**Accrual Swap**
An Interest rate swap where interest on one side accrues only when a certain condition is met.

**Accrued Interest**
The interest earned on a bond since the last coupon payment date.

**Amortizing Swap**
A swap where the notional principal decreases in a predetermined way as time passes.

**Arbitrageur**
An individual engaging in arbitrage.

**Asian Option**
An option with a payoff dependent on the average price of the underlying asset during a specified period.

**Ask Price**
The price that a dealer is offering to sell an asset.

**Asset-or-Nothing Call Option**
An option that provides a payoff equal to the asset price if the asset price is above the strike price and zero otherwise.

**Asset-or-Nothing Put Option**
An option that provides a payoff equal to the asset price if the asset price is below the strike price and zero otherwise.

**At-the-Money Option**
An option in which the strike price equals the price of the underlying asset.

**Average Price Call Option**
An option giving a payoff equal to the greater of zero and the amount by which the average price of the asset exceeds the strike price.

**Average Price Put Option**
An option giving a payoff equal to the greater of zero and the amount by which the strike price exceeds the average price of the asset.

**Average Strike Option**
An option that provides a payoff dependent on the difference between the final asset price and the average asset price.

**Back Testing**
Testing a value-at-risk or other model using historical data.

**Backwards Induction**
A procedure for working from the end of a tree to its beginning in order to value an option.

**Basis Risk**
The risk to a hedger arising from uncertainty about the basis at a future time.

**Basket Option**
An option that provides a payoff dependent on the value of a portfolio of assets.

**Bermudan Option**
An option that can be exercised on specified dates during its life.

**Beta**
A measure of the systematic risk of an asset.

**Bid-Ask Spread**
The amount by which the ask price exceeds the bid price.

**Binary Option**
An option with a discontinuous payoff: for example, a cash-or-nothing option or an asset-or-nothing option.

**Binomial Model**
A model where the price of an asset is monitored over successive short periods of time. In each short period it is assumed that only two price movements are possible.

**Binomial Tree**
A tree that represents how an asset price can evolve under the binomial model.

**Black`s Model**
An extension of the Black-Scholes model for valuing European options on futures contracts.

**Black-Scholes Model**
A model for pricing European options on stocks, developed by Fischer Black, Myron Shcoles and Robert Merton.

**Bond Option**
An option where a bond is the underlying asset.

**Calendar Spread**
A position that is created by taking a long position in a call option that matures at one time and a short position in a similar call option that matures at a different time (A calendar spread can also be created using put options).

**Calibration**
A method for implying volatility parameters from the prices of actively traded options.

**Call Option**
An option to buy an asset at a certain price by a certain date.

**Call Settlement**
A procedure for settling a futures contract in cash rather than by delivering the underlying asset.

**Call-or-Nothing Put Option**
An option that provides a fixed predetermined payoff if the final asset price is below the strike price and zero otherwise.

**Callable Bond**
A bond containing provisions that allow the issuer to buy it back at a predetermined price at certain times during its life.

**Capital Asset Pricing Model**
A model relating the expected return on an asset to its beta.

**Caplet**
One component of an interest rate cap.

**Cash Flow Mapping **
A procedure for representing an instrument as a portfolio of zero-coupon bonds for the purpose of calculating value at risk.

**Cash-or-Nothing Call Option**
An option that provides a fixed predetermined payoff if the final asset price is above the strike price and zero otherwise.

**Clearinghouse**
A firm that guarantees the performance of the parties in an exchange-traded derivatives transaction. (Also referred to as a clearing corporation).

**Commodity Swap**
A swap where cash flows depend on the price of a commodity.

**Compound Option**
An option on an option.

**Constant Maturity Treasury Swap**
A swap where the yield on a Treasury bond is exchanged for either a fixed rate or a floating rate on each payment date.

**Continuous Compounding**
A way of quoting interest rates. It is the limit as the assumed compounding interval is made smaller and smaller.

**Convertible Bond**
A corporate bond that can be converted into a predetermined amount of the company’s equity at certain times during its life.

**Convexity**
A measure of the curvature in the relationship between bond prices and bond yields.

**Coupon**
Interest payment made on a bond.

**Covered Call**
A short position in a call option on an asset combined with a long position in the asset.

**Credit Default Swap**
An instrument that gives the holder the right to sell a bond for its face value in the event of a default by the issuer.

**Credit Rating**
A measure of the creditworthiness of a bond issue.

**Credit Transition Matrix**
A table showing the probability that a company will move from one credit rating to another during a certain period of time.

**Credit Value At Risk**
The credit loss that will not be exceeded at some specified confidence level.

**Currency Swap**
A swap where interest and principal in one currency are exchanged for interest and principal in another currency.

**Day Count**
A convention for quoting interest rates.

**Day Trade**
A trade that is entered into and closed out on the same day.

**Deferred Payment Option **
An option where the price paid is deferred until the end of the option’s life.

**Deffered Swap**
An agreement to enter into a swap at some time in the future.

**Delta Hedging**
A hedging scheme that is designed to make the price of a portfolio of derivatives insensitive to small changes in the price of the underlying asset.

**Delta-Neutral Portfolio**
A portfolio with a delta of zero so that there is no sensitivity to small changes in the price of the underlying asset.

**Diagonal Spread**
A position in two calls where both the strike prices and times to maturity are different (A diagonal spread can also be created with put options).

**Differential Swap**
A swap where a floating rate in one currency is exchanged for a floating rate in another currency and both rates are applied to the same principal.

**Discount Bond**
See zero-coupon bond.

**Discount Instrument**
An instrument, such as a Treasury bill, that provides no coupons.

**Discount Rate**
The annualized dollar return on a Treasury bill or similar instrument expressed as a percentage of the final face value.

**Dividend Yield**
The dividend as a percentage of the stock price.

**Down-and-In Option**
An option that comes into existence when the price of the underlying asset declines to a prespecified level.

**Downgrade Trigger**
A clause in a contract that states that the contract will be terminated with a cash settlement if the credit rating of one side falls below a certain level.

**Drift Rate**
The average increase per unit of time in a stochastic variable.

**Duration**
A measure of the average life of a bond. It is also an approximation to the ratio of the proportional change in the bond price to the absolute change in its yield.

**Duration Matching**
A procedure for matching the durations of assets and liabilities in a financial institution.

**Dynamic Hedging**
A procedure for hedging an option position by periodically changing the position held in the underlying assets. The objective is usually to maintain a delta-neutral position.

**Early Exercise**
An exercise prior to the maturity date.

**Efficient Market Hypothesis**
A hypothesis that asset prices reflect relevant information.

**Embedded Option**
An option that is inseparable part of another instrument.

**Equilibrium Model**
A model for the behaviour of interest rates derived from a model of the company.

**Equity Swap**
A swap where the return on an equity portfolio is exchanged for either a fixed or a floating rate of interest.

**Eurodollar**
A dollar held in a bank outside the United States.

**European Option**
An option that can be exercised only at the end of its life.

**Ex-Dividend Date**
When a dividend is declared, an ex-dividend date is specified. Investors who own shares of the stock up to the ex-dividend date receive the dividend.

**Exchange Option**
An option to exchange one asset for another.

**Exercise Price**
The price at which the underlying asset may be bought or sold in an option contract. (Also called the strike price).

**Exotic Option**
A nonstandard option.

**Expectactions Theory**
The theory that forward interest rates equal expected future spot interest rates.

**Expected Value of a Variable**
The average value of the variable obtained by weighting the alternative values by their probabilities.

**Expiration Date**
The end of life of a contract.

**Exponentially Weighted Moving Average Model**
A model where exponential weighting is used to provide forecasts for a variable from historical data. It is sometimes applied to the variance rate in value at risk calculations.

**Exposure**
The maximum loss from default by a counterparty.

**Extendable Bond**
A bond whose life can be extended at the option of the holder.

**Extendable Swap**
A swap whose life can be extended at the option of one side to the contract.

**Financial Intermediary**
A bank or other financial institution that facilitates the flow of funds between different entities in the economy.

**Flat Volatility**
The name given to volatility used to price a cap when the same volatility is used for each caplet.

**Flex Option**
An option traded on an exchange with terms that are different from the standard options traded by the exchange.

**Foreign Currency Option**
An option on a foreign exchange rate.

**Forward Contract**
A contract that obligates the holder to buy or sell an asset for predetermined delivery price at a predetermined future time.

**Forward Exchange Rate**
The forward price of one unit of a foreign currency.

**Forward Price**
The delivery price in a forward contract that causes the contract to be worth zero.

**Forward Rate Agreement (FRA)**
An agreement that a certain interest rate will apply to a certain principal amount for a certain time period in the future.

**Forward Risk-Neutral World**
A world is forward risk-neutral with respect to a certain asset when the market price of risk equals the volatility of that asset.

**Forward Start Option**
An option designed so that it will be at-the money at some time in the future.

**Forward-Interest Rate**
The interest rate for a future period of time implied by the rates prevailing in the market today.

**Futures Option**
An option on a futures contract.

**Futures Price**
The delivery price currently applicable to a futures contract.

**Gamma**
The rate of change of delta with respect to the asset price.

**Gamma-Neutral Portofolio**
A portfolio with a gamma of zero.

**Hedge Ratio**
A ratio of the size of a position in a hedging instrument to the size of the position being hedged.

**Hedger**
An individual who enters into hedging trades.

**Historic Volatility**
A volatility estimated from historical data.

**Historical Simulation**
A simulation based on historical data.

**Implied Distribution**
A distribution for a future asset price implied from option prices.

**Implied Repo Rate**
The repo rate implied from the price of a Treasury bill and a Treasury bill futures price.

**Implied tree**
A tree describing the movements of an asset price that is constructed to be consisted with observed option prices.

**Implied Volatility**
Volatility implied from an option price using the Black-Scholes or a similar model.

**In-the-Money Option**
Either (a) a call option where the asset price is greater than the strike price or (b) a put option where the asset price is less than the strike price.

**Index Arbitrage**
An arbitrage involving a position in the stocks comprising a stock index and a position in a futures contract on the stock index.

**Index Futures**
A futures contract on a stock index or other index.

**Index Option**
An option contract of a stock index or other index.

**Indexed Principal Swap**
A swap where the principal declines over time. The reduction in the principal on a payment date depends on the level of interest rates.

**Interest-Rate Cap**
An option that provides a payoff when a specified interest rate is above a certain level. The interest rate is a floating rate that is reset periodically.

**Interest-Rate Collar**
A combination of an interest-rate cap and an interest-rate floor.

**Interest-Rate Derivative**
A derivative whose payoffs are dependent on future interest rates.

**Interest-Rate Floor**
An option that provides a payoff when an interest rate is below a certain level. The interest rate is a floating rate that is reset periodically.

**Interest-Rate Option**
An option where the payoff is dependent on the level of interest rates.

**Interest-Rate Swap**
An exchange of a fixed rate of interest on a certain notional principal for a floating rate of interest on the same notional principal.

**Intrinsic Value**
For a call option, this is the greater of the excess of the asset price over the strike price and zero. For a put option, it is the greater of the excess of the strike price over the asset price and zero.

**Inverted Market**
A market where futures prices decrease with maturity.

**Libor Curve**
Libor zero-coupon interest rates as a function of maturity.

**Limit Move**
The maximum price move permitted by the exchange in a single trading session.

**Limit Order**
An order that can be executed only at a specified price or one more favourable to the investor.

**Liquidity Premium**
The amount that forward interest rates exceed expected future spot interest rates.

**Long Hedge**
A hedge involving a long futures position.

**Maintenance Margin**
When the balance in a trader’s margin account falls below the maintenance margin level, the trader receives a margin call requiring the account to be topped up to the initial margin level.

**Marking To Market**
The practice of revaluing an instrument to reflect the current values of the relevant market variables.

**Maturity Date**
The end of the life of a contract.

**Mortgaged-Backed Security**
A security that entitles the owner to a share in the cash flows realized from a pool of mortgages.

**Naked Position**
A short position in a call option that is not combined with a long position in the underlying asset.

**Netting**
The ability to offset contracts with positive and negative values in the event of a default counterparty.

**Nonsystematic Risk**
Risk that can be diversified away.

**Normal Distribution**
The standard bell shaped distribution of statistics.

**Notional Principal**
The principal used to calculate payments in an interest rate swap. The principal is ¨notional¨ because it is neither paid nor received.

**Open Interest**
The total number of long positions outstanding in a futures contract (equals the total number of short positions).

**Option Class**
All options of the same type (call or put) on a particular stock.

**Option Series**
All options of a certain class with the same strike price and expiration date.

**Option-Adjusted Spread**
The spread over the Treasury curve that makes the theoretical price of an interest rate derivative equal to the market price.

**Out-of-the-Money Option**
Either (a) a call option where the asset price is less than the strike price or (b) a put option where the asset price is greater than the strike price.

**Over-the-Counter Market**
Market where traders deal by phone. The traders are usually financial institutions , corporations and fund managers.

**Par Value**
The principal amount of a bond.

**Par Yield**
The coupon on a bond that makes its price equal the principal.

**Path-Dependent Option**
An option whose payoff depends on the whole path followed by the underlying variable – not just its final value.

**Payoff**
The cash realized by the holder of an option or other derivative at the end of its life.

**PO (principal only)**
A mortgage-backed security where the holder receives only principal cash flows on the underlying mortgage pool.

**Portfolio Immunization**
Making a portfolio relatively insensitive to interest rates.

**Portfolio Insurance**
Entering into trades to ensure that the value of a portfolio will not fall below a certain level.

**Position Limit**
The maximum position a trader (or group of traders acting together) is allowed to hold.

**Principal**
The par or face value of a debt instrument.

**Program Trading**
A procedure where trades are automatically generated by a computer and transmitted to the trading floor of an exchange.

**Protective Put**
A put option combined with a long position in the underlying asset.

**Pull-to-Par**
The reversion of a bond’s price to its par value at maturity.

**Put-Call Parity**
The relationship between the price of a European call option and the price of a European put option when they have the same strike price and maturity date.

**Puttable Bond**
A bond where the holder has the right to sell it back to the issuer at certain predetermined times for a predetermined price.

**Puttable Swap**
A swap where one side has the right to terminate early.

**Rainbow Option**
An option whose payoff is dependent on two or more underlying variables.

**Range-Forward Contract**
The combination of a long call and short put or the combination of a short call and long put.

**Rebalancing**
The process of adjusting a trading position periodically. Usually the purpose is to maintain delta neutrality.

**Repo (Repurchase Agreement)**
A procedure for borrowing money by selling securities to a counterparty and agreeing to buy them back later at a slightly higher price.

**Repo Rate**
The rate of interest in a repo transaction.

**Risk-Free Rate**
The rate of interest that can be earned without assuming any risks.

**Risk-Neutral Valuation**
The valuation of an option or other derivative assuming the world is risk neutral. Risk-neutral valuation gives the correct price for a derivative in all worlds, not just in a risk-neutral world.

**Scalper**
A trader who holds positions for a very short period of time.

**Settlement Price**
The average of the prices that a contract trades for immediately before the bell signalling the close of trading for a day. It is used in mark-to-market calculations.

**Short Hadge**
A hedge where a short futures position is taken.

**Short Selling**
Selling in the market shares that have been borrowed from another investor.

**Shout Option**
An option where the holder has the right to lock in a minimum value for the payoff at one time during its life.

**Spread Option**
An option where the payoff is dependent on the difference between two market variables.

**Spread Transaction**
A position in two or more options of the same type.

**Step-up-Swap**
A swap where the principal increases over time in a predetermined way.

**Stochastic Process**
An equation describing the probabilistic behaviour of a stochastic variable.

**Stock Dividend**
A dividend paid in the form of additional shares.

**Stock Index Futures**
Futures on a stock index.

**Stock Index Option**
An option on a stock index.

**Stock Option **
An option on a stock.

**Straddle**
A long position in a call and a put with the same strike price.

**Strangle**
A long position in a call and a put with different strike prices.

**Strap**
A long position in two call options and one put option with the same strike price.

**Stress Testing**
Testing of the impact of extreme market moves on the value of a portfolio.

**Strip**
A long position in one call option and two put options with the same strike price.

**Swap Rate**
The fixed rate in an interest rate swap that causes the swap to have a value of zero.

**Swaption**
An option to enter into an interest rate swap where a specified fixed rate is exchanged for floating.

**Systematic Risk**
Risk that cannot be diversified away.

**Tera Structure of Interest Rates**
The relationship between interest rates and their maturities.

**Terminal Value**
The value at maturity.

**Theta**
The rate of change of the price of an option or other derivative with the passage of time.

**Time Value**
The value of an option arising from the time left to maturity (equals an option’s price minus its intrinsic value).

**Total Return Swap**
A swap of the return on one portfolio of assets for the return on another portfolio of assets.

**Transactions Costs**
The cost of carrying out a trade (commissions plus the difference between the price obtained and the midpoint of the bid-offer spread).

**Treasury Bill**
A short-term non-coupon-bearing instrument issued by the government to finance its debt.

**Treasury Bill Futures**
A futures contract on a Treasury bill.

**Treasury Bond**
A long-term coupon-bearing instrument issued by the government to finance its debt.

**Treasury Bond Futures**
A futures contract on Treasury bonds.

**Treasury Note Futures**
A futures contract on Treasury notes.

**Underlying Variable**
A variable that the price of an option or other derivative depends on.

**Up-and-In Option**
An option that comes into existence when the price of the underlying asset increases to a prespecified level.

**Up-and-Out Option**
An option that ceases to exist when the price of the underlying asset increases to a prespecified level.

**Value At Risk**
A loss that will not be exceeded at some specified confidence level.

**Variance Rate**
The square of volatility.

**Volatility Matrix**
A table showing the variation of implied volatilities with strike price and time to maturity.

**Volatility Skew**
A term used to describe the volatility smile when it is nonsymmetrical.

**Volatility Smile**
The variation of implied volatility with strike price.

**Volatility Term Structure**
The variation of implied volatility with time to maturity.

**Writing An Option**
Selling an option.

**Zero-Coupon Interest Rate**
The interest rate that would be earned on a bond that provides no coupons.