Financial Markets and Products Flashcards

Practice flashcards covering key vocabulary, financial concepts, and derivative terminology from SchweserNotes 2026 FRM Part I Book 3: Financial Markets and Products.

Commercial Banks

Financial institutions that take deposits and make loans, categorized into retail banks (serving individuals/small businesses) and wholesale banks (serving corporate/institutional customers).

Investment Banks

Financial institutions that assist in raising capital by managing debt and equity issuances and advising on corporate finance matters such as mergers and restructurings.

Economic Capital

The amount of capital a bank believes is adequate based on its own risk models to cover unexpected losses.

Regulatory Capital

The minimum amount of capital required by bank regulators to shield against bank failures.

Operational Risk

The possibility of losses arising from failures of a bank’s internal controls, external events like cyberattacks, or human error.

Liquidity Coverage Ratio (LCR)

A requirement meant to ensure that banks have enough funding sources to remain viable for $30$ days during a minor financial stress period.

Net Stable Funding Ratio (NSFR)

A regulation that attempts to control the maturity mismatches between a bank’s assets and liabilities.

Moral Hazard

The phenomenon where insured parties take greater risks than they would normally take because they are protected from the consequences, often associated with deposit insurance.

Firm Commitment

An investment banking arrangement where the bank agrees to purchase an entire securities issue from the issuer at a negotiated price and earns income by reselling it at a spread.

Initial Public Offering (IPO)

The first-time issuance of stock by a firm whose shares are not currently publicly traded.

Dutch Auction

A price discovery process for an IPO where the price is reduced until all units are accepted by bidders; the price of the last shares sold becomes the price for all bidders.

Chinese Walls

Internal controls implemented by banks to prevent the sharing of material nonpublic information between different divisions, such as commercial and investment banking.

Originate-to-Distribute Model

A banking model where banks make loans and then sell them to other parties, increasing liquidity but potentially leading to looser lending standards.

Loss Ratio

For a property and casualty (P&C) insurance company, the percentage of payouts versus premiums generated in a given year.

Combined Ratio

The sum of an insurance company's loss ratio and expense ratio.

Adverse Selection

A situation where an insurer endures more bad risks because it cannot differentiate between good and bad risks and charges the same premium for both.

Longevity Risk

The risk that policyholders will live longer than expected, which increases the cost of annuity payouts for insurance companies.

Solvency II

A set of insurance regulations in the European Union that establishes a Minimum Capital Requirement (MCR) and a Solvency Capital Requirement (SCR).

Defined Benefit Plan

A pension plan where the retirement benefit is known (based on a formula) and the employer bears the investment risk.

Defined Contribution Plan

A pension plan where the employer's contribution is fixed, but the final benefit depends on investment performance, with the employee bearing the risk.

Net Asset Value (NAV)

The value of a mutual fund share, calculated as $\frac{\text{total assets} - \text{liabilities}}{\text{shares outstanding}}$, often determined only after the market closes at 4:00 pm New York City time.

Late Trading

An illegal mutual fund practice where orders are accepted after the 4:00 pm cutoff time, allowing traders to profit from news occurring after the deadline.

Front Running

An illegal practice where a trader executes trades for their own account ahead of a known, large upcoming trade to be made by a fund.

Hurdle Rate

A benchmark return that a hedge fund must beat before its managers can begin charging incentive fees.

High-Water Mark

A clause in hedge fund agreements stating that managers must recoup previous losses before they are eligible to receive incentive fees again.

Lookup Period

A specific time period, often one year, during which hedge fund investors are unable to withdraw their funds.

Linear Derivatives

Derivatives such as forwards and futures that have a payoff profile directly and linearly related to the value of the underlying asset.

American-Style Option

An option contract that may be exercised at any time between the issue date and the expiration date.

Netting

The process of consolidating multiple offsetting long and short positions between counterparties into a single net payment.

Central Counterparty (CCP)

A legal entity that interposes itself between the buyer and the seller in a transaction, acting as the seller to each buyer and the buyer to each seller.

Marking to Market

The daily procedure of adjusting the margin account balance in a futures contract for daily movements in the futures price.

Basis

The difference between the spot price of a hedged asset and the futures price of the hedging instrument, defined as $\text{Basis} = \text{Spot price} - \text{Futures price}$.

Tailing the Hedge

An adjustment to the number of futures contracts in a hedge to account for the impact of daily settlement or marking to market.

Transaction Risk

Foreign exchange risk occurring when a specific cash flow in one currency must be exchanged for another to settle a future transaction.

Interest Rate Parity (IRP)

A theorem suggesting that the discounted spread between domestic and foreign interest rates equals the percentage spread between forward and spot exchange rates.

Cost of Carry

The net cost of holding an asset, including interest and storage costs minus any income derived from the asset.

Convenience Yield

A nonmonetary benefit earned from holding a physical inventory of a commodity, particularly to prevent production disruptions.

Normal Backwardation

A market condition where the futures price is below the expected future spot price.

Contango

A market condition where the futures price is above the current spot price.

SOFR (Secured Overnight Financing Rate)

A one-day, repo-based rate derived from actual transactions used as an alternative to Treasury rates for the risk-free rate.

Duration

The weighted average time until the cash flows on a bond are received, or a measure of a bond's price sensitivity to interest rate changes.

Bond Indenture

A legal document that sets forth the specific obligations of the bond issuer and the rights of the bondholders.

Debentures

Unsecured corporate bonds that have no specific property or assets underlying the issue as collateral.

Weighted Average Coupon (WAC)

The weighted average of the annual mortgage rates for all mortgage loans in an MBS pool.

Single Monthly Mortality (SMM)

A monthly prepayment rate for a mortgage pool, calculated from the annual Conditional Prepayment Rate (CPR).

Option Adjusted Spread (OAS)

A measure of MBS returns representing the spread that makes the average present value of simulated interest rate paths equal to the market price.

Plain Vanilla Swap

An interest rate swap where one party pays a fixed rate and receives a floating rate based on a standard benchmark like SOFR.