An approach to forecasting based on external factors such as economics, government policy and political events. See Technical analysis . Funds The USD/CAD exchange rate for value on the next business day (standard practice for USD/CAD, in preference to spot ). Fungible Able to be combined indistinguishably with an existing position in the same instrument. Future value The amount of money achieved in the future, including interest, by investing a given amount of money now. See Time value of money , Present value . Futures contract A deal to buy or sell some financial instrument or commodity for value on a future date. Unlike a forward deal, futures contracts are traded only on an exchange (rather than OTC), have standardized contract sizes and value dates, and are often only contracts for differences rather than deliverable. FX Foreign exchange. FXA See Forward exchange agreement . Gap analysis Analysis of the difference in exposures to interest rates in different periods. Glossary 305 General risk In measuring position risk for capital adequacy purposes, the risk arising from the market position held by the bank. See Specific risk . GMRA Global Master Repo Agreement, a master agreement for repos and buy/sell-backs. Hedge Protect against the risks arising from potential market movements in exchange rates, interest rates or other variables. See Cover , Arbi- trage , Speculation . Herstatt risk Same as settlement risk in FX. Historic rate rollover A forward swap in FX where the settlement exchange rate for the near date is based on a historic off-market rate rather than the current market rate. This is prohibited by many regulators. Historic VaR A method of calculating VaR by applying historic price movements to the current portfolio of instruments. See Monte Carlo simulation , Variance/covariance . Hit To hit a bid is to deal on the bid price quoted by someone. IFEMA International Foreign Exchange Master Agreement, a master agree- ment for foreign exchange spot and forward deals. IMM See International Monetary Market . Indirect An exchange rate quotation against the US dollar in which the dollar is the base currency and the other currency is the variable currency. Initial margin See Margin . 306 Foreign exchange and money markets Interbank An interbank transaction is one between two banks, as opposed to one between a bank and an end-user. International Monetary Market The financial sector of the Chicago Mercantile Exchange. Interpolation The process of estimating a price or rate for value on a particular date by comparing the prices actually quoted for value dates either side. Intervention Purchases or sales of currencies in the market by central banks in an attempt to reduce exchange rate fluctuations or to maintain the value of a currency within a particular band, or at a particular level. Similarly, central bank operations in the money markets to maintain interest rates at a certain level. Inverted yield curve See Negative yield curve . ISDA master agreement International Swaps and Derivatives Association master agreement for FRAs, swaps, options and other transactions. Judgemental analysis See Fundamental analysis . Large exposure risk The requirement to allocate more capital for capital adequacy purposes if the total exposure to any one counterparty is a particularly large proportion of the bank’s total. Legacy currency (Or national currency unit). One of the former national currencies which became a unit of the euro. Legal risk The risk that the bank’s business is affected by changes in laws and regulations, or by existing laws and regulations which it had not properly taken into account. Glossary 307 LIBID See LIBOR . LIBOR London inter-bank offered rate, the rate at which banks are willing to lend to other banks of top creditworthiness. The term is used both generally to mean the interest rate at any time, and specifically to mean the reference rate at 11:00 a.m., published by the British Bankers’ Association, for the purpose of providing a benchmark to fix an interest payment such as on an FRA settlement. LIBID is similarly London inter-bank bid rate. LIMEAN is the average between LIBID and LIBOR. LIFFE London International Financial Futures and Options Exchange. Lift To lift an offer is to deal on the offered price quoted by someone. LIMEAN See LIBOR . Liquid A liquid market is one where it is easy to find buyers and sellers at good prices. A liquid investment is one which can easily be turned into cash because there is a liquid market in that instrument. Liquidity See Liquid . Liquidity risk The risk of being unable to find a liquid market for a particular instrument. Locals Private traders on a futures exchange dealing for their own account. Long A long position is a surplus of purchases over sales of a given currency or asset, or a situation which naturally gives rise to an organization benefiting from a strengthening of that currency or asset. To a money market dealer, however, a long position is a surplus of borrowings 308 Foreign exchange and money markets taken in over money lent out, (which gives rise to a benefit if that currency weakens rather than strengthens). See Short . Managed floating Same as dirty floating. Mapping In the variance/covariance approach to VaR, the process of repre- senting a position in terms of other standardized instruments. Margin call A call by one party in a transaction for variation margin to be transferred by the other. Margin transfer The transfer of a margin call . Margin Initial margin is collateral placed by one party with a counterparty at the time of a deal, against the possibility that the market price will move against the first party, thereby leaving the counterparty with a credit risk. Variation margin is a payment made, or extra collateral transferred, subsequently from one party to the other because the market price has moved. Variation margin payment is either in effect a settlement of profit/loss (for example, in the case of a futures contract) or the reduction of credit exposure (for example, in the case of a repo). In a loan, margin is the extra interest above a benchmark (e.g. a margin of 0.5% over LIBOR ) required by a lender to compensate for the credit risk of that particular borrower. Market risk The risk that the value of a position falls due to changes in market rates or prices. Mark-to-market The process of revaluing a position at current market rates. Mean Average. Glossary 309 Mine ‘‘I buy the base currency.’’ For example, if someone who has asked for and received a price says ‘‘5 mine!’’ he means ‘‘I buy 5 million units of the base currency’’. See Yours . Model risk The risk that the computer model used to price and value an instru- ment is wrong. Modified duration A factor measuring the sensitivity of a position to changes in interest rates. Modified following The convention that if a value date in the future falls on a non- business day, the value date will be moved to the next following business day, unless this moves the value date to the next month, in which case the value date is moved back to the last previous business day. Money market Short-term market (generally up to 1 year) for financial instruments. See Capital market . Money-market basis An interest rate quoted on an ACT/360 basisissaidtobeona money-market basis. See Bond basis . Monte Carlo simulation A method of calculating VaR by generating a very large number of random prices, applying these to the current portfolio of instru- ments and measuring the net effect. See Historic VaR , Variance/co- variance . Multilateral netting Obligation netting between more than two parties. My risk If someone who has asked for a price says ‘‘my risk’’, he is acknowl- edging that the price may change before he has accepted it. National currency unit See Legacy currency . 310 Foreign exchange and money markets NDF See Non-deliverable forward . Negative skewness A greater probability of a large downward movement than of a large upward movement. Negative yield curve (Or inverted yield curve). A downward-sloping yield curve. See Posi- tive yield curve . Negotiable A security which can be bought and sold in a secondary market is negotiable. Net present value (Or NPV). The net present value of a series of cashflows is the sum of the present values of each cashflow (some or all of which may be negative). Netting Obligation netting is the payment, in the normal course of business, of one net amount from one party to another instead of a gross payment in each direction. Close-out netting allows, in the event of a default, the non-defaulting party to terminate all outstanding transactions and settle them with a single net payment or receipt. Nominal amount Same as face value of a security. Nominal rate A rate of interest as quoted, rather than the effective rate to which it is equivalent. Non-deliverable forward A forward outright where the two parties settle only the change in value between the forward rate dealt and the spot rate 2 working days before maturity, based on a notional principal amount. Glossary 311 Normal probability function A particular probability density, with the formula 1 √ 2 π e x 2 2 Normal yield curve (Or positive yield curve). An upward-sloping yield curve . See Nega- tive yield curve . Notional Contracts for differences require a notional principal amount on which settlement can be calculated. NPV See Net present value . O/N See Overnight . Obligation netting See Netting . Odd date See Broken date . Off If a market maker says ‘‘Off!’’ he means ‘‘The price that I last quoted is no longer valid’’. Off-balance sheet An instrument where the principal amount is either not transferred, or is transferred simultaneously in both directions. Offer (Or ask). In general, the price at which the dealer quoting a price is prepared to sell or lend. The offered price of a foreign exchange quotation is the rate at which the dealer will sell the base currency and buy the variable currency. The offered rate in a deposit quotation is the interest rate at which the dealer will lend the currency involved. The offered rate in a repo is the interest rate at which the dealer will lend the collateral and borrow the cash. See Bid . 312 Foreign exchange and money markets Off-market A rate which is not the current market rate. Open outcry Trading face-to-face on a physical exchange. Operational risk The risk of losses due to failures in the bank’s operations generally. Option forward See Time option . OTC See Over the counter . Outright An outright is the sale or purchase of one foreign currency against another for value on any date other than spot. See Spot , Swap , Forward , Short date . Over the counter (Or OTC). An OTC transaction is one dealt privately between any two parties, with all details agreed between them, as opposed to one dealtonanexchange–forexample,a forward deal as opposed to a futures contract. See Exchange-traded. Overborrowed A position in which a dealer’s liabilities (borrowings taken in) are of longer maturity than the assets (loans out). See Overlent . Overlent A position in which a dealer’s assets (loans out) are of longer maturity than the liabilities (borrowings taken in). See Overborrowed . Overnight (Or O/N or today/tomorrow). A deal from today until the next working day (’tomorrow’). Overnight limit The maximum size of a position which a dealer is allowed to take overnight. Glossary 313 Own funds A bank’s available capital and reserves for the purposes of capital adequacy rules. Par In foreign exchange, when the outright and spot exchange rates are equal, the forward swap is zero or par. When the price of a security is equal to the face value, usually expressed as 100, it is said to be trading at par. Par value See Parity . Parity The exchange rate for a currency against another currency or basket of currencies, considered by the government as its official fixed rate, central rate or target rate. Payee The person to whom something is payable (for example, a bill of exchange ). Payment versus payment (Or PvP). Method for the settlement of a FX transaction, whereby a payment from Bank A to Bank B is made only if, and at the same time as, the corresponding payment is made from Bank B to Bank A. Pips See Points . Points (Or pips). The last two decimal places in an exchange rate. For example, when USD/CHF is 1.7510/1.7520, the points are 10/20. See Big figure . Position risk Same as market risk, used particularly in capital adequacy calcula- tions. Positive yield curve See Normal yield curve . 314 Foreign exchange and money markets PPP See Purchasing power parity . Premium The amount by which a currency is more expensive, in terms of another currency, for future delivery than for spot, is the forward premium (in general, a reflection of interest rate differentials between two currencies). If an exchange rate is ‘at a premium’ (without spec- ifying to which of the two currencies this refers), this means in London (but generally not elsewhere) that the variable currency is at a premium. See Discount . Present value The amount of money which needs to be invested now to achieve a given amount in the future when interest is added. Hence, the value of future cashflow. See Time value of money , Future value . Primary market The primary market for a security refers to its original issue. See Secondary market . Probability density A description of how likely any one of a series of numbers is to occur. Probability distribution See Cumulative probability distribution . Produce To produce dollars (for example, via covered interest arbitrage) gener- ally means effectively to borrow dollars. Promissory note A written promise to pay. Public order member Amemberofa futures exchange able to enter into transactions on behalf of customers. Purchasing power parity The idea that a currency’s exchange rate must move, in the long term, to adjust for inflation differentials against other countries. See Fundamental equilibrium exchange rate . Glossary 315 PvP See Payment versus payment . Real effective exchange rate An effective exchange rate adjusted for inflation differentials bet- ween countries. Reciprocal rate An exchange rate quoted in such a way that the base currency and variable currency are reversed. Redeem A security is said to be redeemed when the principal is repaid. Registered security A security where ownership for the purpose of paying coupons and principal is determined by whoever is recorded centrally as the owner. There might or might not also be a physical piece of paper evidencing ownership. See Bearer security . Replacement risk The risk of losing an unrealized profit because the counterparty defaults. Repo (Or RP). Usually refers in particular to classic repo. Also used as a general term to include classic repos, buy/sell-backs and securities lending. Repurchase agreement See Repo . Reputational risk The risk of damage to a bank’s reputation. Revaluation An official one-off increase in the value of a currency in terms of other currencies. See Devaluation . Reverse repo (Or reverse). The opposite of a repo. 316 Foreign exchange and money markets Reverse See Reverse repo . Risk asset ratio The ratio of a bank’s own funds to its risk-weighted assets. Riskmetrics A variance/covariance model for VaR , made available by JP Morgan. Risk-weighted assets The money which a bank has put at risk for the purposes of capital adequacy rules. Rollover See Tom-next . Also refers to renewal of a loan. RP See Repo. S/N See Spot-next . S/W See spot-a-week . SAFE See Synthetic agreement for forward exchange. SDR See Special drawing right . Secondary market The market for buying and selling a security after it has been issued. See Primary market . Secured Collateralized. Security A financial asset sold initially for cash by a borrowing organization (the issuer). The security is often negotiable and usually has a maturity date when it is redeemed . Same as collateral. Glossary 317 Sell/buy-back Simultaneous spot sale and forward purchase of something, with the forward price calculated to achieve an effect equivalent to a classic repo . Serial months Additional futures delivery months added to the regular cycle, so that the three nearest possible months are always available. Settlement risk The risk that the counterparty does not deliver its side of the deal after we have irrevocably paid or delivered our side. Short date A deal for value on a date other than spot but less than one month after spot. Short A short position is a surplus of sales over purchases of a given currency or asset, or a situation which naturally gives rise to an organization benefiting from a weakening of that currency or asset. To a money market dealer, however, a short position is a surplus of money lent out over borrowings taken in (which gives rise to a benefit if that currency strengthens rather than weakens). See Long . Simple interest When interest on an investment is paid all at maturity or not rein- vested to earn interest-on-interest, the interest is said to be simple. See Compound interest . Special drawing right (Or SDR). The artificial basket currency of the IMF. Specific risk In measuring position risk for capital adequacy purposes, the risk arising from the issuer of a particular security held by the bank. See General risk . Speculation A deal undertaken because the dealer expects prices to move in his favor, as opposed to a hedge or arbitrage. 318 Foreign exchange and money markets Spot A deal to be settled on the customary value date for that particular market. In the foreign exchange market, this is for value in 2 working days’ time. Spot-a-week (Or S/W). A transaction from spot until a week later. Spot-next (Or S/N). A transaction from spot until the next working day. Spread The difference between the bid and offer prices in a quotation. A strategy in which a particular instrument is purchased and a similar instrument is sold, such as a futures spread, in which one futures contract is purchased and another is sold. Square A position in which sales exactly match purchases, or in which assets exactly match liabilities. See Long , Short . Standard deviation A measure of how spread out a series of numbers is around its mean. STIR futures Short-term interest rate futures contract. Stop-loss A price or rate which, if touched in the market, will trigger the closing of a position in order to avoid any further loss. See take profit . STP See Straight-through processing . Straight-through processing (Or STP). The computerization of operational tasks in such a way that each process feeds automatically to the next. Strip Astripof FRAs is a series of FRAs covering consecutive periods, which together create the effect of a longer-term instrument (for example, Glossary 319 4 consecutive 3-month FRAs have an effect similar to a 1 year FRA). Astripof futures is similar. Swap A foreign exchange swap is the purchase of one currency against another for delivery on one date, with a simultaneous sale to reverse the transaction on another value date. SWIFT Society for Worldwide Interbank Financial Transfers, the system for international payments between banks. Synthetic agreement for forward exchange (or SAFE). A generic term for ERAsand FXAs. System risk The risk of losses due to failures in the bank’s computer systems. Systemic risk The risk of failure in the entire payment clearing system or banking system of which the bank is a part. T/N See Tom-next . Tail The exposure to interest rates over a forward-forward period arising from a mismatched position (such as a 2-month borrowing against a 3-month loan). A forward foreign exchange dealer’s exposure to spot movements. The extreme left- and right-hand ends of a probability distribution. Take-profit A price or rate which, if touched in the market, will trigger the closing of a position in order to ensure that an existing profit is captured. See Stop-loss . Technical analysis (Or charting). An approach to forecasting which considers only past price movements. See Fundamental forecasting . 320 Foreign exchange and money markets Tenor The tenor of a security is the length of time until its maturity. Term The time between the beginning and end of a deal or investment. Term deposit Same as fixed deposit. Tick The minimum allowed price movement on a futures contract. Tick value The value of a one tick price change on one futures contract. Time deposit Same as fixed deposit. Time option (Or option forward). A forward currency deal in which the value date is set to be within a period rather than on a particular day. The customer sets the exact date 2 working days before settlement. Time value of money The concept that a future cashflow can be valued as the amount of money which it is necessary to invest now in order to achieve that cashflow in the future. See Present value , Future value . Today–tomorrow See Overnight . Tom-next (Or T/N or rollover). A transaction from the next working day (‘tomorrow’) until the working day after (‘next’ day – i.e. spot in the foreign exchange market.) Trading book For the purposes of capital adequacy, that part of a bank’s business which broadly involves its trading department. Transaction exposure The risk to currency movements arising from a definite, or closely forecast, transaction. Glossary 321 Translation exposure (Or balance sheet exposure). The risk to currency movements arising from an asset or liability on the balance sheet which is denominated in a foreign currency. Treasury bill A short-term security issued by a government, generally with a zero coupon . True yield The yield which is equivalent to the quoted discount rate (for a US or UK treasury bill, for example). Two-way A two-way price includes both bid and offer sides of the price. Under reference If a market-maker or his broker says that a price he has quoted is ‘‘under reference’’, he means that the price must be reconfirmed before a counterparty can deal on it. Underlying The underlying of a futures contract is the commodity or financial instrument on which the contract depends. US-style repo Same as classic repo. Value at risk (Or VaR). The maximum potential loss which an organization might suffer on its positions over a given time period, estimated within a given confidence level. Value basis The theoretical futures price, less the actual futures price. Value date (Or settlement date or maturity date). The date on which a deal is to be consummated. VaR See Value-at-risk . 322 Foreign exchange and money markets Variable currency (Or counter currency). Exchange rates are quoted in terms of the number of units of one currency (the variable or counter currency) which corresponds to 1 unit of the other currency (the base currency ). Variance The square of the standard deviation of a series of numbers. Variance/covariance A method of calculating VaR which applies assumed variances and covariances to a probability distribution which is generally taken as normal. See Historic VaR , Monte Carlo simulation . Variation margin See Margin . Yard One American billion – i.e. 1,000,000,000. Yield The interest rate which can be earned on an investment, currently quoted by the market or implied by the current market price for the investment – as opposed to the coupon paid by an issuer on a security, which is based on the coupon rate and the face value. Yield curve A graph showing the current interest rate for each maturity. Yours ‘‘I sell the base currency’’. For example, if someone who has asked for and received a price says ‘‘5 yours!’’, he means ‘‘I sell 5 million units of the base currency’’. See Mine . Zero-coupon A zero-coupon security is one that does not pay a coupon. Its price is correspondingly less to compensate for this. Index Acceptor, 34, 291 Accrued coupon, 44, 291 ACT/360, 9–11, 12, 291 ACT/365, 9–11, 12, 291 Adjustable peg system, 184, 291 Appreciation, 292 Arbitrage, 4, 26, 88, 145, 292 covered interest arbitrage, 150, 161–7, 283, 297 Around par (A/P), 116, 292 Back office, 209, 292 Backtesting, 224, 292 Balance sheet exposure, 231 Bank for International Settlements (BIS), 224, 294 Bank risk management, 195–229 business risk, 210–11 capital adequacy requirements, 224–9 future developments, 229 own funds, 225 risk asset ratio, 224–5, 316 risk-weighted assets, 225–9 credit risk, 201–7, 298 controls, 203–4 netting, 204–7, 310 fraud, 209 legal and regulatory risk, 210 market risk, 195–201, 308 basis risk, 197–8 controls, 199–201 foreign exchange, 196 gap analysis, 200–1 interest rates, 196–7 limits, 199–200 liquidity risk, 198–9 risk measurement, 199 operational risk, 207–9, 312 controls, 209 segregation of responsibilities, 209 systemic risk, 210 value at risk (VaR), 211–24, 321 approaches, 219–22 BIS recommendations, 223–4 overview, 218–19 problems with calculations, 222 stress-testing, 222–3 Bankers’ acceptance (BA), 34, 292 Banking book, 225, 292 Base currency, 94–5, 292 Basis, 74, 293 bond basis, 294 money-market basis, 309 value basis, 74, 321 Basis point, 30–1, 293 Basis risk, 74, 197–8, 293 Basket arrangements, 184, 293 Bear spread, 293 Bearer security, 29, 293 Bid price, 7, 96–8, 293 Big figure, 98, 293 Bilateral netting, 293 Bill of exchange, 25, 34, 294 Bond basis, 294 Bond yield in last coupon period, 43–4 Bond-equivalent yield, US Treasury bill, 56–7, 278 Borrowing: cost of, 14–15 forward-forwards, 26, 60 break-even, 62–3 pricing, 61–2 Broken dates, 5, 17, 294 BUBOR, 30 Bull spread, 294 Business risk, 210–11 Buy/sell-back, 294 324 Index Cable, 98, 294 Calendar spread, 86–7, 294 Capital adequacy, 294 requirements, 224–9 future developments, 229 own funds, 225 risk asset ratio, 224–5, 316 risk-weighted assets, 225–9 Capital Adequacy Directives (CAD), 224, 294 Capital markets, 25, 295 Cash market, 6–7, 295 Certificate of deposit (CD), 25, 29, 31–2, 276, 295 floating rate (FRCD), 303 paying more than one coupon, 46–8, 276 price of, 39–43 Charting, 188 Cherry-picking, 205, 295 Chicago Mercantile Exchange (CME), 71, 295 Choice price, 98, 295 Clean deposit, 31, 296 Clean price, 44, 296 Clearing houses, 72–3, 202 Collateral, 296 Commercial paper (CP), 25, 33, 296 Competitive exposure, 232–3, 296 Compound interest, 8, 296 Continuous real-time linked settlement (CLS), 207, 296–7 Contract date, 297 Contracts for differences, 6–7, 207, 297 Convertible currency, 297 Corporate risk management, 230–50 analysis of risks, 230–6 economic exposure, 232–6 transaction exposure, 230–1 translation exposures, 231–2 currency exposure reporting, 246–8 internal reporting within the finance department, 247 reporting from divisions, 246–7 reporting from finance department to division, 247–8 forecasts, 242, 244–6 forward premiums and discounts, 245–6 range forecasts, 244–5 policy establishment, 236–42 amount of cover, 239–40 instruments, 241–2 responsibility, 242 speculation, 237–9 what to manage, 237 target setting, 242–4 commercial target rates, 242–3 short-term dealing targets, 243–4 treasury management success evaluation, 248–9 Correlation, 213–15 Correlation coefficient, 214–15, 297 Cost of borrowing, 14–15 Counterparty risk, 201–2, 203, 226–8, 297 factor for transaction type, 226–8 risk weighting for counterparty, 226 Coupon, 29, 39–41, 297 accrued coupon, 44, 291 CDs paying more than one coupon, 46–8 Covariance, 213–15, 297 Cover, 297 amount of, 239–40 Covered interest arbitrage, 150, 161–7, 283, 297 Crawling peg system, 184, 298 Credit risk, 201–7, 298 controls, 203–4 netting, 204–7, 310 contracts for differences, 207 DvP and PvP, 206–7 systems, 206 Cross-rates, 95–6, 298 forwards, 133–6, 282 spot transactions, 95–6, 101–4 Cumulative probability distribution, 217, 298 Currency codes, 3, 284–90 Currency relationships, 182–92 analysing currency movements, 188–92 effective exchange rates, 192 forward rate, 192 fundamental analysis, 188–92 long-term view, 189–90 medium-term view, 190–1 Index 325 short-term influences, 191–2 technical analysis, 188 currency blocs, 182–3 European Monetary Union, 185–7 exchange rate regimes, 183–4 Currency risk, 196, 228 Daylight limit, 200, 298 Delivery versus payment (DvP) system, 207, 298 Deposit, 298 Depreciation, 298 Derivative, 298 Devaluation, 299 Direct exchange rate quotation, 299 Dirty floating system, 184, 299 Dirty price, 44, 299 Discount, 29, 114–17, 299 forecasting, 245–6 Discount instruments, 29, 50–2, 277–8, 299 Discount rate, 29, 52–5, 299 Discounting, 14, 29 Drawee, 34, 299 Drawer, 34, 299 Dual exchange rates, 184, 300 Earnings at risk, 218 Economic exposure, 232–6, 300 hedging, 235–6 Effective date, 300 Effective exchange rate, 192, 300 real effective exchange rate, 192, 315 Effective interest rate, 20–1, 300 Norwegian Treasury bills, 57–8 Eligible bill, 28, 34, 300 End-end dealing, 5, 300 Equivalent interest rates, 19–20, 275, 301 EURIBOR, 30, 69–70, 301 Euro, 186, 301 Eurocurrency, 7, 301 Euromarket, 301 European Central Bank (ECB), 186 European exchange rate mechanism (ERM), 184, 185, 302 ERMII, 187 European Monetary Institute (EMI), 186 European monetary system (EMS), 185–6, 301 European Monetary Union, 185–7, 301 EMU currencies, 186–7 euro and, 186 Exchange controls, 301 Exchange rate agreement (ERA), 141–4, 282–3, 302 Exchange rate mechanism (ERM), see European exchange rate mechanism Exchange rates: effective exchange rate, 192 real effective exchange rate, 192, 315 forward outright exchange rate, 192 Fundamental Equilibrium Exchange Rate (FEER), 190 regimes, 183–4 basket arrangements, 184 crawling peg/adjustable peg, 184 dual rates, 184 fixed-rate regime, 183 floating-rate regime, 183–4 Exchange-traded instruments, 302 Face value, 29, 302 Figure, 302 Fixed deposit, 25, 31, 36–7, 275–6, 302 breaking, 44–6 quoting for fixed deposits with delayed interest settlement, 37 Fixed exchange rate regime, 183, 302 Fixed interest rate, 30 Flat yield curve, 27, 302 Floating exchange rate regime, 183–4, 303 Floating interest rate, 30, 303 Floating rate CD (FRCD), 303 Floating-rate note, 303 Forecasts, 242, 244–6 forward premiums and discounts, 245–6 range forecasts, 244–5 Forward, 303 Forward exchange agreement (FXA), 141–4, 282, 303 326 Index Forward outrights, 107–11, 132, 144–5, 280–1 cross-rate calculation, 133, 282 exchange rate, 192 hedging, 154–5, 179–80 long dates, 139–41, 282 non-deliverable forwards (NDFs), 136–8, 207, 310 prices, 108–11 short dates, 123–7 time options, 138–9, 144, 320 Forward rate agreement (FRA), 26, 60–1, 63–8, 303 applications of, 77–88 arbitrage, 88 calendar spread, 86–7 cross-market spread, 87 hedging, 77–84, 156–61 quoting for fixed deposits with delayed interest settlement, 84–5 speculation, 85–6 strip trading, 86 creation in one currency from an FRA in another currency, 168–71, 283 periods longer than one year, 67–8 pricing, 64–5 rate, 278 settlement, 65–7, 75 vs futures contracts, 75 Forward swaps, 111–23, 144–5, 280–1 covered interest arbitrage, 150, 161–7 cross-rate calculation, 133–5, 282 discounts and premiums, 114–17 forecasting, 245–6 forward-forwards, 127–31 hedging, 150–4, 173–9 historic rate rollovers, 121–3, 305 long dates, 139–41 short dates, 123–7, 134–5 valuation of a swap book, 121 Forward value date, 4–5 Forward-forwards, 303 borrowing, 26, 60 break-even, 62–3 pricing, 61–2 hedging, 155–61, 283 rates, 278 swaps, 127–31, 132, 145 cross-rate calculation, 135 FRABBA, 206 Fraud, 209 Front office, 209, 304 Fundamental analysis, 188–92, 304 effective exchange rates, 192 forward rate, 192 long-term view, 189–90 medium-term view, 190–1 short-term influences, 191–2 Fundamental Equilibrium Exchange Rate (FEER), 190, 304 Funds, 304 Fungible, 73, 304 Future value, 304 Futures contracts, 5, 26, 61, 68–74, 304 applications of, 77–88 arbitrage, 88 calendar spread, 86–7 cross-market spread, 87 hedging, 77–84, 155–61 quoting for fixed deposits with delayed interest settlement, 84–5 speculation, 85–6 strip trading, 86 mechanics of, 72–4 basis, 74 clearing, 72–3 closing out, 73–4 limit up/down, 74 margin requirements, 73 market participants, 72 open outcry vs screen-trading, 72 pricing, 69–72 short-term interest rate (STIR) futures, 68, 70, 279, 318 underlying, 321 vs forward rate agreements, 75 Gap analysis, 199, 200–1, 304 General risk, 229, 305 GMRA (Global Master Repo Agreement), 206, 305 Hedging, 4, 77–84, 144–5, 305 an FRA position with futures, 80–4 economic exposure, 235–6 Index 327 foreign exchange forward-forwards, with FRAs or futures, 155–61, 283 foreign exchange forwards, using borrowings and deposits, 150–5 hedging a forward outright, 154–5, 179–80 hedging a forward swap, 150–4, 173–9 translation exposures, 231–2 See also Corporate risk management Herstatt risk, 202, 305 Historic price movements, 221–2, 305 Historic rate rollover, 121–3, 305 Hit, 98, 305 IFEMA (International Foreign Exchange Master Agreement), 205, 305 In-between months, 5 Indirect exchange rate quotation, 305 Initial margin, 73, 202 Interbank transaction, 306 Interest calculations, 8–9 compounding, see Stripping day/year conventions, 9–12, 271–3, 274 conversion between, 12–13, 274 paying interest with different frequencies, 18–20 Interest rates, 8 bid rate, 30 compounding, see Stripping discount rate, 14, 29, 52–5 effective rate, 20–1, 300 Norwegian Treasury bills, 57–8 equivalent rate, 19–20, 275, 301 fixed rate, 30 floating rate, 30, 303 nominal rate, 19 offer rate, 30 risks, 196–7 yield curve, 26–8, 76–7 influences, 28 International Monetary Market (IMM), 71, 306 Interpolation, 17–18, 275, 306 Intervention, 306 Inverted yield curve, 27 ISDA (International Swaps and Derivatives Association), 205–6, 306 Judgmental forecasting, See Fundamental analysis Large exposure risk, 228, 306 Legacy currency, 187, 306 Legal risk, 210, 306 LIBID, 30 LIBOR, 30, 63–8, 307 Liffe (London International Financial Futures and Options Exchange), 69–70, 72, 307 LIMEAN, 30, 64 Limits, 199–200, 203 Liquid market, 307 Liquidity, 27–8 Liquidity risk, 198–9, 307 London Clearing House (LCH), 72 Long position, 7, 98, 307–8 Long-dated forwards, 139–41, 282 Managed floating system, 184, 308 Mapping, 220, 308 Margin, 73, 202, 308 Margin call, 308 Margin transfer, 308 Market makers, 93 Market risk, see Bank risk management Marking to market, 73, 100, 199, 308 Mean, 211 Mine, 309 Model risk, 199, 309 Modified duration, 199, 309 Modified following convention, 5, 309 Money markets, 25, 309 instruments, 25–6, 31–5 Money-market basis, 309 Monte Carlo simulation, 220–1, 309 Multilateral netting, 309 My risk, 98–9, 309 Negative skewness, 222, 310 Negative yield curve, 27, 310 Negotiable security, 28–9, 310 Net present value (NPV), 121, 310 328 Index Netting, 204–7, 310 bilateral, 293 contracts for differences, 207 DvP and PvP, 206–7 multilateral, 309 systems, 206 Nominal amount, 29, 310 Nominal rate, 310 Non-deliverable forwards (NDFs), 136–8, 207, 310 Normal probability function, 217–18, 311 Normal yield curve, 27, 311 Norwegian Treasury bills, 57–8, 278 Notional principal, 29, 311 Odd dates, 5, 17 Off, 99, 311 Off-balance sheet, 311 Off-market, 312 Offer price, 7, 96–8, 311 Open outcry dealing, 72, 312 Operational risk, 207–9, 312 controls, 209 Option forward, 138 Outright, 107, 312 See also Forward outrights Over the counter (OTC), 68, 312 Overborrowed, 62, 312 Overlent, 62, 312 Overnight limit, 200, 312 Overnight (O/N) swaps, 6, 123–7, 312 Own funds, 313 Par, 116, 313 Parity, 313 Payee, 313 Payment versus payment (PvP) system, 206–7, 313 Points, 97, 313 Position limits, 199 Position risk, 228–9, 313 Position-keeping, 37–9 spot transactions, 99–100 Positive yield curve, 27 Premiums, 114–17, 314 forecasting, 245–6 Present value, 13–14, 274, 314 net present value (NPV), 121, 310 Primary market, 29, 314 Probability density, 215–17, 314 Probability distribution, 217–18, 314
Produce, 314 Promissory note, 314 Public order member, 314 Purchasing power parity (PPP), 189–90, 314 Real effective exchange rate, 192, 315 Reciprocal rate, 101, 315 Redeem, 315 Registered security, 29, 315 Regulatory risk, 210 Replacement risk, 202, 203, 315 Repo, 34–5, 295–6, 315 Repurchase agreement, 26, 35 Reputational risk, 315 Revaluation, 315 Risk asset ratio, 224–5, 316 Risk management, See Bank risk management; Corporate risk management Risk measurement, 199 Risk-weighted assets, 224, 225–9, 316 counterparty risk, 226–8 factor for transaction type, 226–8 risk weighting for counterparty, 226 currency risk, 228 large exposure risk, 228 position risk, 228–9, 313 settlement risk, 229 trading book/general banking book, 225–6 Riskmetrics, 220, 316 Rollover, 316 historic rate rollover, 121–3, 305 SAFEBBA, 206 Screen-trading, 72 SDR (special drawing right) currency, 184 Secondary market, 29, 316 Security, 28–9, 296, 316 bearer, 29, 293 negotiable, 28–9, 310 registered, 29, 315 zero-coupon, 322 Sell/buy-back, 317 Index 329 Serial months, 71, 317 Settlement risk, 202, 203, 229, 317 Short dates, 6, 107, 123–7, 317 Short position, 7, 98, 317 Short-term interest rate (STIR) futures, 68, 70, 279, 318 Simple interest, 8–9, 317 Special drawing right, 317 Specific risk, 317 Speculation, 3–4, 145, 317 company policy, 237–9 forward rate agreements, 85–6 futures contracts, 85–6 spot transactions, 93 Spot transactions, 93–105, 318 market environment, 105 position-keeping, 99–100 quoting of spot rates, 94–9 base currency and variable currency, 94–5 bid and offer rates, 96–8 cross-rates, 95–6, 101–4 reciprocal rates, 101, 315 rate calculation, 279–80 uses of, 93 value date, 4, 94 Spot-a-week (S/W) swaps, 6, 123, 318 Spot-next (S/N) swaps, 6, 123–7, 318 Spread, 7, 97, 318 bear spread, 293 bull spread, 294 calendar spread, 86–7, 294 Square position, 7, 98, 318 Standard deviation, 211–13, 318 STIBOR, 30 Stop loss levels, 200, 318 Straight-through processing (STP), 209, 318 Stress-testing, 222–3 Stripping, 16–17, 86, 275, 318–19 Swaps, 319 See also Forward swaps Swedish Treasury bills, 11 SWIFT (Society for Worldwide Interbank Financial Transfers), 319 currency codes, 3, 284–90 Synthetic agreements for forward exchange (SAFEs), 141–4, 207, 319 advantages of, 142–4 settlement amounts, 282–3 System risk, 207, 319 Systemic risk, 210, 319 Tail, 196, 319 Take profit levels, 200, 319 Taking a position, See Position-keeping Technical analysis, 188, 319 Tenor, 320 Term, 320 Term deposit, 31, 320 Tick, 320 Tick value, 320 Time deposit, 31, 320 Time options, 138–9, 144, 282, 320 Time value of money, 320 Tom-next (T/N) swaps, 6, 123–7, 320 Trading book, 225, 320 Transaction exposure, 230–1, 320 Translation exposures, 231–2, 321 hedging, 231–2 Treasury bill (T-bill), 25, 27–8, 32–3, 321 Norwegian, 57–8, 278 Swedish, 11 US, bond-equivalent yields, 56–7, 278 True yield, 53, 321 Two-way, 321 Under reference, 98, 321 Underlying, 70–1, 321 US Treasury bills, 56–7 bond-equivalent yields, 56–7, 278 Value at risk (VaR), 199, 211–24, 321 approaches, 219–22 historic, 221–2, 305 Monte Carlo simulation, 220–1, 309 variance/covariance, 219–20 BIS recommendations, 223–4 overview, 218–19 problems with calculations, 222 statistics, 211–18 stress-testing, 222–3 Value basis, 74, 321 Value dates, 4–6, 123, 321 330 Index Variable currency, 94–5, 322 Variance, 211–13, 322 Variance/covariance approach, 219–20, 222, 322 Variation margin, 73, 202 Yard, 98, 322 Yield, 29, 53, 275, 322 calculation, 14–15 true yield, 53, 321 Yield curve, 26–8, 76–7, 322 flat, 27, 302 influences, 28 negative, 27, 310 normal, 27, 311 Yours, 322 Zero-coupon security, 322 SECURITIES INSTITUTE Qualifications Membership Securities Institute Diploma - the professional qualification for practitioners leading to Fellowship of the Institute Professionalism through a progressive structure of recognised designations: SIAff, MSI, FSI Investment Advice Certificate - the benchmark examination for financial advisors Over 17,000 students, affiliates, members and fellows SFA Registered Persons Examination - the benchmark examinations for employees of SFA regulated firms Free membership events , providing education and networking opportunities Examination qualification programmes Investment Administration Qualification - the benchmark examination for adminis- tration, operations and IT staff Continuing Learning opportunities through a wide range of courses and conferences with discounts available for members International Capital Markets Qualification - the introduc- tory qualification for overseas and emerging markets Training, Continuing Learning & Publications for the financial services industry The courses, seminars and publications we produce are researched and developed by working closely with market practitioners and employers to produce focussed, high quality and value-for-money training solutions that meet the needs of busy professionals. 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