(See horizontal spread.)
Call
The action taken to pay the principal of bonds prior to the stated maturity date.
Call feature
The type of call option embedded in a callable security.
Call option
An option that gives the buyer the right, but not the obligation, to purchase (go "long") the underlying asset at the specified (strike) price on or before a specified date.
Call premium
A dollar amount paid as a penalty or premium by an issuer who exercises the right to redeem securities prior to the maturity date. The premium is usually expressed as a percentage of the principal. A criterion used to search for a group of bonds meeting defined qualities.
Call protection
A feature that provides assurance to an investor that early or unscheduled redemption of a particular security will not occur due to a decline in interest rates.
Call risk
For a REMIC, the risk that declining interest rates may accelerate mortgage loan prepayment speeds, causing an investor's principal to be returned sooner than expected, thus affecting expected cash flows and the yield on the security. As a consequence, investors may have to reinvest their principal at a lower rate of interest. See Reinvestment risk.
Callable bond
A bond that permits the issuer to redeem it before maturity on specified dates at specified prices.
Callable debt
A debt security whose issuer has the right to redeem the security prior to its stated maturity date at a price established at the time of issuance, on or after a specified date. Fannie Mae's callable debt securities typically become subject to call any time after a specified date and are always redeemed at par.
Callable security
A security that the issuer has the right to redeem prior to maturity.
Cancel(ing) order
An order that deletes a customer's previous order.
Cap
The maximum rate of interest that can be paid on a floating-rate security, adjustable-rate security, or mortgage loan.
Capitalization rate
The rate at which net operating income is discounted to determine the value of a property. It can be viewed as the market's required "yield" of owning a property.
Carrying charge
The cost of storage space, insurance, and finance charges incurred by holding physical commodities such as grains and metals. In interest rate futures markets, it refers to the differential between the yield on a cash instrument and the cost of funds necessary to buy that instrument. Also referred to as "cost of carry" or "carry."
Carryover
Grain and oilseed commodities not consumed during the marketing year and remaining in storage at year's end. These stocks are "carried over" into the next marketing year and added to the stocks produced during that crop year.
Cash commodity
An actual physical commodity someone is buying or selling; e.g., soybeans, corn, gold, silver, Treasury bonds, etc. Also referred to as actuals.
Cash contract
A sales agreement for either immediate or future delivery of the actual product.
Cash market
A place where people buy and sell actual commodities; i.e., grain elevator, bank, etc. Also called the spot market. See also forward contract and futures contract.
Cash settlement
Transactions generally involving index-based futures contracts that are settled in cash based on the actual value of the index on the last trading day, in contrast to those that specify the delivery of a commodity or financial instrument.
CERCLA
Comprehensive Environmental Response, Compensation and Liability Act of 1980. It discusses the potential liability for environmental problems.
Certificate of Deposit (CD)
Negotiable certificates issued by commercial banks with maturities that vary from a few weeks to several years. The bank agrees to pay a fixed interest rate that is based on the money market. CD's are also available as nonnegotiable bank savings deposits with specified maturities.
Certificate of Ownership (CO)
A document issued to shareholders by a trustee of a unit investment trust to show proof of ownership.
Charge-off
The portion of principal and interest due on a loan that is written off when a loan is deemed to be un-collectible.
Charting
The use of charts to analyze market behavior and anticipate future price movements. Those who use charting as a trading method plot such factors as high, low, and settlement prices; average price movements; volume; and open interest. Two basic price charts are bar charts and point-and-figure charts. Anticipating future price movement using historical prices, trading volume, open interest and other trading data to study price patterns.
Cheap
Colloquialism implying that a commodity is under priced.
Cheapest to deliver
A method to determine which particular cash debt instrument is most profitable to deliver against a futures contract.
Chicago Board of Trade (CBOT)
An exchange where grain, gold, and Treasury Bond futures and options are traded.
Class
A bond represents the right to certain payments on the underlying collateral. In REMIC, the issuer pays interest on the bonds on specified dates and redeems the bonds at maturity or on a call date. (See bond)
Clear
The process by which a clearinghouse maintains records of all trades and settles margin flow on a daily mark-to-market basis for its clearing members.
Clearing corporation
An independent corporation that settles all trades made at the Chicago Board of Trade. It acts as a guarantor for all trades cleared by it, reconciles all clearing member firm accounts each day to ensure that all gains have been credited and all losses have been collected, and sets and adjusts clearing member firm margins for changing market conditions.
Clearing house funds
Funds in the form of checks that are transferred between banks through the Federal Reserve System and require three days to clear.
Clearing margin
Financial safeguards to ensure that clearing members (usually companies or corporations) fulfill their obligations to oversee customer margin accounts. Clearing margins are distinct from customer margins that individual buyers and sellers of futures and options contracts are required to deposit with brokers. See Customer Margin. Margins are determined on the basis of market risk and contract value. Also referred to as performance-bond margin.
Clearing member
A member of an exchange clearinghouse. Memberships in clearing organizations are usually held by companies. Clearing members are responsible for the financial commitments of customers that clear through their firm.
Clearing house
An agency or separate corporation of a futures exchange that is responsible for settling trading accounts, clearing trades, collecting and maintaining margin monies, regulating delivery, and reporting trading data. Clearinghouses act as third parties to all futures and options contracts-acting as a buyer to every clearing member seller and a seller to every clearing member buyer.
Close-out
A procedure that allows dealers who have bought securities but have not yet received them to take action to complete the transaction.
Closed-end investment company
An investment company created with a fixed number of shares that are then traded as listed securities on a stock exchange. After the initial offering, existing shares can only be bought from existing shareholders.
The last price paid for a commodity on any trading day. The exchange clearinghouse determines a firm's net gains or losses, margin requirements, and the next day's price limits, based on each futures and options contract settlement price. If there is a closing range of prices, the settlement price is determined by averaging those prices. Also referred to as "settle price."
Closing quotation
A market maker's final bid and asked prices for an issue at the end of the business day.
Closing range
A range of prices at which buy and sell transactions took place during the market close.
Collar
A combination of upper and lower limits (cap and floor, respectively) on the interest rate of a floating-rate security.
Collateral
Assets pledged by a borrower until a loan is repaid. These assets are subject to seizure if the loan is in default.
Collateralized Mortgage Obligation (CMO)
Bond backed by a pool of mortgage pass-through securities or mortgage loans.
Commercial Mortgage-Backed Securities (CMBS)
Securities collateralized by loans on commercial real estate.
Commercial paper
Commercial paper is an unsecured, non-interest bearing, short-term obligation, priced at a discount. Typical maturities on commercial paper are from 3 to 270 days; maturities longer than that are rare because the issue would then have to be registered with the SEC.
Commission
A fee paid to a dealer when the dealer acts as an agent in a securities transaction. The dealer does not receive a commission if he/she is acting as a principal in the trade.
Commission fee
A fee charged by a broker for executing a transaction. Also referred to as brokerage fee.
An individual or organization that solicits or accepts orders to buy or sell futures contracts or options on futures and accepts money or other assets from customers to support such orders. Also referred to as "wire house."
Committee on Uniform Security Identification Procedures (CUSIP)
Committee established under the auspices of the American Bankers Association to develop a uniform method of identifying municipal, U.S. government, and corporate securities. The committee established a unique 9-digit identification number, called the CUSIP number.
Commodity
An article of commerce or a product that can be used for commerce. In a narrow sense, products traded on an authorized commodity exchange. Types of commodities include agricultural products, metals, petroleum, foreign currencies, and financial instruments and index, to name a few.
Commodity Credit Corporation
A branch of the U.S. Department of Agriculture, established in 1933, that supervises the government's farm loan and subsidy programs.
Commodity Futures Trading Commission (CFTC)
A federal regulatory agency established under the Commodity Futures Trading Commission Act, as amended in 1974, which oversees futures trading in the United States. The commission is composed of five commissioners, one of whom is designated as chairman, all appointed by the President subject to Senate confirmation, and is independent of all cabinet departments.
Commodity pool
An enterprise in which funds contributed by a number of persons are combined for the purpose of trading futures contracts or commodity options.
Commodity pool operator
An individual or organization that operates or solicits funds for a commodity pool.
Commodity trading adviser
A person who, for compensation or profit, directly or indirectly advises others as to the value or the advisability of buying or selling futures contracts or commodity options. Advising indirectly includes exercising trading authority over a customer's account as well as providing recommendations through written publications or other media.
Common stock
Securities representing participation in the ownership of an enterprise, generally with the right to participate in dividends and in most cases to vote on major matters affecting stockholder interests. They offer no legal claim to a definite dividend or to a return of capital.
Companion tranche
A REMIC tranche that absorbs a higher level of the impact of collateral prepayment variability in order to stabilize the principal payment schedule for a PAC or TAC tranche in the same offering. Also known as companion or support class.
Compound accreted value
The value of a zero coupon bond at any given time, based on the principal, with interest compounded at a stated rate of return over time.
Computerized Trading Reconstruction System
A Chicago Board of Trade computerized surveillance program that pinpoints for any trade the traders, the contract, the quantity, the price, and time of execution to the nearest minute.
Concession
An allowance or profit an underwriter offers a dealer who is not a member of the underwriting syndicate for helping to sell an offering.
Market indicators showing the general direction of the economy and confirming or denying the trend implied by the leading indicators.
Confirmation
A document used by securities dealers and banks to state in writing the terms and execution of an oral agreement to buy or sell a security.
Constant Maturity Treasury Series (CMT)
The average yield of a range of U.S. Treasuries with various fixed maturities. The five- and ten-year CMT are commonly used as indices on floating-rate notes whose rates are tied to long-term interest rates. The index is published by the Federal Reserve Board and may be found in the Federal Reserve H.15 Report.
Constant prepayment rate (CPR)
The percentage of outstanding mortgage loan principal that prepays in one year, based on the annualization of the Single Monthly Mortality (SMM), which reflects the outstanding mortgage loan principal that prepays in one month. The underlying assumption is that a constant portion of the outstanding loans will prepay each month. See also PSA prepayment speed.
Consumer Price Index (CPI)
A major inflation measure computed by the U.S. Department of Commerce. It measures the change in prices of a fixed market basket of some 385 goods and services in the previous month.
The standard grades of commodities or instruments listed in the rules of the exchanges that must be met when delivering cash commodities against futures contracts. Grades are often accompanied by a schedule of discounts and premiums allowable for delivery of commodities of lesser or greater quality than the standard called for by the exchange.
A specific month in which delivery may take place under the terms of a futures contract.
An arrangement by which the holder of the account gives written power of attorney to another person, often his broker, to make trading decisions. Also known as a discretionary or managed account.
Conventional mortgage loan
A mortgage loan granted by a bank or thrift institution collateralized solely by real estate and not insured or guaranteed by a government agency.
Convergence
A term referring to cash and futures prices tending to come together (i.e., the basis approaches zero) as the futures contract nears expiration.
Conversion factor
A factor used to equate the price of T-bond and T-note futures contracts with the various cash T-bonds and T-notes eligible for delivery. This factor is based on the relationship of the cash-instrument coupon to the required 8 percent deliverable grade of a futures contract as well as taking into account the cash instrument's maturity or call.
Convertible bond
A convertible bond is a bond that gives the holder the right to "convert" or exchange the par amount of the bond for common shares of the issuer at some fixed "conversion ratio" during a particular period. For example, a conversion ratio might give the holder the right to convert $100 par amount of the convertible bonds of Ensolvint Corporation into its common shares at $25 per share. This conversion ratio would be said to be " 4:1" or "four to one".
Convertible bonds are bonds. As bonds, they have some characteristics of fixed income securities. Their conversion feature also gives them features of equity securities. They have a coupon payment and are legally debt securities, which rank prior to all equity securities in a default situation. Their value, like all bonds, depends on the level of prevailing interest rates and the credit quality of the issuer.
The share price affects the value of a convertible substantially. Taking our example, if the shares of the Ensolvint were trading at $10, and the convertible was at a market price of $100, there would be no economic reason for an investor to convert the convertible bonds. For $100 par amount of the bond the investor would only get 4 shares of Ensolvint with a market value of $40. You might ask why the convertible was trading at $100 in this case. The answer would be that the yield of the bond justified this price. If the normal bonds of Ensolvint were trading at 10% yields and the yield of the convertible was 10%, bond investors would buy the bond and keep it at $100. A convertible bond with an "exercise price" far higher than the market price of the stock is called a "busted convertible" and generally trades at its bond value, although the yield is usually a little higher due to its lower or "subordinate" credit status.
Think of the opposite. When the share price attached to the bond is sufficiently high or "in the money", the convertible begins to trade more like an equity. If the exercise price is much lower than the market price of the common shares, the holder of the convertible can convert into the stock attractively. If the exercise price is $25 and the stock is trading at $50, the holder can get 4 shares for $100 par amount that have a market value of $200. This would force the price of the convertible above the bond value and its market price should be above $200 since it would have a higher yield than the common shares.
Issuers sell convertible bonds to provide a higher current yield to investors and equity capital upon conversion. Investors buy convertible bonds to gain a higher current yield and less downside, since the convertible should trade to it bond value in the case of a steep drop in the common share price.
Investors traditionally use "breakeven" analysis to compare the coupon payment of the convertible to the dividend yield of the common shares. Modern techniques of option analysis examine the convertible as a bond with an equity option attached and value it in this manner.
Convexity
A measure of the change in a security's duration with respect to changes in interest rates. The more convex a security is, the more its duration will change with interest rate changes.
A risk factor that measures the curvature of a bond's price/yield curve while duration measures its slope. In other word, bonds with positive convexity perform better than bonds with negative convexity; i.e., Convexity = -( d''p/dy'' )/(price + accrue)*100
The Modified Duration calculation was inaccurate because it failed to account for the convexity of the bond. Convexity is a measure of the amount of "whip" in the bond's price yield curve (see above) and is so named because of the convex shape of the curve. Because of the shape of the price yield curve, for a given change in yield down or up, the gain in price for a drop in yield will be greater than the fall in price due to an equal rise in yields. This slight "upside capture, downside protection" is what convexity accounts for. Mathematically Dmod is the first derivative of price with respect to yield and convexity is the second (or convexity is the first derivative of modified duration) derivative of price with respect to yield. An easier way to think of it is that convexity is the rate of change of duration with yield, and accounts for the fact that as the yield decreases, the slope of the price - yield curve, and duration, will increase. Similarly, as the yield increases, the slope of the curve will decrease, as will the duration. By using convexity in the yield change calculation, a much closer approximation is achieved.
Corporate bond
Debt instrument that is considered a financial obligation of the issuing corporation. Interest from these bonds is fully taxable on all levels. Maturities on corporate bonds can range from three months to one hundred years, and credit quality of issuers varies. Corporate bonds can be broken down into three categories; debentures, medium term notes, and commercial paper. Additionally, corporate bonds can be categorized as belonging to one of four sectors -- industrial, financial, transportation, and utility. They can be issued in both callable and non-callable formats.
Cost of carry (or carry)
For physical commodities such as grains and metals, the cost of storage space, insurance, and finance charges incurred by holding a physical commodity. In interest rate futures markets, it refers to the differential between the yield on a cash instrument and the cost of funds necessary to buy the instrument.
Cost of Funds Index (COFI)
11th District An index of the monthly weighted average interest rate of funds paid by savings institutions in Arizona, California and Nevada that are members of the 11th Federal Home Loan Bank District. Published on the last day of the month, the rate reflects the cost of funds for the prior month and is used to set rates on adjustable-rate mortgages, mortgage-backed securities and public issues of floating-rate debt. Some issues may use the national COFI rather than the 11 District's.
Coupon
A percentage on an annualized basis that the issuer guarantees to pay the holder until maturity. The detachable part of a bearer bond that denotes the amount of interest due, on what date, and where payment is to be made. Coupons generally are payable semiannually. They are presented to an issuer's paying agent or deposited in commercial bank for collection.
Coupon frequency
The number of times per year that bonds or money market instruments pay interest. Most U.S. bonds pay interest on a semi-annual basis. Most non-U.S. domestic bond issues pay annual coupons. Other exceptions are bonds that pay coupons monthly, quarterly or at maturity. In addition to bonds, many money market instruments pay coupons. But unlike bonds, they typically pay a single coupon on the maturity date. Short dated Certificates of Deposit [CDs] are an example of these one-coupon securities.
Coupon payment
The periodic interest paid on an investment based on the coupon rate.
Coupon rate
The interest rate on a debt instrument expressed in terms of a percent on an annualized basis that the issuer guarantees to pay the holder until maturity.
Usually the Federal Reserve Commercial Paper Composite calculated each day by the Federal Reserve Bank of New York by averaging the rate at which the five major commercial paper dealers offer "AA" industrial Commercial Paper for various maturities. Most CP-based floating-rate notes are reset according to the 30- and 90-day CP composites.
CPI-U
The non-seasonally adjusted U.S. City Average All Items Consumer Price Index for All Urban Consumers, published by the Bureau of Labor Statistics of the U.S. Department of Labor.
Credit-related expenses
The sum of foreclosed property expenses plus the provision for losses.
Credit-related losses
The sum of foreclosed property expenses plus charge-offs.
Credit enhancement
A method to reduce credit risk by requiring collateral, letters of credit, mortgage insurance, corporate guarantees, or other agreements to provide an entity with some assurance that it will be recompensed to some degree in the event of a financial loss.
Credit loss ratio
The ratio of credit-related losses to the dollar amount of MBS outstanding and total mortgages owned by the corporation.
Credit risk
The possibility that an issuer or another party may default on its financial obligations to the investor, may have its credit rating downgraded by a rating agency, or may experience changes in the market's perception of its creditworthiness.
Credit scoring
A process that uses recorded information about individuals and their loan requests to assess, in a quantifiable, objective, and consistent manner, their future performance regarding debt repayment.
Credit spread
A yield difference, typically in relation to a comparable U.S. Treasury security, that reflects the issuer's credit quality. Credit spread also refers to the difference between the value of two securities with similar interest rates and maturities when one is sold at a higher price than the other is purchased.
Crop reports
Reports compiled and released throughout the year by the U.S. Department of Agriculture on various agricultural commodities. Information in the reports includes estimates on planted acreage, yield, and expected production, as well as comparison of production from previous years.
Crop (marketing) year
The time span from harvest to harvest for agricultural commodities. The crop marketing year varies slightly with each agricultural commodity, but it tends to begin at harvest and end before the next year's harvest; e.g., the marketing year for soybeans begins September 1 and ends August 31. The futures contract month of November represents the first major new-crop marketing month, and the contract month of July represents the last major old-crop marketing month for soybeans.
Cross-hedging
Hedging a cash commodity using a different but related futures contract when there is no futures contract for the cash commodity being hedged and the cash and futures markets follow similar price trends (e.g., using soybean meal futures to hedge fish meal).
Cross-matching systems
Brings dealers and institutional investors together in e-trading networks that provide real-time or periodic cross-matching sessions.
Cross collateralization
Any deficiency in income or loss on the sale of one property, made up by the income, or sale of another property.
Cross default
Provision to allow the trustee to call all loans into default when any single loan is in default.
Crush spread
The purchase of soybean futures and the simultaneous sale of soybean oil and meal futures.
Currency risk
The risk that a change in value of one or more foreign currencies may cause an asset to lose value.
Current face
The current amount of principal outstanding on a security, which is calculated by multiplying the original face value by the most recent factor. In the case of a mortgage security, current face is computed by multiplying the original face value of the security by the current principal-balance factor.
Current pay class
A term used for any REMIC class that is currently paying principal and/or interest.
Current yield
The ratio of the coupon to the current market price of a debt instrument
A measure of an investor's return on a bond calculated by dividing the annual interest on the bond by the market price. It is the actual income rate or the yield to maturity as opposed to the coupon rate (the two would be the same if a bond was purchased at par). For example, a 10% (coupon rate) bond with a face value (par) of $1000 is bought at a market price of $800. The annual income on the bond is $100, but since $800 was paid for the bond, the current yield is $100 divided by $800 or 12 1/2%.
CUSIP number
A unique, nine-digit number assigned to each publicly traded security maintained and transferred on the Federal Reserve book-entry system. The CUSIP number is generally printed on the face of the security.
Custodial receipt
Evidence of ownership of a security that is actually held by the transfer agent. The security is non-transferable in this form.
Custom pool
A pool issued under the Ginnie Mae II program that has only one issuer.
Within the futures industry, financial guarantees required of both buyers and sellers of futures contracts and sellers of options contracts to ensure fulfillment of contract obligations. Futures Commission Merchants (FCMs) are responsible for overseeing customer margin accounts. Margins are determined on the basis of market risk and contract value and are also referred to as performance-bond margin. Clearing margins are distinct from customer margins that individual buyers and sellers of futures and options contracts are required to deposit with brokers.