Commodity Futures Trading Commission,A body that regulates trading in futures contracts in the United States.;Callable Bond,A bond containing provisions that allow the issuer to buy it back at a predetermined price at certain times during its life.;Zero-Coupon Bond,A bond that provides no coupons.;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.;Extendable Bond,A bond whose life can be extended at the option of the holder.;Synthetic CDO,A CDO created by selling credit default swaps.;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.;Central Clearing Party,A clearing house used for over-the-counter contracts.;Box Spread,A combination of a bull spread created from calls and a bear spread created from puts.;Interest Rate Collar,A combination of an interest-rate cap and an interest rate floor.;Futures Contract,A contract that obligates the holder to buy or sell an asset at a predetermined delivery price during a specified future time period. The contract is settled daily.;Forward Contract,A contract that obligates the holder to buy or sell an asset for a predetermined delivery price at a predetermined future time.;Day Count,A convention for quoting interest rates.;Convertible Bond,A corporate bond that can be converted into a predetermined amount of the company's equity at certain times during its life.;Eurocurrency,A currency that is outside the formal control of the issuing country's monetary authorities.;Package,A derivative that is a portfolio of standard calls and puts, possibly combined with a position in forward contracts and the asset itself.;Quanto,A derivative where the payoff is defined by variables associated with one currency but is paid in another currency.;Credit Derivative,A derivative whose payoff depends on the creditworthiness of one or more companies or countries.;Interest Rate Derivative,A derivative whose payoffs are dependent on future interest rates.;Implied Distribution,A distribution for a future asset price implied from option prices.;Bivariate Normal Distribution,A distribution for two correlated variables, each of which is normal.;Eurodollar,A dollar held in a bank outside the United States.;Conversion Factor,A factor used to determine the number of bonds that must be delivered in the Chicago Board of Trade bond futures contract.;Clearing House,A firm that guarantees the performance of the parties in a derivatives transaction (also referred to as a clearing corporation).;Prepayment function,A function estimating the prepayment of principal on a portfolio of mortgages in terms of other variables.;Index Futures,A futures contract on a stock index or other index.;Treasury Bond Futures,A futures contract on Treasury bonds.;Treasury Note Futures,A futures contract on Treasury notes.;Eurodollar Futures Contract,A futures contract written on a Eurodollar deposit.;Long Hedge,A hedge involving a long futures position.;Static Hedge,A hedge that does not have to be changed once it is initiated.;Short Hedge,A hedge where a short futures position is taken.;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.;Efficient Market Hypothesis,A hypothesis that asset prices reflect relevant information.;Strangle,A long position in a call and a put with different strike prices.;Straddle,A long position in a call and a put with the same strike price.;Bull Spread,A long position in a call with strike price K1 combined with a short position in a call with strike price K2, where K2 > K1. (A bull spread can also be created with put options.);Strip,A long position in one call option and two put options with the same strike price.;Strap,A long position in two call options and one put option with the same strike price.;Value at Risk,A loss that will not be exceeded at some specified confidence level.;Clearing Margin,A margin posted by a member of a clearinghouse.;Inverted Market,A market where futures prices decrease with maturity.;Normal Market,A market where futures prices increase with maturity.;Over-the-Counter Market,A market where traders deal by phone. The traders are usually financial institutions, corporations, and fund managers.;Variance-Covariance Matrix,A matrix showing variances of, and covariances between, anumber of different market variables.;Duration,A measure of the average life 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.;Convenience Yield,A measure of the benefits from ownership of an asset that are not obtained by the holder of a long futures contract on the asset.;Credit Rating,A measure of the creditworthiness of a bond issue.;Convexity,A measure of the curvature in the relationship between bond prices and bond yields.;Kurtosis,A measure of the fatness of the tails of a distribution.;Beta,A measure of the systematic risk of an asset.;Market Price of Risk,A measure of the trade-offs investors make between risk and return.;Volatility,A measure of the uncertainty of the return realized on an asset.;Maximum Likelihood Method,A method for choosing the values of parameters by maximizing the probability of a set of observations occurring.;Finite Difference Method,A method for solving a differential equation.;Implicit Finite Difference Method,A method for valuing a derivative by solving the underlying differential equation. The value of the derivative at time t þ t is related to three values at time t.;Cholesky Decomposition,A method of sampling from a multivariate normal distribution.;Numerical Procedure,A method of valuing an option when no formula is available.;Adaptive Mesh Model,A model developed by Figlewski and Gao that grafts a high-resolution tree on to a low-resolution tree so that there is more detailed modeling of the asset price in critical regions.;Gaussian Copula Model,A model for defining a correlation structure between two or more variables. In some credit derivatives models, it is used to define a correlation structure for times to default.;GARCH Model,A model for forecasting volatility where the variance rate follows a mean-reverting process.;Black-Scholes-Merton Model,A model for pricing European options on stocks, developed by Fischer Black, Myron Scholes, and Robert Merton.;Equilibrium Model,A model for the behavior of interest rates derived from a model of the economy.;No-Arbitrage Interest Rate Model,A model for the behavior of interest rates that is exactly consistent with the initial term structure of interest rates.;Market Model,A model most commonly used by traders.;Capital Asset Pricing Model,A model relating the expected return on an asset to its beta.;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 variances and covariances in value at risk calculations.;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.;Nonstationary Model,A model where the volatility parameters are a function of time.;Modified Duration,A modification to the standard duration measure so that it more accurately describes the relationship between proportional changes in a bond price and actual changes in its yield. The modification takes account of the compounding frequency with which the yield is quoted.;Collateralized Mortgage Obligation,A mortgage-backed security where investors are divided into classes and there are rules for determining how principal repayments are channeled to the classes.;Interest Only,A mortgage-backed security where the holder receives only interest cash flows on the underlying mortgage pool.;Principal Only,A mortgage-backed security where the holder receives only principal cash flows on the underlying mortgage pool.;Parallel Shift,A movement in the yield curve where each point on the curve changes by the same amount.;Exotic Option,A nonstandard option.;Zero-Coupon Yield Curve,A plot of the zero-coupon interest rate against time to maturity.;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.;Gamma-Neutral Portfolio,A portfolio with a gamma of zero.;Vega-Neutral Portfolio,A portfolio with a vega of zero.;Short Position,A position assumed when traders sell shares they do not own.;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.);Spread Transaction,A position in two or more options of the same type.;Combination,A position involving both calls and puts on the same underlying asset.;Long Position,A position involving the purchase of an 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.);Tailing the Hedge,A procedure for adjusting the number of futures contracts used for hedging to reflect daily settlement.;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.;CreditMetrics,A procedure for calculating credit value at risk.;Bootstrap Method,A procedure for calculating the zero-coupon yield curve from market data.;Static Options Replication,A procedure for hedging a portfolio that involves finding another portfolio of approximately equal value on some boundary.;Dynamic Hedging,A procedure for hedging an option position by periodically changing the position held in the underlying asset. The objective is usually to maintain a delta-neutral position.;Duration Matching,A procedure for matching the durations of assets and liabilities in afinancial institution.;Monte Carlo Simulation,A procedure for randomly sampling changes in market variables in order to value a derivative.;Cash Flow Mapping,A procedure for representing an instrument as a portfolio of zero-coupon bonds for the purpose of calculating value at risk.;Backwards Induction,A procedure for working from the end of a tree to its beginning in order to value an option.;Program Trading,A procedure where trades are automatically generated by a computer and transmitted to the trading floor of an exchange.;Principal Protected Note,A product where the return earned depends on the performance of a risky asset but is guaranteed to be nonnegative, so that the investor's principal is preserved.;Variance-Gamma Model,A pure jump model where small jumps occur often and large jumps occur infrequently.;Protective Put,A put option combined with a long position in the underlying asset.;Margin Call,A request for extra margin when the balance in the margin account falls below the maintenance margin level.;Ito's Lemma,A result that enables the stochastic process for a function of a variable to be calculated from the stochastic process for the variable itself.;Yield,A return provided by an instrument.;Mortgage-Backed Security,A security that entitles the owner to a share in the cash flows realized from a pool of mortgages.;Quasi-random Sequences,A sequences of numbers used in a Monte Carlo simulation that are representative of alternative outcomes rather than random.;Cliquet Option,A series of call or put options with rules for determining strike prices. Typically, one option starts when the previous one terminates.;Covered Call,A short position in a call option on an asset combined with a long position in the asset.;Naked Position,A short position in a call option that is not combined with a long position in the underlying asset.;Bear Spread,A short position in a put option with strike price K1 combined with a long position in a put option with strike price K2 where K2 > K1. (It can also be created with call options.);Treasury Bill,A short-term non-coupon-bearing instrument issued by the government to finance its debt.;Contango,A situation where the futures price is above the expected future spot price (also often used to refer to the situation where the futures price is above the current spot price).;Normal Backwardation,A situation where the futures price is below the expected future spot price.;Geometric Brownian Motion,A stochastic process often assumed for asset prices where the logarithm of the underlying variable follows a generalized Wiener process.;Markov Process,A stochastic process where the behavior of the variable over a short period of time depends solely on the value of the variable at the beginning of the period, not on its past history.;Wiener Process,A stochastic process where the change in a variable during each short period of time of length t has a normal distribution with a mean equal to zero and avariance equal to t.;Ito Process,A stochastic process where the change in a variable during each short period of time of length t has a normal distribution. The mean and variance of the distribution are proportional to t and are not necessarily constant.;Generalized Wiener Process,A stochastic process where the change in a variable in time t has a normal distribution with mean and variance both proportional to t.;Employee Stock Option,A stock option issued by company on its own stock and given to its employees as part of their remuneration.;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.;Constant Maturity Swap,A swap where a swap rate is exchanged for either a fixed rate or a floating rate on each payment date.;Commodity Swap,A swap where cash flows depend on the price of a commodity.;Basis Swap,A swap where cash flows determined by one floating reference rate are exchanged for cash flows determined by another floating reference rate.;Currency Swap,A swap where interest and principal in one currency are exchanged for interest and principal in another currency.;Puttable Swap,A swap where one side has the right to terminate early.;Amortizing Swap,A swap where the notional principal decreases in a predetermined way as time passes.;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.;Step-up Swap,A swap where the principal increases over time in a predetermined way.;Total Return Swap,A swap where the return on an asset such as a bond is exchanged for LIBOR plus a spread. The return on the asset includes income such as coupons and the change in value of the asset.;Equity Swap,A swap where the return on an equity portfolio is exchanged for either a fixed or a floating rate of interest.;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.;Extendable Swap,A swap whose life can be extended at the option of one side to the contract.;Collateralization,A system for posting collateral by one or both parties in a derivatives transaction.;Credit Ratings Transition Matrix,A table showing the probability that a company will move from one credit rating to another during a certain period of time.;Volatility Surface,A table showing the variation of implied volatilities with strike price and time to maturity.;Control Variate Technique,A technique that can sometimes be used for improving the accuracy of a numerical procedure.;Triple Witching Hour,A term given to the time when stock index futures, stock index options, and options on stock index futures all expire together.;Plain Vanilla,A term used to describe a standard deal.;Volatility Skew,A term used to describe the volatility smile when it is nonsymmetrical.;Liquidity Preference Theory,A theory leading to the conclusion that forward interest rates are above expected future spot interest rates.;Market Segmentation Theory,A theory that short interest rates are determined independently of long interest rates by the market.;Day Trade,A trade that is entered into and closed out on the same day.;Scalper,A trader who holds positions for a very short period of time.;Market Maker,A trader who is willing to quote both bid and offer prices for an asset.;Implied Tree,A tree describing the movements of an asset price that is constructed to be consistent with observed option prices.;Binomial Tree,A tree that represents how an asset price can evolve under the binomial model.;Trinomial Tree,A tree where there are three branches emanating from each node. It is used in the same way as a binomial tree for valuing derivatives.;Lognormal Distribution,A variable has a lognormal distribution when the logarithm of the variable has a normal distribution.;Underlying Variable,A variable on which the price of an option or other derivative depends.;Deterministic Variable,A variable whose future value is known.;Stochastic Variable,A variable whose future value is uncertain.;Historic Volatility,A volatility estimated from historical data.;Copula,A way of defining the correlation between variables with known distributions.;Collateralized Debt Obligation,A way of packaging credit risk. Several classes of securities (known as tranches) are created from a portfolio of bonds and there are rules for determining how the cost of defaults are allocated to classes.;Continuous Compounding,A way of quoting interest rates. It is the limit as the assumed compounding interval is made smaller and smaller.;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.;Risk-Neutral World,A world where investors are assumed to require no extra return on average for bearing risks.;Martingale,A zero drift stochastic process.;FAS 123,Accounting standard in United States relating to employee stock options.;FAS 133,Accounting standard in United States relating to instruments used for hedging.;Timing Adjustment,Adjustment made to the forward value of a variable to allow for the timing of a payoff from a derivative.;Credit Value Adjustment,Adjustment to value of derivatives outstanding with a counterparty to reflect the counterparty's default risk.;Forward Rate Agreement,Agreement that a certain interest rate will apply to a certain principal amount for a certain time period in the future.;Option Series,All options of a certain class with the same strike price and expiration date.;Option Class,All options of the same type (call or put) on a particular stock.;Recovery Rate,Amount recovered in the event of a default as a percent of the face value.;Deferred Swap,An agreement to enter into a swap at some time in the future (also called a forward swap).;Swap,An agreement to exchange cash flows in the future according to a prearranged formula.;Principal Components Analysis,An analysis aimed at finding a small number of factors that describe most of the variation in a large number of correlated variables (similar to a factor analysis).;Factor analysis,An analysis aimed at finding a small number of factors that describe most of the variation in a large number of correlated variables (similar to a principal components analysis).;Scenario Analysis,An analysis of the effects of possible alternative future movements in market variables on the value of a portfolio.;Black's Approximation,An approximate procedure developed by Fischer Black for valuing a call option on a dividend-paying stock.;Cornish-Fisher Expansion,An approximate relationship between the fractiles of a probability distribution and its moments.;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.;Investment Asset,An asset held by at least some individuals for investment purposes.;Consumption Asset,An asset held for consumption rather than investment.;Stochastic Process,An equation describing the probabilistic behavior of a stochastic variable.;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.;Black's Model,An extension of the Black-Scholes model for valuing European options on futures contracts. As described in Chapter 26, it is used extensively in practice to value European options when the distribution of the asset price at maturity is assumed to be lognormal.;Variation Margin,An extra margin required to bring the balance in a margin account up to the initial margin when there is a margin call.;Uptick,An increase in price.;Stock Index,An index monitoring the value of a portfolio of stocks.;Arbitrageur,An individual engaging in arbitrage.;Specialist,An individual responsible for managing limit orders on some exchanges. The specialist does not make the information on outstanding limit orders available to other traders.;CDO Squared,An instrument in which the default risks in a portfolio of CDO tranches are allocated to new securities.;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.;Discount Instrument,An instrument, such as a Treasury bill, that provides no coupons.;Accrual Swap,An interest rate swap where interest on one side accrues only when a certain condition is met.;Money Market Account,An investment that is initially equal to $1 and, at time t, increases at the very short-term risk-free interest rate prevailing at that time.;Rights Issue,An issue to existing shareholders of a security giving them the right to buy new shares at a certain price.;Newton-Raphson Method,An iterative procedure for solving nonlinear equations.;Index Option,An option contract on a stock index or other index.;Synthetic Option,An option created by trading the underlying asset.;Forward Start Option,An option designed so that it will be at-the-money at some time in the future.;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.;At-the-Money Option,An option in which the strike price equals the price of the underlying asset.;Warrant,An option issued by a company or a financial institution. Call warrants are frequently issued by companies on their own stock.;Foreign Currency Option,An option on a foreign exchange rate.;Futures Option,An option on a futures contract.;Stock Index Option,An option on a stock index.;Compound Option,An option on an option.;American Option,An option that can be exercised at any time during its life.;Bermudan Option,An option that can be exercised on specified dates during its life.;European Option,An option that can be exercised only at the end of its life.;Down-and-Out Option,An option that ceases to exist when the price of the underlying asset declines 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.;Down-and-In Option,An option that comes into existence when the price of the underlying asset declines to a prespecified level.;Up-and-In Option,An option that comes into existence when the price of the underlying asset increases to a prespecified level.;Embedded Option,An option that is an inseparable part of another instrument.;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.;Cash-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.;Average Strike Option,An option that provides a payoff dependent on the difference between the final asset price and the average asset price.;Basket Option,An option that provides a payoff dependent on the value of a portfolio of assets.;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.;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 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.;Call Option,An option to buy an asset at a certain price by a certain date.;Swaption,An option to enter into an interest rate swap where a specified fixed rate is exchanged for floating.;Exchange Option,An option to exchange one asset for another.;Put Option,An option to sell an asset for a certain price by a certain date.;Flex Option,An option traded on an exchange with terms that are different from the standard options traded by the exchange.;Bond Option,An option where a bond is the underlying asset.;Chooser Option,An option where the holder has the right to choose whether it is a call or a put at some point during its life.;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.;Interest Rate Option,An option where the payoff is dependent on the level of interest rates.;Deferred Payment Option,An option where the price paid is deferred until the end of the option's life.;Path-Dependent Option,An option whose payoff depends on the whole path followed by the underlying variable—not just its final value.;Barrier Option,An option whose payoff depends on whether the path of the underlying asset has reached a barrier (i.e., a certain predetermined level).;Lookback Option,An option whose payoff is dependent on the maximum or minimum of the asset price achieved during a certain period.;Rainbow Option,An option whose payoff is dependent on two or more underlying variables.;Asian Option,An option with a payoff dependent on the average price of the underlying asset during a specified period.;Limit Order,An order that can be executed only at a specified price or one more favorable to the investor.;Convexity Adjustment,An overworked term. For example, it can refer to the adjustment necessary to convert a futures interest rate to a forward interest rate. It can also refer to the adjustment to a forward rate that is sometimes necessary when Black's model is used.;Parisian Option,Barrier option where the asset has to be above or below the barrier for a period of time for the option to be knocked in or out.;CAT Bond,Bond where the interest and, possibly, the principal paid are reduced if a particular category of ''catastrophic'' insurance claims exceed a certain amount.;Holiday Calendar,Calendar defining which days are holidays for the purposes of determining payment dates in a swap.;Dirty Price of Bond,Cash price of bond.;CMO,Collateralized Mortgage Obligation.;Basel Committee,Committee responsible for regulation of banks internationally.;Reference Entity,Company for which default protection is bought in a credit default swap.;CEV,Constant Elasticity of Variance Model;CMS,Constant Maturity Swap;Confirmation,Contract confirming verbal agreement between two parties to a trade in the over-the-counter market.;CDD,Cooling degree days;Compound Correlation,Correlation implied from the market price of a CDO tranche.;Implied Correlation,Correlation number implied from the price of a credit derivative using the Gaussian copula or similar model.;Base Correlation,Correlation that leads to the price of a 0% to X% CDO tranche being consistent with the market for a particular value of X.;Agency Costs,Costs arising from a situation where the agent (e.g., manager) is not motivated to act in the best interests of the principal (e.g., shareholder).;Basket Credit Default Swap,Credit default swap where there are several reference entities.;Numeraire,Defines the units in which security prices are measured. For example, if the price of IBM is the numeraire, all security prices are measured relative to IBM. If IBM is $80 and a particular security price is $50, the security price is 0.625 when IBM is the numeraire.;Weather Derivative,Derivative where the payoff depends on the weather.;Haircut,Discount applied to the value of an asset for collateral purposes.;Bond Yield,Discount rate which, when applied to all the cash flows of a bond, causes the present value of the cash flows to equal the bond's market price.;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.;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.;Swing Option,Energy option in which the rate of consumption must be between a minimum and maximum level. There is usually a limit on the number of times the option holder can change the rate at which the energy is consumed.;Portfolio Insurance,Entering into trades to ensure that the value of a portfolio will not fall below a certain level.;Gap Option,European call or put option where there are two strike prices. One determines whether the option is exercised. The other determines the payoff.;Asset Swap,Exchanges the coupon on a bond for LIBOR plus a spread.;Early Exercise,Exercise prior to the maturity date.;EWMA,Exponentially weighted moving average.;Crashophobia,Fear of a stock market crash that some people claim causes the market to increase the price of deep-out-of-the-money put options.;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.;FRA,Forward Rate Agreement;Instantaneous Forward Rate,Forward rate for a very short period of time in the future.;Hedge Funds,Funds that are subject to less regulation and fewer restrictions than mutual funds. They can take short positions and use derivatives, but they cannot publicly offer their securities.;Futures-Style Option,Futures contract on the payoff from an option.;Stock Index Futures,Futures on a stock index.;Futures Commission Merchants,Futures traders who are following instructions from clients.;Greeks,Hedge parameters such as delta, gamma, vega, theta, and rho.;Cross Hedging,Hedging an exposure to the price of one asset with a contract on another asset.;Case-Shiller Index,Index of house prices in the United States.;Credit Index,Index that tracks the cost of buying protection for each company in a portfolio (e.g., CDX NA IG and iTraxx Europe).;Binary Credit Default Swap,Instrument where there is a fixed dollar payoff in the event of a default by a particular company.;ABS CDO,Instrument where tranches are created from the tranches of ABSs.;Sticky Cap,Interest rate cap where the cap rate applicable to an accrual period equals the capped rate for the previous accrual period plus a spread.;Ratchet Cap,Interest rate cap where the cap rate applicable to an accrual period equals the rate for the previous accrual period plus a spread.;Flexi Cap,Interest rate cap where there is a limit on the total number of caplets that can be exercised.;LIBOR Curve,LIBOR zero-coupon interest rates as a function of maturity.;LIBID,London interbank bid rate;LIBOR,London interbank offered rate;LEAPS,Long-term equity anticipation securities;Portfolio Immunization,Making a portfolio relatively insensitive to interest rates.;Exercise Limit,Maximum number of option contracts that can be exercised within a five-day period.;Covariance,Measure of the linear relationship between two variables (equals the correlation between the variables times the product of their standard deviations).;Hazard Rate,Measures probability of default in a short period of time conditional on no earlier default.;Default Correlation,Measures the tendency of two companies to default at about the same time.;Default Probability Density,Measures the unconditional probability of default in a future short period of time.;Calibration,Method for implying a model's parameters from the prices of actively traded options.;Implied Volatility Function Model,Model designed so that it matches the market prices of all European options.;Jump-Diffusion Model,Model where asset price has jumps superimposed on to a diffusion process such as geometric Brownian motion.;Constant Elasticity of Variance Model,Model where the variance of the change in a variable in a short period of time is proportional to the value of the variable.;Diffusion Process,Model where value of asset changes continuously (no jumps).;Credit Spread Option,Option whose payoff depends on the spread between the yields earned on two assets.;Binary Option,Option with a discontinuous payoff, e.g., a cash-or-nothing option or an asset-or-nothing option.;Vesting Period,Period during which an option cannot be exercised.;Backdating,Practice (often illegal) of marking a document with a date that precedes the current date.;Delivery Price,Price agreed to (possibly some time in the past) in a forward contract.;Securitization,Procedure for distributing the risks in a portfolio of assets.;Gaussian Quadrature,Procedure for integrating over a normal distribution.;Cash Settlement,Procedure for settling a futures contract in cash rather than by delivering the underlying asset.;Stack and Roll,Procedure where short-term futures contracts are rolled forward so that long-term hedges are created.;Variance Reduction Procedures,Procedures for reducing the error in a Monte Carlo simulation.;Inception Profit,Profit created by selling a derivative for more than its theoretical value.;Rho,Rate of change of the price of a derivative with the interest rate.;Forward Rate,Rate of interest for a period of time in the future implied by today's zero rates.;Sharpe Ratio,Ratio of excess return less risk-free rate over standard deviation of the excess return.;Exercise Multiple,Ratio of stock price to strike price at time of exercise for employee stock option.;Girsanov's Theorem,Result showing that when we change the measure (e.g., move from real world to risk-neutral world) the expected return of a variable changes but the volatility remains the same.;Systemic Risk,Risk that a default by one financial institution will lead to defaults by other financial institutions.;Nonsystematic Risk,Risk that can be diversified away.;Systematic Risk,Risk that cannot be diversified away.;Liquidity Risk,Risk that it will not be possible to sell a holding of a particular instrument at its theoretical price. Also, the risk that a company will not be able to borrow money to fund its assets.;Writing an Option,Selling an option.;Jump Process,Stochastic process for a variable involving jumps in the value of the variable.;Cancelable Swap,Swap that can be canceled by one side on prespecified dates.;Overnight Indexed Swap,Swap where a fixed rate for a period (e.g., 1 month) is exchanged for the geometric average of the overnight rates during the period.;Compounding Swap,Swap where interest compounds instead of being paid.;LIBOR-in-Arrears Swap,Swap where the interest paid on a date is determined by the interest rate observed on that date (not by the interest rate observed on the previous payment date).;Variance Swap,Swap where the realized variance rate during a period is exchanged for a fixed variance rate. Both are applied to a notional principal.;Volatility Swap,Swap where the realized volatility during a period is exchanged for a fixed volatility. Both percentage volatilities are applied to a notional principal.;Open Outcry,System of trading where traders meet on the floor of the exchange;Back Testing,Testing a value-at-risk or other model using historical data.;Stress Testing,Testing of the impact of extreme market moves on the value of a portfolio.;Netting,The ability to offset contracts with positive and negative values in the event of adefault by a counterparty.;Bid-Ask Spread,The amount by which the ask price exceeds the bid price.;Liquidity Premium,The amount that forward interest rates exceed expected future spot interest rates.;No-Arbitrage Assumption,The assumption that there are no arbitrage opportunities in market prices.;Settlement Price,The average of the prices that a contract trades for immediately before the bell signaling the close of trading for a day. It is used in mark-to-market calculations.;Expected Value of a Variable,The average value of the variable obtained by weighting the alternative values by their probabilities.;Cheapest-to-Deliver Bond,The bond that is cheapest to deliver in the Chicago Board of Trade bond futures contract.;Margin,The cash balance (or security deposit) required from a futures or options trader.;Payoff,The cash realized by the holder of an option or other derivative at the end of its life.;Initial Margin,The cash required from a futures trader at the time of the trade.;Range Forward Contract,The combination of a long call and short put or the combination of a short call and long put.;Stock Split,The conversion of each existing share into more than one new share.;Transaction Costs,The cost of carrying out a trade (commissions plus the difference between the price obtained and the midpoint of the bid-offer spread).;Storage Costs,The costs of storing a commodity.;Par Yield,The coupon on a bond that makes its price equal the principal.;Credit Value at Risk,The credit loss that will not be exceeded at some specified confidence level.;Reset Date,The date in a swap or cap or floor when the floating rate for the next period is set.;Futures Price,The delivery price currently applicable to a futures contract.;Forward Price,The delivery price in a forward contract that causes the contract to be worth zero.;TED Spread,The difference between 3-month LIBOR and the 3-month T-Bill rate.;Basis,The difference between the spot price and the futures price of a commodity.;Dividend Yield,The dividend as a percentage of the stock price.;Swap Rate,The fixed rate in an interest rate swap that causes the swap to have a value of zero.;Forward Exchange Rate,The forward price of one unit of a foreign currency.;Accrued Interest,The interest earned on a bond since the last coupon payment date.;Short Rate,The interest rate applying for a very short period of time.;Forward Interest Rate,The interest rate for a future period of time implied by the rates prevailing in the market today.;Eurodollar Interest Rate,The interest rate on a Eurodollar deposit.;Zero-Coupon Interest Rate,The interest rate that would be earned on a bond that provides no coupons.;Reversion Level,The level to which the value of a market variable (e.g., an interest rate) tends to revert.;Exposure,The maximum loss from default by a counterparty.;Position Limit,The maximum position a trader (or group of traders acting together) is allowed to hold.;Limit Move,The maximum price move permitted by the exchange in a single trading session.;Flat Volatility,The name given to volatility used to price a cap when the same volatility is used for each caplet.;Counterparty,The opposite side in a financial transaction.;Marking to Market,The practice of revaluing an instrument to reflect the current values of the relevant market variables.;Strike Price,The price at which the asset may be bought or sold in an option contract (also called the exercise price).;Premium,The price of an option.;Ask Price,The price that a dealer is offering to sell an asset.;Bid Price,The price that a dealer is prepared to pay for an asset.;Notional Principal,The principal used to calculate payments in an interest rate swap. The principal is ''notional'' because it is neither paid nor received.;Cumulative Distribution Function,The probability that a variable will be less than x as a function of x.;Rebalancing,The process of adjusting a trading position periodically. Usually the purpose is to maintain delta neutrality.;Dollar Duration,The product of a bond's modified duration and the bond price.;Clean Price of Bond,The quoted price of a bond. The cash price paid for the bond (or dirty price) is calculated by adding the accrued interest to the clean price.;London interbank bid rate,The rate bid by banks on Eurocurrency deposits (i.e., the rate at which a bank is willing to borrow from other banks).;Cap Rate,The rate determining payoffs in an interest rate cap.;Floor Rate,The rate in an interest rate floor agreement.;Vega,The rate of change in the price of an option or other derivative with volatility.;Gamma,The rate of change of delta with respect to the asset price.;Delta,The rate of change of the price of a derivative with the price of the underlying asset.;Theta,The rate of change of the price of an option or other derivative with the passage of time.;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.;Hedge Ratio,The ratio of the size of a position in a hedging instrument to the size of the position being hedged.;Term Structure of Interest Rates,The relationship between interest rates and their maturities.;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.;Pull-to-Par,The reversion of a bond's price to its par value at maturity.;Option,The right to buy or sell an asset.;Credit Risk,The risk that a loss will be experienced because of a default by the counterparty in a derivatives transaction.;Basis Risk,The risk to a hedger arising from uncertainty about the basis at a future time.;Option-Adjusted Spread,The spread over the Treasury curve that makes the theoretical price of an interest rate derivative equal to the market price.;Variance Rate,The square of volatility.;Normal Distribution,The standard bell-shaped distribution of statistics.;Cost of Carry,The storage costs plus the cost of financing an asset minus the income earned on the asset.;Credit Contagion,The tendency of a default by one company to lead to defaults by other companies.;Expectations Theory,The theory that forward interest rates equal expected future spot interest rates.;Open Interest,The total number of long positions outstanding in a futures contract (equals the total number of short positions).;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.;Volatility Smile,The variation of implied volatility with strike price.;Volatility Term Structure,The variation of implied volatility with time to maturity.;Spot Volatilities,The volatilities used to price a cap when a different volatility is used for each caplet.;Long-term equity anticipation securities,These are relatively long-term options on individual stocks or stock indices.;IMM Dates,Third Wednesday in March, June, September, and December.;Compounding Frequency,This defines how an interest rate is measured.;International Swaps and Derivatives Association,Trade Association for over-the-counter derivatives and developer of master agreements used in over-the-counter contracts.;Stressed VaR,Value at risk calculated using historical simulation from a period of stressed market conditions.;Implied Volatility,Volatility implied from an option price using the Black-Scholes or asimilar model.;Ex-dividend Date,When a dividend is declared, an ex-dividend date is specified. Investors who own shares of the stock just before the ex-dividend date receive the dividend.;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.;Government National Mortgage Association,A government organization that guaranteed (for a fee) interest and principal payments on qualifying mortgages against default and created the securities that were sold to investors.;