Glossary

  • Ladder option

    A path-dependent option, most often based on an equity index or a foreign exchange rate. The payout of a ladder option increases stepwise as the underlying trades upwards (or downwards) through specified barrier levels (the "rungs" of the ladder). Each time the underlying trades through a new barrier level, the option payout is locked-in at the higher level.

  • Lambda

    A measure of the effective leverage of an instrument. It is defined as the percentage change in the market value of a derivative for a one-percent move in the underlying. Unlike gearing, the lambda value captures the instrument's delta.

  • Lease rate swap

    Similar to an interest rate swap, a lease rate swap is a fixed-for-floating agreement in which gold is borrowed/ lent at a "fixed" rate. The floating leg is re-priced at incremental time periods over the maturity of the swap. At the end of each floating period the agreed upon benchmark lease rate is compared to the contract rate and the party in debit pays the differential. The floating component is then rolled out for a further period.

  • Legal risk

    Legal risk arises from the risk of not legally being able to enforce contracts. It can particularly be an issue in emerging markets where derivatives regulations are still being developed.

  • Leverage

    The ability to control large amounts of an underlying variable for a small initial investment. Futures and options are regarded as leveraged products because the initial premium paid by the purchaser is generally much smaller than the nominal amount of the underlying. Leverage is usually measured as a quantity called lambda.

  • Libor

    The London inter-bank offered rate (LIBOR) is the interest rate charged on short-term interbank loans by banks operating in London. The rate is set on a daily basis and is commonly used as a guide for the future level of interest rates.

  • Linear basket credit default swap

    A basket credit default swap, where investors are exposed to multiple reference entities as if they had entered into a separate credit default swap contract with respect to each reference entity.

  • Linear ex-linked swap

    An interest rate swap with a quasi-fixed coupon that varies with the movement of a chosen spot foreign exchange rate over the life of the deal. These swaps can be structured to pay a higher (or lower) coupon if a given currency weakens (or strengthens) after the outset of the deal. The observation dates for the forex component coincide with the Libor reset dates for coupon calculation. These swaps can be structured with a leveraged forex exposure.

  • Liquidity risk

    The risk associated with transactions made in illiquid markets. Such markets are characterised by wide bid/offer spreads, lack of transparency and large movements in price after a deal of any size. A firm wishing to unwind a portfolio of illiquid instruments (for example, highly tailored structured notes) may find it has to sell them at prices far below their fair values, exacerbating the problems that prompted the decision to unwind.

  • Lite option

    A European-style basket option with a payout determined by the underlying assets that remain in the basket, after a certain number of the best and worst performing assets in the basket were removed at a specified date prior to expiry. Also known as an atlas option.

  • Local cap

    A local cap is the maximum return in each period of a cliquet option, which is used to work out the overall payout.

  • Local floor

    A local floor is the minimum return in each period of a cliquet option, which is used to help work out the overall payout.

  • Longstaff-Schwartz model

    A two-factor model of the term structure of interest rates. It produces a closed-form solution for the price of zero coupon bonds and a quasi-closed-form solution for options on zero coupon bonds. The model is developed in a Cox-Ingersoll-Ross framework with short interest rates and their volatility as the two sources of uncertainty in the equation.

  • Lookback option

    Lookback options give the holder the right at expiration to exercise the option at the most favorable rate or price reached by the underlying over the life of the option. As with average options, the strike may be either fixed or floating. With an optimal rate (or price) lookback option, the strike is fixed at the outset and the option will pay out against the highest (for a call) or lowest spot (for a put) reached over the life of the option, irrespective of the spot at expiry. The option will usually be settled in cash. Since the option is likely to have a larger payout than the corresponding plain vanilla option, it commands a larger premium. The strike for an optimal strike lookback option, on the other hand, is not fixed until expiration, when it is set to be the highest (for a put) or lowest spot (for a call) over the option's life and exercised for cash or physical against the spot prevailing at expiration.

  • Low exercise price option (LEPO)

    A low exercise price option (LEPO) is a call option with an exercise price set deep in-the-money. The limiting case, a zero exercise price option, is when the strike price is zero. It is virtually certain to be exercised and the value and performance of its intrinsic value is effectively identical to that of the underlying equity. These features are designed to allow participation in the performance of an equity price where there are legal or financial obstacles to purchasing the underlying directly. If the LEPO is cash-settled, the buyer profits to the same extent as with a direct holding in the underlying, but without having to transact in it. However, a LEPO holder does not earn dividends or have voting rights over the equity.

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