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 |
An action by an economic agent in a transaction that imposes costs
on economic agents not directly involved in that transaction. |
| Negotiation |
Negotiation, with respect to a security (for example a letter
of credit or a draft) is the presentation of the
security (and supplementary documents, if required) for validation and
payment. |
| Negotiable
Instrument |
A security whose ownership can be transferred in the secondary
market, for example a negotiable CD. |
| Net Amount at
Risk |
In a life insurance policy, the difference between the potential maximum
claim and policy reserves. |
| Net Asset Value (NAV) per share |
With respect to an open-ended mutual fund,
The price at which mutual funds shares are sold (or can be redeemed). It
equals the total market value of the assets of the fund divided by the
number of shares in the fund outstanding. |
| Net
Interest revenue |
Net interest revenue = interest income - interest expense. It
shows the portion of income attributable to lending after deduction of
funding costs. Since both interest income and interest expense
fluctuate with the changing interest rate environment, net interest
revenue is a far more stable measure of revenue than (gross) interest
income. Net interest revenue may also be called net interest
income. |
| Net Premium |
In insurance contract pricing, the gross premium on a policy reduced by
allowances for expenses, commissions and taxes -- i.e., the amount that
can be applied to the expected present value of claims plus adjustment
expenses. |
| No
Arbitrage Condition |
See arbitrage. |
| No Load Fund |
A mutual fund, the purchase of which requires the buyer to pay no fees
(loading) to the fund company or agent selling the fund. |
| Non
Interest Bearing Liabilities |
Non-interest bearing liabilities of an FI include non-equity claims that
do not accrue interest. These may include interest accrued on its
liabilities but not yet paid out, securities
sold short, actuarial
liabilities, minority interests, taxes payable etc. |
| Non-Accrual
Loan |
A loan on which interest income is not being accrued. For example, in
Canada, regulators require that a loan with a payment 180 days late must
be classified as non-accrual. and a loan, other than credit card and well
secured loans are classified as non-accrual where payment is 90 days past. |
| Non-Cumulative
Preferred Shares |
Preferred shares whose dividends, if not paid, are not accumulated for
later payment but are lost to the preferred shareholder forever.
Non-cumulative preferred shares therefore participate fully in losses of
the FI and are classified as Tier I capital. |
| Non-Performing
Assets |
FI assets on which, in the opinion of management, losses may be
suffered. |
| Northbound
Funds |
In Canadian FI parlance, U.S. dollar purchased funds that are
converted
into Canadian dollars with a foreign
exchange swap to achieve hedged Canadian dollar wholesale funding. |
| Note Issuance Facility (NIF) |
A credit facility that allows a borrower
to, over several years, issue short term notes into the money
market confident that, in the event that there is insufficient demand
for the notes, the underwriting
FI (or syndicate) will purchase the notes. |
| Notice
Deposits |
Interest bearing deposits that in law may be withdrawn by the depositor
only after formal prior notice of intention to withdraw. In
practice, notice deposits can usually be can be withdrawn on demand, but
do not have check writing privileges. |
| Notional Value |
The notional value of an off-balance
sheet is the face amount of the position. For a derivative
this is the amount of an underlying security with respect to which the
derivative security is priced. For a credit
substitute, this is the maximum amount available for drawdown or
payout. |
| Novation |
A procedure, written into an original contract that contemplates a
future contract which will, when entered into, cause the original contract
to be renewed and amalgamated with the new contract. Novation is a
legal device useful in facilitating loan assignment
from a loan seller to loan purchaser, without having to go back to the
borrower for approval. |
| O |
|
| OECD |
See Organization for Economic Cooperation
and Development |
| Onshore markets |
Currency and security markets located in the same jurisdiction as the
denomination of the traded instrument. |
| Off
Balance Sheet Accounts |
Off Balance Sheet Accounts are those accounts recording contingent
claims, such that, when a contingent event occurs, this item moves into
the accounts. Off balance sheet accounts of FIs are broadly
classified into credit
substitutes and derivatives |
| Off-Market
Swaps |
Swaps that have nonstandard terms. FIs
frequently write an off-market swaps for client (tailoring them to
clients risk needs) but client must compensate the FI with a higher than
market price for the off-market swap. |
| Offsets |
A reduction (eg of a risk). Particularly, in the BIS
standardized method of calculating regulatory
capital needed to cushion market risk,
long and short positions in fixed
income instruments that individually face interest
rate risk initially reduce each other. These offsets, however
are subject to vertical and horizontal
disallowances. |
| Offshore Bond |
A bond issued in a currency other than that of the currency of the
location of issue. The center of the offshore bond market is in
London, and the preferred currency is the US dollar. Offshore bonds,
prior to the advent of the euro, were called
Eurobonds. |
| Offshore
Markets |
International markets for deposits and securities denominated in
currencies other than the currency of the country where the transaction
occurs. The major offshore market center is London and the major offshore
currency is US dollars. Prior to the advent of the euro
the offshore markets were known as the euromarkets. |
| On
Balance Sheet Accounts |
see off
balance sheet accounts |
| Open Ended Mutual
Fund |
An open ended mutual fund or unit trust is a publicly listed investment
fund that issues and repurchases on a daily basis the shares of the
fund at the discretion of the shareholders at a price equal to the net
asset value per share at the close of business on the transaction
date. See closed end fund. |
| Open
Interest |
In derivatives exchange
terminology, the outstanding number of a specific contract (eg how many
March 2001 Yen futures contracts are outstanding). |
| Operating
Income |
Operating income is the sum of net
interest income and other operating
income. |
| Operating Ratio
|
In P&C insurance, a measure of the
overall profitability the insurer. The operating ratio is the combined
ratio minus the investment ratio. |
| OTC |
See over the counter |
| Other
Operating Income |
Other operating income of FIs is composed of fees for underwriting,
trading, market making, advising, and asset management, LC fees and in
come cases up-front fees on loans (Loans front end fees are sometimes
amortized over loan life and considered part of interest income). |
| Operating Risk |
Operating risk is the risk that the management systems (personnel,
informational, legal, electronic, etc.) will fail. |
| Optimal
Capital Structure |
The debt equity mixture which, given the expected cash flows
to the assets of the FI, maximizes the value of the FI to
shareholders. |
| Option to buy
(sell) |
The right, but not the obligation to buy (sell) a security
during some future period of time. See call
option (put option) |
| The
Organization for Economic Cooperation and Development (OECD) |
The OECD is forum
for social and economic research and policy formulation whose members are
29 rich and middle income countries of Europe, the Americas and
Asia-Pacific. |
| Out of
Sample Performance |
An Ability, particularly of an econometric model, to predict accurately
an outcome from new data, rather than the data used in model
estimation. |
| Over the
Counter (OTC) Market |
A market trading in securities not listed by an organized securities
exchange (e.g., interbank deposits,
OTC call and put options,
foreign exchange, forwards, swaps,
FRAs). |
| P |
|
| P & C
Insurance |
Property and Casualty Insurance, also called "general
insurance" to distinguish it from life and health insurance. |
| Parsimonious
Model |
In economic theory, a model that distils a complex phenomenon into
relatively few critical components. |
| Participation |
(1) With reference to a loan sale, a participation is the purchase of a
share in a loan from the original lender, where the original lender
maintains its relationship with the borrower and the rights and
obligations of the original lender are passed through to the purchaser,
leaving the purchaser with credit exporsure to the seller.
(2) with reference to a syndicated loan
the pro-rata sharing of the rights and obligations of all lending banks by
a bank joining the syndicate. Each participant in a syndicated loan
individually contracts with the borrower and retains contractual rights,
without any credit risk to the arranging or agent bank. |
| Pass-through |
A securitization mechanism whereby the
cash flows of the underlying assets are passed through, essentially
unchanged (after deduction of administrative expenses) to the security
holder. Traditional Ginnie Mae MBS
are passthroughs. |
| Payee |
The party receiving payment e.g. in a draft. |
| Payout and
Closure |
In deposit insurance administration, the action of a deposit
insurer paying out the claims of a failed deposit-taking FI's
insured deposits and the closure (dissolution) of the FI (i.e., by either
assuming its assets or selling them to third parties) |
| Performance
Bond |
A guarantee (often in the form of a standby
LC) typically extended by an FI in relation to an engineering
contract, where the FI guarantees the performance of a contractor in
completing (some portion of) a large project. The beneficiary would
be the project company and the account party would be the
contractor. In the event that the project company determines that
the contractor has not fulfilled its obligation, the project company
requires the FI to make payment under the bond and the FI seeks
reimbursement from the account party. |
| Policy |
In insurance, the contract that specifies the insured event,
the premiums, and the terms under which payment
will be made by the insurer. |
| Policy Loan |
In life insurance, a loan made by an insurance company to a policy
holder using his/her policy as collateral. The terms of policy loans
are frequently written into the life insurance contract. |
| Policy
Reserves |
see actuarial liabilities. |
| Premium |
The periodic (typically annual) fee paid to the insurer to
obtain insurance. |
| Primary Issue of
Securities |
The issue of securities by the obligor (eg, the issue of treasury shares
by the company or of bonds by the borrower) to be distinguished from secondary
trading of issued securities. |
| Primary
Reserves |
In FI liquidity risk management, the most
liquid reserves, being bank notes plus coin plus deposits with the central
bank. In RTGS systems, primary reserves also
include securities that can be repoed or pledged to
the central bank to obtain clearing balances. |
| Prime Rate |
A variable per annum rate of interest, publicly announced by a lending
FI, that can be changed at any time without notice, at the discretion of
the lending FI, charged to a FI's most credit worthy borrowers |
| Private
placement |
A non-public placement of securities. Private placements are
typically medium to long term loans made by a non-traditional lender such
as an insurance companies or pension funds to a corporate borrower usually
arranged by a bank or investment bank. |
| Probability
of default |
The chance, expressed as a number between 0 and 1 that a
borrower will not make payment when legally obliged to do so. This is one
of the key factors in quantifying credit risk
and is a function of the willingness and the ability of the borrower to
make payment. See also loss given
default and correlation of defaults.
Probability of default is analogous to the insurance concept of frequency
of loss. |
| Prompt
Offer Prospectus
|
A Canadian system of obtaining regulatory approval for offering of
securities for a qualified issuer (that makes regular filings with the
securities commission) that allows the issuer to file a short form
prospectus, substantially reducing the time it takes to issue public
securities from weeks to days. |
| Project Finance |
A branch of structured finance wherein projects are financed with
limited recourse to project sponsors. |
| Prospective
Method of Reserve Calculation |
In insurance, the usual method for calculating reserves, which sets
reserves equal to the difference between the expected present values of
future premiums and future claims and expenses of life insurance policies |
| Prospectus |
A sales document stating the terms and conditions of a newly issued
publicly offered security and truthfully, fully, and plainly describing
the issuing company. |
| Prudent
person rule |
A legal standard of fiduciary responsibility that requires the agent to
exercise the same care in managing the portfolio as would a prudent person
managing his or her own portfolio. |
| Pull to
Maturity |
The tendency of the variance of a bond's price to decrease as maturity
approaches. |
| Purchase
and Assumption |
In deposit insurance, the action by a deposit insurer or FI regulator to
merge a failed FI with a healthy FI |
| Purchasing
Power Parity |
The international macroeconomic condition whereby changes in the
exchange rate tend to offset differential inflation across
countries. |
| Put Option |
A derivative security that gives the
purchaser the right, but not the obligation, to sell the underlying
security from the writer of the option at a specified exercise price. |
| Q |
|
| Quality Swap |
A fixed- floating interest rate swap between two parties of
different credit ratings. |
| R |
|
| RAROC |
see risk adjusted return on capital. |
| Real Interest
Rate |
The difference between a nominal interest rate (i.e., the quoted rate)
and the expected rate of inflation. |
| Real Time Gross Settlement
System |
An RTGS system is a clearing and settlements system by which final
settlement is made through gross payments across the books of the central
settlement authority (usually a central bank)
in real time. |
| Receivership |
The status of a borrower in which the lender receives the collateral
over which it has a lien when the borrower defaults on
the loan. Many failing companies never go into formal bankruptcy
because all assets are pledged and the unsecured creditors are left with
nothing. |
| Recourse |
The ability of an asset purchaser to sell an asset or loan back to the
original seller should the credit quality of that asset deteriorate. |
| Recovery
rate of a loan in default |
1 minus the percent loss given
default |
| Refinancing
Risk |
The interest rate risk faced by an FI
that the cost of borrowed funds to be re-priced or
re-borrowed will rise above the returns being earned on asset investments
because of market changes in interest rates. |
| Registered retirement
income fund (RRIF) |
A Canadian tax shelter set up by the government to serve as a post
retirement trust fund from which the retiree must withdraw specific
amounts of taxable income each year. Each individual's RRIF
principal comes from the accumulated investments of her RRSP. |
| Registered retirement
savings plan (RRSP) |
A Canadian a tax shelter set up by the government, to encourage
individuals to save (up to certain limits) for retirement. Initial
contributions to and interest on the RRSP are tax deductible. |
| Registered
Securities |
Securities for which registration by the issuer is necessary to
establish ownership (see bearer securities
and book entry securities). |
| Regulatory
Burden |
With reference to an FI, the difference between the private costs of
meeting regulations (eg filing costs, costs of holding excessive
capital and/or liquidity, costs of being excluded from certain markets and
sales practices) and the private benefits of the regulatory regime (eg
protection from competition). Also called "net regulatory
burden." |
| Regulatory
Capital |
The amount of equity capital and certain subordinated debt required by
FI regulators to be held as a cushion against insolvency. See Tier
I and Tier II capital. |
| Reinvestment
Risk |
The interest rate risk faced by an FI
that the returns on invested funds to be re-priced
will fall below the cost of funds because of market interest rates
falling. |
| Representation
and Warranty |
A representation or warranty is a guaranty of a statement of
fact that a contractor makes in a contract. In a loan agreement, borrowers
frequently represent or warrant that they have the legal authority to
borrow, that they have gained all appropriate approvals, that the
information that they have given to the lender is true, etc. This helps
protect lenders from being cheated by borrowers misrepresenting facts by
establishing what those facts are and making the signatories legally
liable for them. |
| Re-pricing |
The re-setting of the interest rate on that loan or deposit (e.g., a 5
year term loan whose interest rate is re-set every 90 days is re-priced
every 90 days). |
| Repricing Gap |
See interest rate gap. |
| Repudiation of debts |
The unilateral denial by the borrower of the validity of its obligations
to the lender. Debt repudiation is sometimes encountered as a sovereign
risk where a government denies the validity of debts incurred by
previous governments. |
| Repurchase Agreement |
A repurchase agreement (more accurately called a "sale and
repurchase agreement" and commonly called a "repo") is a
very short term collateralized loan where title to the securities used as collateral
passes to the lender at drawdown and is returned to the borrower at
repayment. |
| Rescheduling of a
loan |
Changing the contractual terms of the loan such as its maturity and
interest payments, typically to accommodate the projected cash flows of a
borrower in distress where the lender considers the chance of repayment to
be high, notwithstanding the distress. |
| Retail
Banking |
Consumer and SME banking involving principal amounts too low
to quality as wholesale banking
amounts. |
| Retail
Deposit Broker |
A broker that breaks up a large deposit of a wholesale
depositor into smaller
units to place each at a different deposit-taking FIs to ensuring full deposit
insurance coverage. |
| Return on Assets |
 |
| Return on Equity |
 |
| Revolving
Line of Credit |
See line of credit. The word
"revolving" is added simply to emphasize the fact that the line
can be dawn down, repaid and drawn down again repeatedly during its period
of effectiveness. |
| Riding
the Yield Curve |
A strategy that can be followed by an FIs that takes interest
rate exposure as a matter of course to earn profits by borrowing at
short term rates and lending long term rates of interest. Riding the
yield curve has taken advantage in the past of the typically upward
sloping yield curve that prevailed through most
of the 20th century. |
| Risk Adjusted
Return on Capital |
The risk adjusted return on capital (RAROC) of a position or
portfolio is the ratio of the expected return (or, retrospectively, the
realized return) on a portfolio divided by the
risk capital of that portfolio. |
| Risk
Assets |
In the calculation of regulatory
capital, the amount of credit risk exposure
an FI is deemed to face. The amount is calculated by weighting the value
of each asset by its regulatory risk weighting. Off-balance
sheet exposures are weighted to calculate a credit equivalent amount
and then risk weighted. |
| Risk
Capital |
The capital put at
risk by a position or capital available to support maximum expected losses
from a risk position, where the maximum expected loss is the value at risk (VAR).
Often the term capital at risk is used as a synonym for
VAR. |
| Risk
Participation |
An agreement related to a loan or guarantee extended by an FI that
subsequently wishes to reduce its risk (the risk off-laying FI). A
risk assuming FI agrees, for a fee, to reimburse the risk off-laying FI if
there is a default by the borrower (or if the guaranteed is called). |
| Risk Vertex |
An aggregation of risks and/or cash flows into a single risk point
(often called a bucket) for analytical purposes
(for example in an interest rate gapping
model or a VAR model). |
| Roll Over
Date |
The date on which a term deposit (or loan) that is expected to be
renewed matures. The depositor (borrower) does not withdraw (repay) the
interest and principal but "rolls" the total into a new deposit
(loan). |
| run |
The rapid withdrawal of a substantial portion of an FI's
deposit base. See deposit run |
| Runoffs |
Periodic cash flows of interest and principal on a fixed income
portfolio. |
| S |
|
| Samarai Bonds |
See foreign bonds |
| Schedule I Bank |
In the Canadian Bank regulatory system, a bank that is widely-held and,
chartered by act of Parliament or letters patent of the Ministry of
Finance, to conduct banking as defined in the Bank Act. All of the
large domestic banks in Canada are Schedule I banks. |
| Schedule II
Bank |
In the Canadian Bank regulatory system, a bank that is closely-held FI,
authorized by letters patent of the Ministry of Finance, to conduct
banking as defined in the Bank Act. Most Schedule II banks are
subsidiaries of non-Canadian FIs. |
| Seasoned |
The characteristic of a publicly traded security of having been traded
on the open market for more than a specified length of time (e.g., 90 days
). |
| SEC |
Securities and Exchange Commission of
the US federal government is the agency responsible for public securities
trading and filing of required disclosure documents. |
| Secondary
Reserves |
Assets maintained for liquidity risk
management purposes being less liquid than primary
reserves, typically made up of liquid deposits with other FIs. |
| Secondary
Trading of Securities |
The purchase and sale of securities from investors, market makers and
traders in the secondary market, i.e., not from the primary obligor on a primary
issue of new securities. |
| Securities
Exchange |
A self-regulating venue (either physical or virtual) where securities
are traded according to specific set of rules agreed to by the members who
are allowed to trade therein. |
| Securities
Sold Short |
Securities sold short are securities that an FI borrowers from another
party (for example from securities the FI holds in trust for clients
of its asset management operations) and then sells. Since the
borrowed security has to be returned eventually to its owner, it is
recorded as a liability on the balance
sheet. |
| Securitization |
The creation of a new marketable security from a pool of fixed
income assets. The original holder of the assets sells them to a
bankruptcy-remote, special
purpose vehicle that finances the purchase through the issuing of the
new marketable securities. |
| Select Life
Tables |
Insurance company mortality tables for
policy holders who have passed a medical examination. |
| Self Regulatory Organization |
A Self-Regulatory Organization (SRO) is an industry association that has
been granted powers by the government to regulate its members. |
| Settlement |
Making of final payment through transfer of funds from the account of
the payer FI to the account of the payee FI with the central
bank. |
| Settlement
Price |
The price at which a trade is concluded. In futures
transactions, it is the average prices at which futures trade immediately
before the end of the day's trading activity and is used by the exchange
in marking all outstanding contracts to market |
| Specific
Allowance for Loan Losses |
An allowance for loan losses
assigned to a specific borrower based on the deterioration of the
borrower's credit worthiness or loan delinquency representing the amount
that the FI believes will be lost on the loan. |
| Severity of
Loss |
The dollar amount of loss in a given circumstance. 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. Severity of loss is analogous to the credit
risk concept of loss given default. |
| Shelf
Registration |
A method of registration with the SEC of securities
to be issued in the US under Rule 415 of the Securities Act of 1933
whereby securities are not necessarily to be sold in a single discrete
offering immediately upon effectiveness, but rather are proposed to be
sold in a number of tranches over a period of time
or on a continuous basis. Shelf registration effectively give the shelf
registrant flexibility to raise money as needed, timing entries into the
capital market allowing issues to be made in days, rather than
weeks. |
| Short |
Having a net liability position in a security, so that if its price
increases, the value of the position decreases. Shorts in futures
are simply accomplished by taking the opposite side of the long.
Shorts in other securities must be constructed by actually borrowing the
security from a party who already owns it and making delivery of it to the
purchaser to whom you have sold the security short. Since illiquid
securities may be expensive, difficult or impossible to borrow,
constructing a short position in a given security may not be
feasible. |
| Soft Dollars |
A practice typically found in in retail investment banking, involving an
unethical (and possibly illegal) action by which a service seller uses
gains from an overpriced service to give to the service buyer's investment
bank a free or underpriced service. |
| Soft Loan |
A loan with a below-market rate of interest. |
| Solvency |
The condition of an economic entity having having the fair
value of its assets greater than the accounting value of its liabilities
or, equivalently, having positive net worth. . |
| Sovereign Loan |
A loan made to a sovereign (i.e., independent) government. Loans
to municipal, regional, provincial and state governments are not usually
considered sovereign. |
| Sovereign Risk |
A form of credit risk relating to a loan to a
borrower in a different country from the lender where the government of
the borrower (who may be the government itself or a citizen of the
government's country) causes the borrower to default on the loan.
Sovereign risk events typically occur with respect to sovereign
loans and/or where the currency of the loan is not the domestic
currency of the borrower and foreign currency controls are imposed by the
government preventing timely debt service. |
| Special Drawing Right (SDR) |
A unit of the reserve currency of the International
Monetary Fund defined by various amounts of each of several major
currencies of member countries. |
| Special Purpose Vehicle |
A corporate entity or trust account created for a specific financial
purpose, typically to hold assets and claims separate from sponsors of the
transaction. SPVs are used widely in project
finance and securitization. |
| Specific
Risk Charge |
In the BIS Method for market
risk assessment, an addition to required regulatory
capital to account for the credit and liquidity
risk of a trading portfolio of fixed
income securities. |
| Speculative
Grade Bond |
A high yield bond that is rated Ba or lower by Moody's, BB or lower by
Standard and Poors, or is unrated by rating agencies. If the bond is
speculative grade at the time of issue, it is called a "junk
bond". Otherwise it is known as a "fallen angel" |
| Spot Market |
In the foreign exchange market, the collection of over
the counter purchases and sales of currencies for
"immediate" delivery. "Immediate delivery" for
standard spot contracts in most currencies is in two days and for US
dollar-Mexican Peso and US dollar - Canadian dollar transactions is in one
day. Same day delivery is also available, time zones permitting but
constitute less liquid markets than spot. |
| Spread of a Loan |
The difference between the marginal cost of funds for the FI financing
the loan and the all-in rate of interest charged the borrower for the
loan. |
| Standby
Letter of Credit |
A standby letter of credit (SBLC) is a letter
of credit that functions as a financial guarantee. If the
beneficiary determines that the account party has not fulfilled its
obligations under the guaranteed contract, that beneficiary presents a
statement to that effect together with the SBLC and the demand for
payment. |
| Stationary
Population |
A theoretical population used in mortality
tables which experienced exactly the same birth and mortality
characteristics for a very long time until the population of each age
group stabilized. See actuarial model. |
| Street Name |
A method of attributing ownership of assets under administration whereby
the asset administer holds title from the point of view of the
registration of securities with the securities depository (and the
securities issuer), but legally holds the assets in trust
for its clients. For example, a broker will hold equity shares of
retail clients. Corporate registries and depositories will show the
owner under a "street name", that of the broker. |
| Stress
Testing |
An analytical technique used in valuation (eg, in a VAR
model) based on assumptions of future conditions that are highly adverse
to the portfolio owner so as to give a "worst case" estimation
of predicted value. |
| Strike Price |
The price in a call (put)
option at which the underlying security can be purchased
(sold). |
| Subordinated
debt |
Debt whose payment claims are not exercisable until
all other debtors claims have been satisfied. From the point of view of
the superior debt claimants, subordinated debt functions as cushion
similar to equity. |
| Supplier Credit |
An export credit loan to the exporter to
finance the working capital needed to
produce and sell the export. |
| Surety
Insurance |
Insurance that guarantees the performance of one party to another,
required under a the terms of a commercial contract between them. |
| Surrender
Value |
The amount to be received by an insurance policyholder should she
cashing in the policy prior to maturity. |
| Swap |
An over the counter agreement between
two counterparties to periodically exchange cash flows a predetermined
dates where the among of the cash flows exchanged on each date depends on
some predetermined notional principal outstanding and a pricing mechanism
with relation to that notional principal. See interest
rate swap and currency swap. |
| Swap Buyer |
In an interest rate swap the party
who pays the fixed rate of interest and receives the floating rate of
interest. |
| SWIFT |
The Society
for Worldwide Interbank Financial Telecommunications |
| Syndicated Loan |
A single loan too large to be comfortably lent by a single FI, extended
to the borrower by a group of FIs and administered by an agent bank/FI for
an agency fee. |
| Systematic
Risk |
The risk, in a portfolio, that cannot be diversified away
because it reflects the degree to which the value of the assets in the
economy move in together. Systematic risk in an equity portfolio
was described rigorously by
William Sharp in his Nobel Prize winning CAPM
model. |
| Systemic Risk |
The risk to the entire economy posed by the financial service
sector. Systemic risk events include contagious bank runs, collapses
of market liquidity, failures of payments systems, etc. |
| T |
|
| Take-or-pay Contract |
In project finance, a contract whereby
the off-take purchaser agrees to pay for a specified amount of off-take
over a specified period whether or not the purchaser actually takes
delivery, provided that the product is available for delivery |
| Tenor |
The final maturity of a credit facility. |
| Term
Structure of Credit Risk |
The term structure of credit risk is the term
structure of interest rates (i.e., a zero
coupon yield curve) where the lowest
schedule in yield - maturity space is riskless (typically sovereign
obligations of the currency of the curve -- eg., US treasuries in a
US$ curve), and successive schedules above that correspond to successively
poorer credits (eg., Aaa, Aa, A, Baa, Ba, B etc). The term structure
of credit risk is critical in calculating VAR of a
credit portfolio using the Creditmetrics approach. |
| Term
Structure of Interest Rates |
The yield curve. |
| Tier I Capital |
The BIS definition of core equity capital available
to meet regulatory capital requirements
being the sum of common shareholders' equity common shares, contributed
surplus, retained earnings, non-cumulative preferred shares
plus minority
interests in subsidiaries from Tier 1 capital minus goodwill. |
| Tier II Capital |
The BIS definition of supplementary capital which
must be
- unsecured
- subordinated to deposits
- fully paid up
- not redeemable at the option of the holder within 5 years and
- available to participate in losses
This includes
|
| Time
to close |
Time to close, with reference to market
risk VAR of an FI, is the time that it would take
to close out a position (i.e., buy back the securities of a short
position or sell the securities of a long position)
without shifting the market adversely against the FI due to low market
liquidity relative to the amount of the FI's position. |
| Time
to repricing |
The time to repricing of the asset or liability is the time
until the asset or liability's interest rate is reset. It is important to
distinguish time to repricing from maturity, since many of the FI's assets
and liabilities are repriced on a floating basis. For example, a prime
based loan's time to repricing is one day, even though it may be of
several years' maturity. Time to repricing is used in both interest
rate gap analysis and duration analysis of interest
rate risk. |
| Too Big to Fail |
The condition, ascribed to an FI by creditors and/or the general public,
of being too big for the government to allow the FI to be liquidated in a
normal bankruptcy. Creditors and/or the
general public typically believe such an FI is too big to fail because, if
it were to fail, the failure would impose an unacceptable systemic
risk on the economy. |
| Total Debt Service Ratio |
A ratio used by FIs in analyzing the credit risk
of a borrower, typically a mortgage borrower. The ratio of the TDS
is the prospective borrower's total accommodation expenses plus all other
debt service payments. The denominator is the prospective
borrower's gross income before taxes. |
| The Traders' Rule |
A rule of thumb for remembering how the bid-ask
pricing works: "When I enter the markets for my own account, I'm
always on the wrong side of the bid-ask spread." |
| Tranche |
A part of a financing, from the French word meaning
"slice." A single credit facility are often divided into
different tranches with different maturity, drawdown, interest payment,
repayment, credit support, etc. conditions. |
| Trust Account |
A legal arrangement under which money or other property is held by one
person or company (the trustee), often a trust
company, for the benefit of another person or persons. These assets
are administered according to the terms of the trust agreement. Each
province has a trustee act, which regulates the kinds of investments
that can be made by the trustees of a trust fund. |
| Trust Company |
An FI that can act as a trustee. |
| Trust Indenture |
An agreement signed between the bond issuer and the trustee
for the bond holders that defines the obligations of the bond
issuer. |
| Trustee |
A trustee is a legal representative, acting on behalf of another person
or group of people in any of a variety of transactions. The trustee
can manage the affairs of a beneficiary (possibly managing a trust
account), invest, manage or distribute property, be an executor of a
will, receive property in a bankruptcy, be the agent for bondholders in a
bond issue, etc. |
| Turnkey Basis |
A method of contracting the construction of a manufacturing, power
generating, transportation or other large engineering facility frequently
used in project finance whereby the
contractor undertakes to provide the facilities (including all
installation and training) in a completed, fully-tested, working form so
that the principal just as to "turn the key" to produce the
desired product or service. |
| U |
|
| Unappropriated
Surplus |
The retained earnings of a mutually owned insurance company or mutually
owned credit union. |
| Uncovered
Interest Rate Parity |
The condition in international economics whereby the discounted spread
between the domestic and foreign interest rates equals the percentage
spread between expected future spot and spot exchange rates.
Uncovered interest rate parity is a stronger economic condition than covered
interest rate parity and, because of risk aversion in the
market, holds only approximately at best. |
| Underwriting
of Securities |
A fixed commitment of an FI to arrange a primary placement of securities
at a fixed price or, failing than, to purchase the unplaced securities at
the fixed price. An underwriting is to be contrasted with the placing of
securities on a best efforts basis. |
| Uninformed
run |
See capricious run. |
| Unit Trust |
See open ended mutual fund. |
| Universal
Bank |
An FI that engages in a broad range of financial service activities,
typically including retail banking, commercial lending, insurance,
investment banking etc. |
| Unsecured Loan |
A loan that is backed by no lien over specific collateral
but relies only on a general claim to the assets of the borrower if
default occurs. |
| Unwinding a
Position |
A term used by traders to describe reversing the booking
of a risk. For example, if the original risk was booked by buying an
asset, the trader could unwind the position by selling the asset, by taking
the opposite position in a derivative or by
selling short a highly correlated asset so that the original position's
risk is cancelled. Unwinding a position may involve the
booking of basis risk. |
| Usance LC |
A commercial letter of credit on which
time (not sight) drafts are drawn. For example,
a usance LC may specify that payment is to be made 90 days after
presenting of documents. |
| Usury |
The sin of charging too high rates of interest. Various countries
have differing definitions of "too high" written as usury
ceilings written into their criminal codes ranging upwards from the
Islamic total proscription of any interest. |
| V |
|
| Value-at-Risk (VAR) model |
A statistical model that assigns a probability per unit of time to a
calculated amount of losses occurring in an FI's portfolio. While
VAR models were originally developed for trading portfolios, the concepts
are also being applied to credit and other risk portfolios. |
| Value
in operations (versus value in liquidation) |
A company's total value of assets including the
appropriately present valued expected returns to all factors of production
used to produce goods or services assuming that those assets and factors
continue to be used in their current configuration. A company's
value in operations is typically greater than its value in liquidation
(i.e., if they are sold quickly and separately in a liquidation) if
employees have accumulated knowledge that allows them to use assets
efficiently in cooperation with other employees or if the assets are
illiquid, being unable to command their fair value in the short time span
of a liquidation. Liquidation itself is expensive because of legal,
administrative, and accounting costs. Chapter
11 is a US device for preserving value in operations.. |
| Venture Capital |
Funds that venture capital companies or individuals provide to
young, private firms with superior growth potential. Most venture
capitalists require some control over the ventures in which they invest,
have medium term investment horizons, high risk tolerance, and high
expected rates of return, and structure their contributions as mezzanine
financing. |
| Vertical
Disallowance |
In the BIS Method for determining regulatory capital
necessary to cushion market risk, a reversal of
the offsets of a general risk charge
of a long position by a short position in two or more securities in the
same time band in the yield curve where the
securities have differing credit risks. |
| Vesting |
The conferring of full ownership rights. In pension plans, vesting
refers to conferring on the employee the legal right receive at retirement
age the deferred pension benefits regardless of employment termination or
plan dissolution. |
| W |
|
| Warranty |
See Representation
and Warranty |
| Wholesale
banking |
Wholesale banking involved transacting amounts greater than
those of retail customers. The
dividing line between wholesale and retail is not clear. One
definition is the minimum balance that is typically transacted in
interbank over-the-counter markets,
typically greater than US$1 million. Another definition is deposits
greater than those covered by deposit insurance contacts. For the FDIC
in the US, that amount is US$100,000. For the CDIC
it is C$60,000. Wholesale deposits are are important sources
of funds for FIs with inadequate retail funding and repositories for FIs
excess liquidity. They are highly sensitive to the creditworthiness
of the FI. |
| Working Capital |
A non-FI corporate finance concept, being current assets minus current
liabilities. Working capital is often calculated by
subtracting cash and short term investments from current assets and
subtracting short term bank debt and money market financing from current
liabilities. The largest components in non-cash working
capital to be financed are inventories and accounts receivable. The
largest financing within working capital so calculated comes from trade
payables. |
| Waiver |
In legal agreements (e.g. a credit facility agreement) the intentional
relinquishment of a known right. |
| Watch Listed
Credit |
In FI credit risk management, the
identification by the lending FI of a credit as having a high risk of
future debt service problems and therefore deserving of special
monitoring. |
| When Issued
Trading |
Trading in securities prior to their actual issue, so delivery will take
place at the contracted price only after issuance occurs. |
| X |
|
| X- efficiencies |
A term used in the scale and scope econometric literature (that seeks to
measure optimal size of the FI) meaning the inefficiencies in FI service
production that separate the costs of production of best-practice FI from
others producing essentially the same services. X-efficiencies have
found to greatly exceed economies of scale in large FIs. |
| Y |
|
| Yankee Bonds |
See foreign bonds |
| Yield Curve |
A graph that shows, for borrowers with the same credit
risk, the yield of bonds of different maturities. See also |
| Z |
|
| Zero-coupon
bonds |
A bond that does not pay any coupon interest over the life of the bond.
Instead it makes a single payment of principal face value on maturity. |