1.
Security (finance)
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A security is a tradable financial asset. The term commonly refers to any form of instrument. In some jurisdictions the term specifically excludes financial instruments other than equities, in some jurisdictions it includes some instruments that are close to equities and fixed income, e. g. equity warrants. In the United States, a security is a financial asset of any kind. Securities are broadly categorized into, debt securities equity securities derivatives, the company or other entity issuing the security is called the issuer. A countrys regulatory structure determines what qualifies as a security, for example, private investment pools may have some features of securities, but they may not be registered or regulated as such if they meet various restrictions. Securities may be represented by a certificate or, more typically, non-certificated, region or country Market capitalization State Securities are the traditional way that commercial enterprises raise new capital. These may be an alternative to bank loans depending on their pricing. Another disadvantage of bank loans as a source of financing is that the bank may seek a measure of protection against default by the borrower via extensive financial covenants, through securities, capital is provided by investors who purchase the securities upon their initial issuance. In a similar way, a government may issue securities too when it needs to increase government debt, investors in securities may be retail, i. e. members of the public investing other than by way of business. The greatest part of investment, in terms of volume, is wholesale, i. e. by financial institutions acting on their own account, important institutional investors include investment banks, insurance companies, pension funds and other managed funds. The traditional economic function of the purchase of securities is investment, debt securities generally offer a higher rate of interest than bank deposits, and equities may offer the prospect of capital growth. Equity investment may also control of the business of the issuer. Debt holdings may also offer some measure of control to the if the company is a fledgling start-up or an old giant undergoing restructuring. In these cases, if interest payments are missed, the creditors may take control of the company, the last decade has seen an enormous growth in the use of securities as collateral. Purchasing securities with borrowed money secured by other securities or cash itself is called buying on margin, where A is owed a debt or other obligation by B, A may require B to deliver property rights in securities to A, either at inception or only in default. Collateral arrangements are divided into two categories, namely security interests and outright collateral transfers. Commonly, commercial banks, investment banks, government agencies and other investors such as mutual funds are significant collateral takers as well as providers
2.
Banknote
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A banknote is a type of negotiable instrument known as a promissory note, made by a bank, payable to the bearer on demand. Banknotes were originally issued by banks, who were legally required to redeem the notes for legal tender when presented to the chief cashier of the originating bank. These commercial banknotes only traded at face value in the served by the issuing bank. Commercial banknotes have primarily been replaced by national banknotes issued by central banks, national banknotes are generally legal tender, meaning that medium of payment is allowed by law or recognized by a legal system to be valid for meeting a financial obligation. Historically, banks sought to ensure that they could always pay customers in coins when they presented banknotes for payment and this practice of backing notes with something of substance is the basis for the history of central banks backing their currencies in gold or silver. Today, most national currencies have no backing in precious metals or commodities and have value only by fiat, with the exception of non-circulating high-value or precious metal issues, coins are used for lower valued monetary units, while banknotes are used for higher values. The idea of using a durable light-weight substance as evidence of a promise to pay a bearer on demand originated in China during the Han Dynasty in 118 BC, the first known banknote was first developed in China during the Tang and Song dynasties, starting in the 7th century. Its roots were in merchant receipts of deposit during the Tang Dynasty, as merchants, during the Yuan Dynasty, banknotes were adopted by the Mongol Empire. In Europe, the concept of banknotes was first introduced during the 13th century by such as Marco Polo. Counterfeiting, the forgery of banknotes, is an inherent challenge in issuing currency and it is countered by anticounterfeiting measures in the printing of banknotes. Fighting the counterfeiting of banknotes and cheques has been a driver of security printing methods development in recent centuries. Paper currency first developed in the Tang Dynasty China during the 7th century, although true paper money did not appear until the 11th century, the usage of paper currency later spread throughout the Mongol Empire. European explorers like Marco Polo introduced the concept in Europe during the 13th century, napoleon issued paper banknotes in the early 1800s. Paper money originated in two forms, drafts, which are receipts for value held on account, and bills, the perception of banknotes as money has evolved over time. Originally, money was based on precious metals, Banknotes were seen as essentially an I. O. U. or promissory note, a promise to pay someone in precious metal on presentation. With the gradual removal of precious metals from the system, banknotes evolved to represent credit money. Notes or bills were referred to in 18th century novels and were often a key part of the plot such as a note drawn by Lord X for £100 which becomes due in 3 months time. Its roots were in merchant receipts of deposit during the Tang Dynasty, as merchants, before the use of paper, the Chinese used coins that were circular, with a rectangular hole in the middle
3.
Debenture
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In corporate finance, a debenture is a medium to long-term debt instrument used by large companies to borrow money, at a fixed rate of interest. The legal term debenture originally referred to a document that creates a debt or acknowledges it. Senior debentures get paid before subordinate debentures, and there are varying rates of risk, debentures are generally freely transferable by the debenture holder. Debenture holders have no rights to vote in the general meetings of shareholders. The interest paid to them is a charge against profit in the financial statements. There are also features that minimize risk, such as a sinking fund. This decreases risk for the creditors, as a hedge against inflation, bankruptcy, a sinking fund makes the bond less risky, and therefore gives it a smaller coupon. There are also options for convertibility, which means a creditor may turn their bonds into equity in the if it does well. Companies also reserve the right to call their bonds, which mean they can call it sooner than the maturity date. Often there is a clause in the contract that allows this, for example, if a bond issuer wishes to rebuy a 30-year bond at the 25th year, if a bond is called, it means that less interest is paid out. Failure to pay a bond effectively means bankruptcy, bondholders who have not received their interest can throw an offending company into bankruptcy, or seize its assets if that is stipulated in the contract. Where security is provided for loan stocks or bonds in the US, however, in the United Kingdom a debenture is usually secured. In Canada, a debenture refers to a secured loan instrument where security is generally over the debtors credit, but security is not pledged to specific assets. There are two types of debentures, Convertible debentures, which are convertible bonds or bonds that can be converted into equity shares of the company after a predetermined period of time. Convertibility is a feature that corporations may add to the bonds they issue to them more attractive to buyers. In other words, it is a feature that a corporate bond may carry. As a result of the advantage a buyer gets from the ability to convert, non-convertible debentures, which are simply regular debentures, cannot be converted into equity shares of the liable company. They are debentures without the convertibility feature attached to them, as a result, they usually carry higher interest rates than their convertible counterparts
4.
Derivative (finance)
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In finance, a derivative is a contract that derives its value from the performance of an underlying entity. This underlying entity can be an asset, index, or interest rate, some of the more common derivatives include forwards, futures, options, swaps, and variations of these such as synthetic collateralized debt obligations and credit default swaps. Most derivatives are traded over-the-counter or on a such as the Bombay Stock Exchange. Derivatives are one of the three categories of financial instruments, the other two being stocks and debt. More recent historical origin is Bucket shop that were outlawed a century ago, Derivatives are contracts between two parties that specify conditions under which payments are to be made between the parties. The assets include commodities, stocks, bonds, interest rates and currencies, but they can also be other derivatives, from the economic point of view, financial derivatives are cash flows, that are conditioned stochastically and discounted to present value. The market risk inherent in the asset is attached to the financial derivative through contractual agreements. The underlying asset does not have to be acquired, Derivatives therefore allow the breakup of ownership and participation in the market value of an asset. This also provides an amount of freedom regarding the contract design. That contractual freedom allows to modify the participation in the performance of the underlying asset almost arbitrarily, thus, the participation in the market value of the underlying can be effectively weaker, stronger, or implemented as inverse. Hence, specifically the price risk of the underlying asset can be controlled in almost every situation. Derivatives are more common in the era, but their origins trace back several centuries. One of the oldest derivatives is rice futures, which have traded on the Dojima Rice Exchange since the eighteenth century. Derivatives are broadly categorized by the relationship between the asset and the derivative, the type of underlying asset, the market in which they trade. Derivatives may broadly be categorized as lock or option products, lock products obligate the contractual parties to the terms over the life of the contract. Option products provide the buyer the right, but not the obligation to enter the contract under the terms specified, Derivatives can be used either for risk management or for speculation. Along with many financial products and services, derivatives reform is an element of the Dodd–Frank Wall Street Reform. The Act delegated many rule-making details of regulatory oversight to the Commodity Futures Trading Commission, however, these are notional values, and some economists say that this value greatly exaggerates the market value and the true credit risk faced by the parties involved
5.
Stock
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The stock of a corporation is constituted of the equity stock of its owners. A single share of the stock represents fractional ownership of the corporation in proportion to the number of shares. In liquidation, the stock represents the residual assets of the company that would be due to stockholders after discharge of all senior claims such as secured and unsecured debt. Stockholders equity cannot be withdrawn from the company in a way that is intended to be detrimental to the companys creditors, the stock of a corporation is partitioned into shares, the total of which are stated at the time of business formation. Additional shares may subsequently be authorized by the shareholders and issued by the company. In some jurisdictions, each share of stock has a certain declared par value, in other jurisdictions, however, shares of stock may be issued without associated par value. Shares represent a fraction of ownership in a business, a business may declare different types of shares, each having distinctive ownership rules, privileges, or share values. Ownership of shares may be documented by issuance of a stock certificate. A stock certificate is a document that specifies the amount of shares owned by the shareholder. Stock typically takes the form of shares of common stock or preferred stock. As a unit of ownership, common stock typically carries voting rights that can be exercised in corporate decisions, shares of such stock are called convertible preferred shares. New equity issue may have specific legal clauses attached that differentiate them from previous issues of the issuer. Some shares of stock may be issued without the typical voting rights, for instance, or some shares may have special rights unique to them. Often, new issues that have not been registered with a governing body may be restricted from resale for certain periods of time. Preferred stock may be hybrid by having the qualities of bonds of fixed returns and they also have preference in the payment of dividends over common stock and also have been given preference at the time of liquidation over common stock. They have other features of accumulation in dividend, Rule 144 Stock is an American term given to shares of stock subject to SEC Rule 144, Selling Restricted and Control Securities. Under Rule 144, restricted and controlled securities are acquired in unregistered form, investors either purchase or take ownership of these securities through private sales from the issuing company or from an affiliate of the issuer. Investors wishing to sell these securities are subject to different rules than those selling traditional common or preferred stock and these individuals will only be allowed to liquidate their securities after meeting the specific conditions set forth by SEC Rule 144
6.
Financial market
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A financial market is a market in which people trade financial securities, commodities, and other fungible items of value at low transaction costs and at prices that reflect supply and demand. Securities include stocks and bonds, and commodities include precious metals or agricultural products, in economics, typically, the term market means the aggregate of possible buyers and sellers of a certain good or service and the transactions between them. The term market is used for what are more strictly exchanges, organizations that facilitate the trade in financial securities. This may be a location or an electronic system. Another common use of the term is as a catchall for all the markets in the financial sector, capital markets which to consist of, Stock markets, which provide financing through the issuance of shares or common stock, and enable the subsequent trading thereof. Bond markets, which provide financing through the issuance of bonds, commodity markets, which facilitate the trading of commodities. Money markets, which provide short term debt financing and investment, derivatives markets, which provide instruments for the management of financial risk. Futures markets, which provide standardized forward contracts for trading products at some future date, Foreign exchange markets, which facilitate the trading of foreign exchange. Spot market Interbanks market The capital markets may also be divided into primary markets, newly formed securities are bought or sold in primary markets, such as during initial public offerings. Secondary markets allow investors to buy and sell existing securities, the transactions in primary markets exist between issuers and investors, while secondary market transactions exist among investors. Liquidity is an aspect of securities that are traded in secondary markets. Liquidity refers to the ease with which a security can be sold without a loss of value, securities with an active secondary market mean that there are many buyers and sellers at a given point in time. Investors benefit from liquid securities because they can sell their assets whenever they want, Financial markets attract funds from investors and channel them to corporations—they thus allow corporations to finance their operations and achieve growth. Money markets allow firms to borrow funds on a term basis. Without financial markets, borrowers would have difficulty finding lenders themselves, intermediaries such as banks, Investment Banks, and Boutique Investment Banks can help in this process. Banks take deposits from those who have money to save and they can then lend money from this pool of deposited money to those who seek to borrow. Banks popularly lend money in the form of loans and mortgages, a good example of a financial market is a stock exchange. A company can raise money by selling shares to investors and its shares can be bought or sold
7.
Stock market
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Examples of the latter include shares of private companies which are sold to investors through equity crowdfunding platforms. Stock exchanges list shares of equity as well as other security types, e. g. corporate bonds. Stocks can be categorised in various way, one way is by the country where the company is domiciled. S. At the close of 2012, the size of the stock market was about US$55 trillion. By country, the largest market was the United States, followed by Japan, as of 2015, there are a total of 60 stock exchanges in the world with a total market capitalization of $69 trillion. Of these, there are 16 exchanges with a capitalization of $1 trillion or more. Apart from the Australian Securities Exchange, these 16 exchanges are based in one of three continents, North America, Europe and Asia, a stock exchange is a place where, or an organization through which, individuals and organisations can trade stocks. Many large companies have their stock listed on a stock exchange and this makes the stock more liquid and thus more attractive to many investors. It may also act as a guarantor of settlement, other stocks may be traded over the counter, that is, through a dealer. Some large companies will have their stock listed on more than one exchange in different countries, Stock exchanges may also cover other types of securities, such as fixed interest securities or derivatives, which are more likely to be traded OTC. Trade in stock markets means the transfer for money of a stock or security from a seller to a buyer and this requires these two parties to agree on a price. Equities confer an ownership interest in a particular company and their buy or sell orders may be executed on their behalf by a stock exchange trader. Some exchanges are physical locations where transactions are carried out on a trading floor and this method is used in some stock exchanges and commodity exchanges, and involves traders shouting bid and offer prices. The other type of exchange has a network of computers where trades are made electronically. An example of such an exchange is the NASDAQ, a potential buyer bids a specific price for a stock, and a potential seller asks a specific price for the same stock. Buying or selling at the means you will accept any ask price or bid price for the stock. When the bid and ask prices match, a sale takes place, on a first-come, the purpose of a stock exchange is to facilitate the exchange of securities between buyers and sellers, thus providing a marketplace. The exchanges provide real-time trading information on the securities, facilitating price discovery
8.
Commodity market
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A commodity market is a market that trades in primary economic sector rather than manufactured products. Soft commodities are products such as wheat, coffee, cocoa. Hard commodities are mined, such as gold and oil, Investors access about 50 major commodity markets worldwide with purely financial transactions increasingly outnumbering physical trades in which goods are delivered. Futures contracts are the oldest way of investing in commodities, Futures are secured by physical assets. Commodity markets can include physical trading and derivatives trading using spot prices, forwards, futures, farmers have used a simple form of derivative trading in the commodity market for centuries for price risk management. A financial derivative is an instrument whose value is derived from a commodity termed an underlier. Derivatives are either exchange-traded or over-the-counter, derivatives such as futures contracts, Swaps, Exchange-traded Commodities, forward contracts have become the primary trading instruments in commodity markets. Futures are traded on regulated commodities exchanges, Over-the-counter contracts are privately negotiated bilateral contracts entered into between the contracting parties directly. Exchange-traded funds began to feature commodities in 2003, Gold ETFs are based on electronic gold that does not entail the ownership of physical bullion, with its added costs of insurance and storage in repositories such as the London bullion market. According to the World Gold Council, ETFs allow investors to be exposed to the market without the risk of price volatility associated with gold as a physical commodity. Commodity-based money and commodity markets in an early form are believed to have originated in Sumer between 4500 BC and 4000 BC. Sumerians first used clay tokens sealed in a vessel, then clay writing tablets to represent the amount—for example. These promises of time and date of delivery resemble futures contract, early civilizations variously used pigs, rare seashells, or other items as commodity money. Since that time traders have sought ways to simplify and standardize trade contracts, Gold and silver markets evolved in classical civilizations. At first the precious metals were valued for their beauty and intrinsic worth and were associated with royalty, in time, they were used for trading and were exchanged for other goods and commodities, or for payments of labor. Gold, measured out, then became money, golds scarcity, unique density and the way it could be easily melted, shaped, and measured made it a natural trading asset. Beginning in the late 10th century, commodity markets grew as a mechanism for allocating goods, labor, land, indeed, the Amsterdam Stock Exchange, often cited as the first stock exchange, originated as a market for the exchange of commodities. Early trading on the Amsterdam Stock Exchange often involved the use of sophisticated contracts, including short sales, forward contracts
9.
Foreign exchange market
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The foreign exchange market is a global decentralized market for the trading of currencies. This includes all aspects of buying, selling and exchanging currencies at current or determined prices, in terms of trading volume, it is by far the largest market in the world, followed by the Credit market. The main participants in this market are the international banks. Financial centers around the function as anchors of trading between a wide range of multiple types of buyers and sellers around the clock, with the exception of weekends. The foreign exchange market does not determine the values of different currencies. The foreign exchange market works through financial institutions, and operates on several levels, behind the scenes, banks turn to a smaller number of financial firms known as dealers, who are actively involved in large quantities of foreign exchange trading. Most foreign exchange dealers are banks, so this behind-the-scenes market is called the interbank market. Trades between foreign exchange dealers can be large, involving hundreds of millions of dollars. Because of the sovereignty issue when involving two currencies, Forex has little supervisory entity regulating its actions, the foreign exchange market assists international trade and investments by enabling currency conversion. It also supports direct speculation and evaluation relative to the value of currencies, in a typical foreign exchange transaction, a party purchases some quantity of one currency by paying with some quantity of another currency. The modern foreign exchange market began forming during the 1970s. e, as such, it has been referred to as the market closest to the ideal of perfect competition, notwithstanding currency intervention by central banks.1 trillion per day in April 2016. This is down from $5.4 trillion in April 2013, Foreign exchange swaps were the most actively traded instruments in April 2016, at $2.4 trillion per day, followed by spot trading at $1.7 trillion. According to the Bank for International Settlements, as of April 2016 and this marks a decline of approximately 5% from the $5.355 trillion daily volume as of April 2013. Some firms specializing in the exchange market had put the average daily turnover in excess of US$4 trillion. Money-changers were living in the Holy Land in the times of the Talmudic writings and these people used city stalls, and at feast times the Temples Court of the Gentiles instead. Money-changers were also the silversmiths and/or goldsmiths of more recent ancient times, during the 4th century AD, the Byzantine government kept a monopoly on the exchange of currency. Papyri PCZ I59021, shows the occurrences of exchange of coinage in Ancient Egypt, Currency and exchange were important elements of trade in the ancient world, enabling people to buy and sell items like food, pottery and raw materials. If a Greek coin held more gold than an Egyptian coin due to its size or content, then a merchant could barter fewer Greek gold coins for more Egyptian ones, or for more material goods
10.
Futures exchange
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These types of contracts fall into the category of derivatives. The opposite of the market is the spots market, where trades will occur immediately after a transaction agreement has been made. Futures instruments are priced according to the movement of the underlying asset, the aforementioned category is named derivatives because the value of these instruments are derived from another asset class. Speculators absorb some of the risk but hedging appears to drive most commodity markets, the equilibrium futures price can be either below or above the expected future price. Rollover hedges can extend insurance from short-horizon contracts over longer periods. In Ancient Mesopotamia, around 1750 BC, the sixth Babylonian king, Hammurabi, created one of the first legal codes, the Code of Hammurabi. Hammurabi’s Code allowed sales of goods and assets to be delivered for a price, at a future date, required contracts to be in writing and witnessed. The code facilitated the first derivatives, in the form of forward, an active derivatives market existed, with trading carried out at temples. One of the earliest written records of futures trading is in Aristotles Politics and he tells the story of Thales, a poor philosopher from Miletus who developed a financial device, which involves a principle of universal application. Thales used his skill in forecasting and predicted that the olive harvest would be exceptionally good the next autumn. Confident in his prediction, he made agreements with local olive-press owners to deposit his money with them to guarantee him exclusive use of their olive presses when the harvest was ready, the first modern organized futures exchange began in 1710 at the Dojima Rice Exchange in Osaka, Japan. The London Metal Market and Exchange Company was founded in 1877, but the market traces its origins back to 1571, before the exchange was created, business was conducted by traders in London coffee houses using a makeshift ring drawn in chalk on the floor. At first only copper was traded, lead and zinc were soon added but only gained official trading status in 1920. The exchange was closed during World War II and did not re-open until 1952, the range of metals traded was extended to include aluminium, nickel, tin, aluminium alloy, steel, and minor metals cobalt and molybdenum. The exchange ceased trading plastics in 2011, the total value of the trade is around $US11.6 trillion annually. The United States followed in the early 19th century, Chicago has the largest future exchange in the world, the Chicago Mercantile Exchange. In March 2008 the Chicago Mercantile Exchange announced its acquisition of NYMEX Holdings, Inc. the parent company of the New York Mercantile Exchange, cMEs acquisition of NYMEX was completed in August 2008. For most exchanges, forward contracts were standard at the time, however, most forward contracts were not honored by both the buyer and the seller. In 1848 the Chicago Board of Trade was formed, Trading was originally in forward contracts, the first contract was written on March 13,1851
11.
Over-the-counter (finance)
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Over-the-counter or off-exchange trading is done directly between two parties, without the supervision of an exchange. It is contrasted with exchange trading, which occurs via exchanges, in an OTC trade, the price is not necessarily published for the public. OTC trading, as well as trading, occurs with commodities, financial instruments. Products traded on the exchange must be well standardized and this means that exchanged deliverables match a narrow range of quantity, quality, and identity which is defined by the exchange and identical to all transactions of that product. This is necessary for there to be transparency in trading, the OTC market does not have this limitation. They may agree on a quantity, for example. In OTC market contracts are bilateral, each party could have credit risk concerns with respect to the other party, OTC derivative market is significant in some asset classes, interest rate, foreign exchange, stocks, and commodities. In 2008 approximately 16 percent of all U. S. stock trades were off-exchange trading, by April 2014 that number increased to about forty percent. Although the notional amount outstanding of OTC derivatives in late 2012 had declined 3. 3% over the previous year, the Bank for International Settlements statistics on OTC derivatives markets showed that notional amounts outstanding totalled $693 trillion at the end of June 2013. In the United States, over-the-counter trading in stock is carried out by market makers using inter-dealer quotation services such as OTC Link, the OTCBB licenses the services of OTC Link for their OTCBB securities. Although exchange-listed stocks can be traded OTC on the third market, usually OTC stocks are not listed nor traded on exchanges, and vice versa. Stocks quoted on the OTCBB must comply with certain limited U. S. Securities, the SEC imposes more stringent financial and reporting requirements on other OTC stocks, specifically the OTCQX stocks. Other OTC stocks have no reporting requirements, for example Pink Sheets securities, some companies, with Wal-Mart as one of the largest, began trading as OTC stocks and eventually upgraded to a listing on fully regulated market. By 1969 Wal-Mart Stores Inc. was incorporated, in 1972, with stores in five states, including Arkansas, Kansas, Louisiana, Oklahoma and Missouri, Wal-Mart began trading as over-the-counter stocks. By 1972 Walmart had earned over US$1 billion in sales — the fastest company to accomplish this. In 1972 Wal-Mart was listed on the New York Stock Exchange under the ticker symbol WMT, an over-the-counter is a bilateral contract in which two parties agree on how a particular trade or agreement is to be settled in the future. It is usually from an investment bank to its clients directly, forwards and swaps are prime examples of such contracts. It is mostly done online or by telephone, for derivatives, these agreements are usually governed by an International Swaps and Derivatives Association agreement
12.
Spot market
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The spot market or cash market is a public financial market in which financial instruments or commodities are traded for immediate delivery. It contrasts with a market, in which delivery is due at a later date. In a spot market, settlement normally happens in t+2 working days, i. e. delivery of cash, a spot market can be through an exchange or over-the-counter. Spot markets can operate wherever the infrastructure exists to conduct the transaction, securities and commodities are traded on an exchange using, making, and possibly changing the current market price. In the over the market, trades are based on contracts made directly between two parties, and not subject to the rules of an exchange. The contract terms are agreed between the parties and may be non-standard, the price will probably not be published. The spot foreign exchange market imposes a two-day delivery period, originally due to the time it would take to move cash from one bank to another, most speculative retail forex trading is done as spot transactions on an online trading platform. Spot markets can be privately operated or controlled by industry organizations or government agencies. They frequently attract speculators, since spot market prices are known to the public almost as soon as deals are transacted, examples of energy spot markets for natural gas in Europe are the Title Transfer Facility in the Netherlands and the National Balancing Point in the United Kingdom
13.
Floating rate note
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Floating rate notes are bonds that have a variable coupon, equal to a money market reference rate, like LIBOR or federal funds rate, plus a quoted spread. The spread is a rate that remains constant, almost all FRNs have quarterly coupons, i. e. they pay out interest every three months. At the beginning of each period, the coupon is calculated by taking the fixing of the reference rate for that day. A typical coupon would look like 3 months USD LIBOR +0. 20%, in Europe, the main issuers are banks. Some FRNs have special features such as maximum or minimum coupons, called capped FRNs and those with both minimum and maximum coupons are called collared FRNs. Perpetual FRNs are another form of FRNs that are also called irredeemable or unrated FRNs and are akin to a form of capital, FRNs can also be obtained synthetically by the combination of a fixed rate bond and an interest rate swap. This combination is known as an asset swap, deleveraged FRN = long pure FRN + short x swap A leveraged or super floater gives the investor increased exposure to an underlying index, the leverage factor is always greater than one. Leveraged floaters also require a floor, since the rate can never be negative. Leveraged FRN = long pure FRN + long x swap + long x floor FRNs carry little interest rate risk, an FRN has a duration close to zero, and its price shows very low sensitivity to changes in market rates. When market rates rise, the coupons of the FRN increase in line with the increase in forward rates. Thus, FRNs differ from fixed rate bonds, whose prices decline when market rates rise, as FRNs are almost immune to interest rate risk, they are considered conservative investments for investors who believe market rates will increase. The risk that remains is credit risk, securities dealers make markets in FRNs. They are traded over-the-counter, instead of on a stock exchange, in Europe, most FRNs are liquid, as the biggest investors are banks. In the U. S. FRNs are mostly held to maturity, in the wholesale markets, FRNs are typically quoted as a spread over the reference rate. Suppose a new 5 year FRN pays a coupon of 3 months LIBOR +0. 20%, if the perception of the credit-worthiness of the issuer goes down, investors will demand a higher interest rate, say LIBOR +0. 25%. If a trade is agreed, the price is calculated, in this example, LIBOR +0. 25% would be roughly equivalent to a price of 99.75. This can be calculated as par, minus the difference between the coupon and the price that was agreed, multiplied by the maturity, the simple margin is a measure of the effective spread of a FRN that is not traded at par. If the FRN trades at par, the simple margin will equal the quoted spread, second, adjust the above for the fact that the FRN is bought at a discount or premium to the nominal value,100 Clean price ×
14.
Inflation-indexed bond
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They are thus designed to hedge the inflation risk of a bond. The first known inflation-indexed bond was issued by the Massachusetts Bay Company in 1780, the market has grown dramatically since the British government began issuing inflation-linked Gilts in 1981. As of 2008, government-issued inflation-linked bonds comprise over $1.5 trillion of the debt market. The inflation-linked market primarily consists of sovereign bonds, with privately issued inflation-linked bonds constituting a small portion of the market, daily inflation-indexed bonds pay a periodic coupon that is equal to the product of the daily inflation index and the nominal coupon rate. The relationship between coupon payments, breakeven daily inflation and real interest rates is given by the Fisher equation, a rise in coupon payments is a result of an increase in inflation expectations, real rates, or both. For some bonds, such as the Series I Savings Bonds, for other bonds, such as in the case of TIPS, the underlying principal of the bond changes, which results in a higher interest payment when multiplied by the same rate. For example, if the coupon of the bond were 5% and the underlying principal of the bond were 100 units. If the inflation index increased by 10%, the principal of the bond would increase to 110 units, the coupon rate would remain at 5%, resulting in an interest payment of 110 x 5% =5.5 units. The real yield of any bond is the growth rate. The most liquid instruments are Treasury Inflation-Protected Securities, a type of US Treasury security, the other important inflation-linked markets are the UK Index-linked Gilts with over $300 billion outstanding and the French OATi/OAT€i market with about $200 billion outstanding. Germany, Canada, Greece, Australia, Italy, Japan, Sweden and Iceland also issue inflation-indexed bonds, as well as a number of Emerging Markets, Fisher equation Constant Item Purchasing Power Accounting TIPS U. S. Series I Savings Bonds Inflation-linked Gilts Deacon, Mark, Andrew Derry, and Dariush Mirfendereski, Inflation-Indexed Securities, Bonds, Swaps, benaben, Brice, and Sebastien Goldenberg, Inflation Risks and Products Riskbooks. Canty, Paul and Markus Heider, Inflation Markets, A Comprehensive and Cohesive Guide Risk Books
15.
Zero-coupon bond
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A zero-coupon bond is a bond bought at a price lower than its face value, with the face value repaid at the time of maturity. Note that this assumes a positive time value of money. It does not make periodic interest payments, or have so-called coupons, when the bond reaches maturity, its investor receives its par value. Examples of zero-coupon bonds include U. S. Treasury bills, U. S. savings bonds, long-term zero-coupon bonds, in contrast, an investor who has a regular bond receives income from coupon payments, which are made semi-annually or annually. The investor also receives the principal or face value of the investment when the bond matures, zero coupon bonds may be long or short term investments. Long-term zero coupon maturity dates typically start at ten to fifteen years, the bonds can be held until maturity or sold on secondary bond markets. Short-term zero coupon bonds generally have maturities of less than one year and are called bills, the U. S. Treasury bill market is the most active and liquid debt market in the world. Zero coupon bonds have an equal to the bonds time to maturity. This creates a supply of new zero coupon bonds, the coupons and residue are sold separately to investors. Each of these investments then pays a lump sum. This method of creating zero coupon bonds is known as stripping, STRIPS stands for Separate Trading of Registered Interest and Principal Securities. Dealers normally purchase a block of high-quality and non-callable bonds—often government issues—to create strip bonds, a strip bond has no reinvestment risk because the payment to the investor occurs only at maturity. The impact of interest rate fluctuations on strip bonds, known as the duration, is higher than for a coupon bond. A zero coupon bond always has an equal to its maturity. Strip bonds are available from investment dealers maturing at terms up to 30 years. For some Canadian bonds the maturity may be over 90 years, in Canada, investors may purchase packages of strip bonds, so that the cash flows are tailored to meet their needs in a single security. These packages may consist of a combination of interest and/or principal strips, in New Zealand, bonds are stripped first into two pieces—the coupons and the principal. The coupons may be traded as a unit or further subdivided into the payment dates
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Commercial paper
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Commercial paper, in the global financial market, is an unsecured promissory note with a fixed maturity of not more than 270 days. Since it is not backed by collateral, only firms with excellent credit ratings from a credit rating agency will be able to sell their commercial paper at a reasonable price. Commercial paper is sold at a discount from face value. Typically, the longer the maturity on a note, the higher the interest rate the issuing institution pays, interest rates fluctuate with market conditions, but are typically lower than banks rates. Commercial paper – though a short-term obligation – is issued as part of a rolling program. The use of paper has been adopted by every state in the United States except Louisiana. At the end of 2009, more than 1,700 companies in the United States issued commercial paper, outside of the United States the international Euro-Commercial Paper Market has over $500 billion in outstandings, made up of instruments denominated predominately in euros, dollars and sterling. Commercial credit, in the form of notes issued by corporations, has existed since at least the 19th century. For instance, Marcus Goldman, founder of Goldman Sachs got his start trading commercial paper in New York in 1869. Commercial paper – though a short-term obligation – is issued as part of a significantly longer rolling program. If the maturity is less than 270 days, the issuer does not have to file a statement with the SEC. There are two methods of issuing credit, the issuer can market the securities directly to a buy and hold investor such as most money market funds. Alternatively, it can sell the paper to a dealer, who sells the paper in the market. The dealer market for commercial paper involves large securities firms and subsidiaries of bank holding companies, most of these firms also are dealers in US Treasury securities. Direct issuers of commercial paper usually are financial companies that have frequent and sizable borrowing needs, in the United States, direct issuers save a dealer fee of approximately 5 basis points, or 0. 05% annualized, which translates to $50,000 on every $100 million outstanding. This saving compensates for the cost of maintaining a permanent sales staff to market the paper, dealer fees tend to be lower outside the United States. Commercial paper is a lower-cost alternative to a line of credit with a bank, once a business becomes established, and builds a high credit rating, it is often cheaper to draw on a commercial paper than on a bank line of credit. Nevertheless, many companies still maintain bank lines of credit as a backup, advantages of commercial paper, High credit ratings fetch a lower cost of capital
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Corporate bond
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A corporate bond is a bond issued by a corporation in order to raise financing for a variety of reasons such as to ongoing operations, M&A, or to expand business. The term is applied to longer-term debt instruments, with maturity of at least one year. Corporate debt instruments with maturity shorter than one year are referred to as commercial paper, the term corporate bond is not strictly defined. Sometimes, the term is used to include all bonds except those issued by governments in their own currencies, in this case governments issuing in other currencies will be included. The term sometimes also encompasses bonds issued by supranational organizations, strictly speaking, however, it only applies to those issued by corporations. The bonds of local authorities are not included, Corporate bonds trade in decentralized, dealer-based, over-the-counter markets. In over-the-counter trading dealers act as intermediaries between buyers and sellers, Corporate bonds are sometimes listed on exchanges and ECNs. However, vast majority of trading volume happens over-the-counter, by far the largest market for corporate bonds is in corporate bonds denominated in US Dollars. US Dollar corporate bond market is the oldest, largest, as the term corporate bond is not well defined, the size of the market varies according to who is doing the counting, but it is in the $5 to $6 trillion range. The second largest market is in Euro denominated corporate bonds, other markets tend to be small by comparison and are usually not well developed, with low trading volumes. Many corporations from other issue in either US Dollars or Euros. Foreign corporates issuing bonds in the US Dollar market are called Yankees, Corporate bonds are divided into two main categories High Grade and High Yield according to their credit rating. Bonds rated AAA, AA, A, and BBB are High Grade, while bonds rated BB and this is a significant distinction as High Grade and High Yield bonds are traded by different trading desks and held by different investors. For example, many pension funds and insurance companies are prohibited from holding more than an amount of High Yield bonds. The distinction between High Grade and High Yield is also common to most corporate bond markets, the coupon is usually taxable for the investor. It is tax deductible for the corporation paying it, for US Dollar corporates, the coupon is almost always semi annual, while Euro denominated corporates pay coupon quarterly. In this case the bond, a bond, is sold at a discount. The investor benefits by paying $80, but collecting $100 at maturity, the $20 gain is in lieu of the regular coupon
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Government bond
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A government bond is a bond issued by a national government, generally with a promise to pay periodic interest payments and to repay the face value on the maturity date. Government bonds are denominated in the countrys own currency. Government bonds are referred to as sovereign bonds. If a government or sovereign is close to default on its debt the media often refer to this as a debt crisis. The terms on which a government can sell bonds depend on how creditworthy the market considers it to be, international credit rating agencies will provide ratings for the bonds, but market participants will make up their own minds about this. The first general government bonds were issued in the Netherlands in 1517, because the Netherlands did not exist at that time, the bonds issued by the city of Amsterdam are considered their predecessor which later merged into Netherlands government bonds. The average interest rate at that time fluctuated around 20%, the first ever bond issued by a national government was issued by the Bank of England in 1694 to raise money to fund a war against France. It was in the form of a tontine, later, governments in Europe started issuing perpetual bonds to fund wars and other government spending. The use of perpetual bonds ceased in the 20th century, a Government bond in a countrys own currency is strictly speaking a risk-free bond, because the government can if necessary create additional currency in order to redeem the bond at maturity. There have however been instances where a government has chosen to default on its domestic currency debt, currency risk is the risk that the value of the currency a bond pays out will decline compared to the holders reference currency. A bond paying in a currency that does not have a history of keeping its value may not be a deal even if a high interest rate is offered. Inflation risk is the risk that the value of the currency a bond pays out will decline over time, investors expect some amount of inflation, so the risk is that the inflation rate will be higher than expected. Many governments issue inflation-indexed bonds, which protect investors against inflation risk by linking both interest payments and maturity payments to a consumer prices index. If a central bank purchases a government security, such as a bond or treasury bill, it increases the money supply, in the UK, government bonds are called gilts. Older issues have names such as Treasury Stock and newer issues are called Treasury Gilt, inflation-indexed gilts are called Index-linked gilts
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Municipal bond
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A municipal bond is a bond issued by a local government or territory, or one of their agencies. It is generally used to public projects such as roads, schools, airports and seaports. The term municipal bond is used in the United States. As of 2011, the bond market was valued at $3.7 trillion. Municipal bonds may be general obligations of the issuer or secured by specified revenues, the state and local exemption was the subject of recent litigation in Department of Revenue of Kentucky v. Davis,553 U. S.328. Unlike new issue stocks that are brought to market with price restrictions until the deal is sold, professional traders regularly trade and re-trade the same bonds several times a week. A feature of this market is a proportion of smaller retail investors compared to other sectors of the U. S. securities markets. Some municipal bonds, often with higher risk credits, are issued subject to transfer restrictions, outside of the United States, many other countries in the world also issue similar bonds, sometimes called local authority bonds or other names. The key defining feature of such bonds is that they are issued by an entity at a lower level of government than the sovereign. Such bonds follow similar market patterns as U. S. bonds and that said, the U. S. municipal bond market is unique for its size, liquidity, legal and tax structure and bankruptcy protection afforded by the U. S. Constitution. Historically, municipal debt predates corporate debt by several centuries—the early Renaissance Italian city-states borrowed money from major banking families, borrowing by American cities dates to the nineteenth century, and records of U. S. municipal bonds indicate use around the early 1800s. Officially the first recorded municipal bond was a general obligation bond issued by the City of New York for a canal in 1812, during the 1840s, many U. S. cities were in debt, and by 1843 cities had roughly $25 million in outstanding debt. In the ensuing decades, rapid urban development demonstrated a correspondingly explosive growth in municipal debt, the debt was used to finance both urban improvements and a growing system of free public education. Years after the Civil War, significant local debt was issued to build railroads, railroads were private corporations and these bonds were very similar to todays industrial revenue bonds. Construction costs in 1873 for one of the largest transcontinental railroads, around the same time, the largest bank of the country of the time, which was owned by the same investor as that of Northern Pacific, collapsed. Smaller firms followed suit as well as the stock market, the 1873 panic and years of depression that followed put an abrupt but temporary halt to the rapid growth of municipal debt. Responding to widespread defaults that jolted the municipal market of the day. Several states wrote these restrictions into their constitutions, railroad bonds and their legality were widely challenged, and this gave rise to the market-wide demand that an opinion of qualified bond counsel accompany each new issue
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Pfandbrief
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The Pfandbrief, a mostly triple-A rated German bank debenture, has become the blueprint of many covered bond models in Europe and beyond. The Pfandbrief is collateralized by long-term assets such as property mortgages or public sector loans as stipulated in the Pfandbrief Act, total volume outstanding in Pfandbriefe was EUR806 billion as at end-2008. Pfandbrief bonds make up the third largest segment of the German bond market after public sector bonds, the roots of the German Pfandbrief system reach back to the year 1769. Based on his decree, Prussia set up so-called ”Landschaften, ” compulsory public-law associations of noble landowners. This Pfandbrief system rapidly spread throughout all of Europe, towards the end of the nineteenth century, it was widely adopted for the refinancing of public sector loans. As before the loans raised by the Landschaften were not paid out in cash, in 1862, the first German mortgage bank, Frankfurter Hypothekenbank in Frankfurt am Main, opened its doors. Numerous other mortgage banks followed in succession in almost all German federal states. By the beginning of the twentieth century 40 private mortgage banks existed, Mortgage banks concentrated from the outset on real estate financing. The rapidly expanding towns and cities in the area of industrialization were in need of the housing construction, the 1900 Mortgage Bank Act is deemed pioneering legislation until today. It provided a legally prescribed, uniform organizational framework for this group of credit institutions and it was in force for more than a century until the Pfandbrief Act entered into force in 2005. The Pfandbrief Act, established in 2005 and amended in 2009, while most European countries have covered bond legislation, the United States and UK initially preferred non-legislative guidelines. The 2005 Pfandbrief Act increased potential issuers to include all licensed credit institutions that meet certain requirements, formerly, only specialized private mortgage banks and public sector banks could issue covered bonds in Germany. The Pfandbrief Act supersedes all prior existing Pfandbrief legislations, the 2009 amendment introduced the Aircraft Pfandbrief as the fourth Pfandbrief type. In their cover business, Pfandbrief banks grant property finance, public sector, ship, Pfandbriefe have an average maturity of about five to seven years. While Pfandbriefe tend to be associated with asset-backed securities they are fundamentally different, Pfandbrief cover-assets remain on the banks balance sheet. By contrast, asset-backed securities are typically off-balance-sheet transactions, another difference, Pfandbrief cover pools are dynamic. Their composition can and usually change over time, depending on the maturities. Due to the stringent legal provisions that govern their issuance Pfandbriefe are deemed particularly safe, an independent cover pool trustee appointed by the Federal Financial Supervisory Authority records cover assets and cover asset replacements in the cover register
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Equity (finance)
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In accounting, equity is the difference between the value of the assets and the value of the liabilities of something owed. Equity can be negative if liabilities exceeds assets, shareholders equity represents the equity of a company as divided among shareholders of common or preferred stock. Negative shareholders equity is often referred to as a shareholders deficit, alternatively, equity can also refer to the capital stock of a corporation. The value of the stock depends on the future economic prospects. For a company in liquidation proceedings, the equity is that which remains after all liabilities have been paid, when starting a business, the owners fund the business to finance various operations. Throughout the businesss existence, the equity of the business will be the difference between its assets and debt liabilities, this is the accounting equation, when a business liquidates during bankruptcy, the proceeds from the assets are used to reimburse creditors. The creditors are ranked by priority, with secured creditors being paid first, other creditors being paid next, owners equity is this remaining or residual claim against assets, which is paid only after all other creditors are paid. In such cases where even creditors could not get money to pay their bills. In financial accounting, owners equity consists of the net assets of an entity, net assets is the difference between the total assets and total liabilities. Equity appears on the sheet, one of the four primary financial statements. The assets of an entity can be tangible and intangible items. Intangible assets include such as brand names, copyrights or goodwill. Tangible assets include land, equipment, and cash, issue of new equity in which the firm obtains new capital increases the total shareholders equity. Share repurchases, in which a firm returns money to investors, reducing on the side its financial assets. For practical purposes, share repurchasing is similar to a dividend payment, rather than giving money to all shareholders immediately in the form of a dividend payment, a share repurchase reduces the number of shares outstanding. Dividends paid out to preferred stock owners are considered an expense to be subtracted from net income, sometimes assets bought and held in other countries get translated back into the reporting currency at different exchange rates, resulting in a changed value. When the owners are shareholders, the interest can be called shareholders equity, the remains the same. If all shareholders are in one and the class, they share equally in ownership equity from all perspectives
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Share (finance)
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In financial markets, share is a unit of account for various investments. It often means the stock of a corporation, but is used for collective investments such as mutual funds, limited partnerships. Corporations issue shares which are offered for sale to raise share capital, the owner of shares in the corporation is a shareholder of the corporation. A share is a unit of capital, expressing the ownership relationship between the company and the shareholder. The denominated value of a share is its value, and the total of the face value of issued shares represent the capital of a company. The income received from the ownership of shares is a dividend, the process of purchasing and selling shares often involves going through a stockbroker as a middle man. The liquidity of markets is a consideration as to whether a share is able to be sold at any given time. An actual sale transaction of shares between buyer and seller is usually considered to provide the best prima facie market indicator as to the value of shares at that particular time. Shares outstanding are those that are authorized by the government, issued by the company, the number of shares outstanding times the share price gives the market capitalization of the company, which if the trading price held constant would be sufficient to purchase the company. Treasury shares are authorized, issued, and held by the company itself, issued shares is the sum of shares outstanding and treasury shares. Shares authorized include both issued and unissued but authorized by the constitutional documents. Tax treatment of dividends varies between tax jurisdictions, for instance, in India, dividends are tax free in the hands of the shareholder, but the company paying the dividend has to pay dividend distribution tax at 12. 5%. There is also the concept of a dividend, which is not tax free. Further, Indian tax laws include provisions to stop dividend stripping, historically, investors were given share certificates as evidence of their ownership of shares. In modern times, certificates are not always given and ownership may be recorded electronically by a system such as CREST, a securities depository
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Initial public offering
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Through this process, a privately held company transforms into a public company. Initial public offerings are used by companies to raise the expansion of capital, possibly to monetize the investments of early private investors. A company selling shares is never required to repay the capital to its public investors, after the IPO, when shares trade freely in the open market, money passes between public investors. The IPO process is known as going public. Details of the offering are disclosed to potential purchasers in the form of a lengthy document known as a prospectus. Most companies undertake an IPO with the assistance of an investment banking firm acting in the capacity of an underwriter, underwriters provide several services, including help with correctly assessing the value of shares and establishing a public market for shares. Alternative methods such as the dutch auction have also been explored, in terms of size and public participation, the two most notable examples of this method is the Google IPO and Snapchats parent company Snap Inc. China has recently emerged as a major IPO market, with several of the largest IPOs taking place in that country, the earliest form of a company which issued public shares was the case of the publicani during the Roman Republic. Like modern joint-stock companies, the publicani were legal bodies independent of their members whose ownership was divided into shares, there is evidence that these shares were sold to public investors and traded in a type of over-the-counter market in the Forum, near the Temple of Castor and Pollux. The shares fluctuated in value, encouraging the activity of speculators, mere evidence remains of the prices for which partes were sold, the nature of initial public offerings, or a description of stock market behavior. Publicanis lost favor with the fall of the Republic and the rise of the Empire, the first modern IPO occurred in March 1602 when the Dutch East India Company offered shares of the company to the public in order to raise capital. All the shares were tradable, and the shareholders received receipts for the purchase, a share certificate documenting payment and ownership such as we know today was not issued but ownership was instead entered in the companys share register. In the United States, the first IPO was the offering of Bank of North America around 1783. An IPO, therefore, allows a company to tap into a pool of potential investors to provide itself with capital for future growth, repayment of debt. A company selling shares is never required to repay the capital to its public investors. Those investors must endure the unpredictable nature of the market to price. After the IPO, when shares trade freely in the open market, for early private investors who choose to sell shares as part of the IPO process, the IPO represents an opportunity to monetize their investment. This type of offering is not dilutive, since no new shares are being created, once a company is listed, it is able to issue additional common shares in a number of different ways, one of which is the follow-on offering
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Short (finance)
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In finance, short selling is the practice of selling securities or other financial instruments that are not currently owned, and subsequently repurchasing them. In the event of a price decline, the short seller profits. Conversely, the short position closes out at a if the price of a shorted instrument rises prior to repurchase. Potential loss on a sale is theoretically unlimited, as there is no theoretical limit to a rise in the price of the instrument. In the securities markets, the seller generally must borrow the securities to effect delivery in the short sale. In practical terms, going short can be considered the opposite of the practice of going long. Mathematically, the return from a position is equivalent to that of owning a negative amount of the instrument. A short sale may have a variety of objectives, traders or fund managers may hedge a long position or a portfolio through one or more short positions. In contrast to a merchant who starts out to buy low, sell high. Although some feel that short selling is morally wrong, research indicates that banning short selling is ineffective and has effects on markets. The following example describes the sale of a security. To profit from a decrease in the price of a security, when the seller decides that the time is right, the seller buys equivalent securities and returns them to the lender. In most market conditions there is a supply of securities to be borrowed, held by pension funds, mutual funds. The act of buying back the securities that were sold short is called covering the short or covering the position, a short position can be covered at any time before the securities are due to be returned. Once the position is covered, the seller is not affected by subsequent rises or falls in the price of the securities. Short selling refers broadly to any used by an investor to profit from the decline in price of a borrowed asset or financial instrument. Derivatives contracts include futures, options, and swaps, shares in ACME Inc. currently trade at $10 per share. A short seller investor borrows from a lender 100 shares of ACME Inc. subsequently, the price of the shares falls to $8 per share
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Investment fund
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An investment fund is a way of investing money alongside other investors in order to benefit from the inherent advantages of working as part of a group. e. Lower transaction costs, increase the asset diversification to reduce some unsystematic risk, terminology varies with country but investment funds are often referred to as investment pools, collective investment vehicles, collective investment schemes, managed funds, or simply funds. The regulatory term is undertaking for collective investment in transferable securities, Investment funds are promoted with a wide range of investment aims either targeting specific geographic regions or specified industry sectors. Depending on the there is normally a bias towards the domestic market due to familiarity. Funds are often selected on the basis of these specified investment aims, their past investment performance, the term collective investment scheme is a legal concept deriving initially from a set of European Union Directives to regulate mutual fund investment and management. The basic aim of collective investment scheme regulation is that the products that are sold to the public are sufficiently transparent. Collective investment vehicles may be formed under company law, by legal trust or by statute, the nature of the vehicle and its limitations are often linked to its constitutional nature and the associated tax rules for the type of structure within a given jurisdiction. Typically there is, A fund manager or investment manager who manages the investment decisions, a fund administrator who manages the trading, reconciliations, valuation and unit pricing. A board of directors or trustees who safeguards the assets and ensures compliance with laws, regulations, the shareholders or unitholders who own the assets and associated income. A marketing or distribution company to promote and sell shares/units of the fund, please see below for general information on specific forms of vehicles in different jurisdictions. The net asset value or NAV is the value of a vehicles assets minus the value of its liabilities, the method for calculating this varies between vehicle types and jurisdiction and can be subject to complex regulation. An open-end fund is divided into shares which vary in price in direct proportion to the variation in value of the funds net asset value. Each time money is invested, new shares or units are created to match the prevailing price, each time shares are redeemed. In this way there is no supply or demand created for shares, a closed-end fund issues a limited number of shares in an initial public offering or through private placement. If shares are issued through an IPO, they are traded on an exchange or directly through the fund manager to create a secondary market subject to market forces. If demand for the shares is high, they may trade at a premium to net asset value, if demand is low they may trade at a discount to net asset value. Further share offerings may be made by the vehicle if demand is high although this may affect the share price, for listed funds, the added element of market forces tends to amplify the performance of the fund increasing investment risk through increased volatility. Some collective investment vehicles have the power to borrow money to further investments
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Hedge fund
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It is administered by a professional investment management firm, and often structured as a limited partnership, limited liability company, or similar vehicle. The name hedge fund originated from the long and short positions that the first of these funds used to hedge market risk. Over time, the types and nature of the hedging concepts expanded, today, hedge funds engage in a diverse range of markets and strategies and employ a wide variety of financial instruments and risk management techniques. Hedge funds are available only to certain accredited investors and cannot be offered or sold to the general public. Hedge funds have existed for decades, and became increasingly popular, growing to be a substantial fraction of asset management. Hedge funds are almost always open-ended and allow additions or withdrawals by their investors, the value of an investors holding is directly related to the fund net asset value. Many hedge fund investment strategies aim to achieve a return on investment regardless of whether markets are rising or falling. Hedge fund managers often invest money of their own in the fund they manage, a hedge fund typically pays its investment manager an annual management fee, and a performance fee. Both co-investment and performance fees serve to align the interests of managers with those of the investors in the fund, some hedge funds have several billion dollars of assets under management. The word hedge, meaning a line of bushes around a field, has long used as a metaphor for the placing of limits on risk. Early hedge funds sought to hedge specific investments against general market fluctuations by shorting the market, nowadays, however, many different investment strategies are used, many of which do not hedge risk. During the US bull market of the 1920s, there were numerous private investment vehicles available to wealthy investors. The sociologist Alfred W. Jones is credited with coining the phrase hedged fund and is credited with creating the first hedge fund structure in 1949, although this has been disputed. Jones referred to his fund as being hedged, a term commonly used on Wall Street to describe the management of investment risk due to changes in the financial markets. In the 1970s, hedge funds specialized in a single strategy, many hedge funds closed during the recession of 1969–70 and the 1973–1974 stock market crash due to heavy losses. They received renewed attention in the late 1980s, during the 1990s, the number of hedge funds increased significantly, funded with wealth created during the 1990s stock market rise. The increased interest was due to the aligned-interest compensation structure and the promise of high returns. Over the next decade hedge fund strategies expanded to include, credit arbitrage, distressed debt, fixed income, quantitative, US institutional investors such as pension and endowment funds began allocating greater portions of their portfolios to hedge funds
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Agency security
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Agency securities are specific securities that are issued by either Ginnie Mae, Fannie Mae, Freddie Mac or the Federal Home Loan Banks. Agency securities also used as collateral for the supply of money released by the Federal Reserve and this collateral is chiefly held in the form of U. S. Treasury, federal agency, and government-sponsored enterprise securities. Due to the expectation of federal backing, these securities historically hold the highest credit rating possible, Fannie Mae Freddie Mac Ginnie Mae
28.
Asset-backed security
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An asset-backed security is a security whose income payments and hence value are derived from and collateralized by a specified pool of underlying assets. The pool of assets is typically a group of small and illiquid assets which are unable to be sold individually. The pools of underlying assets can include common payments from credit cards, auto loans, often a separate institution, called a special purpose vehicle, is created to handle the securitization of asset backed securities. The special purpose vehicle, which creates and sells the securities, uses the proceeds of the sale to pay back the bank that created, or originated and this allows banks to invest more of their capital in new loans or other assets and possibly have a lower capital requirement. In the first case, collateralized debt obligations and mortgage-backed securities, are subsets and it has also interpreted the phrase discrete pool to exclude those that can change in composition over time. However, such securities may be shelf-registered on Form S-3 only if the value of the leased property represents less than 20% of the original securitized pool balance. However, consistent with current practice, shelf registration on will be only if delinquent assets constitute 20% or less of the original asset pool. Exceptions to the Discrete Pool Requirement, the new rules generally codify the SEC staff’s position that a security must be backed by a discrete pool of assets in order to be considered an ABS. However, the new rules establish the following exceptions to address market practices, any security issued in a master trust structure would meet the definition of asset-backed security without limitation. Asset-backed securities will also include securities with a period of up to one year during which up to 50% of the offering proceeds may be used for subsequent purchases of pool assets. The new rules also include within the definition of asset-backed security securities with revolving periods during which new financial assets may be acquired, however, the new assets added to the pool during the revolving period must be of the same general character as the original pool assets. Investors typically refer to HELs as any nonagency loans that do not fit either the jumbo or alt-A loan categories. While early HELs were mostly second lien subprime mortgages, first-lien loans now make up the majority of issuance, Subprime mortgage borrowers have a less than perfect credit history and are required to pay interest rates higher than what would be available to a typical agency borrower. The second largest subsector in the ABS market is auto loans, auto finance companies issue securities backed by underlying pools of auto-related loans. Auto ABS are classified into three categories, prime, nonprime, and subprime, Prime auto ABS are collaterized by loans made to borrowers with strong credit histories, nonprime auto ABS consist of loans made to lesser credit quality consumers, which may have higher cumulative losses. Subprime borrowers will typically have lower incomes, tainted credited histories, owner trusts are the most common structure used when issuing auto loans and allow investors to receive interest and principal on sequential basis. Deals can also be structured to pay on a pro-rata or combination of the two, Securities backed by credit card receivables have been benchmark for the ABS market since they were first introduced in 1987. Credit card holders may borrow funds on a basis up to an assigned credit limit
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Mortgage-backed security
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A mortgage-backed security is a type of asset-backed security that is secured by a mortgage or collection of mortgages. The mortgages are sold to a group of individuals that securitizes, or packages, other types of MBS include collateralized mortgage obligations and collateralized debt obligations. Tranches—especially the lower-priority, higher-interest tranches—of an MBS are/were often further repackaged and these subprime MBSs issued by investment banks were a major issue in the subprime mortgage crisis of 2006–2008. This decrease in value is measured by the MBSs factor. The process of securitization is complex and depends greatly on the jurisdiction within which the process is conducted, among other things, securitization distributes risk and permits investors to choose different levels of investment and risk. The basics are, Mortgage loans are purchased from banks and other lenders, the purchaser or assignee assembles these loans into collections, or pools. The purchaser or assignee securitizes the pools by issuing mortgage-backed securities, a CMBS is usually structured as a different type of security than an RMBS. In the United States, the most common securitization trusts are sponsored by Fannie Mae and Freddie Mac, some private institutions also securitize mortgages, known as private-label mortgage securities. Unlike the traditional localized, inefficient mortgage market where there might be a shortage or surplus of funds at any one time, MBSs were national in scope, however, mortgage-backed securities also led inexorably to the rise of the subprime industry and created hidden, systemic risks. They also undid the connection between borrowers and lenders, among the early examples of mortgage-backed securities in the United States were the farm railroad mortgage bonds of the mid-19th century which contributed to the panic of 1857. There was also an extensive commercial MBS market in the 1920s, the FHA helped develop and standardize the fixed-rate mortgage as an alternative to the balloon payment mortgage by insuring them, and helped the mortgage design garner usage. Ginnie Mae does not invest in private mortgages, Ginnie Mae guaranteed the first mortgage pass-through security of an approved lender in 1968. In 1971, Freddie Mac issued its first mortgage pass-through, called a participation certificate, in 1981, Fannie Mae issued its first mortgage pass-through, called a mortgage-backed security. In 1983, Freddie Mac issued the first collateralized mortgage obligation, in 1983 the Federal Reserve Board amended Regulation T to allow broker-dealers to use pass-throughs as margin collateral, equivalent to over-the-counter non-convertible bonds. The Tax Reform Act of 1986 allowed the creation of the real estate mortgage investment conduit special purpose vehicle for the express purpose of issuing pass-throughs. Low-quality mortgage-backed securities backed by mortgages in the United States caused a crisis that played a major role in the 2007–12 global financial crisis. By 2012 the market for high-quality mortgage-backed securities had recovered and was a center for US banks. Most bonds backed by mortgages are classified as an MBS and this can be confusing, because a security derived from an MBS is also called an MBS
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Commercial mortgage-backed security
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Commercial mortgage-backed securities are a type of mortgage-backed security backed by commercial mortgages rather than residential real estate. CMBS tend to be complex and volatile than residential mortgage-backed securities due to the unique nature of the underlying property assets. CMBS issues are usually structured as multiple tranches, similar to collateralized mortgage obligations, many American CMBSs carry less prepayment risk than other MBS types, thanks to the structure of commercial mortgages. Commercial mortgages often contain lockout provisions after which they can be subject to defeasance, yield maintenance, european CMBS issues typically have less prepayment protection. Interest on the bonds may be a rate or a floating rate. Portfolio loans are originated by a lender and held on its balance sheet through maturity, in a CMBS transaction, many single mortgage loans of varying size, property type and location are pooled and transferred to a trust. The trust issues a series of bonds that may vary in yield, duration, investors choose which CMBS bonds to purchase based on the level of credit risk/yield/duration that they seek. Then interest is paid to the holders of the next highest rated bonds, the same thing occurs with principal as payments are received. This sequential payment structure is referred to as the waterfall. The typical structure for the securitization of commercial real estate loans is a real estate mortgage investment conduit, a REMIC is a creation of the tax law that allows the trust to be a pass-through entity which is not subject to tax at the trust level. The CMBS transaction is structured and priced based on the assumption that it not be subject to tax with respect to its activities, therefore. CMBS has become a capital source for commercial mortgage lending because the bonds backed by a pool of loans are generally worth more than the sum of the value of the whole loans. The enhanced liquidity and structure of CMBS attracts a range of investors to the commercial mortgage market. This value creation effect allows loans intended for securitization to be aggressively priced, in some cases the borrower may deal with a primary servicer that may also be the loan originator or mortgage banker who sourced the loan. The primary servicer maintains the direct contact, and the master servicer may sub-contract certain loan administration duties to the primary or sub-servicer. The master servicer’s responsibility is to service the loans in the pool through to maturity unless the borrower defaults, the master servicer manages the flow of payments and information and is responsible for the ongoing interaction with the performing borrower. Upon the occurrence of certain specified events, primarily a default, besides handling defaulted loans, the special servicer also has approval authority over material servicing actions, such as loan assumptions. The most subordinate bond class outstanding at any point is considered to be the directing certificateholder
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Residential mortgage-backed security
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There are multiple important differences between mortgage loans originated and serviced by banks and kept on the books of the bank and a mortgage loan that has been securitized as part of an RMBS. Likewise, the yield is only the calculation of an imputed interest yield that stems from the receipt of the cashflows, the RMBS market represents the largest source of funding of residential mortgage loans to US homeowners. There are many different types of RMBS, including mortgage pass-throughs, collateralized mortgage obligations, in 1968, Ginnie Mae was the first to issue a new type of government-backed bond, known as the residential mortgage-backed security. This bond took a number of loans, pooled the monthly principal and interest payments. Because banks and other mortgage originators could sell their mortgages in an RMBS, because these bonds had the full faith and backing of the United States government, they received high credit ratings and paid an interest rate that was only slightly higher than Treasury bonds. Following the success of Ginnie Maes offerings, the other two government-sponsored housing agencies, Fannie Mae and Freddie Mac, began offering their own versions of RMBS, the governments guarantee of the mortgage loans assured investors that if the borrower defaulted, they would be repaid in full. But in return for that guarantee, borrowers were held to strict underwriting standards. For example, with Fannie Mae, homebuyers had to make a minimum payment of 10 percent of the home value. In the late 1970s, a team from Salomon Brothers worked with Bank of America to create the first residential-mortgage backed security that wasnt government-guaranteed, a Salomon Brothers bond-trader by the name of Lewis Ranieri was instrumental in this effort. He coined the term securitizing during this period after joining the project in 1977, according to author Alyssa Katz, Ranieris ambition was to revolutionize the mortgage market, which at this time was heavily dependent on the government sponsored housing insurance institutions. As long as a bond got one of the top ratings from the agencies — meaning that in the agencies’ opinions, “We believe that the ratings services do offer substantial investor protection, ” Ranieri testified before Congress in early 1984. It created the market for the private label MBS that did not exist when Ranieri was first developing them in 1977 and they wanted to find products they could profit from where they didnt have to compete with Fannie. Thus the subprime market became the realm of private label Mortgage-Backed Securities, the first private label deals in the late 1980s and early 1990 often had only two tranches, but by 2005–06 the deals became more complex. One typical mortgage-backed deal from one of the years of private label subprime mortgage securities was described in the Financial Crisis Inquiry Report. The entity issued 19 tranches of mortgage-backed bonds worth $947 million, since Citigroup and other firms focused on achieving high ratings, the senior ranches rated triple A made up 78% or $737 million of the deal. Eleven tranches were mezzanine – three rated AA, three A, three BBB and two BB, the most junior tranche was known as equity or residual or first loss. It had no rating and was split between Citigroup and a hedge fund. The more junior the tranche, the higher its risk and the higher its interest rate in compensation, according to business columnist Joe Nocera, as of mid-2013, the market for private mortgage-backed securities
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Tranche
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In structured finance, a tranche is one of a number of related securities offered as part of the same transaction. The word tranche is French for slice, section, series, or portion, in the financial sense of the word, each bond is a different slice of the deals risk. Transaction documentation usually defines the tranches as different classes of notes, the term tranche is used in fields of finance other than structured finance, but the terms use in structured finance may be singled out as particularly important. Use of tranche as a verb is limited almost exclusively to this field, all the tranches together make up what is referred to as the deals capital structure or liability structure. They are generally paid sequentially from the most senior to most subordinate, the more senior rated tranches generally have higher bond credit ratings than the lower rated tranches. For example, senior tranches may be rated AAA, AA or A, while a junior, however, ratings can fluctuate after the debt is issued and even senior tranches could be rated below investment grade. The deals indenture usually details the payment of the tranches in a section referred to as the waterfall. Tranches with a first lien on the assets of the pool are referred to as senior tranches and are generally safer investments. Typical investors of these types of securities tend to be conduits, insurance companies, pension funds, tranches with either a second lien or no lien are often referred to as junior notes. These are more risky investments because they are not secured by specific assets, the natural buyers of these securities tend to be hedge funds and other investors seeking higher risk/return profiles. Here is an example to demonstrate the principle, A bank transfers risk in its loan portfolio by entering into a default swap with a ring-fenced special purpose vehicle. The SPV sells 4 tranches of credit linked notes with a structure whereby, Tranche D absorbs the first 25% of losses on the portfolio. Tranche C absorbs the next 25% of losses Tranche B the next 25% Tranche A the final 25%, is the least risky, tranches A, B and C are sold to outside investors. Tranche D is bought by the bank itself and this is accomplished through the use of credit support specified within the transaction structure to create securities with different risk-return profiles. The equity/first-loss tranche absorbs initial losses, followed by the mezzanine tranches which absorb some additional losses, Tranching can be very helpful in many different circumstances. So essentially it allows investors to further diversify their portfolio, Tranching poses the following risks, Tranching can add complexity to deals. With increased complexity, less sophisticated investors have a harder time understanding them, one must be very careful investing in structured products. As shown above, tranches from the same offering have different risk, reward and these factors have come to light in the subprime mortgage crisis
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Collateralized debt obligation
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A collateralized debt obligation is a type of structured asset-backed security. Originally developed for the debt markets, over time CDOs evolved to encompass the mortgage. The CDO is sliced into tranches, which catch the cash flow of interest, if some loans default and the cash collected by the CDO is insufficient to pay all of its investors, those in the lowest, most junior tranches suffer losses first. The last to lose payment from default are the safest, most senior tranches, as an example, a CDO might issue the following tranches in order of safeness, Senior AAA, Junior AAA, AA, A, BBB, Residual. Separate special purpose entities—rather than the parent investment bank—issue the CDOs, as CDOs developed, some sponsors repackaged tranches into yet another iteration, known as CDO-squared, CDOs of CDOs or synthetic CDOs. In the early 2000s, CDOs were generally diversified, but by 2006–2007—when the CDO market grew to hundreds of billions of dollars—this changed. CDO collateral became dominated not by loans, but by lower level tranches recycled from other asset-backed securities, whose assets were usually sub-prime mortgages, the first CDO was issued in 1987 by bankers at now-defunct Drexel Burnham Lambert Inc. for the also now-defunct Imperial Savings Association. During the 1990s the collateral of CDOs was generally corporate and emerging market bonds, after 1998 multi-sector CDOs were developed by Prudential Securities, but CDOs remained fairly obscure until after 2000. In 2002 and 2003 CDOs had a setback when rating agencies were forced to downgrade hundreds of the securities, from 2004 through 2007, $1.4 trillion worth of CDOs were issued. Early CDOs were diversified, and might include everything from aircraft lease-equipment debt, manufactured housing loans, to student loans, another selling point was that CDOs offered returns that were sometimes 2-3 percentage points higher than corporate bonds with the same credit rating. Advantages of securitization -- Depository banks had incentive to securitize loans they originated—often in the form of CDO securities—because this removes the loans from their books, the transfer of these loans to security-buying investors in return for cash replenishes the banks capital. This enabled them to remain in compliance with capital requirement laws while lending again, the low yield of the safe US Treasury bonds created demand by global investors for subprime mortgage-backed CDOs with their relatively high-yields but credit ratings as high as the Treasuries. This search for yield by global investors caused many to purchase CDOs, pricing models -- Gaussian copula models, introduced in 2001 by David X. Li, allowed for the rapid pricing of CDOs. Around 2005, as the CDO market continued to grow, subprime mortgages began to replace the diversified consumer loans as collateral, by 2004, mortgage-backed securities accounted for more than half of the collateral in CDOs. CDOs not only bought crucial tranches of subprime mortgage-backed securities, they provided cash for the funding of the securities. Between 2003 and 2007, Wall Street issued almost $700 billion in CDOs that included mortgage-backed securities as collateral, pooling low-rated tranches to make CDOs—helped push sales of CDOs to about $500 billion in 2006, with a global CDO market of over USD $1.5 trillion. CDO was the sector of the structured finance market between 2003 and 2006, the number of CDO tranches issued in 2006 was almost twice the number of tranches issued in 2005. CDOs, like mortgage-backed securities, were financed with debt, enhancing their profits, subprime mortgages had been financed by mortgage-backed securities
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Collateralized mortgage obligation
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CMOs were first created in 1983 by the investment banks Salomon Brothers and First Boston for the U. S. mortgage liquidity provider Freddie Mac. Legally, a CMO is a security issued by an abstraction - a special purpose entity - and is not a debt owed by the institution creating and operating the entity. The entity is the owner of a set of mortgages. Investors in a CMO buy bonds issued by the entity, the legal entity, collateral, and structure are collectively referred to as the deal. Unlike traditional mortgage pass-through securities, CMOs feature different payment streams and risks, for tax purposes, CMOs are generally structured as Real Estate Mortgage Investment Conduits, which avoid the potential for double-taxation. Investors in CMOs include banks, hedge funds, insurance companies, pension funds, mutual funds, government agencies and this article focuses primarily on CMO bonds as traded in the United States of America. The most basic way a mortgage loan can be transformed into a suitable for purchase by an investor would simply be to split it. For example, a $300,00030 year mortgage with an interest rate of 6. 5% could be split into 3001000 dollar bonds and these bonds would have a 30-year amortization, and an interest rate of 6. 00% for example. This is known as prepayment risk, a 30-year time frame is a long time for an investors money to be locked away. Only a small percentage of investors would be interested in locking away their money for this long and this is known as interest rate risk. Most normal bonds can be thought of as interest only loans, on a normal mortgage, interest and principal are paid each month, causing the amount of interest earned to decrease. This is undesirable to investors because they are forced to reinvest the principal. This is known as reinvestment risk, the latter event is known as default risk. Salomon Brothers and First Boston created the CMO concept to address these issues, a CMO is essentially a way to create many different kinds of bonds from the same mortgage loan so as to please many different kinds of investors. For example, A group of mortgages could create 4 different classes of bonds, the first group would receive any prepayments before the second group would, and so on. Thus the first group of bonds would be expected to pay off sooner, thus a 30-year mortgage is transformed into bonds of various lengths suitable for various investors with various goals. A group of mortgages could create 4 different classes of bonds, any losses would go against the first group, before going against the second group, etc. The first group would have the highest interest rate, while the second would have slightly less, thus an investor could choose the bond that is right for the risk they want to take
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Unsecured debt
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The unsecured creditors will usually realize a smaller proportion of their claims than the secured creditors. Under risk-based pricing, creditors tend to demand extremely high interest rates as a condition of extending unsecured debt, the maximum loss on a properly collateralized loan is the difference between the fair market value of the collateral and the outstanding debt. Thus, in the context of secured lending, the use of collateral reduces the size of the bet taken by the creditor on the debtors creditworthiness. Without collateral, the stands to lose the entire sum outstanding at the point of default. Where high interest rates are considered usurious, unsecured loans are not made at all. Unsecured loans are often out in cases where additional capital is required although existing assets have been pledged to secure prior debt. Secured lenders will more often than not include language in the agreement that prevents debtor from assuming additional secured loans or pledging any assets to a creditor. In Malaysia, there are personal loans for the sector and for the government sector. The personal loan interest rate for the sector is always higher than the government sector because it is of lower risk for the bank to lend to the government sector. An example of these loans are cooperative loans, interest rates for personal loans in Malaysia are influenced by either one of these factors, loan amount, loan tenure and income of the applicant. In some cases, the bank will take 2 or even 3 of these factors to decide on the appropriate interest rate to be applied to the personal loan, in 2013, the Malaysian Central Bank introduces a new maximum loan tenure of 10 years for personal loan. High-yield debt Guarantor loan Medical debt Merchant cash advance Peer-to-peer lending Term deposit
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Forward contract
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The party agreeing to buy the underlying asset in the future assumes a long position, and the party agreeing to sell the asset in the future assumes a short position. A closely related contract is a contract, they differ in certain respects. Forward contracts are similar to futures contracts, except they are not exchange-traded. However, being traded over the counter, forward contracts specification can be customized and may include mark-to-market, hence, a forward contract arrangement might call for the loss party to pledge collateral or additional collateral to better secure the party at gain. g. The value of a position at maturity depends on the relationship between the delivery price and the underlying price at that time. At the same time, suppose that Andy currently owns a $100,000 house that he wishes to sell a year from now, both parties could enter into a forward contract with each other. Suppose that they agree on the sale price in one years time of $104,000. Andy and Bob have entered into a forward contract, Bob, because he is buying the underlying, is said to have entered a long forward contract. Conversely, Andy will have the forward contract. At the end of one year, suppose that the current market valuation of Andys house is $110,000, then, because Andy is obliged to sell to Bob for only $104,000, Bob will make a profit of $6,000. To see why this is so, one only to recognize that Bob can buy from Andy for $104,000. Bob has made the difference in profit, in contrast, Andy has made a potential loss of $6,000, and an actual profit of $4,000. In a currency forward, the amounts of currencies are specified. Continuing on the example above, suppose now that the price of Andys house is $100,000. But since Andy knows that he can sell for $100,000 and place the proceeds in the bank. Suppose that the free rate of return R for one year is 4%. Then the money in the bank would grow to $104,000, so Andy would want at least $104,000 one year from now for the contract to be worthwhile for him – the opportunity cost will be covered. For liquid assets, spot–forward parity provides the link between the market and the forward market
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Futures contract
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In finance, a futures contract is a standardized forward contract which can be easily traded between parties other than the two initial parties to the contract. The parties initially agree to buy and sell an asset for an agreed upon today, with delivery and payment occurring at a future point. Because it is a function of an asset, a futures contract is a derivative product. Contracts are negotiated at futures exchanges, which act as a marketplace between buyers and sellers, the buyer of a contract is said to be long position holder, and the selling party is said to be short position holder. For example, in gold trading, the margin varies between 2% and 20% depending on the volatility of the spot market. The first futures contracts were negotiated for agricultural commodities, and later contracts were negotiated for natural resources such as oil. The original use of futures contracts was to mitigate the risk of price or exchange rate movements by allowing parties to fix prices or rates in advance for future transactions. The Chicago Board of Trade listed the first-ever standardized exchange traded forward contracts in 1864, by 1875 cotton futures were being traded in Bombay in India and within a few years this had expanded to futures on edible oilseeds complex, raw jute and jute goods and bullion. The 1972 creation of the International Monetary Market, the worlds first financial futures exchange, in 1976, the IMM added interest rate futures on US treasury bills, and in 1982 they added stock market index futures. Although futures contract are oriented towards a future point, their main purpose is to mitigate risk of default by either party in the intervening period. In this vein, the futures exchange requires both parties to put up initial cash, or a bond, known as the margin. To mitigate the risk of default, the product is marked to market on a basis where the difference between the initial agreed-upon price and the actual daily futures price is reevaluated daily. If the margin account goes below a certain value set by the Exchange, then a call is made. This process is known as marking to market, thus on the delivery date, the amount exchanged is not the specified price on the contract but the spot value. Upon marketing the strike price is reached and creates lots of income for the caller. To minimize credit risk to the exchange, traders must post a margin or a performance bond, to minimize counterparty risk to traders, trades executed on regulated futures exchanges are guaranteed by a clearing house. The clearing house becomes the buyer to each seller, and the seller to each Buyer and this enables traders to transact without performing due diligence on their counterparty. Margin requirements are waived or reduced in cases for hedgers who have physical ownership of the covered commodity or spread traders who have offsetting contracts balancing the position
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Option (finance)
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The strike price may be set by reference to the spot price of the underlying security or commodity on the day an option is taken out, or it may be fixed at a discount in a premium. The seller has the obligation to fulfill the transaction – to sell or buy – if the buyer exercises the option. Both are commonly used in and by the old traded, when an option is exercised, the cost to the buyer of the asset acquired is the strike price plus the premium, if any. When the option expiration date passes without the option being exercised, then the option expires, in any case, the premium is income to the seller, and normally a capital loss to the buyer. The owner of an option may on-sell the option to a party in a secondary market, in either an over-the-counter transaction or on an options exchange. The market price of an American-style option normally closely follows that of the underlying stock, being the difference between the market price of the stock and the strike price of the option. The ownership of an option does not generally entitle the holder to any rights associated with the asset, such as voting rights or any income from the underlying asset. Contracts similar to options have been used since ancient times, the first reputed option buyer was the ancient Greek mathematician and philosopher Thales of Miletus. When spring came and the olive harvest was larger than expected he exercised his options, in London, puts and refusals first became well-known trading instruments in the 1690s during the reign of William and Mary. Privileges were options sold over the counter in nineteenth century America and their exercise price was fixed at a rounded-off market price on the day or week that the option was bought, and the expiry date was generally three months after purchase. They were not traded in secondary markets, film or theatrical producers often buy the right — but not the obligation — to dramatize a specific book or script. Lines of credit give the borrower the right — but not the obligation — to borrow within a specified time period. Many choices, or embedded options, have traditionally included in bond contracts. For example, many bonds are convertible into common stock at the buyers option, mortgage borrowers have long had the option to repay the loan early, which corresponds to a callable bond option. Options contracts have been known for decades, the Chicago Board Options Exchange was established in 1973, which set up a regime using standardized forms and terms and trade through a guaranteed clearing house. Trading activity and academic interest has increased since then, Options are part of a larger class of financial instruments known as derivative products, or simply, derivatives. A financial option is a contract between two counterparties with the terms of the option specified in a term sheet, Exchange traded options have standardized contracts, and are settled through a clearing house with fulfillment guaranteed by the Options Clearing Corporation. Since the contracts are standardized, accurate pricing models are often available, the terms of an OTC option are unrestricted and may be individually tailored to meet any business need
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