Financial Terms Details

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Covered writing: the writing (selling) of an option in which the exercise of the option results in the closing out of an existing position (Thus, the owner of equity shares would close out the equity position upon writing and subsequent exercise of a covered call. Similarly, a short position in equity shares would be closed out upon the writing and subsequent exercise of a covered put.).

Crack spread: the difference in price between crude oil and products, such as gasoline and heating oil, extracted from it, especially in the futures market. The term arises from the fact that the chemical process that refiners use to extract these products from crude oil is called “cracking”.

Credit cliff: a slang term used for the rapid deterioration in a corporation’s credit standing that can occur when the corporation begins to encounter financial difficulties, as financial covenants in their loan agreements are invoked and it becomes more difficult to borrow, just when the corporation needs funds the most.

Credit default swap: a contract in which a “protection buyer” pays a periodic premium (“swap spread”) to the “protection seller” in return for the seller’s willingness to compensate the buyer in the event of default of a third party (the “reference entity”). This contract is economically equivalent to credit insurance, except that the protection buyer need have no “insurable interest” in the viability of reference entity.

Credit risk: the risk that an entity will fail to make full and timely payment of a financial obligation.

Credit spread: the difference in yield between two bonds that are identical, except for credit quality (i.e. likelihood that their issuers will default.).

Cross hedge: the use of a given security to hedge the imperfectly correlated price movements of another security (e.g. the use of crude oil futures to hedge exposures to gasoline price fluctuations).

Currency risk: the risk that the assets denominated in a foreign currency will depreciate in value because a unit of the foreign currency declines in value relative to the domestic currency.

Default premium: the amount of additional interest that a borrower such as a bond issuer would have to pay to compensate a lender for the possibility that the borrower might default on its payments.

Delta: the change in price of an option with respect to a unit change in price of its underlying. For vanilla call options, delta is between 0 and 1; for vanilla puts, delta is between -1 and 0.

Delta hedge: a hedge against possible price changes in an option due to price changes in the underlying. The hedge consists of selling delta units of the underlying (See definition of “delta” above) for every unit position in the option. Note that this implies selling a positive number of shares to hedge a call option and selling a negative number of shares (i.e. buying a positive number of shares) to hedge a put option.

Dirty price: the price for a bond includes accrued interest to the time of settlement.

ETF (Exchange Traded Fund): a mutual fund structured such that shares of that fund can be traded on an exchange like shares of a stock.

Earnings per share (EPS): the ratio whose numerator is the difference between annual corporate income and dividend payments and whose denominator is the number of shares in the corporation that are outstanding.

Elasticity: In economics, the percentage change of one quantity with respect to percentage changes of another quantity that has a causal effect on the first, such as a percentage change in the price of a commodity when its supply changes by a given percentage.

European option: an option that can only be exercised at its maturity date.

Floor: An option on a series of periodic interest rates in which a periodic payout is made when interest rates decline below the strike rate of the option.

Floating exchange rate: a rate of exchange between two currencies that is allowed to “float,” i.e. vary with market demand.

FOMC meeting: a meeting of the Open Market Committee of the Federal Reserve. At such meetings, the Open Market Committee has the statutory authority to raise or lower the “Fed Funds Rate,” which is the overnight interest rate that the Federal Reserve Bank charges member banks.

Forward contract: a contract to buy a security at some date after the contract is signed, but at a price that is agreed upon “up front”.

Forward rate agreement: A contract in which the parties agree to exchange interest rate payments over a specific future period. One party pays a rate that is agreed upon at the inception of the agreement; the other pays the spot interest rate over the relevant period. Typically, the payments are made as soon as the relevant spot rate becomes known. Also, only the net amount of the two payments changes hands.

Fully leveraged purchase: the purchase of a security when all of the funds required to do so are borrowed.

Gamma: the second (calculus) derivative of an option price with respect to the price of its underlying. Note that this quantity is also the first derivative of an option price with respect to the price of its underlying.

General obligation bond: a municipal bond that is funded by the “full faith and credit” of the issuing municipality.

Green field investment: the undertaking of a new enterprise that involves building “from the ground up”, as opposed to purchasing something already existing. This term is often used in the context of foreign direct investment.

Held for trading: a term used to describe securities on which the owner is hoping to make a short term profit. If the owner files financial statements, the profit and loss on such securities is reported as “net income”.

Haircut: the difference between the value of an asset being used as loan collateral and the amount of the exposure that is being collateralized.

Hedge fund: a money management vehicle that is available only “qualified” i.e. wealthy investors, and is therefore not subject to many of the SEC regulations intended to protect the investing public. Hedge funds are characterized by their sophisticated trading strategies, including the purchase of and simultaneous sale of a pair of securities, thus hedging the first with the second (Hence the name hedge fund).