Risk Management and Derivatives Vocabulary

Vocabulary practice flashcards covering essential financial terms, market mechanisms, pricing formulas, hedging concepts, derivatives, and swaps from the lecture material.

Derivatives Exchange

A market where individuals and companies trade standardized contracts defined by the exchange.

Central Counterparty (CCP)

An entity that stands between two parties in an over-the-counter (OTC) derivative transaction to clear the trade and manage counterparty credit risk.

Swap Execution Facility (SEF)

A trading platform in the United States similar to an exchange where market participants can post bid and ask quotes and trade standardized OTC derivatives.

Forward Contract

An agreement to buy or sell an asset at a specified future time for a delivery price specified today.

Spot Contract

An agreement to buy or sell an asset almost immediately at the prevailing market price.

Short Position

A financial position where an investor agrees to sell the underlying asset on a specified future date or holds a position that profits when the asset price declines.

Long Position

A financial position where an investor agrees to buy the underlying asset on a specified future date or holds a position that profits when the asset price rises.

Futures Contract

A standardized exchange-traded agreement between two parties to buy or sell an underlying asset at a specified future date for a specified price.

Call Option

A financial contract giving the holder the right, but not the obligation, to buy an underlying asset by a certain date for a specified strike price.

Put Option

A financial contract giving the holder the right, but not the obligation, to sell an underlying asset by a certain date for a specified strike price.

Writing an Option

The act of selling an option contract, which obligates the seller to fulfill the contract terms if the option holder exercises it.

Hedger

A market participant who uses derivative contracts to reduce exposure to potential adverse movements in market variables.

Speculator

A market participant who takes positions in derivatives to bet on the future direction of market variables for profit.

Arbitrageur

A market participant who simultaneously takes offsetting positions in two or more financial instruments to lock in a riskless profit.

Limit Down

The maximum price decline allowed by an exchange in a single trading day from the previous day's closing price.

Limit Up

The maximum price increase allowed by an exchange in a single trading day from the previous day's closing price.

Position Limits

The maximum number of speculative futures or options contracts that a single market participant is permitted to hold.

Variation Margin

The daily flow of funds between traders and the margin account to reflect mark-to-market gains and losses.

Maintenance Margin

The minimum account balance that an investor must maintain in a margin account to keep a open futures position without receiving a margin call.

Settlement Price

The price calculated at the close of trading used by exchanges for determining daily margin requirements, gains, and losses.

Basis Point

A unit equal to $0.0100$\% per annum ($0.0001$), commonly used to express changes in yields and interest rates.

Treasury Rates

The interest rates earned on government-issued debt instruments such as Treasury bills and Treasury bonds.

Effective Federal Funds Rate

The weighted average interest rate on brokered overnight interbank lending transactions in the United States.

Repo Rate

The interest rate involved in a repurchase agreement, where a financial institution sells securities and commits to repurchase them at a higher price later.

Secured Overnight Financing Rate (SOFR)

A volume-weighted median rate of overnight repurchase agreement (repo) transactions secured by U.S. Treasuries, widely used as a risk-free reference rate.

Par Yield

The coupon rate that sets the present value of a bond's payments equal to its face value.

Zero Rate

The interest rate earned on an investment that begins today and pays no intermediate coupons, providing a single payoff at maturity time $T$.

Bootstrapping

An iterative procedure used to extract zero-coupon interest rates sequentially from market prices of coupon-bearing instruments.

Duration

A measure of the first-order percentage sensitivity of a fixed-income instrument's price to changes in yield.

Convexity

A second-order measure that captures the curvature in the relationship between bond prices and yield changes.

Perfect Hedge

A hedging position that completely eliminates exposure to market price risk.

Short Hedge

A hedging strategy involving a short futures position, appropriate for an entity that owns or expects to sell an asset.

Long Hedge

A hedging strategy involving a long futures position, appropriate for an entity that needs to purchase an asset in the future.

Basis

The difference between the spot price of an asset to be hedged and the futures price of the contract used ($\text{Basis} = S_0 - F_0$).

Stack-and-Roll

A strategy for hedging long-dated exposures by entering short-dated liquid futures contracts and rolling them over into new contracts as they approach maturity.

Investment Asset

An asset held purely for investment purposes by at least some market participants, such as stocks, bonds, or gold.

Consumption Asset

An asset held primarily for direct physical consumption or use in production rather than investment, such as crude oil or wheat.

Cash-and-Carry Arbitrage

An arbitrage strategy executed when a forward contract is overpriced ($F_0 > S_0 e^{rT}$), involving buying spot, borrowing, and shorting the forward contract.

Reverse Cash-and-Carry Arbitrage

An arbitrage strategy executed when a forward contract is underpriced ($F_0 < S_0 e^{rT}$), involving shorting spot, investing proceeds, and buying the forward contract.

Convenience Yield

The non-monetary benefit or commercial advantage derived from physically holding a physical commodity asset rather than holding derivative contracts.

Cost of Carry

The total net cost of holding an asset, equal to financing costs plus storage costs minus income earned ($c = r + u - q$).

Normal Backwardation

A market condition where the theoretical futures price is below the expected future spot price ($F_0 < E(S_T)$), typically reflecting a positive systematic risk premium.

Normal Contango

A market condition where the theoretical futures price is above the expected future spot price ($F_0 > E(S_T)$), typically reflecting a negative systematic risk premium.

Interest Rate Swap

A financial derivative contract in which two counterparties agree to exchange interest rate cash flow streams on specified dates based on a specified notional principal.

Notional Principal

The reference principal amount used solely to calculate interest cash flows in a swap, which is not exchanged in plain-vanilla interest rate swaps.

Overnight Indexed Swap (OIS)

An interest rate swap where the floating interest rate is determined by compounding an overnight reference rate over the payment period.

Credit Default Swap (CDS)

A derivative contract that functions as insurance against a credit event or default of a reference entity.

CDS Spread

The annual premium fee paid by the protection buyer in a credit default swap to the protection seller, expressed in basis points of the reference notional.