Glossary

Accreting
A description, applicable to a variety of instruments, denoting that the notional principal increase successively over the life of the instrument, eg, caps, collars, swaps and swaptions. If the increase takes place in increments, the instrument may be known as a stepup.

Accrual corridor
The range within which an underlyin reference rate must trade for coupon payments to accrue in a range note or corridor option.

Accrual period
Period over which net payment or receipt pertaining to swaps is accrued. It is inclusive of the start date and runs to the end date without including the end date.

Alpha
Alpha is used to measure the performance of a fund in relation to its benchmark. An alpha that measures 2.0 indicates a fund has achieved a return 2% better than could have been expected from its benchmark.

Alternative Risk Transfert
An approach to risk management combining capital markets, reinsurance and investment banking techniques that allows a party to either free itself from risks not easily transferred via traditional insurance, or alternatively cover such risks in a nontraditional way, such as by using the capital markets.

Altiplano
An Altiplano is a type of mountain range structure that offers investors a fixed payout at he end of the product's life on the condition that none of the assets that make up the underlying basket have decreased below a given level. If the level is breached, the product pays a capital guarantee plus participation in the growth of the total underlying basket.

Americanstyle option
The holder of an Americanstyle option has the right to exercise the option at any time during the life of the option, up to and including the expiry date.

Amortizing
A description, applicable to a variety of instruments, denoting that the notional principal decreases successively over the life of an instrument, eg, amortizing swap, index amortizing rate swap, amortizing cap, amortizing collar, amortizing swaption. If the decrease takes place in increments,the instrument may be known as a stepdown. Mortgagestyle amortization refers to an amortizing swap such that the principal amortization plus interest is the same amount in each interest period.

Annapurna
An Annapurna is a typeof mountain range product that offers a return equal to the greater of a capital guarantee plus a fixed coupon and a participation in the performance of the underlying basket. The level of the fixed coupon and of the participation rate in the performance depends on if and when the worstperforming stock breaches a downside barrier. The later the breach, the higher the fixed coupon and equity participation rate.

Annuity swap
An interest rate swap in which a series of irregular cashflows are exchanged for a stream of regular cashflows of equivalent present value.

Arbitrage
A guaranteed or riskless profit from simultaneously buying and selling instruments that are perfect equivalents, the first being cheaper than the second.

Arbitragefree model
Any model that does not allow arbitrage on the underlying variable. Some simple early models assumed parallel shifts in the yield curve, but the varying yields of different duration bonds could be arbitraged using butterfly strategies.

Asset allocation
The distribution of investment funds within a single asset class or across a number of asset classes (such as equities, bonds and commodities) with the aim of diversifying risk or adding value to a portfolio.

Asset backed security
An asset backed security is a security collateralized by assets such as bonds, credit card repayments, loan repayments or real estate.

Asset swap
A package of a cash credit instrument and a corresponding swap that transforms the cash flows of the nonpar instrument (bond or loan), into a par (floating interest rate) structure. Asset swaps typically transform fixedrate bonds into par floaters, bearing a net coupon of Libor plus a spread, although crosscurrency asset swaps, transforming cashflows from one currency to another are also common.

Asset/ liability management
The practice of matching the term structure and cashflows of an organization's asset and liability portfolios in order to maximize returns and minimize risk. An institutional example of this would be a bank converting a fixedrate loan (asset) by utilizing a fixedforfloating interest rate swap to match its floating rate funding (deposits).

Atthemoney
 Atthemoney forward: An option whose strike is set at the same level as the prevailing market price of the underlying forward contract. With a BlackScholes model, the delta of a Europeanstyle, atthemoney forward option will be close to 50%
 . Atthemoney spot: An option whose strike is set the same as the prevailing market price of the underlying. Because forwards commonly trade at a premium or discount to the spot, the delta may not be close to 50%.

Autocap
A standard cap consists of a series of caplets hedging future floating rate payments. However, autocaps only provide a hedge for the first prespecified number of inthemoney caplets after which the option expires, and so are a cheaper alternative to caps.

Autoregressive conditional heteroscedasticity (Arch)
A discrete time model for a random variable. It assumes that variance is stochastic and is a function of the variance of previous time steps and the level of the underlying.

Average option
A plain vanilla option pays out the difference between its predetermined strike price and the spot rate (or price) of the underlying at the time of expiry. The purchaser of an average option (average price, average strike, average hybrid, average ratio), on the other hand, will receive a payout which depends on the average value of the underlying. The average can be calculated in a number of ways (arithmetic or geometric, weighted or simple) from the spot rate on a predetermined series of dates. An average rate (or average price) option is a cashsettled option with a predetermined (ie fixed) strike which is exercised at expiry against the average value of the underlying over the specified dates. In general, hedging with an average option is cheaper than using a portfolio of vanilla options, since the averaging process offsets high values with low ones and therefore lowers volatility and premium. Average options, also known as Asian options, are particularly popular in the equity, currency and commodity markets. In contrast, the strike for an average strike option is not fixed until the end of the averaging period which is typically much before the expiry. When the strike is set, the option is exercised against the prevailing spot rate. Unlike average price options, average strike options may be either cash or physically settled. In the case of an average hybrid option (also known as an averagein/averageout option), both the strike and settlement price of the option are determined using the average, where the strike averaging period typically precedes the settlement price averaging period. For the average ratio option, both the strike and settlement price of the option are determined using the average as in the hybrid case.The final payout is determined by comparing the ratio of settlement price to strike and a fixed percent strike.