Here you can find a list of definitions for terms associated with risk management. These terms are listed alphabetically, alternatively you can use the find facility within your internet browser (by pressing control + F simultaneously) to search for terms within this page.
Accreting Swap
A swap arrangement where the amount of the two sets of cash flows to be exchanged increases over time.
Alternative Risk Transfer (ART)
The transfer of risk, that falls outside the normal perimeter of (re)insurance, to another party, by buying insurance that uses unconventional techniques and solutions, establishing a captive insurance company or issuing unconventional debt securities.
American Option (American Style Option)
A type of derivative that it is widely used in the USA. It gives its holder the right to buy or to sell a certain amount of the underlying financial product at any time from its purchase to its date of expiry.
Amortising Swap
A swap arrangement where the amount of the two sets of cash flows to be exchanged decreases over time.
Asian Option
A type of option where the amount that needs to be repaid is determined by the underlying asset’s average value over a specific period of time.
As-You-Like-It Option
An option which, at a specific date, can be exercised either as a call or put option.
Atlantic Style Option
See Bermudan option.
At-the-Money (Option)
A situation where the strike price of an option is equivalent to the underlying instrument’s current market price.
Back-end Set Swaps
Interest rate swap where the floating rate is set at the end of the interest period and not at its start.
Backwardation
The extent to wich a spot price of a foreign currency plus carrying costs exceeds the forward price.
Balance Sheet Translation Exposure
See translation exposure.
Bargain Renewal Option
An option that allows the holder to renew/extend a contract at less than the fair market value in exchange for periodic payments.
Barrier Option
An option that is initiated or terminated if the underlying asset’s value exceeds or goes below a reference price threshold.
Basis
In futures markets, the price differential between the price of the asset underlying the futures contract and the price of the futures contract.
Basis Risk
The risk of unpredictable price movements of the basis before expiry of the futures contract.
Basis (Rate) Swap
An arrangement where payments based on different floating rates are swapped. The payments can also be denominated in different currencies. Also known as floating swap or money market swap.
Basket Option
An option whose value is determined by that of a weighted basket of more than two different commodities, currencies, indices, interest rates or stocks set against the value of a buyer’s asset related to a single commodity, currency, index, interest rate or stock.
Bear Position
See short position.
Bermudan Option
A derivative giving its holder the right to buy or to sell a certain amount of the underlying financial product at a number of specific dates before its expiry. Also known as quasi-American option or Atlantic-style option.
Bid Rate
The price at which banks and other market participants are willing to buy currencies, securities, commodities, instruments, derivatives or to take deposits.
Bid-offer Spreads
The difference between the prices that a holder or trader of assets (generally a financial institution or financial intermediary) is willing to buy and sell those assets. These assets can be currencies, shares, fund units, etc.
Binary Option
An option where the full value is only repaid when the underlying asset fulfils the trigger criteria. See digital option.
Black & Scholes Model
A method of determining the price of an option contract by taking into account the price of the underlying asset, strike price, date of expiry, risk-free interest rate and volatility of the option.
Break Even Point
The point in time or value level where the rate or price of a transaction results in neither gain nor loss.
Business Interruption Insurance
A cover for losses incurred from a disruption of business activities caused by an unforeseen event.
Business Risk
See strategic risk.
Butterfly Spread
Option strategy using call or put options to limit risk in return for restricting profit potential.
Call Option
The option to buy a certain amount of an underlying financial product on (a) specific date(s) at a predetermined price.
Cap
A maximum limit on a price, interest rate or coupon.
Capital Adequacy
The capability of a financial institution’s capital in absorbing probable credit- and market-related losses. Mandatory levels of capital adequacy are usually set by the country’s central bank, in line with the Basel Committee recommendations.
Capital Adequacy Ratio
A ratio that measures a bank’s capital in relation to its risk-weighted credit exposures. The Basel Committee has issued specific recommendations with regard to capital adequacy ratios in its member countries.
Capital Risk
See principal risk.
Capped Option
An exotic option where the payout on the underlying security or commodity is capped at a specific price.
Capped Swap
An interest or currency swap where the floating rate liability is capped.
Cash Deposit Risk
Represents the risk that the institution holding a third-party cash deposit may fail. Pooling of cash deposits through the use of a money market fund or by spreading cash deposits over a number of rated institutions can mitigate such a risk.
Cash Market
See spot market.
Catastrophe Risk
The risk that significant losses may be incurred by unforeseen events of major magnitude such as natural disasters. By extension, refers to the measurement of such risk.
Cliquet Option
See ratchet option.
Collar (Interest Rate or Foreign Exchange Rate Collar)
A risk management arrangement where the purchase of an option and sale of another occur contemporaneously for the same underlying financial product. The payment acquired from the sale reduces the cost of the purchase. If both the payment and receipt match exactly, this is known as a zero-cost collar. The collar places a band around the potential outcome for this risk hedging technique.
Commercial Risk
The risk that a debtor will be unable to meet its financial obligations as a result of business developments.
Compound Option
A derivative giving its holder the right (front option) to buy or to sell another specific option (back option) for a specific amount at a specific date.
Confirmation
A document through which a market participant notifies its counterparties or customers of the details of a trade/transaction and, typically, allows them time to affirm or question the trade/transaction. The issue and matching of confirmations is one of the key controls in treasury dealing activity.
Continuous Linked Settlement (CLS)
A global real-time settlement system for foreign exchange transactions that eliminates foreign exchange settlement risk caused by delays arising from time-zone differences; the so-called Herstatt risk.
Contract for Differences
Definition of agreements or instruments such as forwards, futures, options and swaps.
Convertible Currency
A currency which can be freely converted into foreign currencies or gold.
Counterparty
One of the opposing parties involved in a transaction.
Counterparty Risk
The risk associated with entering into a contractual obligation with another party.
Country Risk
The risk involved with undertaking transactions in a specific country or holding assets in or of that country.
Covenant Risk
The risk of a company not fulfilling the requirements stipulated in its bank credit, loan and other financing agreements.
Credit Derivative
A contract allowing for the transfer of credit risk via a derivative instrument. The party transferring credit risk is obliged to pay a fee to the transferee.
Credit Risk/Exposure
The risk that a counterparty will not settle an obligation for full value, either when due or at any time thereafter. In exchange-for-value settlement systems, the risk is generally defined to include replacement cost risk and principal risk.
Currency Convertibility
The ability to convert a currency into either foreign currencies or gold. Certain governments do not possess significant amounts of hard currency and consequently currency convertibility is sometimes controlled through foreign exchange controls.
Currency Fluctuations
The variations in the value of a particular currency compared to another currency.
Currency Forward Contract
An agreement to buy or sell a specified amount of a foreign currency at a future date for a predetermined price.
Currency Futures
Written agreements on the delivery of a fixed amount of foreign currency at a specific price and at a specific date in the future.
Currency Hedging
The process of eliminating or limiting the impact of foreign currency fluctuations or volatility through the use of foreign exchange derivative products.
Currency Market
A financial market where foreign currencies are purchased and sold, either on a spot or forward basis, and where exchange rates are determined. Also known as foreign exchange market.
Currency Option
A derivative giving its holder the right, but not the obligation, to buy or to sell a certain amount of a foreign currency at a predetermined price on a specified date.
Currency Risk
The risk that fluctuations or volatility in exchange rates will affect business or investment results.
Cylinder
The instance when the purchase of a currency, interest rate or other price call or put option and the sale of a corresponding put or call option, both at different strike prices, occur contemporaneously. Also termed collar.
Default
Default Risk
The risk that a debtor or counterparty will fail to honour repayments of principal or payments of interest as specified or other contractual obligations.
Delta
Measure of the sensitivity of an option’s value to changes in the underlying values.
Derivative (Derivative Security)
An instrument, such as an option, future or swap, of which the criteria and value are determined by those of an underlying asset such as a stock, currency or commodity. Derivatives are used extensively in the hedging of financial- and treasury-type risks.
Differential Swap
An arrangement involving the exchange of payments denominated in different currencies and with a different floating exchange rate. However, actual payments are always denominated in the same base currency.
Digital Option
See binary option.
Disclaimer (Disclaimer Clause)
A clause in a contract or a published document that aims to prevent potential liability claims.
Diversifiable Risk
The part of the total investment risk that can be reduced by diversification. Also known as non-market risk or non-systematic risk. See diversification, modern portfolio theory (MPT).
Diversification
A risk management technique that consists of mitigating risk by taking positions in different asset classes or with different counterparties.
Down-and-In Option
A barrier option, which becomes effective if the underlying asset’s value exceeds or goes below a reference price threshold. May also be called knock-in option.
Down-and-Out Option
A barrier option, which is terminated if the underlying asset’s value exceeds or goes below a reference price threshold. May also be called knock-out option.
Economic Exposure
Degree to which an entity’s cash flow, competitive position or value will be affected because of macro-economic changes as reflected in the foreign exchange rate.
Equity Index Swap
An arrangement where the final payments of both parties to a transaction are a function of a specific equity index.
European Option (European Style Option)
A derivative that gives its holder the right to buy or to sell a certain amount of the underlying financial product on its date of expiry or for a short specific period (i.e. one day) just beforehand.
Exchanges
Financial markets where securities, currencies, interest rate instruments, futures, options or other derivatives can be traded. See currency market.
Exchange Rate
The value of a particular currency denominated in terms of another currency.
Exchange Risk
See currency risk.
Exchange Traded Option
An option that is traded on an exchange, as opposed to over the counter, i.e. with a bank or other financial institution. Also known as listed option.
Exchange Trading
The act of exchanging one currency for another.
Exercise Price
The predetermined price in a contract at which the option holder can either purchase or sell the underlying security, instrument or commodity.
Exotic Option
A range of options with unconventional payout structures and underlying securities/commodities.
Expiry Date
The final day that an option holder can purchase or sell an underlying security/commodity.
Exposure Management
The management of a situation where there is a risk that losses may be incurred due to exposure to foreign exchange rate, interest rate, commodity or other price movements.
Fair Market Purchase Option
An option to purchase an asset at fair market value on maturity or upon expiry.
FAS 133
The Financial Accounting Standard Board's Accounting Directive stipulates that every derivative instrument should be recorded in a company's balance sheet at its fair value as an asset or liability. Changes in the fair value should be reported in the company's profit and loss statements.
Finality Risk
The risk that a transaction will not be recalled before it has become irrevocable.
Financial Futures
Written agreements on the delivery of a security/commodity at a specific date in the future. They are used extensively both to hedge risk and to take risk.
Financial Risk
The risk that a borrower or issuer of a bond will be unable to meet its financial obligations i.e. repay the principal and interest as specified. See credit risk.
Financial Risk Sensitivity Analysis
An analysis that aims to identify the possible impact of market movements and variables such as interest rates, exchange rates or commodity prices on the financial situation of the company with regard to cash flow, profit and loss, and balance sheet. Financial risk sensitivity analysis is important for the management of the financial risks of a company.
Floating Swap
See basis (rate) swap.
Floor
The minimum interest rate paid on a security or under a derivative agreement.
Foreign Currency Option
A contract where the buyer/holder has the right, but not the obligation, to purchase/sell a fixed amount of a foreign currency at a specific price within a specific timeframe.
Foreign Currency Swap
An agreement in which specific amounts of two different currencies are exchanged and the amounts repaid by reversing the transaction at a future date.
Foreign Exchange Exposure Management
The practice whereby the potential impact of foreign exchange rate fluctuations or volatility on a company's business is eliminated or controlled.
Foreign Exchange Forward Contract
A contractual obligation to buy or sell a specified foreign currency amount at the exchange rate agreed on the day the contract in signed for delivery at a specific point in the future.
Foreign Exchange Market
See currency market.
Foreign Exchange Portal
A browser-based electronic marketplace that regroups several foreign exchange providers who provide online quotes in real time, thereby enabling foreign exchange products to be traded on a fully automated basis. Foreign exchange portals are increasingly being used for smaller foreign exchange trades that do not require human intervention.
Foreign Exchange (FX) Rate
The price at which one currency is bought or sold for another.
Foreign Exchange (Rate) Risk
The risk of loss of value due to the impact of negative changes in exchange rates on cash flows, profits, assets or liabilities denominated in foreign currencies.
Foreign Exchange Settlement Risk
The risk that one party to a foreign exchange transaction will pay the currency it sold but not receive the currency it bought. This is also called cross-currency settlement risk or principal risk. It is also referred to as Herstatt risk, although this is an inappropriate term given the differing circumstances in which this risk has materialised.
Foreign Exchange Swap
A swap arrangement where certain amounts of one particular currency are exchanged between two parties on a specific date.
Foreign Exchange Transaction Exposure
The risk that cash flows, denominated in foreign currencies, arising from the trading operations of a company will lose value as a result of fluctuations in the foreign exchange rate.
Foreign Exchange Translation Exposure
The risk that fluctuations in foreign currency exchange rates will negatively affect a company's financial statements and financial position, principally due to profits and balance sheet assets and liabilities being denominated in foreign currency.
Forward
See forward contract.
Forward Discount
The situation in which the spot price of a currency is greater than the forward price of that currency.
Forward Foreign Exchange Contract
Foreign exchange contracts that are constructed to mature and be settled at a future date. They are priced by adjusting the spot rate to reflect the interest rate differential between the two currencies involved for the forward period. They are used to hedge against future value fluctuation by locking in future price or rates.
Forward Foreign Exchange Rate
The agreed exchange rate on the day a transaction is entered into for a foreign currency transaction that settles more than two days in the future. The rate is determined by adjusting the spot rate to reflect the interest rate differential between the two currencies involved for the forward period.
Forward Forward
A foreign exchange swap or other swap arrangement where the transaction commences at some date in the future and is in force for a further future period.
Forward Market
A marketplace that allows same-day price fixing of currencies, commodities and securities that will be delivered at a future date.
Forward Premium
The premium that has to be paid when a traded currency's forward price is greater than its spot price.
Forward Price
The price for a transaction that has a start date in the future or later than the spot date.
Forward Rate
A fixed rate to be applied to a transaction that will come into force at a specific date in the future.
Forward Rate Agreement (FRA)
A bilateral forward contract that fixes the interest rate on the day of the agreement for payment at a future settlement date; typically this can be up to two years later. FRAs are used to hedge against interest rate exposure in the sense that one of the parties pays a fixed rate and the other a variable rate. If, at the settlement date, the market rate is lower than the previously agreed rate, the purchaser will indemnify the seller for that difference and conversely, if the market rate has risen, the seller will compensate the purchaser. Also called future rate agreement.
Forward Start Swap
Swap arrangement agreed today but where the commencement of the swap is delayed for a period exceeding the market standard. The pricing and terms of the transaction are agreed today.
Forward Swap
A swap arrangement to start sometime in the future, but where the rates to be applied are predetermined.
Funding and Liquidity Risk
The risk of a company lacking sufficient liquid funds to be able meet its liabilities and other payment obligations when they mature. Companies use cash flow forecasts as an essential tool in order to assess possible cash deficits and for developing various funding opportunities.
Fungibility
Ability to substitute one type or class of securities or assets with another type or class. This is particularly relevant to the trade of options and futures where the fungibility of options that share the same strike price and expiration dates allows investors to offset their positions.
Futures (Futures Contracts)
Contracts stipulating the purchase or sale of commodities, currencies or securities of a specified quantity, at a specific price and on a predetermined date in the future. Futures, like derivatives, are traded on exchanges. In contrast to forward contracts, futures contracts are not usually intended for the actual delivery of the underlying financial instruments, but for trading and hedging purposes. Also, in contrast to forward contracts, futures are not tailored contracts but are standardised in terms of quantity, price and maturity periods.
Gamma
The rate at which an option's delta changes with the price of the underlying asset.
Gap Analysis
Methodology used to measure the mismatch of maturities and interest rate risk.
Hedge
The application of a hedging instrument of which the objective is to reduce or eliminate the impact of fluctuations in the price of foreign exchange, interest rates or commodities on an organisation's profits or corporate value.
Hedging
The implementation of a set of strategies and processes used by an organisation with the explicit aim of limiting or eliminating, through the use of hedging instruments, the impact of fluctuations in the price of credit, foreign exchange or commodities on an organisation's profits, corporate value or investments.
Hedging Instruments
Types of derivative instruments or assets/liabilities whose cash flows or fair market value can be used to fully or partially offset the changes in those of hedged items. They include forward contracts, FRAs, swaps, futures, options and other structures based on these.
Herstatt Risk
Exposure due to timing differences of clearing or settling arrangements where there is a risk of paying out in one time-zone and expecting to receive payment in another later time-zone. Named after the Herstatt Bank failure.
Historical Volatility
Refers the volatility of market prices of financial instruments over time. Historical volatility is one important variable in the option pricing models used to estimate the fair market value of options, though options are usually traded on price, from which an implied volatility of future prices is derived.
Hybrids
Securities that combine both debt and equity features e.g. convertible bonds, warrants. Is also used as a synonym for synthetics.
IAS 32
International Accounting Standard for the presentation and disclosure of financial instruments.
IAS 39
International Accounting Standard for the recognition and measurement of financial instruments.
Implied Volatility
The volatility of the asset, liability, security or commodity underlying a derivative, which is derived from the option pricing formula and the anchor price of the option itself.
Indemnities
Contracts or clauses in a contract made with the purpose of insuring against any losses incurred.
Insurance
A written promise to compensate for any losses incurred.
Interest Rate Caps
Maximum thresholds applied to the amount of interest that can be charged on debtors' periodic payments. See cap.
Interest Rate Collar
A combination of a cap and a floor. See collar.
Interest Rate Exchange Agreement
See interest rate swap.
Interest Rate Exposure
Exposure to the potential impact of interest rate movements on an organisation's profitability, due, in particular, to resulting changes in the cost of financing or return on surplus cash investment. See interest rate risk.
Interest Rate Floor
See floor.
Interest Rate Futures
A futures contract that has a debt instrument as underlying security. See futures.
Interest Rate Option
An option that has a debt instrument as underlying security. See options.
Interest Rate Parity
A foreign exchange pricing theory which postulates that interest rate differentials between countries determine whether their currencies trade at parity, discount or premium in the forward market compared to the spot market.
Interest Rate Risk
The risk that a change in interest rates or in the yield curve will have a negative impact on a company's financial performance, especially due to increased cost of funds or reduced return on surplus cash invested. See interest rate exposure.
Interest Rate Swap (IRS)
A swap arrangement where interest payments on a certain amount of principal are exchanged between two parties on a specific date. One of the payment streams involved is usually based on a fixed interest rate, while the other is based on a floating rate. Sometimes referred to as interest rate exchange agreement.
ISDA (International Swaps and Derivatives Association)
International trade association, composed of over 600 members, for institutions dealing in derivatives, swaps and options.
Knock-in Option
See down-and-in option.
Knock-out Option
See down-and-out option.
Legal Risk
The risk that a change in law or a legal action undertaken against an organisation may affect the organisation's value or income.
Liquidity Risk
See funding and liquidity risk.
LOCH (London Options Clearing House)
Acts as the clearing counterparty for the majority of the UK's exchange traded options and futures.
Long-dated Swap
A long-term agreement between two parties to exchange a set of cash flows for a minimum of one year and up to 15 years in the future.
Long Position
When an entity buys a traded asset, currency or derivative with the view of benefiting from a rising market in the given asset, currency or derivative. In corporate treasury terms, it normally refers to a situation where the company has a surplus cash or revenue position in a currency arising from its business trading activities. See short position.
Margin
In the futures/commodity markets, a margin is a good faith deposit (of money, securities or other financial instruments) required by the futures clearing system to ensure performance.
Market Risk
The risk of change in market prices or in market conditions that is inherent to the market and that cannot be mitigated by diversification. Sometimes referred to as systematic risk.
Marking-to-Market
The practice of revaluing securities and financial instruments using current market prices. In some cases, unsettled contracts to purchase and sell securities are marked to market and the counterparty with an, as yet, unrealised loss on the contract is required to transfer funds or securities equal to the value of the loss to the other counterparty. See variation margin.
Matching
Model Risk
Risk generated by inadequate pricing or hedging models.
Money Market Swap
See basis (rate) swap.
Monte Carlo Technique
A method of determining the price of derivative instrument through simulating how underlying securities/commodities develop.
Natural Risk
Risk associated with the potential occurrence of natural disasters such as earthquakes, floods, storms etc. See catastrophe risk.
Non-commercial Risk
Any type of risk, of a foreign debtor being unable to meet its financial obligations, which does not derive from business developments.
Non-market Risk
See diversifiable risk.
Non-systematic Risk
See diversifiable risk.
Notional Principal Amount (Notional Principal)
In derivatives contract, the proportion of underlying assets used to calculate the obligations between the different parties.
Offer Rate
The price at which currencies, assets, securities, commodities or instruments are sold or money/funds are lent by market participants.
Open Position
A foreign exchange, interest rate or commodity price exposure/position that is not hedged and which is open to the impact of market rate/price fluctuations or volatility.
Operational Risk Management
The management of the risk that losses will be incurred as a result of operational processes or systems failure.
Option
A derivative giving its holder the right, but not the obligation, to buy or to sell a certain amount of the underlying financial product, usually a security, on a specific date at a predetermined price. See call option, put option.
Options on Options
See compound option.
Out-of-the-Money (OTM)
A revalued derivative position showing a loss because of market changes.
Partial Hedging
The use of financial instruments (such as forwards, swaps, options and futures) to reduce some part of the potential negative impact of fluctuations in the price of credit, foreign exchange or commodities on its profits or corporate value. This is usually done by hedging a portion of the actual exposure value or a portion of the timeframe of the exposure.
Participating Forward (or Profit Sharing Forward)
A forward contract where the hedging party shares in some of the potential gain from favourable rate/price movements should they occur, but not in the loss from unfavourable movements.
Payment Versus Payment (PVP)
A mechanism in a foreign exchange settlement system that aims to eliminate foreign exchange risk by ensuring that a final transfer of one currency only occurs when the final transfer of the other currency or currencies takes place. See continuous linked settlement (CLS).
Pensions Risk
The risk represented by the future pension liabilities of an organisation.
Performance Risk
The risk that a party in an agreement will fail to perform and fulfil its contractual obligations.
Political Risk
The risk that a loss will be incurred because of modifications to a country's political structure or policies.
Pre-credit Risk
The risk that a purchaser of goods or services will fail before the contract has been fully honoured.
Prepayment Risk
The risk of a security (particularly fixed rate CMO tranches) being redeemed/called earlier than expected as a result of falling interest rates, forcing the holder to reinvest at lower rates.
Principal Risk
The credit risk that a party will lose the principal value involved in a transaction. In the settlement process, this term is typically associated with exchange-for-value transactions when there is a lag between the final settlement of the various legs of a transaction (i.e. the absence of delivery versus payment). Principal risk that arises from the settlement of foreign exchange transactions is sometimes called cross-currency settlement risk. See credit risk/exposure.
Profit Translation Exposure
Profits earned by group entities operating abroad in foreign currency are exposed to value volatility when consolidated into group accounts due to foreign exchange rate movements.
Put Option
The option to sell a certain amount of an underlying financial product on
specific date(s) at a predetermined price.
PVO1
The present value of a one basis point movement in an interest rate.
Quasi-American Option
See Bermudan option.
Queuing
A risk management approach adopted by a settlement system or participants that consists of keeping transfer orders on hold by the originator/deliverer or by the system until sufficient cover is available on the originator's/deliverer's clearing account or under the limits set against the payor. In some cases, the cover may include unused credit lines or available collateral. See caps.
Rainbow Option
An option where the remaining payments are affected by the performance of two or more assets. Also called multi-factor option.
Ratchet Option
An option that permits the buyer to fix interest on the underlying financial product at specific periods before the option's expiry. Also known as a rest option or cliquet option.
Regression Analysis
A statistical technique that establishes the best linear relationship between two or more quantifiable variables to be predicted from one or more independent or explanatory variables.
Regulatory Risk
The risk arising from changes in the regulatory framework.
Reinvestment Risk
The risk that the income from an investment will be reinvested at a lower rate than achieved on the original investment. This is common when interest rates fall.
Replacement Cost Risk
Defined by the European Central Bank and the Bank for International Settlements as the risk that a counterparty to an outstanding transaction to be completed at a future date will fail to perform on the settlement date. This failure may leave the solvent party with an unhedged or open market position or deny the solvent party unrealised gains on the position. The resulting exposure is the cost of replacing, at current market prices, the original transaction. See credit risk/exposure.
Risk
Future outcomes against which probabilities can be assigned, which can therefore be insured.
Risk Adjusted Return on Capital (RAROC)
Comparative investment analysis that takes into account the potential risks of the compared investments, i.e. the investment that has a higher risk profile needs to offer a higher return to compensate for that risk.
Risk Free Return
A particular interest rate traditionally provided by government debt.
Risk Insurance
Any type of insurance (or other cover) against the probability of incurring loss.
Risk Management Strategies
The set of measures taken and techniques adopted under approved policies to reduce the potential loss of income, profit and/or capital arising from exposure to the financial and commodity markets.
Risk Reward Profile
The trade-off between the anticipated returns from assuming different levels of risk for a particular situation.
Risk Transfer
A transfer of risk between parties where the party that transfers the risk pays some form of compensation. Risk can be transferred in various ways including through the use of derivatives or the purchase of insurance.
SAFEs (Synthetic Agreements for Forward Exchange)
Agreements permitting trade in forward foreign exchange swaps i.e. foreign exchange agreements and forward exchange agreements.
Short Position
When an entity sells a traded asset, currency or derivative with the view of buying back the same amount of said asset, currency or derivative at a lower price. In corporate treasury terms, this refers to a situation where a company has an excess of expenditure in a currency. See long position.
Short Selling
The selling of borrowed assets with the aim of repurchasing them at a later date for a lower price. Short selling can also be done through the use of derivatives.
Short-dated Swap
A short-term agreement between two parties to exchange a set of cash flows at a maximum of five years in the future.
Sovereign Risk
The risk that a loss will be incurred due to a negative change in a foreign government's policies, its credit rating or its failure to fulfil a debt obligation.
Speculation
Taking a position with the aim of profiting from an expected change.
Spot Market
A market in which a currency or commodity is traded for immediate delivery and against cash payment. Settlement usually occurs within two business days. Also known as cash market.
Spot Price
The rate or price applying to the immediate delivery of a commodity or currency.
Spot Rate
Spot Transaction
A transaction where both parties agree to pay each other a specific amount in a foreign currency either on the same day or within a maximum two days of each other.
Standard Deviation
The measurement of volatility through the tracking of the distribution of a certain set of data.
Stop Loss Policy
A risk management technique where thresholds are set up to trigger an automatic sale or purchase in the event of a negative price movement.
Straddle
An option strategy using a put and a call on the same underlying asset with the same maturity and strike price.
Strategic Risk
A generic term covering all the risks associated with conducting business.
Strike Price
The price in an option contract at which the option can be initiated i.e. the price at which the option's underlying security/commodity can be bought or sold.
Swap
An agreement between two parties to exchange (or swap), under specified conditions, a set of cash flows at a future point in time.
Swaption
An option on a swap where the buyer of the option has the right, but not the obligation, to enter into a specified swap at a specific future date.
Synthetics
Customised securities that are created by repackaging existing assets, i.e. are only available on the secondary market. Synthetics generally combine both debt and equity features.
Synthetic Hedging Instruments
Hedging instruments that are not readily available on the primary market but are artificially constructed using existing instruments and assets to cover against specific exposures.
Systematic Risk
See market risk.
Systemic Risk
The risk that the failure of a major market participant may endanger the overall stability of the international financial system.
Systems Risk
The risk that an organisation may incur losses as a result of a technical or security failure of its systems.
Terrorism Risk
Risk resulting from terrorist acts and their consequences.
Time Value of Money
Concept that the value of money is linked to time because of its capacity to earn interest over time. Thus, a given amount of money available today is worth more than a given amount of money to be received tomorrow, because the amount available now can be invested immediately.
Trading
The purchasing or selling of currencies, interest rate products, securities, commodities and derivatives.
Transaction Exposure
The vulnerability of a company's known future cash flows, including receivables or payables, to changes in exchange rates from the time a transaction is entered into until it is completed. Also known as transaction risk.
Transaction Risk
See transaction exposure.
Transfer Risk
The risk involved with undertaking cross-border transactions i.e. the risk of being subject to difficulties or restrictions.
Translation Exposure
The potential negative impacts on a company's reported profits or balance sheet from exchange rate fluctuations. This typically occurs in international corporations when a foreign subsidiary's financial statements (covering profits, assets and liabilities in foreign currency) are converted into the parent company's base currency to consolidate the parent company's financial statements.
Translation Risk
See translation exposure.
Uncertainty
Future outcomes against which probabilities cannot be assigned, which cannot therefore be insured.
Underlying
The contracted asset behind a forward, future or option.
Value at Risk (VAR)
Method for determining the maximum loss that can be incurred by an organisation on its open positions.
Variation Margin (or Marked-to-Market Payments)
The amount which is paid by a counterparty to reduce replacement cost exposures resulting from changes in market prices, following the revaluation of securities or financial instruments that are the subject of unsettled trades.
Volatility
The level of fluctuation in the rate/price of financial instruments and assets.
Yield Spread Risk
The risk associated with parallel shifts in the yield curve.
Zero-cost Collar
A situation where a simultaneous purchase and sale of options is structured to result in nil cost. This technique is often used by companies to limit the risks arising from treasury-type exposures. See collar.
Zero-coupon Swap
An agreement between two parties to exchange (or swap) a set of cash flows, neither of which yield any interest for the investor until they mature.
Zero-hour Clause
A provision in the bankruptcy laws of a certain number of countries which may retroactively render transactions of a closed institution ineffective after 00:00 local time on the date on which the institution is ordered to be closed.
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