Glossary
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A American option: An option contract that can be exercised on or before the expiry date. Appreciation: An increase in the value of one currency in terms of another, resulting from an increase in market demand. Arbitrage: The act of simultaneous buying and selling in two different markets, with the aim of taking advantage of the temporary differential that exists between the two prices. Ask: The price/rate at which the market maker is willing to sell a currency or lend money .It is the higher of the two rates in case of a two way quote. (Also called "offer" rate) At-the-money option: An option whose strike price is equal to the current market price of the underlying, either at the money spot or at-the-money-forward. Aussie: A commonly used market term for the Australian Dollar. B Basis point: One hundredth of one percentage point is a basis point. Used mostly in relation to interest rates. Bear: A person who expects a decline in prices or in the value of a currency. A person who has a pessimistic view on the market. A bear market observes declining prices, with a general sentiment for further weakening of prices to occur. Bid: The price / rate at which the market maker is willing to buy a currency or borrow money. Bid-offer spread: The difference between the price quoted by a market maker for buying and selling a currency or security. For Eg: USD/INR: 46.82/86 – the spread in this case is 4 paise. Bull: A person with an optimistic view on the market, who expects the value of a currency to rise. A bull market observes rising prices, with a general sentiment for further strengthening of prices to occur. C Cable: The commonly used market term for sterling/dollar exchange rate. Call option: An option which gives the holder the right, but not the obligation, to buy a specified amount of foreign currency (or any other asset) at a specific price on or before a specific maturity date. Cap: An option agreement that puts an upper limit on interest rates. A cap provides borrowers interest rate risk protection in case of floating rate loans. The borrower is compensated for any rise in the rate, beyond the cap. Caps allow borrowers to take advantage of falling rates but do not expose them to high rates. Cash market: A market where deal and delivery of the transaction is done on the same day. Collar: A transaction, which combines both the purchase of a cap and sale of a floor. This establishes a desired band in which buyer of the collar wants to operate in. If interest rates rise above the cap, the buyer of collar will be compensated for the difference and if the rate falls below the floor, he in turn pays the difference amount. Contingent option: A kind of knock-in option, in which the premium (higher than for a plain vanilla option) is paid only when the underlying asset reaches a specific level, before the expiry of the option. E.g. a put on the Euro at $0.8800, but exercisable only if Euro LIBOR is more than say 5.50%. Contract month: The month in which futures contract may be settled by making or accepting a delivery. Convertible currency: A currency is called convertible in a country when it can be exchanged for other currencies or gold without any special authorization from the central bank of that country or any other government authority. Counter party risk: The risk that a party in a transaction is exposed to, arising from the possibility that the counter party may default or fail to deliver his or her obligation. Country risk: It comprises of a wide range of risks, associated with lending or depositing funds, or doing other financial transaction in a particular country. It includes economic risk, political risk, currency blockage, expropriation, and inadequate access to hard currencies. Covered Interest Arbitrage: The process of borrowing in one currency, converting it to another currency at spot, where it is invested, and selling this second currency forward against the initial currency. A market player does this series of transactions, with the aim of making riskless profits from discrepancies between interest differentials and the percentage discount or premium between currencies, in the forward transaction. Credit risk: The risk that a counter-party may not meet his/her obligation in a contract. Same as counter-party risk Cross rate: A cross currency rate is an exchange rate between two currencies, neither of which is the USD. For e.g. EUR/JPY, GBP/CHF. In the Indian forex market, the cross rate is loosely referred to the rate for any currency pair which excludes the Indian rupee. For e.g. USD/JPY Currency Option: A currency option gives the buyer, the right but not the obligation, to buy or sell, a specific amount of currency at a specified exchange rate, on or before a future date. D Delivery: The act of settlement of a financial transaction. Depreciation: Decrease in the value of one currency in terms of another, resulting from a decline in market demand. Derivative: The generic term used to categorize a wide variety of financial instruments whose value is ‘derived from’ or ‘depends on’ the value of the underlying instrument, reference rate or index. Direct rate: An exchange rate quote in which one unit of foreign currency is quoted in terms of x units of home currency. In India the USD/INR is a direct quote. $1 = Rs. 46.73 Dirty float: A floating currency which is regularly subject to intervention, usually by the central bank, and therefore does not freely respond to market pressures. Down-and-in option: An option which comes into existence only when the price of the underlying security moves below a predefined level. Down-and-out option: An option that expires if the price of the underlying moves below a predefined level. E Early exercise: The exercise of an American style option before its expiry date. Euro market: A collective term used to describe a series of offshore money and capital market operations of the international bankers. Euro market comprises of euro currency, euro credit and euro bond markets. The predominant centre of these markets is London except for the Euro sterling market, which is centred in Paris. Eurocurrency: A currency borrowed or deposited outside the country of origin or the home country. A US Dollar deposit outside the US is called a Eurodollar deposit while sterling deposit held outside UK would be Eurosterling deposit. Eurocurrency is different from the Euro, the common currency of the Eurozone and the latest currency in the international foreign exchange markets. Euro: The common currency of the Eurozone, which comprises 11 countries. European Option: An option that can be exercised only on the date of expiry and not prior to that. Exchange control: Monetary authority’s rules and regulations used to protect or preserve the value of any country’s currency. These rules may restrict imports, investments abroad, travel, or other activities involving foreign exchange transaction. Exchange rate futures: A futures contract for currencies. Also see futures. Exchange rate risk: Risk arising from the possibility of adverse movement in the exchange rates. Exchange rate: It is the rate of conversion of one currency into another. The number of units of one currency expressed in terms of a unit of another currency. Exchange traded contract (ETC): A generic term used to describe all the derivative instruments that are traded on the floor of an organized exchange. Exposure: In foreign exchange related transactions, the potential gain or loss, because of movements in foreign exchange rates. There are three types of exposure –transaction, translation and economic.
F Fed funds rate (Federal fund rate): It is the overnight rate of interest at which Fed funds are traded among financial institutions. Fed Funds are non-interest bearing deposits held by member banks with the Federal Reserve. It is regarded as a key indicator of all US domestic interest rates. Fixed exchange rate: When the value of a currency is fixed against another major currency, such as US dollar, Euro etc., the exchange rate is said to be fixed or pegged. Fluctuations in the exchange rate around this parity are managed by official intervention and by internal regulations limiting exchange transactions. In most cases, there is a narrow band of 1 or 2%, within which the exchange rate is allowed to fluctuate on either side of the fixed rate. Eg: Malaysian Ringgit, Chinese Yuan and the Saudi Riyal. Also called pegged exchange rate. Fixed-date forward: Forward contract where delivery must occur on a single day as opposed to delivery within an option period. Floating exchange rate: When exchange rate is not fixed by the government but fluctuates depending on the demand and supply of the currencies in the market. Floating rate loan: Loans on which the interest rates are periodically reset. In the international financial markets, the LIBOR related loans are the most common of the floating rate loans. Floor: An option agreement that puts a lower limit on the interest rate .It provides lenders/investors with interest rate risk protection in case the rate goes below the floor rate. The lender/investor is compensated for any fall in rate below the floor rate. Foreign currency reserves (Forex reserves): The official foreign currency reserves maintained by the central bank of a country. The reserves are used to meet current and other liabilities of a country. The central bank could use these reserves for intervention purposes also. FOREX: Commonly used term for foreign exchange. Forward contract: An agreement between two parties to exchange a specific amount of a currency at a specific date/period in the future. The rate at which the exchange is to be made, the delivery date/period and the amounts involved are fixed at the time of the agreement. Forward rate: The rate quoted today for delivery of a specified amount of currency on a specific date/period in the future. Fundamental Analysis: A branch of analysing future price trends based on the study of economic factors affecting demand and supply of the underlying. Also see technical analysis. Futures: Any contract to buy or sell a standard financial instrument, currency or index, at a predetermined future date and at a price agreed through a transaction on an exchange. H Hedge fund: The collective investment fund that takes large and often leveraged risk, with the aim of earning high return. Hedge ratio: The percentage/portion of cover taken, in relation to the total exposure. Hedge: The generic term describing the risk management concept of taking suitable action to either reduce or eliminate risk using various instruments such as forward contracts, futures, options or swaps etc. Hedger: A person who uses hedging instruments to protect his exposures is called a hedger. Historic volatility: The volatility for a particular time period measured from past behaviour. This is done by means of standard deviation of a sample of daily movements. Historical volatility may not be a true indicator of the future behaviour of price. I Implied volatility: The volatility derived from actual price quoted in the market. Given the quoted price, the volatility is obtained by working the model backward. Inflation: Reduction in the purchasing power of a currency. Initial margin: The amount of cash or security that has to be kept by a party in a clearinghouse before entering into an options or futures contract. It is an estimated amount that would help the clearing member to meet its obligations in the event of default by the party in question. Interest rate parity theorem: The theorem holds that under normal conditions, the difference between the forward exchange rate and spot rate of a currency pair depends on the difference between the interest rates of the currencies. For e.g. If the 6 month interest rate in the US is 6.5% and that for Swiss Franc is 3.5%, the US Dollar six month forward rate against the Swiss franc will be at a discount of 3% (6.5 - 3.5) on the spot $/CHF rate. In-the-money option: An option whose strike price is favorable in comparison to the current price. Eg: A Yen call option at 110 strike when the current price is 108.00 or a Euro call option at 0.8200 strike when the current price is .8500 Intrinsic value: The positive difference between the strike price and the current market price of an option is the intrinsic value of the option. It is measured by the present value of the amount by which it is in the money. Investor: Investors are those who purchase financial instruments with a long-term objective of earning a profit. An investor is different from a speculator who enters the market with the sole objective of making quick, short-term profits. K Kiwi: A commonly used market term for the New Zealand Dollar. Knock out options: An option that expires when the underlying reaches a predetermined level. Knock-in-options: An option that comes to life only after the underlying reaches a predetermined level. L LIBID: London Interbank bid rate. It is the rate at which prime banks bid for funds. It can also be described as the rate at which prime banks can place money. LIBOR: London Interbank offered rate. It is the rate at which the prime banks are willing to offer money. It can also be described as the rate at which prime banks can borrow from each other. LIMEAN: The mean of the LIBOR and LIBID of a currency for a particular period. Loonie: A commonly used market term for the Canadian Dollar. M Market lot: The standard amount for which prices are quoted in the inter-bank market. Market maker: An entity who makes the two-way quotes providing both a bid and an offer in the market. Mark-to-market: The valuation of the portfolio with reference to the current market prices. Maturity: The date on which a contract is due to be settled. Money market: Money market is the market for dealing in monetary assets of short term nature., short-term being referred to tenor of remaining maturity of less than one year. Money market instruments include call money, term money, certificates of deposit, commercial paper and money market mutual funds. N NEER (Nominal effective exchange rate): NEER is the weighted average of bilateral nominal exchange rates. It measures the appreciation/depreciation of a currency against the weighted basket of currencies whose countries are the main trading partners or competitors of the country of the currency under study. Nominal exchange rate is the actual exchange rate quote in the market at a given time. Netting: Calculating the net exposure of a party, by offsetting the receivables in a currency with the payables in the same currency, for the same dates. Nostro account: A bank’s account with his correspondent banker abroad, ordinarily in the home currency of that country. E.g. An Indian bank having a Swiss franc account with a bank in Switzerland or in any other international financial centre. O Odd date forward: When the forward contract is for a non-standard date. Typical standard dates are 1, 2, 3, 6 and twelve months from the spot date. Offer rate: The price/rate at which the market maker is ready to sell the currency or lend money. Offset: Liquidation of a long or short position by an opposite transaction. A sale transaction offsets a long position and a purchase transaction offsets a short position. Open position: The net amount of foreign currency payable or receivable is an open position. In case of a net payable, it is a short position, a net receivable is a long position. Out- of-the-money: An option whose strike price is unfavorable in comparison to the current price. E.g. a Yen put option at 110 strike when the current price is 108.00 or a Euro put option at 0.8200 strike when the current price is 0.8500 P Pegged Exchange rate: See Fixed Exchange rate Physical settlement: In a futures contract, the actual receipt or delivery of the underlying. Pip: The most junior digit in a currency quotation. In most currencies, it denotes the fifth decimal place. Plain vanilla: A simple derivative with standard features is termed as a plain vanilla. Price risk: The risk of adverse movements in prices. Prime rate: The interest rate charged by major banks to their most creditworthy customers. Put option: An option which gives the holder the right, but not the obligation, to sell a specific amount of foreign currency at a specific price on or before a specific maturity date. R Rating: A grading of a security’s investment quality. REER (Real effective exchange rate): REER is the nominal effective exchange rate(NEER) adjusted for inflation. In other words, the REER is calculated by dividing the home country’s nominal effective exchange rate by an index of the ratio of average foreign prices to home prices. REER may change even without any change in the exchange rate. Recession: A period of decline in the overall economic activity of a country. It is measured by the decline in real GDP for two consecutive quarters. Repo: A simultaneous sale and repurchase of a security. It is a structure devised to borrow money at fine rates on a secured basis. The institution borrows money by selling a security for one delivery date with a simultaneous repurchase of the same security for a different delivery date. Commonly, this type of transaction is used to fund bond trading activities. It is a financial tool often used by Central banks in their open market operations to drain liquidity from the System. Reverse repo: The transaction undertaken by the counterparty to a repo. It involves the purchase of security for a particular delivery date with a simultaneous sale of the same security for a different delivery date. Central banks use this to pump liquidity into the System. S Speculator: A person who buys and sells in a market with the sole aim of profiting from the subsequent price movements. Sterilization: The process followed by a central bank to increase or decrease the money supply in order to offset a money-supply change caused by intervention in the foreign exchange market. T T-bill (Treasury bill): Short-term government debt instrument normally issued at a discount. Technical analysis: A branch of market analysis that studies the historical price movements and forecasts the future movements based on past behaviour. Trend: When the market is heading in a particular direction- up or down. V Value date: The date of actual exchange of currency. It is the date on which the contract is affected. For a spot contract, the value date is the second working day from the date of the transaction. VaR : Probable worst case scenario for a position calculated using a statistical model, to a given confidence level , typically 95% over a specified holding period. Value at risk (VaR) is a single, summary, statistical measure that provides a reading of the worst possible scenario for a particular exposure, or set of exposures. VaR is calculated by using the distribution of returns from a particular asset, finding its standard deviation (volatility), and taking certain number of standard deviations to give the 95% confidence level. Vostro account: The local currency account of a foreign bank/branch. E.g. Indian rupee account maintained by a bank in London with a bank in India. . W Writer: A seller of an option. Y Yield curve : The diagrammatic representation of the yield on money market instruments and their respective maturity. |
