benefit of direct
clearers made by the central bank whereby
the eligible bank will purchase eligible securities at a discount with an
agreement to sell them back to the direct clearer at par at a specified
future time. The central bank makes and accepts payment using its clearing
balances. The central bank can act through the discount window
as a lender of last resort. |
| Diseconomies
of Scale |
A cost structure whereby, at a specified level of output, as the
output increases, average costs of production also increase. |
| Diseconomies
of Scope |
A cost structure whereby, at a specified level of output, the costs of
jointly producing two services (goods) are higher than if they
were produced separately. independently. |
| Disintermediation |
Disintermediation means removing the middleman. With reference to
financial services, it is the removal of the FI. Securities are
placed directly with ultimate suppliers of the capital and risk absorption,
rather than with FIs. Note, however, that FIs find roles in
servicing the disintermediated market. |
| Dividend
Discount Model |
The simply dividend discount model for estimating the cost of equity
capital of an FI uses notes that, if a dividend paying company's expected
rate of dividend growth g can be considered to be constant from a
dividend per share base of dt+1
one period from the present time t and if the t price is Pt
, then the cost of equity, kequity must be:

Actual calculations are very sensitive to g which is typically
calculated based on past dividend historical growth. |
| Documentary Credit |
See letter of
credit. |
| Draft |
A draft (also called a bill of exchange) is an unconditional order in
writing, signed by the maker, to pay a specific amount to a specific
person (or the bearer) at sight or on a specific future date. A cheque is
one example of a draft. The party who makes the draft is called a
drawer (if you write a cheque, you are the drawer). The party to the
draft orders to make payment is the drawee (the bank in the case of the
cheque). The recipient of the payment is the beneficiary or payee.
A commercial draft is a business-to-business order to make payment (such
as an invoice). |
| Duration |
A measure of interest rate elasticity of the price of an interest
bearing instrument. Duration is calculated as

Where:
CFt = Cash flow received on the
security at end of period t
T = The last period in which the cash flow is
received
DFt = The discount factor = 1/(1 +
R)t
R = Yield (current level of interest rates in the
market)
PVt = Present value of cash flow at
period t = CFt X DFt |
| Duration Gap |
A balance sheet measure of the interest rate risk faced by the equity of
an FI calculated as

Where
DA= duration of assets
DL= duration of liabilities and
k= L/A |
| Drawee |
The party on whom a draft
is drawn -- i.e., the party that makes payment to the beneficiary. |
| E |
|
| Early
Intervention |
Early intervention, with regard to the action of a liability insurer or
an FI regulator is the taking over a financially distressed FI before its
equity capital has been fully depleted. |
|
Earning Assets
|
Earning assets of an FI are those assets that generate fixed income
(i.e., interest or bond coupons) |
| Economies of
Scale |
A cost structure whereby, at a specified level of output, as the
output increases, average cost of production decreases. |
| Economies of
Scope |
A cost structure whereby, at a specified level of output, the costs of
jointly producing two services (goods) are lower than if they
were produced separately. independently. |
| Efficiency
Ratio |
The efficiency ratio, the ratio of non-interest expenses to total
revenue, is used by deposit taking FIs as a general measure of efficiency. |
| Equity
as a call option |
A view of shareholders equity that that sees in equity an imbedded
call option. Equity holders can purchase
the assets of the firm from the debtholders by buying back the debt of the
debtholders. If the firm goes bankrupt, because of the limited liability
of equity, the equityholders will lose no more than the value of
contributed equity. From the debtholders perspective, this equivalence of
equity to a call option causes debtholders to strive to reduce the value
of the option by reducing the time between monitoring, reducing the
volatility of the asset value and increasing the capital cushion (decrease
the strike price relative to the value of the assets). |
| Equity in
the Property |
In real estate lending, the difference between the market value of the
real estate and the value of the claims of senior creditors |
| Escrow Account |
In lending, a trust account, established by
a borrower for the benefit of a lender, where the account receives funds
(e.g. from sales proceeds) for a specified use (e.g., debt service) and
the excess funds ultimately reverts to the borrower. |
| Expected Value |
The value of each possible outcome of the event multiplied by the
probability of that outcome occurring. All possibilities must be
considered, since the sum of probabilities must be 1. Note that this
definition applies to discrete not continuous distributions. |
| Expense Ratio |
In P&C insurance, the ratio of
expenses accrued (excluding those allocated to particular claims) to
premiums earned in a specified period. |
| Export Credit |
A loan to finance exports granted by or guaranteed by an export credit
agency, a government FI devoted to stimulating its country's
exports. Two major types of export credits are buyer
credits and supplier credits. |
| Euro |
The single currency of the Euroland. |
| Eurobond |
see international bond |
| Euroland |
The countries of the European Union that participate in the European
Monetary Union using the euro as the currency: Belgium, Germany, Spain,
France, Ireland, Italy, Luxembourg, Netherlands, Austria, Portugal and
Finland. |
| Euromarkets |
See offshore markets. |
| F |
|
| Factoring |
The process by which an FI purchases accounts receivable from
corporations at a discount, usually with no recourse to the corporation
should the receivable go bad. |
| Fallen Angel Bond |
see Speculative Grade Bond |
| Fed Funds |
The interest rate for onshore, unsecured
US dollars in the interbank market, so
named because value is given by the lending bank crediting the account of
the borrowing bank with the US
federal reserve. |
FI
|
An FI is a financial institution, including commercial banks, savings
banks, credit unions, savings and loans companies, mortgage lenders and
brokers, investment banks, investment brokers, dealers, merchant bankers,
venture capitalists, hedge funds, life insurance companies, property and
casualty insurance companies, general insurance companies, monoline
insurers, asset managers, pension fund managers, mutual fund managers,
mutual funds, special purpose vehicles, investment advisors, stock and
derivatives exchanges, trading systems providers of financial information,
bond rating agencies |
| FI Regulators |
FI regulators are government bodies that empower FIs to provide
services, set the specific rules for FI activity within the legal
framework and monitor FIs' adherence to those rules. Separate
FI regulators may be at both the national and the provincial/state level
and the regulatory function may be split between different bank, credit
union, insurance, pension, securities, etc.
regulators. |
| Fidelity
Insurance |
Insurance guaranteeing the performance of the agent to a principal --
typically taken out by corporations to protect themselves from employee
fraud. |
| Fiduciary |
A person whom another person (the beneficiary) legally entrusts to
perform a task (from Latin fiducia:trust)
for the benefit of the beneficiary. The fiduciary has rights and
powers which would normally belong to the beneficiary and must not allow
any conflict of interest to affect their duties towards beneficiary.
Fiduciaries must use a high standard of care to protect and promote the
interests of beneficiary. |
| Financing Gap |
A measuring tool in FI liquidity risk
management, being the difference between an FI=s
non-reserve assets to be funded and core funds. |
| Fire Wall |
Firewalls in FI corporate structure refer to legal limitations on
intercorporate dealings intended to prevent the financial distress of one
FI from spreading to another FI within the same group. |
| Fire Sale Price |
A slang term to describe a realization of liquidity
risk wherein the price received for an asset that has to be liquidated
(sold) immediately is less than its fair market value. |
| Fiscal Agent |
(1) In a bond issue or securitization, the agent that administers the
cash flows.
(2) In a government, the agency that acts as the treasury. Often
a monetary authority or central bank often acts as the fiscal agent for a
government. |
| Fisher Effect |
In macroeconomics, the observation, named after Irving Fisher, that the
nominal rate of interest is made up of two components: the real rate of
interest and the expected rate of inflation. |
| Fixed Charge |
With respect to collateral on a credit
facility, a lien that relates to specific
assets that are individually identified. |
| Fixed
Charge Coverage Ratio |
A ratio frequently used in assessing the credit risk of a
borrower. It is like the debt service
ratio, but here the numerator is the funds available for debt service
and the denominator is the debt service requirements. |
| Fixed Income
Securities |
Assets which accrue a set of future cash flows which, in the absence of credit
risk are known, regardless of what happens in the future. Fixed
income securities include loans, bonds, accounts receivable, lease
payments, rental income, etc. and exclude equity claims and contingent
claims. |
| Float |
A float is non-interest bearing funds obtained by the FI because of the
favorable timing of payment versus receipt of funds that are nominally
simultaneous. If funds are paid with delay to the FI but the FI
delays in crediting the payee's account, the FI will
enjoy a positive float. |
| Floating Charge |
A lien over a class of assets where the individual
assets may change over time (such as receivables or inventories). |
| Floating Rate Note (FRN) |
A bond with a floating rate of interest. FRNs are common in
the offshore bond market where their interest
rate is typically periodically set at a spread over LIBOR. |
| Floor |
A put option issued on interest rates, often
with multiple exercise dates that effectively sets the minimum interest
rate the issuer would pay on underlying debt. |
| Foreclosure |
Taking possession by the mortgagee (i.e., the lender from whom the
mortgaged property is collateral) of the mortgaged property in
satisfaction of indebtedness of a defaulting borrower. |
| Foreign Bond |
A bond, issued in a domestic capital market, by a corporation whose
place of residence is in a different country from the market. A
foreign bond is one type of international
bond. Foreign bonds include Yankee bonds (issued by non-US
companies in the US), Bulldogs (issued by non-UK companies in the UK) and
Samarais (issued by non-Japanese companies in Japan. |
| Foreign
Exchange Swap |
A foreign exchange swap is a forward purchase and spot sale (or
vice versa) of foreign exchange with no interest payments between its two
payment dates. Foreign exchange swaps, are not usually categorized
as "swaps" by anybody but foreign exchange
traders, because they are far simpler than, for example, currency
swaps. |
| Forward/Forward
Deposits |
An agreement to place a deposit with an FI at a specified future time on
specified conditions. Unlike the case in and FRA,
where net settlement based on market interest rates occurs, in a forward
forward, the deposit is actually placed. |
| Forward Purchase (Sale)
Agreement |
A forward purchase or sale agreement (usually just called a
"forward") is an over the counter
agreement between two parties, a buyer and a seller, to effect the sale of
a specific amount of a specific item at a specific date in the future for
a specific price, determined at the time of concluding the forward
agreement. The item may be bonds, stocks, foreign exchange, commodities,
or any other good or service. In financial markets very liquid
forward markets are in foreign exchange and (to a lesser extent)
commodities. |
| Forward Rate Agreement (FRA) |
An FRA is a forward agreement in deposits used to
hedge against or speculate in interest rate
risk where delivery does not take place but where cash flow settlement
occurs on the notional deposit placement day. |
| Frequency of
Loss |
The probability of occurrence of a loss. In calculating the expected
value of an insurance policy (or credit risk),
actuarial value of an insurance policy, one needs joint estimates of the severities
of losses and the frequency of each such loss. (See also in
credit risk probability of default) |
| Futures Contract |
A pure bet made through a standardized (with respect to quality,
quantity, timing of delivery, etc.) contract(s) at an
exchange between two members (who may be acting for their clients) one
who longs and one who shorts
the contract(s). The contractors face only the credit
risk of the exchange, which intermediates the bet and must maintain
margin accounts into and out of which is a daily marking
to market of the contract. A futures may be considered to be
like forward contract, intermediated by an exchange
where there is recontracting daily. |
| Futures Option |
A put or call option
contract that, when exercised, results in the delivery of a futures
contract on the underlying asset . |
| G |
|
| G-10 Countries |
G-10 refers to the Group of Ten countries: Belgium, Canada,
France, Germany, Italy, Japan, Netherlands, Sweden, UK and
USA. |
| Gap |
In FI management, applied in three different situations: 1. To measure interest rate risk
in the interest rate gap for a given bucket.
2. To measure interest rate risk
for the whole portfolio in the duration gap
and
3. To measure liquidity risk in the financing
gap. |
|
Gearing
|
See leverage |
| General
Allowance for Loan Losses |
An allowance for loan losses
not assigned to any specific borrower but to an entire portfolio of like
loans. Based on past experience of losses of the portfolio, the
general allowance represents the amount of losses that the FI believes it
is likely experience. |
| General Risk
Charge |
In the BIS Method for assessing market
risk for regulatory capital,
in order to set capital , a charge to account for the interest
rate risk of a trading portfolio fixed income security. |
| Ginnie
Mae |
The US government-owned mortgage corporation and the first body to
sponsor US government risk mortgage backed securities. |
| Goodwill |
An accounting asset which may be booked when a company acquires another
company for a value greater than the book value of equity. The
difference acquired value and book value is recorded as
goodwill. |
| Greenfield
Project |
A term used in project finance to denote
a totally new project, starting from a "green field" (i.e., an
empty construction site). |
| Gross Debt Service Ratio |
In consumer lending, the ratio of a prospective borrower's total
accommodation expenses (mortgage, lease, condominium management fees, real
estate taxes etc) divided by gross income before taxes. |
| H |
|
| Hedge Ratio |
The ratio of the notional principal of the hedge to the amount of the
exposure to hedge, often calculated as the beta coefficient of the return
of the hedge instrument regressed on the return of the exposure to
hedge. The hedge ratio of a naive hedge
is one. |
| High Power
Money |
Bank notes issued (or guaranteed) by the Central Bank, coins issued by
the mint and deposits of clearing bank deposits held with the central
bank. The money supply (including bank deposits) is a multiple of high
power money. See outside
money. |
| Hitting a Bid |
The act of a market participant selling a security to a market maker who
has quoted a bid to buy the security. A market
maker whose bid is hit increases his inventory in the security. See lifting
an ask. |
| Homogenous
market expectations |
The condition, unlikely to be achieved in practice, whereby all market
participants share the same beliefs about the fair value of an asset. |
| Horizontal
Disallowance |
A disallowance of offsets
to required capital used the BIS
Method for assessing market
risk for regulatory
capital. In order to
calculate the capital required for interest
rate risk of a trading portfolio, the BIS Method allows offsets of long
and short positions. Yet interest rate risk of
instruments at different horizontal points of the yield
curve are not perfectly correlated. Hence, the BIS Method
requires that a portion of these offsets be disallowed. |
| I |
|
| IBRD |
International Bank for Reconstruction and Development, the main FI in
the World Bank Group |
| IDA |
International Development Association, the soft
loans window of the World
Bank Group |
| IFC |
International Finance Corporation the FI in the World
Bank Group dedicated to stimulating private sector investment by,
among other means, co-financing. |
| Imbedded
Option |
A subset of rights within a complex security that give the
holder of the security the same rights as an option.
For example, a loans with a fixed rates of interest and the right to
prepay the principal prior to final maturity contains an imbedded interest
rate option. Such an option will affect the interest
rate risk of the portfolio, making simple gapping
and duration analysis inadequate measures of
interest rate risk. Another example, from credit
risk management sees equity as an
option over a firm's assets |
| IMF |
International Monetary Fund the
international FI, owned by member countries (with voting rights roughly
proportion to GDP) dedicated to promoting monetary cooperation by
consultation and collaboration. The IMF seeks to facilitate the
growth of international trade, employment and income, to promote exchange
stability, to reduce foreign exchange restrictions and to help members
over balance of payments maladjustments |
| IMF
Conditionality |
The requirement that various economic reforms be implemented prior to
drawdown of an IMF loan. |
| Immunize |
In hedging of risk, the action which results in the portfolio being
fully protected against the risk hedged. For example, an FI setting
the duration gap to zero would immunize its
portfolio from interest rate risk
as long as interest rate changes involved only parallel shifts in the yield
curve. |
| Implicit
Deposit Insurance |
Because of the systemic risk
posed by deposit-taking FIs, governments face political pressure to
prevent them from failing. This is often tantamount to guaranteeing the
retail (and possibly wholesale) deposits of FIs even in the absence of
formal deposit insurance. |
| Implicit
Interest |
A payment for use of funds in a form other than explicit interest.
For example, the uncharged costs of check clearing services is implicit
interest "paid" to the deposit holder. Front end fees are
implicit interest for a loan. |
| In the Money |
In the money, with respect to a specific derivative
refers the FI being owed more net cashflows (appropriately present-valued)
than it owes the counterparty. An in the money position (if
marketable) can be sold for a positive net present value. |
| Indirect Quote |
In foreign exchange pricing, the reciprocal of the direct
quote (i.e. the price of domestic currency, expressed as the number of
units of foreign currency that must be given up to acquire one unit of
domestic currency). |
| Informed
Run |
A deposit run where the
depositors believe that the FI's solvency is in
doubt, and where their beliefs are true. The threat of a run serves
as a disciplining device to pressure banks to maintain adequate amounts of
capital. See capricious run. |
| Initial public offering or
IPO |
The first issue of the debt or equity securities of a corporation for
public distribution. |
| Institutional
Investors |
Large, non-bank, investing FIs such as life insurance companies,
pension, trust, mutual and other and investment funds. |
| Insurable
Interest |
With respect to life insurance, an insurable interest in a person is a
continuing benefit from the life that person. With respect to
property insurance, the insurable interest is ownership. One must
have an insurable interest in order to purchase insurance. |
| Insurance Agent |
A sales representative for an insurance company. |
| Insurance
Broker |
An independent person or company who acts on behalf of the insured to
place an insurance contract with an underwriter. The broker also may
represent the interests of insured or beneficiary to the underwriter in
the event of a claim. |
| Insurance
Underwriter |
The FI that assumes the obligations under the insurance contract by
insuring a particular risk. |
| Interbank
Market |
The wholesale, over-the-counter
market where FIs borrow and place unsecured deposits with each other. |
| Interbank
offer and bid rates |
The interest rate charged by one bank to another in
wholesale markets for deposits (e.g., LIBOR and LIBID). |
| Interbank
Ratio |
A measurement tool used in liquidity management defined as
the ratio of interbank deposits placed over interbank deposits
purchased. |
| Interest Rate
Gap |
A measurement tool used in interest rate
risk management, being, for a specific re-pricing bucket,
the total principal of rate sensitive assets minus rate sensitive
liabilities. |
| Interest
Rate Parity |
More accurately known as covered interest rate parity, this is the
relationship between foreign exchange markets and the money markets of the
two currencies in the foreign exchange transaction forced by arbitrage
whereby the discounted spread between domestic and foreign interest rates
equals the percentage spread between forward and spot exchange
rates. See also
uncovered interest rate parity. |
| Interest Rate
Risk |
The risk that the net market value of a security or a portfolio will
decrease and/or, with respect to an FI, the risk that its net income will
be adversely affected due to changes in interest rates |
| Interest Rate
Swap |
A swap where (typically) one counterparty is the
payer of fixed rate interest and the other is the payer of floating rate
interest, with both payments being in the same currency. If, in a
given period, the fixed rate of interest is greater (less) than the
floating rate of interest, at the end of that period, the payer of fixed
(floating) pays the payer of floating (fixed) the amount by which the
gross interest calculated on the fixed basis exceeded (was less than) the
gross interest calculated on the floating basis. Interbank
rates are frequently used as standards for calculating the floating
rates of interest in swaps. |
| International
Bond |
An international bond is a bond that is issued in a location outside of
the country of the main place of business of the issuer (called a foreign
bond) or in a currency other than that of the location of issue (called an
offshore bond) or both. Offshore bonds, prior to the advent of the euro,
were called Eurobonds. |
| Investment
Banking |
The servicing securities markets, including underwriting,
selling, trading, valuing, administering, and managing securities and
advising clients about these activities. See merchant
banking. |
| Investment
Ratio |
In P&C insurance, the gross yield on premiums invested from the time
of receipt to the time of payout. |
| J |
|
| Jobber |
A primary distributor of a publicly listed securities. I have only
heard the term used for government bonds. See designated
jobber. |
| Junk Bond |
See Speculative Grade Bond |
| K |
|
| Kiting |
Writing a cheque against a bank account with insufficient funds to cover
the cheque in the hopes that the money will become available before the
cheque is cashed. Especially if the beneficiary of the cheque will,
based on the funds drawn under the cheque, make funds available to the
drawer and if the drawer repeatedly uses this technique to obtain
financing. |
| L |
|
| Large Value Transfer System |
The LVTS is the real time settlement system implemented by the CPA
in Canada. Although the LVTS gives finality of payment in real time,
it is not a true real time gross settlement system (RTGS)
because settlement is net at the end of the day. |
| Law of one
Price |
In international economics, the strongest form of purchasing
power parity whereby prices of identical products in different
countries are equated by their exchange rates. This "law" is
only in force by arbitrage under conditions of
free trade and zero transportation costs. |
| Lender
of last resort |
A source of liquidity for an entity which otherwise would
fail in its payment obligations. For a
direct clearer, the lender of last resort is typically the central
bank, operating through a discount window.
Although some lenders of last resort claim only to provide liquidity to
solvent banks against liquid collateral, others may subsidize insolvent
banks viewed as too big to fail and by
providing ultimate liquidity may inflate the high
power money supply. |
| Letter of
Credit |
A letter of credit is a unilateral undertaking of an FI to make
payment to a beneficiary upon presentation to the FI of a set of documents
specified in the letter of credit. Letters of credit facilitate,
among other activities, international trade, where the beneficiary is the
exporter and the documents include a bill of lading (or other shipping
documents evidencing delivery of the goods. Letters of Credit are
often called LCs, L/Cs or documentary letters of credit. Guide to L/Cs are found
at several banks' websites, for example Scotiabank's
web site. |
| Letter of Credit
Advising |
The informing of the beneficiary of a letter
of credit (LC) about the exact conditions of the LC that
has been opened in its favor by an FI (typically the beneficiary's bank)
who may also serve as the negotiating
bank. |
| Leverage |
Leverage, or gearing, is the extent to which an economic entity funds
itself with borrowed money rather than with the equity. Leverage is
measured as debt/assets or debt/equity. Since payments to debt are
contractually fixed, the higher the leverage, the greater the volatility
of (residual) cash flows to equity holders. |
| LIBID |
The London Interbank Bid Rate is the rate quoted by banks active
in the offshore interbank
market for deposits in London in US dollar deposits at which they will
take deposits with from banks. The bid-ask
spread between LIBOR and LIBID is fluctuates around
10 basis points but can increase at times of crisis. |
| LIBOR |
The London Interbank Offer Rate, being the rate quoted by banks active
in the offshore interbank
market for deposits in London in US dollar deposits at which they will
place deposits with other banks. |
| Life Annuity |
An agreement by an FI to make specified annual payments to the annuitant
as long as she lives. |
| Lifting an Ask |
The act of a market participant buying a security from a market maker
who has quoted an ask price to sell the security.
A market maker whose ask is lifted decreases his inventory in the
security. See hitting a bid. |
| Lien |
A charge (i.e. a legal claim) over property as security for a debt (for
example a mortgage) |
| Limited
liability |
The shareholders of a company can lose no more than their
contributed capital. Limited liability plus stochastic value of assets
through time gives allows equity to be viewed as a
call option on the firm assets. |
| Line of Credit |
A line of credit is an undertaking of an FI to provide a loan up to a
maximum principal amount to a borrower, where the loan can be drawn down
subject to very short notice by the borrower and repaid at the discretion
of the borrower. Lines of credit can be either committed (in which
case the FI is obliged to make the funds available on demand) or
uncommitted. |
| Liquidity
Reserves |
Assets maintained by an entity facing liquidity
risk that either are cash (notes and coins and demand
deposits) or can be converted to cash at a their fair market value,
where that fair market value is subject to minimal market
risk. For a clearing bank or
other direct clearer. Liquidty
reserves can be divided by their liquidity into primary,
secondary and tertiary
reserves. |
| Liquidity Risk |
Liquidity is the ease of converting an asset into cash. Liquidity
risk of an asset is the risk that it can not be so converted without
substantial loss of value relative to the its fair market value.
Liquidity risk of an FI is the risk that it will not be able to meet its
payment commitments as they come due without substantial loss due to asset
illiquidity relative to liability and off-balance
sheet liability liquidity. |
| Loan Loss
Provision |
A charge to the income of a credit granting FI to recognize likelihood
of loan losses. The loan loss provision is used to increase the balance
sheet's asset contra-account allowance
for loan losses. |
| Loan Loss
Reserves |
see allowance for loan losses. |
| Long |
Having a net asset position in a security, so that if its price
increases, the value of the position also increases. |
| Loss
given default |
The amount, typically expressed as a percent of all
principal and accrued interest, that a lender will lose in the event that
the borrower defaults. It is a function of the value and liquidity of the
assets of the borrower, the priority and ease of exercise of the claim
that the lender has over the collateral and the costs of obtaining
possession of and liquidating those assets. It is one of the three
important factors in determining the VAR of a credit
portfolio, the other two being probability
of default and correlation of
default. Loss given default is analogous to the insurance
concept of severity of loss. |
| Loss Ratio |
In P&C insurance, the ratio of
losses incurred to premiums earned for a specified period expressed as a
percent. Losses include claims, independent adjusters fees and legal fees
allocated to particular claims. |
| M |
|
| Management fee |
A flat fee payable to the arranger(s) of a syndicated
loan or other credit facility usually
on or shortly after loan signing. |
| Margin Loan |
A loan by a broker to its client to finance the purchase of securities. Collateral
for the loan is provided by the client's securities portfolio, the value
of which must be maintained at a specified multiple (eg 125%) of the
loan. If the market value of the securities portfolio drops below
that multiple and the client fails to answer a margin call (i.e., the
broker's request that the client contribute more cash to his portfolio),
the broker will sell stocks to repay the loan until the specified multiple
is reached. |
| Market-to-Book
Ratio |
The ratio of the market capitalization of a firm (equal to the number of
shares of common equity times the current share price) to the book value
of that equity (being the paid in capital plus retained earnings
attributable to common equity shareholders) as recorded on the balance
sheet. This ratio reflects the market premium or discount that investors
are willing to pay to own the firm's equity. |
| Mark to market |
In a portfolio (of assets, liabilities, derivatives,
or other off-balance sheet
claims) adjusting the recorded values to reflect current market
prices. In a futures position, daily marking
to market involves, for the holder of a long position,
making payment from (receiving payment to) the margin
account to (from) the exchange in the event of a futures price fall
(rise). The margin account of the holder of the short
position will make or receive the opposite cash flows. |
| Market Risk |
Market Risk is the risk that the market price of a security or component
of a security held long (short) declines (increases). Market risk
can include various other risks. For example, take a highly liquid benchmark
Canada bond with no credit
risk. Its market risk is identical to its interest rate
risk). |
| Merchant
Banking |
In North American usage, merchant banking refers to investment banking
where the FI also books a significant amount of continuing risk (in the
form of bridge financing, mezzanine
debt and/or equity) to a company for which it arranges security issues
or gives financial advice. In U.K. traditional usage, merchant banking
refers generally to investment banking. |
| Mezzanine
Financing |
Unsecured debt that is subordinate to bank debt and is frequently
convertible into common shares. |
| Micro-hedging |
Using derivatives contracts to hedge specific assets or liabilities, one
transaction at a time, rather than hedging the entire portfolio taking
into consideration asset and liability covariance. |
| Model Risk |
Model risk is the risk that the theoretical model used to price a given
security is substantially in error due to assumptions and/or
structure. Actuarial
risk is a form of model risk. |
| Money Market |
The money market is the market for short term (i.e. less than 365 days)
liquid securities, primarily BAs CDs, commercial
paper, finance company paper and government T-bills. |
| Money
Supply |
Theoretically, the total value of assets in the society that
are considered to money. There are many different practical
definitions starting from the narrowest money (notes, coin and demand
deposits of banks) and increasingly broad definitions that can
include notice deposits of banks, deposits
of non-bank FIs, foreign currency deposits, mutual
funds, etc. |
| Monoline Insurers |
Financial risk insurance companies who specialize in insuring bond and ABS
issues. A "monoline wrap" is a guarantee issued by such
insurers covering fully the repayment of principal and interest of the
bonds or ABS. |
| Monte Carlo
Analysis |
A simulation technique (eg for valuation or cash flow analysis) where
the simulation output is a non-linear function of input random
variables. The technique involves performing repeated random draws
from a hypothesized known distribution in order to obtain the value of the
input variables that are then used to calculate the value of a
function. In FI risk analysis, Monte Carlo Analysis is often used as
an alternative technique for calculating a VAR. |
| Moral Hazard |
An agency risk that a party to an economic
contract will alter her behavior after contracting in order to
benefit from the contract in a way not anticipated by the contract
counterparty. For example, the insured/beneficiary in an insurance
contract may undertake more risky activities following entering a
contract, the price of which was based on a lower level of
risk. |
| Morbidity
Risk |
The risk of ill health |
| Mortality
table |
An actuarial model of the mortality experience of a population (also
called a "life table") used to calculate life insurance premia. |
| Mortgage Backed Securities (MBS) |
An undivided interest in a pool of mortgage loans. Many MBS are
guaranteed by agencies such as Canada
Mortgage and Housing Association in Canada and Fannie
Mae, Freddie Mac and Ginnie
Mae in the US, while others are guaranteed by monoline
insurers or unguaranteed. |
| Mortgagee |
The lender in a mortgage loan who holds the mortgaged title to the
property. |
| Multilateral
Banks |
A multilateral bank is a supra-national FI, devoted to
promoting development in a particular region. Multilateral banks are more
like finance companies than banks because they do not take deposits or
make payments but do finance themselves in capital markets. Among
the multilaterals are the IBRD, the Asian
Development Bank, the Inter American
Development Bank, the African
Development Bank, etc. |
| Mutual Fund |
See open ended mutual fund. |
| Mutual
Ownership |
In FI corporate structure, the ownership of the FI by the users of the
FI service. Examples of mutual ownership are mutual insurance
companies, where participating policy holders own shares in the company
and credit unions where each depositor is a shareholder. |
| N |
|
| Naive Hedge |
A derivative micro
hedge of a risk exposure where the notional
principal of the hedge is of the same amount as the asset, liability
or expected cash flow to be hedged. In the presence of
basis risk, a naive hedge may be suboptimal to using a hedge
ratio different from one. |
| Naked
Exposure |
An unhedged exposure. For example, the writer of a call
option on stock who did not own of the stock (or security closely
correlated with the stock) would be said to have written naked
calls. |
| Name at Lloyds |
A "Name at Lloyds" is a member of Lloyd's
of London, a P&C insurance market specializing in marine
insurance, specialty insurance, and large disaster and liability insurance
and reinsurance. Names are the final risk bearers
insurance contracts underwritten in the market organized by Lloyd's |
| Named Perils
Policy |
A property insurance policy that insures the property only for the
risks named (excluding, for example, earthquake insurance) |
| Negative
Externality |