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).
The Hong Kong Monetary Authority has a Guide to Hong Kong Money and Banking Terms with the Chinese language translations of terms while the Hong Kong Justice Department has a legal Chinese English legal glossary.
A Glossary of Securitization terms is found on ABSNet' Site
Please let me know about any problems you find with my definitions.
A B C D E F G H I J K L M N O P Q R S T U V W X Y Z
| 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 |
| 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 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. |
| 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. |
| 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</ |
