Glossary

Anticipatory hedge: A transaction in which a hedger expects to make a transaction in the spot market at a future date and is attempting to protect against a change in the spot price by trading a derivative.

Bid-ask spread: The difference between the ask price or rate and the bid price or rate.

Credit risk: The risk that a party to an over-the-counter derivative contract will not pay as required.

Currency Futures Contract: Is an agreement between two parties in which one party agrees to buy the currency from another party at a later date at an exchange rate agreed upon today. It trades on a futures exchange and works essentially the same as any other type of futures contract.

Exercise price (strike price): The price at which an option permits its owner to buy or sell the underlying security, futures, or currency.

Financial engineering: The process of developing, designing, and implementing creative financial contracts, frequently involving derivatives, for the purpose of solving specific risk management problems.

Foreign currency futures: A futures contract providing for the purchase of a foreign currency.

Foreign currency option: An option providing for the purchase or sale of a foreign currency.

Forward contract: An agreement between two parties, a buyer and a seller, to buy an asset or currency at a later date at a fixed price.

Forward discount: The relationship between the spot and forward exchange rates of a foreign currency in which the forward rate of a currency is less than the spot rate.

Forward premium: The relationship between the spot and forward exchange rates of a foreign currency in whcih the forward rate of a currency is greater than the spot rate.

Hedge: A transaction in which an investor seeks to protect a position or anticipated postion in the spot market by using an opposite position in derivatives.

Hedge accounting: An accounting method in which the profit from a derivatives transaction is added to the profit from the asset it is used to hedge. The profit of the overall hedged position is then reported as one transaction.

Intial margin: The minimum amount of money that must be in an investment account on the day of a transaction. On futures accounts, the intial margin must be met on any day in which the opening balance starts off below the maintenance margin requirement.

In-the-money: A call (put) option in which the price of the asset or futures or the currency exchange rate exceeds 9is less than) the exercise price.

Long: A position involving the purchase of a security or derivative. It also refers to the person holding the long position.

Maintenance Margin: The minimum amount of money that must be kept in a margin account on any day other than the day of a transaction.

Option: A contract granting the right to buy or sell an asset, currency, or futures at a fixed price for a specific time period.

Option on Futures: An option to buy or sell a futures contract

Put: An option to sell an asset, currency, or future.

Risk aversion: The characteristic referring to an investor who dislikes risk and will not assume more risk without additional return

Risk preferences: An investor's feelings towards risk.

Risk premium: The additional return risk-adverse investors expect for assuming risk.

Risk-return trade-off: The concept in whcih additional risk must be accepted to increase expected returns.

Settlement price: The official price established by the clearing house at the end of each day for use in the daily settlement.

Short: A term used to refer to holding a short position or to the party holding the short position.

Speculation: Investments characterized by a high degree of risk and usually short holding periods.

Spot market: The market for assets that invloves the immediate sale and deleivery of the asset.

Spot price: The price of an asset in the spot market.