Accrued Interest

The interest earned on a bond or swap between payments.

Amend and Extend

Extending the maturity of an interest rate swap which may raise or lower the existing fixed rate.

American Style Option

Exercisable at any time up to expiration.

AML

Anti-money laundering – typically refers to laws and regulations in the US and other countries enacted to stop illegal financial transactions and the use of banks and other financial institutions to facilitate such transactions.

Basis Point

1/100 of 1 percent (.01%) refers to a change in yield.  For example, if the swap rate increases from 2.00% to 2.01%.  Banks will quote a spread over the swap mid-market in basis point terms.

Basis Risk

An interest rate swap risk that the variable rate paid by the issuer to its bondholders will differ from the swap rate. This can happen when the floating rate of the bond is based on a different index than the floating swap rate.

Bond Convexity

Is a measure of how the duration of a bond changes when interest rates change.  If an interest rate move is small or the duration of a bond is low, a bond’s convexity will not matter very much.  However, for bigger interest rate moves and higher durations, bond convexity becomes a useful tool for understanding interest rate volatility.  Convexity also applies to interest rate swaps.

Call Option

Provides the purchaser the right, but not the obligation to sell a specific asset at a certain strike price.

Callable Swap

A swap that may be terminated prior to its scheduled maturity at the discretion of the fixed-rate payer.

Collar (FX)

Offsetting options (put and call) are combined to set a minimum and maximum exchange rate. This can be done as a “no cost” option by offsetting premiums or can include an uneven offset, which generates a premium.

Collar (IR)

The purchase of an interest rate cap and the sale of an interest rate floor.  The premium of the floor is used to purchase the cap.  Collars can be structured at “zero cost” or at a premium.  A collar establishes a range of maximum and minimum interest rates.

Collateral Risk

Some swap agreements include a Credit Support Annex (CSA) to the ISDA.  If the value of the swap breaches a pre-determined threshold, then the affected counterparty must post collateral.

Consumer Confidence

An index that measures how optimistic or pessimistic consumers are with respect to the economy in the near future.

Convexity

a measure of how a bond’s duration changes as the interest rate also changes.

Counterparty

The entity or individual on the other side of a transaction.

Counterparty Risk

The credit risk if a counterparty (A or B) is not able to meet the financial obligations under a financial contract.

CPI

Consumer Price Index (CPI) – A predetermined basket of goods and services which measures the prices for the same goods for each year in order to measure inflation. Goods and services include items such as transportation, food and medical care.

Credit Support Annex

Often referred to as the “CSA” is a document within the schedule to the ISDA for posting of collateral.

Currency Code

Common currency abbreviations used in currency trading. Click here* for a list.

Derivative

A financial instrument whose value is derived from the value of a referenced index.  For example, the value of an interest rate swap is derived from the Eurdollar futures contracts for 3M LIBOR.

Dodd-Frank Legislation

Enacted in 2010, this set of laws passed in the US was intended to lower risk in the US financial system. It has brought about additional, significant regulatory burdens on the financial system as well as numerous unintended consequences. The Volker Rule, in particular, affects derivatives trading and regulation thereof.

Effective Date

The initial date in the active life of an interest rate swap.

EURIBOR

Rate at which large European banks lend to each other. An important European money market benchmark.

Eurodollar Futures Contract

The most liquid contract in the world for 3M LIBOR traded on the Chicago Mercantile Exchange.  These contracts are used by market participants in the interest rate swap market who need to manage interest rate risk.

Eurodollars

US dollars held outside of the United States aka Offshore USD.

European Style Option

Exercisable only at expiration.

European Swaption

A swaption that allows the holder to enter the swap only on the expiration date of the swaption. This is the most common kind of swaption.

Existing Home Sales

An economic indicator of both the number and prices of existing single-family homes, condos and co-op sales over a one-month period. The existing home sales report is released monthly by the U.S. National Association of Realtors. It is a lagging indicator as it tends to react after a change in mortgage rates.

Federal Funds Rate

The interest rate at which banks lend money to each other overnight.

Fixed-to-Floating Rate Swap

Counterparty A agrees to pay a fixed rate and in return receives from Counterparty B a floating rate.  Used to synthetically convert floating rate debt to a fixed rate.

Floating-to-Fixed Rate Swap

Counterparty A agrees to pay a floating rate and in return receives from Counterparty B a fixed rate.  A method to convert fixed rate debt to floating.

Forward Contract (FX)

An agreement between two parties to buy or sell a specific amount of currency or other asset at a future date (or over a set period of future dates) for a specified price.

Forward Starting Swap

An interest rate swap under which the exchange of cash flows begins at a later date.

FX Close Rate

Rates fixed and published by WM Reuters at 16:00 UK Time. Widely used as independent benchmarks to value foreign currency holdings. See WM Reuters Rate below.

FX Market Rate

Typically refers to the interbank bid or offer. May also be used by fx providers when quoting a rate as in, “the market is trading at…” even if the quoted rate includes added margin.

FX or Forex

Abbreviations for Foreign Exchange.

FX Provider

A bank, broker or other entity that offers foreign exchange trading and related services to corporates and/or individuals.

GDP

Gross Domestic Product (GDP) – the total value of goods produced and services provided in a country during one year

Global Markets Entity Identifier (“GMEI”)

A unique alpha-numeric code required for any entity that wishes to execute a derivative transaction.

Hedge

A financial product used to limit potential losses.

In-The-Money (“ITM”)

An instrument with a current market value that is lower than the present market value.

Incumbency Certificate

Certifies the signers are legally authorized to execute an interest rate swap or other financial obligations.

Interbank FX Rate

This is a rate at which foreign exchange dealers – banks and large institutions (funds, central banks, some very large corporates) trade with each other in amounts typically $1MM, $2MM, $3MM, $5MM, $10MM. These trades set the market rates, which can also contribute to benchmark or reference rates. They are also rates to which spread or margin is applied when an FX provider prices a trade for a non-dealer client.

Interest Rate Cap

A contract between a borrower and financial counterparty which protects the borrower if the variable rate rises above the pre-determined rate.  The borrower pays an up-front premium for the protection.

Interest Rate Collar

See Collar IR above

Interest Rate Floor

A contract that establishes a minimum interest rate.  Floors can be used in a credit facility to place a minimum “Floor” on the variable rate paid by the borrower.  Floors can also be used to structure hedges (Collar).

Interest Rate Risk

The risk that future rates will deviate from its expected value.  The borrower could have been better off floating (opportunity cost) or better off having fixed future rates.

Interest Rate Swap

An agreement to exchange (“Swap”) a fixed rate for a floating rate for a pre-determined period of time and notional.

IRMA

Independent Registered Municipal Advisor – Before entering into certain types of financial transactions, municipalities must obtain (but not necessarily follow) the advice of a qualified independent advisor.

ISDA

The International Swap and Derivatives Association, Inc.

ISDA Master Agreement

The standardized legal definitions for governing derivative transactions.

ISDA Schedule to the Master Agreement

Establishes the specific business terms and conditions governing the transactions executed under the agreement.

KYC

Know your client (customer) – A set of information that must be collected by financial institutions and advisors to verify the identity of their client for AML adherence as well as investment disclosure regulations.

Lagging Indicator

A lagging indicator is a measurable economic factor that changes only after the economy has begun to follow a particular pattern or trend. It is often a technical indicator that trails the price action of an underlying asset, and traders use it to generate transaction signals or confirm the strength of a given trend.

Leading Indicators

A leading indicator is a measurable economic factor that changes before the economy starts to follow a particular pattern or trend. Leading indicators are used to predict changes in the economy, but they are not always accurate.

LIBOR

London Interbank Offered Rate – The rate at which many large international banks lend to each other. It is a major international benchmark upon which the rates of numerous loans and debt instruments are calculated. It is based on five currencies: USD, GBP. EUR, CHF, JPY and is established for the following maturities: ON, 1W, 1M, 2M, 3M, 6M, 12M. The most commonly quoted is the 3M USD LIBOR.

Mandatory Hedge

Typically, a lender of a floating rate debt instrument requires that the borrower enter into an additional financial contract or contracts to limit a market and/or credit exposure.

Margin

May be used interchangeably with spread. Indicates markup from interbank rates. This is distinct from margin for collateral purposes.

Mark up

Pips or percentage added to interbank rate when selling fx trades to a downstream client.

Mark-to-Market (“MTM”)

An updated present valuation of an asset based on current market value.

Modified Following – Business Day Conventions

Cash flows that fall on a non-business day are assumed to be distributed on the following business day.

NDF

Non-deliverable forward – A forward contract that is settled in one currency based on the fix rate of the currency that is not freely traded (non-deliverable) to the base currency to synthesize a deliverable currency in restricted or highly illiquid currencies.

Net Present Value – NPV

The sum of the present values of all cashflows.

New Home Sales

A macroeconomic indicator for residential mortgage markets. New home sales measures sales of newly built homes. Released by the U.S. Department of Commerce’s Census Bureau, it includes both quantity and price statistics. It is considered to be an indicator of demand in the market and to affect mortgage rates.

Notional Amount

The principal amount off which the interest rate is calculated in an interest rate swap. The principal itself is never exchanged.

OIS – Overnight index swaps

Overnight index swaps are popular among financial institutions because the overnight index is considered to be a good indicator of the interbank credit markets and less risky than other traditional interest rate spreads.

Out-of-the-Money (“OTM”)

An instrument with a current market value that is lower than the present market value.

Par Coupon

Bond price equals face value.

Pip

Smallest figure used in quoting typical fx rates. For EUR/USD and GBP/USD, it is the fourth figure from the decimal. If the euro is trading at 1.0808, adding one pip would make the price 1.0809. Interbank spreads typically consist of one or more pips. For JPY, the pip is the second figure after the decimal.

PPI

The Producer Price index (PPI) is a family of indexes that measures the average change in selling prices received by domestic producers of goods and services over time.

Preferred FX Rate

Any rate that is better than a provider’s “standard” or “sheet rate”.

Present Value – PV01

The value today of a future sum of money or stream of payments. It is calculated by taking the future amount and applying a given discount rate, which usually represents an expected or required rate of return.

Prime Rate

Used to be considered the preferred rate commercial banks charge their most credit-worthy customers.  Banks set their own Prime rate, however most banks Prime rate is the same.  The Prime rate moves higher or lower when the Federal Reserve adjusts the Federal Funds rate. Prime is no longer considered the benchmark for credit-worthy customers.  Most regional or large commercial banks use LIBOR (considered the rate a AA rated bank can borrow money) as the index plus a credit spread.  The relationship between Prime and LIBOR has historically been 300 basis points. LIBOR + 3.00% is equivalent to Prime.

Put Option

Provides the purchaser the right, but not the obligation to sell a specific asset at a certain strike price.

Qualified Independent Representative (“QIR”)

QIR can be any individual or entity that has sufficient knowledge to evaluate the transaction and risks of a given swap, is independent of the swap dealer or major swap participant, undertakes a duty to act in the best interests of the special entity it represents, makes appropriate and timely disclosures to the special entity, evaluates the fair pricing and the appropriateness of the swap consistent with the entity’s swap policy, and agrees to refrain from making certain political contributions.

Reset Dates

The scheduled dates for the resets of the floating rate of interest on swaps.

SIFMA

The 7 day index for tax-exempt variable rate obligations.  The rate is determined by the Municipal Securities Rule Making Board’s based upon a basket of high-grade securities.

Spot

Foreign exchange trade for value in two business days (except USD/CAD, which is one business day during North American trading). This is the typical FX trade, accounting for the majority of daily trades in the FX markets.

Spot curve

Plot of bond coupon rates across various maturities.

Spread

The difference between the bid and offer (aka ask) rates in the market. Also used to describe a markup from interbank exchange rates.

Strike Price

The price at which a derivative contract can be exercised.

Swap

A contract to exchange securities, currencies, commodities, or interest rates on or before a specific date in the future.

Swap Advisor

A municipal advisor that advises on municipal derivatives. A swap advisor works in conjunction with the financial advisor to help get the best pricing and terms from dealers in the swap marketplace and to help facilitate swap transactions.

Swaption

An option on a swap.  The swaption purchaser for a premium has the right, but not the obligation to enter into specific swap fir a defined period of time. See American and European swaptions.

SWIFT

Society for Worldwide Interbank Financial Telecommunications – A secure, proprietary, standardized means for financial institutions to transmit payments and information about financial transactions.

TED spread

The difference between the interest rate on Treasury bills and the interest rate on Eurodollar deposits of similar maturities.

Termination Risk

The risk of having to pay to terminate an interest rate swap prior to maturity.  For example, a pay fix interest rate swap has a coupon of 3.00% and if the replacement rate is 2.50%.  The break-funding  cost is based upon the difference between the original fixed rate and replacement rate times the present value of future cash flows.  If the replacement rate is higher, then the fixed rate payer would receive the present value of future cash flows.

Trade Date

The date a transaction is entered into by the parties. Also book date.

Unemployment Rate

A rate measured by the United States Bureau of Labor Statistics (BLS). The BLS surveys Americans and reports the percentage of which have applied for a job in the last four weeks but have not received a job offer.

Value Date

Settlement date of a transaction. Also maturity date.

Variable Rate Demand Obligation (“VRDO”)

A variable rate long-term municipal security generally adjusted weekly (SIFMA) and can be redeemed at par.

Vega

The rate of change in the price on an option or other derivative with volatility.

Volatility

A measure of the uncertainty of the return realized on an asset.

WM Reuters Rate

One of the most widely used benchmark “fix” rates in foreign exchange. Compilation methodology is currently under review, but it represents a series of interbank trades over a slice of time, which are averaged (there is actually a complicated process involved in compiling the rate, but average is close enough for descriptive purposes) to provide a snapshot of the market at a certain time of day. Investments and assets as well as daily mark to market calculations are often done on the basis of this rate, with many using the London 4 pm “close” rate.

Yield Curve

Term structure of interest rates – an illustration of interest rates (yields) for a particular quality of bond across various maturities. A typical yield curve is plotted for maturities from one month to thirty years.