Agio Premium or surcharge, mark-up. Surplus of forward price over spot price.
American option This type of option can be exercised at any time, i.e. not just on maturity date contrary to European options.
Arbitrage Exploiting price differences for identical securities on various submarkets by buying on the submarket with the lower price and selling on the market with the higher price.
At the money An option is “at the money” when the price of the underlying instrument is the same or very close to the strike price. In Foreign Exchange this term often replaces its actual meaning “at-the-money-forward” referring to the forward price being that of the strike.
Bear Market participant who believes in a falling market price.
Bid/ask spread Is the difference between bank’s buy and sell price, determined by the transaction costs of the trading service plus a profit margin.
Bond Security issued with a nominal value that pays a fixed rate of interest over a specific period. Bonds can be issued by private persons, institutions, companies and by the government and are generally rated by an independent agency to measure their financial standing.
Breakeven level The price a financial instrument has to reach in order to compensate the options purchaser for the paid premium, so that he makes neither a profit nor a loss. In the case of a call option, the breakeven level covers the strike price and the premium paid, in the case of a put option it is the strike price less the premium. The breakeven level is also described as a breakeven point or a minimum of absolute total cost.
Bretton Woods System Fixed exchange rate system introduced after the Second World War with bandwidths in which every member of the IMF fixed a certain parity for its currency against gold or the dollar and undertook to keep price fluctuations within a spread of +/- 1% of parity by interventions by the central banks.
Broken date Non-standard value date for a forward exchange transaction. Standard deadlines are 1 week, 2 weeks, 1,2,3,6 and 12 months.
Broker Intermediates financial market transactions for a commission.
Bull Market participant who believes in a rising market price.
Call money Overnight money; Money can be lent by banks for very short periods, which can be “called” daily: on the same day, at one day’s notice or at two day’s notice.
Call option Right to buy a specific amount of foreign exchange at an exchange rate or price fixed in advance, on the maturity date set in the contract by the options creator (option writer/seller) (=European option) cf. option.
Cash transactions Foreign exchange transactions where the fulfillment of (spot) mutual delivery commitments takes places at the latest two working days after conclusion (usually on second working day).
Central bank Issuing bank. Bank granted the right to issue bank notes, which acts as the monetary and credit policy authority of a currency area. Its other duties include: supplying the economy with money and credit, controlling domestic and foreign payment transactions, maintaining domestic and external monetary stability.
Charts Graphic representation of the development of foreign exchanges rates. Primarily used for short-term evaluation and forecasting of future exchange rate movement, cf. technical analysis.
Chooser cap Unlike a normal cap with, e.g. Ten caplets, the buyer only has a right to the payment of five freely selected caplets.
Collar With a collar, a cap is bought and a floor is sold or vice versa. In foreign exchange a similar strategy exists in and is termed a risk reversal.
Consumer price index The consumer price index (CPI) measures variations in price for consumer goods within a country over a period of time. It is based on a basket of items roughly equivalent to the consumption habits of the typical consumer.
Contingent Swaption The buyer of a swaption must only pay the premium when the swaption is in the money on maturity.
Credit risk Risk of inability or unwillingness to pay.
Cross rates Exchange rates which are not officially listed against the dollar.
Currency Term for the actual form of cash of a country, e.g. Swiss francs.
Currency overlay Process whereby the exchange rate risk of a portfolio is administered independently of remaining investment decisions.
Currency snake System of cooperation on currency policy established in 1972 between the countries, which were then members of the EC. The monetary system was replaced by the Eurpean Monetary Union (EMU) in 1979.
Delta Indicator showing the change in the value of an option if the price of the underlying instrument shifts by one unit. An at-the-money option has a delta of approx. 0.5. The delta rises towards 1, the deeper the option is in the money, and moves towards 0, the farther the option is out of the money.
Delta hedging Method of hedging exposure that arises out f writing of an option by selling or buying a share of the underlying instrument which corresponds to the delta.
Deposit money Also known as bank money or chequebook money: deposit account, current account and post office credits are convertible into cash at any time, but are generally used for cashless transactions.
Depreciation Rise in the exchange rate of a currency (Definition:domestic/foreign currency); takes place when there are free exchange rates on the FX market for the price in a domestic currency for a unit of foreign currency. If there are fixed exchange rates, the process is called “devaluation”, when the parity of the domestic currency is officially increased against the foreign currency (price of a unit of foreign currency, expressed in domestic currency).
Digital option The bearer/holder either receives nothing or a specific fixed sum on maturity.
Digits The last decimal places of a price listing are called “pips” in foreign exchange dealing. The smallest price change up or down (=1 point) is called “tick” in futures trading.
Discount The rate used to adjust spot to a forward date, refers to the case where the interest rate of the base currency is higher than that of the alternative currency. See also Premium.
Eurocapital market Euromarket for the international long-term bonds, Eurobonds.
Eurocredit market Euromarket for medium-term loans.
Eurocurrency International money market in Western Europe’s most important financial centres, mainly London, Luxembourg and Zurich, that exists in parallel to the national money markets.
Eurodollar Credit balances and receivables in USD held by institutions in the Euromarket.
European option In contrast to the American option, can only be exercised on the maturity date.
Exchange rate system Also exchange rate regime. Covers the exchange rate of all currencies that are formed by the same exchange rate policy principle. Currency prices are formed on the foreign exchange market by supply and demand, forming a system of free exchange rates. A system of fixed exchange rates arises by tying the currency unit to a reference parameter (e.g., gold, USD, ECU, etc.).
Exotic options Exotic options are standard options with additional features that allow a solution specially tailored to suit specific customer needs.
Expiration In options transactions, the last day on which an option can be exercised.
Financial futures Foreign exchange transactions where the fulfillment of mutual delivery commitments takes place later than the second working day after conclusion of the transaction.
Fiscal policy Fiscal policy deals with public finance, i.e., with all government activities that result in expenditure and income.
Fixed exchange rate Exchange rate fixed by the administration.
Fixed-term deposits Funds invested with a bank at a specific rate of interest for a term fixed in advance.
Fixing Setting the official rate, e.g., LIBOR fixing.
Flexible exchange rate Exchange rate left to the free play of supply and demand, i.e., market forces.
Floating 1. Formation of free exchange rates without intervention by the central bank. Rate formation takes place according to supply and demand on the foreign exchange market.
2. Dirty floating: Currency policy that basically recognises free exchange rate formation but tries to influence the exchange rate by more or less frequent intervention.
Floor Offers protection against falling interest rates.
Foreign Exchange Monetary claims made out in foreign currency and payable abroad (bank deposits, cheques, bills of exchange); does not include foreign coins and bank notes. Not to be confused with foreign cash.State control of all payment transactions and capital control transactions with foreign countries.Worldwide system of constant telphone, telegraph and electronic market communication between the foreign exchange managers of non-banks and foreign exchange traders at banks, and between foreign exchange traders; market where foreign exchange rates are set.
Forward In contrast to a futures contract, a non-standardised forward transaction specially tailored to customer needs. Forwards are not officially traded on the stock exchanges.
Forward rate agreement Two parties can cover themselves against future interest rate changes with forward rate agreements (also known as future rate agreement). They agree on an interest rate for a future period in a specific currency segment, and this rate applies to a sum, also agreed in advance. The risk and the final account are equal to the transfer of the interest difference on the sum agreed on conclusion of contract. Unlike futures, FRAs are not standardised and are offered in interbank dealings and not on stock exchanges.
Fundamental analysis Looks at the basic economic data of a market demand, to predict the future movement of the price traded product. Fundamental exchange rate analysis is based on economic and cyclical data from the relevant country, and provides longer-term exchange rate forecasts.
Futures contract Standardised set-term contract, officially traded on a stock exchange (CBOT, IMM, LIFFE, COMEX, NYMEX, Eurex). The contract comprises a set quantity of qualitatively defined goods or fixed amounts of financial instruments.
G7 (= Group of 7) Body of the economically most important industrial nations, which, in view of the global economic importance of its member countries, has set itself the goal of coordinating their national economic policy. Economic, currency and monetary policy goals are coordinated at the level of government, issuing bank, or other institution. The member states are: USA, France, Great Britain, Germany, Japan, Canada and Italy.
Gamma Change of delta with a marginal change in the price of the instrument underlying the option.
Gross Domestic Product(GDP) Total income earned nationally. Equal to the total of consumer expenditure of private households, government expenditure for goods and services, investment expenditure and net exports.
Hedge fund An actively managed investment portfolio that is only accessible to a limited group of investors and that pursues strategies not available to traditional investment funds, e.g., short strategies.
Hedge ratio The proportion of the underlying instrument or of options which has to be used to secure a seller’s/taker’s option. The hedge ratio is determined by the amount of the delta.
Hedging Securing an open position against possible loss from price changes by making an offsetting deal (e.g., financial futures).
IMF International Monetary Fund. Based on the treaty concluded by the Allies at Bretton Woods in 1944, the IMF began work in Washington in 1946. Its aim is to maintain stable currency conditions. The IMF supports countries that have balance of payment difficulties with loans.
IMM International Money Market.
Implied volatility Expected price change of an underlying security calculated from an option using an option valuation model.
Inflation Reduction of buying power of money, caused by sustained rise in prices.
Initial margin Starting margin, which has to be deposited by both the buyer aand the seller at the clearing house through the respective brokers or banks on conclusion of a financial futures deal.
Interbank dealings Trading between commercial banks.
Interest arbitrage The attempt to earn a profit from different interest rates for different terms and/or different instruments.
Interest parity Investments at home and abroad have equal value if the domestic interest rate is equal to the foreign interest rate plus the expected change in the exchange rate.
Intervention (on the foreign exchange market). Buying or selling the national currency by the central bank against foreign currency (usually USD), in order to support or weaken the exchange rate.
In the money An option is “in-the-money” in the following cases:
Call: Spot price> Strike price
Put: Spot price<Strike price
For the European option, the market
price is replaced by the forward price per option on maturity date.
Intrinsic value Difference between the strike price of an option and the forward price of the underlying instrument until maturity, if the option is in the money. The premium of an option comprises the current market value and the intrinsic value.
Knock-out cap If the interest rate on the fixing date of a caplet is above the outstrike, there is no payout on the caplet.
Leverage 1. Method by which an investment size is increased artificially to obtain increased profits (or losses).2. Expresses the disproportionate change in premium of an option, measured by the relative price shift of the underlying instrument.
LIBID London InterBank Bid Rate (abbr.). Interest rate at which banks in London are willing to accept monies short-term among themselves.
LIBOR London InterBank Offered Rate (abbr.). Interest rate that banks in London charge each other for short-term investments.
Limit option An additional feature of limit options is a threshold value, at which the option becomes valid or lapses.
Liquidity 1. The ability of a company to meet its financial obligations at any time.
2. Presence of liquid funds in an economy.
3. Possibility of implementing financial transactions without influencing the market.
Lombard rate Interest rate used when extending credit against a pledge on movable, easily sellable objects (goods or securities).
Margin 1. Spread between bid and offer price.
2. The margin of error to cover the price risk that the writer of an option, or the buyer of a forward or futures contract, has to pay or deposit, cf. initial margin.
3. Cf. valuation margin.
Markdown Discount of a forward price against the cash or spot price, i.e., the futures price is lower than the cash price. See also Discount and Premium.
Market maker Foreign exchange trader who offers buy and sell prices for foreign exchange, depending on supply and demand in the market, also carries out customer orders.
Middle market price Average of bid and offer prices.
Money market The market where supply and demand for short-term funds meet.
Money supply The amount of money in the economy according to various definitions, e.g., domestic cash and deposit money (“M1” or “narrow money”). Money supply is controlled by the countries’ central bank.
Offer price Price at which a bank is ready to sell foreign exchange or lend money.
Official listing A currency can be quoted either directly or indirectly. Direct official listing gives the equivalent value of a certain amount of foreign currency (usually in 100 or 1) in the domestic currency. Indirect market quotation is used less often. This values the domestic currency in the foreign currency units.
Offsetting Covering an open position (securities, foreign exchange or goods) by a corresponding deal.
Option Contractually agreed right to buy (=call) or sell(=put) a specific amount of a certain instrument at a previously agreed price (= European option) or up to a future date (= American option), cf. option writer.
Option writer/seller Party issuing an option (also called option seller). The option writer undertakes to guarantee the conditions of the option contract at the discretion of the buyer for the entire term of the option. He receives a premium for this, paid by the buyer of the option.
OTC Over-the-counter market. Unregulated securities trading, not tied to a time or place.
OTC trading OTC trading is distinguished from exchange trading. Unlike the latter it is not limited to a particular location and is conducted directly between traders, brokers and customers.
Out of the money An option is “out-of-the-money” in the following situations:
Call: Spot price < Strike price
Put: Spot price> Strike price
For the European option the market price is replaced by the forward price of the underlying instrument on the option maturity date.
Outright A foreign exchange purchase or sale on a set date that is not offset by a matching cash transaction, i.e., not covered by swaps.
Overnight Swap from settlement day to following working day, i.e., one day, or three days over the weekend.
Pip The smallest unit of an exchange rate listing with four digits behind the decimal point. To speed up communications, market makers often only show the last two digits, as the others only change when there are major movements in the exchange rate.
Plain vanilla Another term for standard option, traded on the stock exchange and not custom-made to customer’s requirements.
Premium 1. cf. premium and agio. The rate used to adjust spot to a forward date, refers to the case where the interest rate of the base currency is lower than that of the alternative currency.
2. Equivalent to the price of the option paid by the option buyer to the option writer.
Prime brokerage Special service provided by brokerage firm for investment companies, especially hedge funds. Prime brokerage offers customers non-standardised services such as the processing of very large volume transactions, securities lending and borrowing, etc.
Put option Opposite of call option.
Realignment Simultaneous and coordinated upward revaluation and devaluation of several countries’ currencies. The term was first used in December 1971 for the exchange rate adjustments by a number of countries carried out under the Smithsonian Agreement. Since then it has mainly been used for exchange rate adjustments (“appreciation” and “depreciation”) within the European Monetary Union.
Roll-over 1. Extension of a maturing foreign exchange transaction by conclusion of a swap transaction (e.g., tom/next swap).
2. Interest rate variability in relation to the applicable rates of the Euromarket (usually LIBOR) of a medium-term loan (roll-over credit).
Spot Cash transactions. Normally with settlement and two value dates.
Spot/next Swap transaction, with a normally valued cash side and a forward side due one day later.
Spread options Options with a yield consisting of the difference between two interest rates, in either the same or different currencies.
Stop-loss order Order to buy foreign exchange (in a short position) or sell it (in a long position), at worse rate than is currently in the market if the price rises above or falls below a certain limit. When the price reaches the set limit, the order is carried out at the next price. This can differ widely from the limit price, depending on the market position. This strategy is employed to either “stop loss” to limit losses should the trade move in an unfavourable direction or can be used to lock in a given profit if it goes in a favourable direction.
Strike price Price at which the option buyer has the right to buy (call option) or sell (put option) the underlying currency.
Strip Series of financial contracts with sequential maturities. Strips are normally bought for security when using Eurocurrency futures.
Swaption With a swaption, the buyer receives the right, but not the obligation, to undertake a swap transaction at a specific time and under conditions fixed in advance.
Swap transaction Purchase of a currency against another currency at a specific maturity and simultaneous redemption by the same contracting parties at another maturity. Normally this is a spot sale/purchase against a forward purchase/sale.
Tau Represents the change in value of an option when there is a 1% change in implicit volatility.
Technical analysis Looks at past movements in prices and volumes on a market – often using chart analysis- to forecast price movements in the traded goods. Technical exchange rate analysis is often used in professional trading for short-term exchange rate forecasts.
Theta This indicator expresses the change in price of an option over time (i.e., change in premium) per time unit. Mathematically, this is equal to the first derivative of the option premium with respect to time.
Tom/next Swap transaction with the cash side maturing on the working day following conclusion and forward side maturing on the following working day,i.e., on the normal cash value date.
Trade-weighted exchange rate The change in value of a currency is determined as an index by comparison to a basket of currencies. The currencies in the basket and their weighting are determined according to export ratios of the country whose currency is being valued in relation to its trading partners.
Trend A directional move or development of the underlying instrument.
Valuation margin Safety margin which the buyer of a forward or futures contract has to deposit if the initial margin is used up by price losses during the term of the futures transaction.
Vega Represents the change in value of an option when there is a 1% change in, e.g., from 10 to 11, not 10 to 10.1, cf. implicit volatility.
Volatility Extent of relative variation of a price from the mean.
Volatility value Equal to the value of an option if the intrinsic value is nil. This only reflects possible price changes of the underlying instrument, therefore the option could reach an intrinsic value at a later date.