A-Z Financial Instruments

Questions and answers Financial instruments A-Z of financial instruments
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A-Z of financial instruments
Publicationdate:30Nov2005
A B C D E F G H I J K L M N O P Q R S T U V W X Y Z
NoteTheglossarybelowisbasedontherequirementsoftherevisedversionofIAS39asat31March2004and incorporatesthefollowingamendmentsmadebytheIASBtoIAS39. Transitionandinitialrecognitionoffinancialassetsandfinancialliabilities Cashflowhedgeaccountingofforecastintra-grouptransactions Thefairvalueoption Financialguaranteecontracts Althoughthesummaryhasbeenwritteninthecontextofinternationalfinancialreportingstandards,mostofthetermsare relevantforUKGAAPreporters. AAA/aaa rating:isthehighestcreditratinggivenbythetwomainagencies(Standard&Poor'sandMoody's). Arbitrage:isthesimultaneouspurchaseandsaleofsimilarfinancialinstrumentsinordertoprofitfromdistortionscaused bypricerelationships. Absolute rate:abidmadeatanabsoluterateisonewhichisnotexpressedinrelationtoaparticularfundingbasesuchas LIBORorUStreasuryrates. Accreting:occurswhenthenotionaloractualamountofafinancialinstrumentincreasessuccessivelyoverthelifeofthe instrument.Itisapplicabletoanumberofinstruments. Accreting (or drawdown) swap:isaninterestrateorcurrencyswapwithanotionaloractualprincipalamount,which increasesinstepsoverthelifeoftheswap.Suchanarrangementwouldbestructuredtomirrorthedrawingdownoffunds underaborrowingfacility. Accrued interest:istheinterestearnedbutnotyetdueandpayable.Thebuyerofabond,forinstance,paysthesellerthe bond'sagreedpriceplusinterestaccruedsincethelastinterestdate,uptoandincludingthevaluedate. Active market:amarketisconsideredactiveifquotedpricesarereadilyandregularlyavailablefromanexchange,dealer, broker,industrygroup,pricingserviceorregulatoryagency,andthosepricesrepresentactualandregularlyoccurring markettransactionsonanarm'slengthbasis. Actual or cash instrument:anactualisaphysicalfinancialinstrument,suchascash,asdistinguishedfromafutures contract. American depositary receipts (ADR):Aformofinternational'equity'isthedepositaryreceipt.Themostwidelyknown formofthedepositaryreceiptistheADRorAmericanDepositaryReceipt.Thereareotherformssuchasinternational depositaryreceipts,buttheprocessisbroadlythesame. ADRsmaybecreatedaspartofasponsoredprogrammebyacompanytoraisetheprofileofthecompanyanditsproducts intheUS.Atitssimplest,however,thecreationofanADRresultsfromthesaleofanonUSstocktoaUSshareholder
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whowantstoretainthatstockinaDollardenominatedform.InthiscaseanintermediarysuchasanomineeUSbankinthe UKwouldactasadepositaryforthestockcertificatesofaUKcompanywhoseshareshavebeensoldtoaUSinvestor.The USofficeofthatbankthenissuesreceiptsforthosestocksdenominatedintheUSDollars. ThereceiptsthemselveswouldthenbeissuedtotheinvestorandwouldbetradedasUSDollardenominatedstock,either listedorunlistedontheUSexchanges.Theprocessworksinreverseinmuchthesameway;ADRsbeingtransformed throughthedepositarybanks'systemsbackintofungibleequitiesintheUK. American option:isanoptionthatcanbeexercisedbythepurchaser/holderatanytimepriortoitsexpiration.Generally AmericanoptionsaremorevaluablethanEuropeanoptions,duetothepossibilityofearlyexercise. Amortised cost of a financial asset or liability:isthe: amountatwhichthefinancialassetorfinancialliabilityismeasuredatinitialrecognition*; minus:principalrepayments; plusorminus:thecumulativeamortisationusingtheeffectiveinterestmethodofanydifferencebetweentheinitial amountandthematurityamount;and minus(inthecaseofafinancialassetonly):anyreduction(directlyorthroughtheuseofanallowanceaccount)for impairmentoruncollectability.
* beingfairvalueplus,inthecaseofafinancialassetorfinancialliabilitynotatfairvalue,transactioncoststhataredirectlyattributabletotheacquisitionorissueofthefinancialassetorfinancial liability.Transactioncostsinthecaseofafinancialassetorfinancialliabilityheldatfairvalueareexpensedimmediately.
Amortising swap:Theseareswapsforwhichthenotionalprincipalalters(forexample,reducesorincreases)overtheterm oftheswap.Thisisparticularlyusefulforborrowersthathaveissuedredeemabledebtasitmayfacilitatetheirinterestrate hedgingwiththeredemptionprofileofthedebt. Asian option:isanoptionwherethepayoffdependsontheaveragepriceoftheunderlyingassetduringatleastsomepart oftheoption'slife.Asianoptionscomeintwoforms: Averagepriceoptionsthepayoutisthedifferencebetweentheagreedstrikepriceandtheaverageassetpricefor theperiod. Averagestrikeoptionsthestrikepriceissetastheaverageofassetpricesovertheperiodandthepayoutisthe differencebetweenthestrikepriceandthespotpriceonthematuritydate.
Averagingtheunderlyingassetpricereducesvolatility,asoptionpricesarelargelydeterminedbyvolatility.Thepremium onanAsianoption,therefore,tendstobecheaperthanonaEuropeanoption. Ask (or asked):anask,oranaskedprice,denotesthepricelevelatwhichsellersoffersecuritiestobuyers.Insome marketsitisusedasanalternativetoofferprice. Asset backed securities:thedistinctivefeatureofassetbackedsecuritiesisthatthereturnonthesecuritiesisderivedfrom theperformanceofspecificassets(althoughthisperformancemaybesupportedbyvariousformsofguarantee).Ingeneral, manyformsofassetsareavailableforsecuritisation,providingtheyhaveacontractualcashflow.Inanissueofasset backedsecurities,specificassetsbothserveascollateralforthesecuritiesandgeneratethepaymentstreamsthatareusedto financethepaymentofinterestandprincipaltotheinvestorsinthesecurity.Thiscompareswithacorporatebondwhere paymentstoinvestorsaremadeoutofcashflowsderivedfromtheentity'soperationsasawhole(albeitthatsomebonds maybesecuredbychargesonassetsintheeventofadefault). Asset swap:assetswapsaresimilartointerestrateandcurrencyswaps,exceptthattheyareundertakenbyholdersofassets ratherthanliabilities.Assetswapisageneraltermforanyrepackagingofadebtinstrumentpayingfixedinterestinto floating,orvice versa,orinvolvingachangeincurrencyofinterestand/orprincipal.Forexample,aninvestormaybe holdingafixedratebondandmayenterintoaswaptoconvertthecashflowstofloatingrates. Assignment:isanexercisenoticethatisgiventoanoptionwriter(seller)thatobligateshim/hertosell(inthecaseofa
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call)orpurchase(inthecaseofaput)theunderlyingsecurityatthespecifiedstrikeprice. Assignment (statutory and equitable):Thetransferofrights(toprincipalandinterest)butnotobligations,toathirdparty (the'assignee')maybeaffectedbyeitherastatutoryorequitableassignment.Inastatutoryassignment,whichmustrelateto thewholeoftheloan(finacialasset),noticemustbegiveninwritingtotheborrowerandotherobligors(forexample,a guarantor).Anequitableassignmentmayrelatetoonlypartoftheloan(financialasset)anddoesnotrequirenoticetothe borrowerorotherobligors. At-the-money:iswhenthecurrentpriceoftheunderlyinginstrument(forexample,shares)equalsthestrikepriceofan option.Whenanoptionisatthemoney,itsholderdoesnotexercisetheoption,becausethereisnothingtogainbydoing so. Auction market preferred shares (AMPS):AMPSarepreferencesharesthatareentitledtodividendsdeterminedin accordancewithanauctionprocessinwhichapanelofinvestorsparticipates,thesharesbeingtransferredatafixedpriceto theinvestorwhowillacceptthelowestdividend.Iftheauctionprocessfails-forexamplebecausenobidsarereceivedthesharesremainintheownershipoftheformerholderandthedividendisincreasedtoarate,knownasthedefaultrate, thatiscalculatedinaccordancewithaprescribedformula.(Thisdefaultratemaychangeifthereisanychangeinthecredit ratingoftheissuer.)Insomecasesdividendsmaybepassedattheoptionoftheissuerandinanyeventwillnotbepaidby aUKcompanyifthereareinsufficientdistributableprofits.IfthedividendisnotpaidtheholdersoftheAMPSdonot obtainanyadditionalrights,forexampletodemandredemption.AMPSareredeemableattheoptionoftheissuer,usually attheissueprice. Available-for-sale:arethosenon-derivativefinancialassetsthataredesignatedasavailable-for-saleorarenotcategorised as;(a)loansandreceivables;(b)held-to-maturityinvestments;or(c)financialassetsatfairvaluethroughprofitorloss. Available-for-saledoesnotmeanthattheyareactuallybeingheld-for-salewithinthemeaninginIFRS5.Available-for-sale financialassetsarecarriedatfairvalue(withoutanydeductionfortransactioncostsitmayincuronsaleorotherdisposal), unlesstheyareinvestmentswhichcannotbereliablymeasuredandderivativesthatarelinkedtoandmustbesettledby deliveryofsuchunquotedequityinstruments,whentheyarecarriedatcostlessimpairment. Againorlossarisingfromachangeinfairvalueofanavailable-for-salefinancialassetisrecogniseddirectlyinequity, throughthestatementofchangesinequity,orthestatementofrecognisedincomeandexpense,exceptforimpairment lossesandforeignexchangegainsandlosses.Whenthefinancialassetisderecognised,thecumulativegainorloss previouslyrecognisedinequityisrecognisedinprofitorloss. However,interestcalculatedusingtheeffectiveinterestmethodisrecognisedinprofitorloss. Dividendsonavailable-for-saleequityinstrumentsarerecognisedinprofitorlosswhentheentity'srighttoreceivepayment isestablished. Average strike option: see Asianoption. Top Bank deposits:depositorsclassifythemas'Loansandreceivables'thatarecarriedatamortisedcost.Notethatfor presentationpurposes,thesemaybeincludedincashandcashequivalents.Bankscarrysuchliabilitiesatamortisedcost. Ifabankdepositorintendstoselltheinstrumentimmediatelyorinthenearterm,thedepositisclassifiedasafinancial assetheldfortradingandismeasuredatfairvaluethroughprofitorloss. Bank loans:borrowerscarrythematamortisedcost.Iforiginated,banksgenerallyclassifythemas'Loansandreceivables' andcarrythematamortisedcost.Loanspurchasedfromthirdpartiesareclassifiedas'Loansandreceivables'(unlessthey arequoted)butmaybeclassifiedas'atfairvaluethroughprofitorloss',held-to-maturityoravailable-for-sale. Base currency:isthecurrencywhichisquotedfirstinaforeignexchangerate,forexample,thedollarin$/yen.The exchangerateisthenumberofthequotedcurrencythatequalsoneunitofthebasecurrency,forexample,$/yen123,where 123yenequals1dollar.
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Basis:thisisthedifferencebetweenthecashpriceofafinancialinstrumentandthepriceofarelatedfinancialfutures contract. Basis adjustment:abasisadjustmentariseswhenanentityhedgesthefuturepurchaseofanassetorthefutureissueofa liability.OneexampleisthatofaUKentitythatexpectstomakeahighlyprobablefuturepurchaseofaGermanmachine thatitwillpayforineuro.Theentityentersintoaderivativetohedgeagainstpossiblefuturechangesinthesterling/euro exchangerate.Providedthatthedocumentation,designationandeffectivenesscriteriaaremet,suchahedgemaybe classifiedasacashflowhedgeunderIAS39,withtheeffectthatgainsandlossesonthehedginginstrument(totheextent thatthehedgeiseffective)areinitiallyrecognisedinequity.Whentheforecasttransactionhasoccurredthecumulative hedginggainorlossmayberemovedfromequityandrecognisedaspartoftheinitialcarryingamountoftheassetor liability(intheexampleabove,themachine).Infutureperiods,thehedginggainorlossisautomaticallyrecognisedin profitorlossaspartofdepreciationexpense(forafixedasset),interestincomeorexpense(forafinancialassetorfinancial liability),orcostofsales(forinventories).Thistreatmentiscommonlyreferredtoasa'basisadjustment'.Thisapproachis onlyappropriateforhedgesofforecasttransactionsthatwillresultintherecognitionofanon-financialassetoranonfinancialliability. Basis convergence:Thephenomenonwherebythemarketvalueofafuturescontractapproachesthespotpriceforthe underlyingitemasthedeliverydatenears. Basis point:isone-hundredthofapercent(thatis,0.01%or0.0001),andistypicallyusedinexpressinganychangein interestrates.Thechangefrom7.00%to7.03%,forexample,isthreebasispoints. Basis risk:istheriskofmovementbetweentwodifferentinterestrateprofilesforexample,LIBORandUStreasury rates.Thetermcanalsobeusedinfuturesmarketstodescribetheriskthattherelationshipbetweenthespotrateofthe underlyinganditsfuturepricewillchange. Basis swap:Thisisaswapwheretheinterestpaymentsexchangedarebasedontwodifferentfloatingrateindices.For example,aUSdollarLIBORversusUSTreasuryBillrateswap. Bear:Thisisatermforapersonwhoexpectspriceswillmovelower. Bear spread:Abearspreadisanoptionstrategythatinvolvescombiningtwoormorepositionsatdifferentstrikepricesor differentexpirydates. Anexampleisthesaleofacalloptionwithalowexercisepricetogetherwiththepurchaseofacalloptionwithahigh exerciseprice.Theinvestortherebyprofitsifpricesfall. Bed and breakfast: see Washsales. Bermudan option:isanoptionwhichtheholdercanexerciseononeormorepossibledatespriortoitsexpiry.Itisalso knownasalimitedexercise,amid-Atlanticorasemi-Americanoption. Bid:istherateatwhichamarketmakerborrowsfromamarkettaker;thepriceoryieldonasecurityatwhichthe purchaseriswillingtobuy. Bid-offer (or bid-ask) spread:istheamountthattheoffer(orask)priceisgreaterthanthebidpriceofaninstrument. WhenusedinIAS39inthecontextofquotedmarketpricesthistermcomprisestransactioncostsonly.Otheradjustments toarriveatfairvalue(forexample,forcounterpartycreditrisk)arenotincludedinthe'bid-ask'spread. Bid price:isthequotedmarketpricethatamarketmarkerwillpayforaninstrumentincludingtransactioncosts. Bifurcate:istosplitordivideintwo.Thisisthetermusedwhen,forexample,anissuerofacompoundinstrumentsplits thatinstrumentintoitsdebtandequityelements,oraholderofahybridinstrumentsplitsitintoahostcontractand embeddedderivative.
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Black-Scholes:Amodelforpricingoptions.Themodelusestheshareprice,therisk-freeinterestrate,thetimeto expirationoftheoptionandtheexpectedstandarddeviationofthesharereturn(distributions). Bonds:arecertificatesofdebt,generallylong-term,whereanissuercontractstopaytheholderafixedprincipalamounton aspecifiedfuturedateand,often,aseriesofinterest(fixedorvariable)paymentsduringitslife. Bondsheldasassetsgenerallyshouldbeclassifiedas'Loansandreceivables'(whereacquiredfromtheissuerdirectlyor viaabrokerorotherintermediaryandprovidingthattheyarenotquoted).Bondassetsmaybeclassifiedasheld-tomaturity,atfairvaluethroughprofitorlossoravailable-for-sale.Bondsclassifiedas'Loansandreceivables'orheld-tomaturityarecarriedatamortisedcostlessimpairment,whilstthoseintheothertwoclassificationsarecarriedatfairvalue. Bondsissuedbyanentityarefinancialliabilitiesandarecarriedatamortisedcost.Unlessthebondsformpartofatrading portfolioortheissuerdesignates,wherepermitted,atinceptiontofairvalueabond,theissuercannotclassifytheliability asonetobemeasuredatfairvalue. Borrow long:Thisisaborrowingoflong-termcash.Thistermisalsousedincomparisonwithinvestingshort,wherethe termforborrowingisgreaterthanthetermfortheinvesting. Borrow short:Toborrowshort-termcash.Thistermisalsousedincomparisonwithinvestinglong,wherethetermforthe borrowingislessthanthetermfortheinvesting. Bull:Thisisatermforapersonwhoexpectspriceswillmovehigher. Bullet bonds:Thesearebondswherethewholeoftheparvalueofabondisredeemedbytheissueronaspecifiedmaturity date.Adebtsecuritythatisredeemedinthiswayisknownasa'bullet'. Bull spread:Abullspreadinvolvesthepurchaseofacalloptionwitharelativelylowexercisepriceandthesaleofacall optionwitharelativelyhighexerciseprice. Butterfly spread:Optionsstrategiesthatinvolvecombiningtwoormorepositionswithdifferentstrikeprices,ordifferent expirydates,arecalledspreads. Bycombiningabearspreadandabullspread,aninvestorcantakeadvantageofamarketthathe/sheexpectstoremain relativelystable,whilstlimitingtheriskoflossfromlargepricemovements. Buy in:Thisisapurchasemadetocover,offsetorcloseashortposition. Top Call:Therighttoacquiretheunderlyinginstrumentatapredeterminedpriceatafuturedate. Call option:Acalloptionisacontractthatconveystherightbutnottheobligationtothepurchaser/holdertobuythe underlyingatthestrike/exercisepriceatafixeddate(wheretheoptionisEuropean)orduringafixedperiodoftime(where theoptionisAmerican). Callable instrument:isaninstrumentthatgivestheissuertherighttocallitbackfromtheholder(thatis,toterminatethe instrument). Cap and floor options:Capsandfloorsmodifytheplainvanillavarietyofoptionswithaprovision.Thesellerofacapis obligedtoreimbursethebuyershouldtheprevailingprice/rateonexpiryexceedthecap'sstrikerate.Atypicalfloorseller agreestocompensatethebuyershouldtheratefallbelowtheagreedstrikeprice.Thesellerofeitheracaporfloorreceives apremiumfortakingonthisrisk. Specifically,aninterestratecapisanagreementbythecapsellertopaythebuyertheexcessoftheprevailingmarketrate (forexample,threemonthLIBOR)overacaprate(forexample,6percent)baseduponanagreednotionalprincipal amount.Conversely,aninterestratefloorisanagreementbythefloorsellertopaythebuyerexcessofafloorrateovera prevailingmarketinterestbaseduponanagreednotionalprincipalamount.Accordingly,buyingacap(long)andsellinga
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floor(short)struckatthesamerate,basedonthesameindex,notionalandmaturity,isequivalenttoenteringintoapayer's interestrateswapwithafixedrateequaltothestrikeofthecap/floor. Onesignificantdifferencebetweenaplainvanillainterestrateoptionandacaporflooroptionisthatthereareoftenreset dateswithinthecontractlivesofcapsandfloors(forexample,marketrateisthreemonthLIBORwhichresetseverythree months)onwhichthesellermustpaythebuyeranamountbywhichtheprevailingrateexceeds(inthecaseofcaps)orfalls below(inthecaseoffloors)thestrikeprice/rate. Foracap,paymentsareonlymadebythesellerifthemarketrateexceedsthecaprate,therefore,themaximumlosstothe purchaseristhepremium.Similarly,forafloor,paymentsareonlymadebythesellerifthefloorrateexceedsthemarket rate;therefore,themaximumlosstothepurchaserisalsothepremium.Accordingly,uponreceiptofthepremiumfromthe buyer,thesellerbearsnocreditriskforthesetypesoftransactions. Captions and floortions:acaptionisanoptiontobuyacapoptioninthefuture.Afloortionisanoptiontobuyafloor optioninthefuture.Acaptionisusefulifacompanyisuncertainoffutureinterestrates;itmightbeinvolvedinamajor acquisitionandneedstobeabletofixborrowingcosts.Afloortionisusefulifacompanywantstodepositatafloatingrate whilestillleavingthepotentialforupwardmovementsinrates. Cash flow interest rate risk:istheriskthatfuturecashflowsofamonetaryfinancialinstrumentwillfluctuatebecauseof changesinmarketinterestrates.Inthecaseofafloatingratedebtinstrument,forexample,suchfluctuationsresultina changeintheeffectiveinterestrateofthefinancialinstrument,usuallywithoutacorrespondingchangeinitsfairvalue. Cash flow hedges:ahedgeoftheexposuretovariabilityincashflowsthat: isattributabletoaparticularriskassociatedwitharecognisedassetorliability(suchasallorsomefutureinterest paymentsonvariableratedebt)orahighlyprobableforecasttransaction;and couldaffectprofitorloss.
GuidanceontheimplementationofIAS39statesthatahedgedforecasttransactionmustbehighlyprobable,which indicatesamuchgreaterlikelihoodofithappeningthantheterm'morelikelythannot'andisalsosignificantlyhigherthan probable.Thisassessmentshouldbesupportedbyobservablefactsandcircumstances. Cashflowhedgesareaccountedforasfollows: theportionofthegainorlossonthehedginginstrumentthatisdeterminedtobeaneffectivehedgeisrecognised directlyinequitythroughthestatementofchangesinequity;and theineffectiveportionofthegainorlossonthehedginginstrumentisrecogniseddirectlyinprofitorloss.
Cash pooling:thisisthenamegiventoamechanismwherebycashsurplusesandoverdraftsresidinginanentity'sor group'svariousbankaccountsarepooledtogetherattheendofthedaytocreateanetsurplusoroverdraft.Cashpoolingis usedtorealisesavings,eitherthroughminimisinginterestexpenseormaximisinginterestincome. CashpoolingmechanismsareunlikelytomeetIAS32'srequirementsforoffsettingofcashbalancesandoverdraftsfor presentationinthebalancesheet. Certificates of deposit:theseareamountsdepositedwithabankthatitwillredeematastatedmaturitydateandonwhich interestwillhaveaccrued.Theseinstrumentscanbetraded.Whenacquiredfromtheissuerdirectlyorviaabroker,theyare classifiedasloansandreceivables(providedtheyarenotquoted)andheldatamortisedcost,unlesstheyareheldfortrading andarethusmeasuredatfairvaluethroughprofitorloss.Bankscarrysuchliabilitiesatamortisedcost,unlesstheyareheld intheportfoliofortradinginwhichcasetheyarecarriedatfairvaluethroughprofitorloss. Clean price:thisisthetotalpriceofafinancialinstrumentlessaccruedinterest. Climatic, geographical or other physical variables:suchvariablesmaybefoundincontractswhichcanbedividedinto twocategories:
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Contractsthatrequireapaymentonlyifaparticularleveloftheunderlyingclimatic,geological,orotherphysical variablesadverselyaffectsthecontractholder.TheseareinsurancecontractsasdefinedinIFRS4.Forexample,a pluviousinsurancetakenoutbyafeteorganiseragainsttheeffectifitrainsonthedayofthefete. Contractsthatrequireapaymentbasedonaspecifiedleveloftheunderlyingclimate,geologicalorotherphysical variable,regardlessofwhetherthereisanadverseeffectonthecontractholder(forexample,abetthatitwillsnow onChristmasday).ThesearederivativesandIFRS4removesapreviousscopeexclusiontobringthemwithinIAS 39'sscope.
Cliquet (ratchet) option:acliquet(or'ratchet')optionisasequentialseriesofforwardstartoptionswherethestrike price/rateforthenextperiodisresetateachperiodendupordowntothemarketpriceatthattime.Anexamplewouldbe anoptionthatisduetostartinthreemonthstimeandrunforafurthersixmonths.Theinitialstrikepriceisnotdetermined untilthestartdateandisusuallythecurrentspotpriceatthatdate.Thisstrikepriceisthenresettomatchtheprevailing assetpriceonsetpredetermineddates.Wheneverthestrikepriceisresettheintrinsicvalueislockedin. Collar:acollaristhesimultaneouspurchaseofacapandaflooroption.Thepremiumfromsellingtheput(thefloor) reducesthecostofpurchasingthecall(thecap).Theamountsaveddependsonthestrikerateofthetwooptions.Ifthe premiumraisedbythesaleoftheputexactlymatchesthecostofthecall,thestrategyisknownasazerocostcollar. Collateral:properties,cashorotherassetsthatareofferedtothelendertosecurealoanorothercreditincasetheborrower failstopaybacktheloan.Collateralisthussubjecttoseizurebythelenderondefault. Collateralised bond obligation (CBO):bondsthatareassignedoneofthetopfourcreditratingsthatarebackedbybonds withaspeculativeratingthatislower(thatis,junkorhighyieldbonds). Collateralised debt obligation (CDO):ageneraltermthatincludescollateralisedbondobligations,collateralisedloan obligationsandcollateralisedmortgageobligations. Collateralised loan obligation (CLO):isasecuritybackedbyapoolofloans(commercialorpersonal).Theseare structuredsuchthatthereareseveralclasses(tranches)ofbondholderswithvaryingmaturities. Collateralised mortgage obligation (CMO):isasecuritybackedbyapoolofmortgages(commercialorhome).Theseare structuredsuchthatthereareseveralclasses(tranches)ofbondholderswithvaryingmaturities.Theprincipalpayments fromtheunderlyingmortgagesareusedtoextinguish(thatis,payback)theCMObondsonaprioritybasisasspecifiedin theprospectusforthesesecurities. Combination options:acombinationoptioncombinesputsandcallsonthesameunderlyinginstrumentorcommodity,so thattheyareeitherbothboughtorbothwrittenoptions.Twopopularcombinationsarestraddlesandstrangles. Commercial paper:commercialpaperissuesarenegotiablepromissorynoteswithshort-termmaturities.Theirmost importantcharacteristicsare: Thematuritiesareflexibleandarefixedbytheissueratthetimeofissue.Inmostmarketstheywillrangefromafew daystoayear. Thenotesareusuallyissuedinhigherdenominationsthanisthecasewithlonger-datedsecurities.USdollareurocommercialpaperissues,forexample,areissuedin$250,000denominations,comparedwith$1,000foreurobonds. Thisreflectsthedominationofmarketsbylargeandprofessionalinvestors.
Themajorityofcommercialpaperissuesareunsecured.However,mostcommercialpaperprogramsaregivenratingsby theleadingcreditratingagenciesinasimilarwaytobonds.Moody'sratingsforcommercialpaperarefromP1toP3,and StandardandPoor'srangefromA1toA3. Commercialpapercanbeissuedininterestbearingform,analogoustolongerdatedinstruments(withprincipalamountand

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bearingastatedinterestrate).However,itismoreusualforthepapertobeissuedatadiscounttoitsfacevalue.Theyield ontheinstrumentisreflectedinthedifferencebetweenthediscountedpriceandtheparvalueatwhichitwillberedeemed. Commercialpaperisquotedinthesecondarymarketsonayieldbasisratherthanatapriceexpressedaspercentageofpar. Commercialpaperisissuedinbearerform.Inotherwords,investorsdonothavetoberegistered,andownershipis evidencedbyphysicalpossession. Commercialpaperisafinancialassetoftheholderandwillgenerallybeclassifiedatfairvaluethroughprofitorloss(if heldfortrading)orasavailable-for-sale.Inbothcasesitwillbemeasuredatfairvalue.Commercialpaperissuedbyan issuerwillgenerallybemeasuredatamortisedcost. Commitment fee:thisisanamountthatlendinginstitutionschargetheirborrowersforcreditthatisunusedorcreditthat hasbeenpromisedbythelenderataspecifiedfuturedate. Committed facility:acredit(loan)facilitywherebythetermsandconditionsaredefinedbythelenderandimposedupon theborrower. Commodity derivatives:contractstobuyorsellanon-financialitem(forexample,hardcommodities(suchasmetals)and softcommodities(suchasoils,grains,cocoa,porkbellies,coffee,cotton,soya,beans,sugar,gas,electricityetc))thatgive eitherpartytherighttosettleincashorsomeotherfinancialinstrument,orbyexchangingfinancialinstruments.Theyare derivativesandmustbecarriedatfairvalue,withtheexceptionofthoseenteredintoandwhichcontinuetobeheldforthe purposeofreceiptordeliveryofanon-financialiteminaccordancewiththeentity'sexpectedpurchase,saleorusage requirements. CommoditycontractsexcludedfromIAS39'sscopearenotrecognisedasassets,but,whenonerous,maybereportedas liabilitiesinaccordancewithIAS37. IAS32and39clarifythatthis'normalpurchasesandsales'exemptiondependsontheentity'sexperiencewithrespectto similarcontractsanddoesnotextendtoanentitywithapracticeandhistoryofnetcashsettlement,evenifthereisno contractualormarketsettlement. Commodity futures:acommodityfutureisacontracttradedonanexchangethatgivestheholdertherighttobuyorsella specifiedamountofacommodityatastatedpriceanddateinthefuture.Examplesofcommoditiesareagriculturalproducts (wheat,coffee,corn,cocoa,etc),preciousmetals(gold,platinum,etc)non-ferrousmetals(copper,zincetc)andpetroleum products(crudeoil,fueloiletc).Therearealsomeatandmeatproductfutures(hogs,cattle,etc)andanumberofother products(frozenorangejuice,plywoodandeggs). Compound instrument:acompoundinstrumentisanon-derivativefinancialinstrumentwhosetermsdeterminethat,from theissuer'sperspective,itcontainsbothaliabilityandanequitycomponent.Anissuerrecognisesseparatelythe componentsofafinancialinstrumentthat:(a)createsafinancialliabilityoftheentity;and(b)grantsanoptiontotheholder oftheinstrumenttoconvertitintoanequityinstrumentoftheentity.Theequityconversionoptionisa'derivativeoverown shares'andissubjecttotherulesunderIAS32onalternativesettlementprovisions.Fromtheholder'sperspectivethis contractisahybridinstrument. Compound option:thisisanoptiononanoptionforaspecificcurrency.Itisthecurrencyequivalentof captions/floortions.Theoptionpremiumontheinitialoptionislowerthanaconventionaloption,but,ifexercised,the overallcostwillbehigherthanthepurchaseofanoutrightcurrencyoption. Contingent settlement provision:thisiswhereafinancialinstrumentmayrequiretheissuertodelivercashoranother financialinstrument,orotherwisesettleitinsuchawaythatitwouldbeafinancialliabilityintheeventoftheoccurrence ornon-occurrenceofuncertainfutureevents(orontheoutcomeofuncertaincircumstances)thatarebeyondthecontrolof boththeissuerandholderoftheinstrument,suchaschangeinstockmarketindex,consumerpriceindex,interestrateor taxationrequirements,ortheissuer'sfuturerevenues,netincomeordebt-to-equityratio.Theissuerofsuchaninstrument doesnothavetheunconditionalrighttoavoiddeliveringcashoranotherfinancialasset(orotherwisetosettleitinsucha waythatitwouldbeafinancialliability).Therefore,itisafinancialliabilityoftheissuerunless:
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thepartofthecontingentsettlementprovisionthatcouldrequiresettlementincashoranotherfinancialasset(or otherwiseinsuchawaythatitwouldbeafinancialliability)isnotgenuine;or theissuercanberequiredtosettletheobligationincashoranotherfinancialasset(orotherwisetosettleitinsucha waythatitwouldbeafinancialliability)onlyintheeventofliquidationoftheissuer.
Continuing involvement:iswhereanentityneithertransfersnorretainssubstantiallyalltherisksandrewardsof ownershipofatransferredasset,butretainscontrolofthetransferredasset,inwhichcasetheentitycontinuestorecognise thetransferredassettotheextentofitscontinuinginvolvement.Theextentoftheentity'scontinuinginvolvementinthe transferredassetistheextenttowhichitisexposedtochangesinthevalueofthetransferredasset. Contract:isanagreementbetweentwoormorepartiesthathascleareconomicconsequencesthatthepartieshavelittle,if any,discretiontoavoid,usuallybecausetheagreementisenforceableatlaw.Contractsmaytakeavarietyofformsand neednotbeinwriting. Covenant:apromiseinadebtagreementthatagreedactivitieswillbeundertaken(positive)ornotdone(negative).A breachofacovenantisadefaultonthedebt. Convertible bonds:arecompoundinstrumentsthat(fortheholder)cannotbeheld-to-maturityinvestments,unlessthey onlyconvertatthefinalmaturitydate.Insteadtheyareclassifiedasavailable-for-saleprovidedtheyarenotpurchasedfor tradingpurposes.Theycontainanembeddedderivativetheoptiontoconvertintoshares.Forthoseclassifiedasavailablefor-sale(thatis,carriedatfairvaluewithgainsandlossesreportedinequityuntilthebondissold),theequityconversion option(theembeddedderivative)isseparated.Theamountpaidforthebondissplitbetweenthedebtinstrumentwithout theconversionoptionandtheequityconversionoption.Changesinthefairvalueoftheequityconversionoptionare recognisedinprofitorlossunlesstheoptionispartofacashflowhedgingrelationship. Iftheconvertiblebondismeasuredatfairvaluewithchangesinfairvaluerecognisedinprofitorloss,separatingthe embeddedderivativefromthehostbondisnotpermitted. Fromtheperspectiveoftheissuer,suchaninstrumentcomprisestwoelements:afinancialliability(acontractual arrangementtodelivercashorotherfinancialassets)andanequityinstrument(acalloptiongrantingtheholdertheright, foraspecifiedperiodoftime,toconvertintoissuer'sshares).Theeconomiceffectofissuingsuchaninstrumentis substantiallythesameasissuingsimultaneouslyadebtinstrumentwithanearlysettlementprovisionandwarrantsto purchaseequityshares,orissuingadebtinstrumentwithdetachablesharepurchasewarrants.Accordingly,inallcases,the issuerpresentstheliabilityandequityelementsseparatelyonitsbalancesheet.Theequityelementisa'derivativeoverown shares'andissubjecttotherulesunderIAS32onalternativesettlementprovisions.Wherethereisnocashalternative,the equityelementisincludedinequity.However,wherethereisasettlementprovisionthatallowstheissuertosettlethe equityelementincashratherthaninafixednumberofequityshares,theequityelementisaderivativeliability,whichis heldatfairvaluewithmovementstakenthroughprofitorloss. Classificationoftheliabilityandequityelementsofaconvertibleinstrumentisnotrevisedasaresultofachangeinthe likelihoodthataconversionoptionwillbeexercised,evenwhenexerciseoftheoptionmayappeartohavebecome economicallyadvantageoustosomeholders.Holdersmaynotalwaysactinthemannerthatmightbeexpected,because,for example,thetaxconsequencesresultingfromconversionmaydifferamongholders.Furthermore,thelikelihoodof conversionwillchangefromtimetotime.Theissuer'sobligationtomakefuturepaymentsremainsoutstandinguntilitis extinguishedthroughconversion,thematurityoftheinstrumentorsomeothertransaction. Coupon:generally,thisisthenominalannualrateofinterestexpressedasapercentageoftheprincipalvalue,whichthe borrowerpromisestopaytheholderofafixedincomesecurity. Covered call option:thewritingofacalloptionforwhichthewriterownsaninstrumentorcommoditythatcouldbe deliveredifthecalloptionisexercisedbyitsholder. Covered put option:thewritingofaputoptiononaninstrumentorcommodityinwhichthewriterhasashortposition.
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Credit default swap:thisisacreditderivativethattransferscreditrisk(thatis,theriskofdefault)fromtheholderofthe swaptotheissuer.Incomereceivedandtheriskassumedbyonepartyextendingcredittoanentitymaybeswappedforthe incomeandriskassociatedwithgivingcredittoanotherparty.Itmaybeafinancialinstrumentoraninsurancecontract dependingonwhetherornotitrelatestoaspecifiedfinancialassetownedbytheholderoftheswap. Credit derivative:thecreditderivativeisarelativelynewderivativeproduct.Thecreditderivativeseekseithertohedge againstortoassumetheriskofdefaultbyoneornumberofcounterparties.Optionstylecreditderivativesbehaveinmuch thesamewayasinsurancecontracts,asthesecannotbeexercisedunlessthereisacounterpartydefault.Thecontractwould normallystatethecounterpartiescoveredandanabsolutelevelofexposuretothesellerof,say$10million.Thepricingand characteristicsareconceptuallythesameasforacalloption. Credit insurance:isinsurancethatprovidesforspecifiedpaymentstobemadetoreimbursetheholderforthelossitincurs becauseaspecifieddebtorfailstomakepaymentwhendueunderthedebtinstrument'soriginalormodifiedterms.These contractscanhavevariouslegalforms,suchasthatofaguarantee,sometypesofletterofcredit,acreditderivativedefault contractorinsurancecontract. Acredit-relatedguaranteethatdoesnot,asapre-conditionforpayment,requirethattheholderisexpectedtobeexposedto, andhasincurredalosson,thefailureofthedebtortomakepaymentsontheguaranteedassetwhendueisafinancial instrumentandisnotaninsurancecontract. Credit rating:thisisaletter,orcombinationoflettersandnumbers,thatsignifiesasecurity'sinvestmentrating.Themain ratingagenciesareMoody'sandStandard&Poor's. Credit risk:istheriskthatonepartytoafinancialinstrumentwillfailtodischargeanobligationandcausetheotherparty toincurafinancialloss. Critical terms matching:thisisamethodthat,inverylimitedcircumstances,anentitymayadoptinordertoassesshedge effectiveness.Criticaltermsmatchingcanonlybeusediftheentityiscertainthatcriticaltermsmatchexactlyatthe inceptionofthehedgeandalsothattheyexpectthistocontinuethroughoutthelifeofthehedgingrelationship.Ifthe principaltermsofthehedginginstrumentandofthehedgedasset,liability,firmcommitmentorhighlyprobableforecast transactionareidentical,thechangesinfairvalueandcashflowsattributabletotheriskbeinghedgedmaybelikelyto offseteachotherfully,bothwhenthehedgeisenteredintoandafterwards.Forexample,aninterestrateswapislikelytobe aneffectivehedgeifthenotionalandprincipalamounts,term,repricingdates,datesofinterestandprincipalreceiptsand payments,andbasisformeasuringinterestratesareidenticalforthehedginginstrumentandthehedgeditem.Inaddition,a hedgeofahighlyprobableforecastpurchaseofacommoditywithaforwardcontractislikelytobehighlyeffectiveif: theforwardcontractisforthepurchaseofthesamequantityofthesamecommodityatthesametimeandlocationas thehedgedforecastpurchase; thefairvalueoftheforwardcontractatinceptioniszero;and eitherthechangeinthediscountorpremiumontheforwardcontractisexcludedfromtheassessmentof effectivenessandrecognisedinprofitorlossorthechangeinexpectedcashflowsonthehighlyprobableforecast transactionisbasedontheforwardpriceforthecommodity.
Cross currency interest rate swaps:areinstrumentsthatenableanentitytoswapboththecurrencyofaprincipalamount aswellastheinterestpayments.Afixedtofixedcrosscurrencyinterestrateswapinvolvesanexchangeofinterest liabilitiesbetweencurrencies.Itmayconsistofthreestages: Aspotexchangeofprincipal.Thisdoesnotalwaysformpartoftheswapagreement,asasimilareffectcanbe obtainedbyusingthespotforeignexchangemarket. Continuingexchangeoffixedinterestpaymentsduringthetermoftheswap,wherethetimingoftheinterestflows onbothlegsintheswapisidentified.Thisineffectreqresentsaseriesofforwardforeignexchangecontractsduring
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thetermoftheswapcontract.Thisistypicallydoneatthesameexchangerateasthespotrateusedattheswap's inception.Thisisbecauseinterestpaymentsaremadebetweenthepartiesduringtheswap'slifebasedontheinterest ratesavailableinthetwocurrenciesatthecontract'sinception.Ifanyotherexchangerateisusedonre-exchange,this isbecausethebankisbuildinginpartofitsprofitinexchangeratetermsratherthanasfeeorinterestspreadterms. Anydifferencebetweentheinitialandfinalprincipalexchangesisknownastheexchangediscountorpremium. Re-exchangeofprincipalonmaturityatthespotrateatinceptioniftherewasanexchangeofprincipalatinception.
Inessencethereisaformalisedlong-termforeignexchangedeal,fullyreflectingallinherentdifferentialsanddocumented inalegalagreement. Afixedtofloatingorafloatingtofloatingcrosscurrencyinterestrateswapisonethatexchangesafixedorfloatinginterest paymentinonecurrencyforafloatingratepaymentinanothercurrency.Thesetypesofswapsdonotrepresentaseriesof forwardforeignexchangecontractsduetothefloatingnatureofoneorbothlegs. Currency forwards:thesearecontractstobuyorsellanamountofcurrencyatanagreedexchangeratewithsettlement anddeliveryataspecifiedfuturedate. Currency risk:isamarketrisktheriskthatthevalueofafinancialinstrumentwillfluctuateduetochangesinforeign exchangerates. Top Debt for equity swap:here,onepartypaysfixedorfloatingcouponsinterestandreceivesinterestcouponsbaseduponthe performanceofanequityindex.Iftheindexfalls(foraproductwithpayoffbaseduponriseintheindex)theequity-linked couponisnotpaid. Deep discounted bonds:deepdiscountedorzerocouponbonds(ZCB)arebondsthatmakenoperiodicinterestpayments andare,therefore,soldatalargediscount('deepdiscount')totheirnominalvalue.Insteadofinterestpaymentsthebuyerof suchabondreceivesasareturnthedifferencebetweenthepurchasepriceandthehigherredemptionproceeds.Thereare onlytwocashflowsthatariseonazerocouponbond:theproceedsatthedateofissue(which,ifthebondistoberedeemed atpar,willbeatasubstantialdiscounttoparvalue),andthepaymentonredemptiondate. Theissuewillbepricedatalargerdiscounttoparvaluethelongerthezerocouponbond'slife.Thebond'spriceinthe secondarymarketwillgraduallyaccreteasthematuritydateapproaches. Default:thefailuretopaypromptlyinterestorprincipalonadebtsecurityortootherwisecomplywiththeprovisionsofa loanagreementsuchasabreachofacovenant. Delta:isdefinedastherelationshipbetweenachangeinthederivativepriceandacorrespondingchangeinthepriceofthe underlyingasset.Thedeltaofanoptionisamostimportantconcept,becauseitisusedinareassuchasmargining(see margin)andhedginganoptionsportfolio. Thedeltaofanoptionistheprimedeterminantoftheriskfactorsusedbymanyexchangesindeterminingthemarginfunds thatarerequiredtobedepositedbysellersandperhapsbuyersofoptions. Theoveralldeltaofaportfoliorevealshowmuchitsvaluewillchangeforachangeintheassetprice.Itisthusa fundamentalmeasureoftheportfolio'srisk. Delta hedging:Theconceptofdeltaisusedinamethodofhedgingoptions.Thepriceorvalueofanoptionwillmoveby anamountequaltothemovementinpriceofdeltamultipliedbytheunderlyingquantityoftheinstrumenttowhichthe optionrelates.Thusatanytimethewriterofanoptioncanprotecthimselffromtheeffectofanypricemovementsonthe optionbyholdinganamount,delta,oftheunderlyinginstrument.Howeverthisisonlyvalidforinfinitelysmallmovements intheoption'spriceandisparticularlydifficulttoapplywhenanoptionisatornearthemoney,asatthispointthetime valueoftheoptionreachesitsmaximum.Transactioncostspresentproblemsfor'deltahedgers',fortheyobstructthe continuedreadjustmentsofthehedgethatisassumedbythetheory.
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Delta-neutral hedging:isahedgingstrategythatinvolvesconstantlyadjustingthequantityofthehedginginstrumentin ordertomaintainadescribedhedgeratiotoachieveadelta-neutralpositioninsensitivetochangesinthefairvalueofthe hedgeditem. ImplementationguidancetoIAS39statesthatadelta-neutralhedgingstrategyispossibletoqualifyforhedgeaccounting asitisaformof"dynamic hedging strategy that assesses both the intrinsic value and the time value of a option contract". Forexample,aportfolioinsurancestrategythatseekstoensurethatthefairvalueofthehedgeditemdoesnotdropbelow acertainlevel,whileallowingthefairvaluetoincrease,mayqualifyforhedgeaccounting. Toqualifyforhedgeaccounting,theentitymustdocumenthowitwillmonitorandupdatethehedgeandmeasurehedge effectiveness,beabletotrackproperlyallterminationsandredesignationsofthehedginginstrumentanddemonstratethat allothercriteriaforhedgeaccountingaremet.Also,itmustbeabletodemonstrateanexpectationthatthehedgewillbe highlyeffectiveforaspecifiedshortperiodoftimeduringwhichthehedgeisnotexpectedtobeadjusted. Depth of the market:thisistheamountofagivensecuritythatcanbedealtinthemarketatagiventimewithoutcausing pricefluctuation.Thinmarketsareusuallycharacterisedbywidespreadsandsubstantialpricefluctuationsduringashort periodoftime.Strongmarketstendtobecharacterisedbyrelativelynarrowspreadsandstableprices. Derecognition of a financial asset:istheremovalofapreviouslyrecognisedfinancialassetfromanentity'sbalancesheet. Derecognitionoccursonlywhenthesellerhastransferredtheasset'sriskandrewards(eithersubstantiallyorpartially)or controlofthecontractualrightshavebeentransferredfromthesellertothebuyer.Theevaluationofthetransferofrisks andrewardsshouldprecedeanevaluationofthetransferofcontrolforalltypesoftransaction.Thepositionsofboththe sellerandthebuyershouldbeconsidered,buttheseller'spositionisseenasmorerelevant.Thereafter,anenterprisemay achievepartialderecognitionwhereitrecognisesthecomponentsthathavebeenretained,ornewassetsorliabilitiessuchas thosethatarisefromissuingaguarantee. Iftheentitydeterminesthatithasneitherretainednortransferredsubstantiallyallofanasset'srisksandrewardsandthatit hasretainedcontrol,theentityshouldcontinuetorecognisetheassettotheextentofitscontinuinginvolvement. Onderecognition,thedifferencebetweentheamountreceivedandtheasset'scarryingamountisrecognisedinprofitor loss.Anyfairvalueadjustmenttotheassetformerlyreportedinequityisthenrecycledtoprofitorloss. Derecognition of a financial liability:financialliabilities(orpartofafinancialliability)areremovedfromthebalance sheetwhen,andonlywhen,extinguishedthatis,whentheobligationspecifiedinthecontractisdischarged,cancelledor expires.Forexample,derecognitionoccurswhenaliabilityispaidorthedebtorisreleasedfromprimaryresponsibilityfor theliabilityeitherbyprocessoflaworbythecreditor. Onderecognition,thedifferencebetweentheconsiderationpaidandtheliability'scarryingamountisrecognisedinprofitor loss. Derivative:asdefinedinIAS39isafinancialinstrumentorothercontract: whosevaluechangesinresponsetochangesinaspecifiedinterestrate,financialinstrumentprice,commodityprice, foreignexchangerate,indexofpricesorrates,creditratingorcreditindex,orothervariable,providedinthecaseof anon-financialvariablethatthevariableisnotspecifictoapartytothecontract(sometimescalledthe'underlying'); thatrequirednoinitialnetinvestmentoraninitialnetinvestmentthatissmallerthanwouldberequiredforother typesofcontractsthatwouldbeexpectedtohaveasimilarresponsetochangesinmarketfactors;and thatissettledatafuturedate.
Allderivativesmustbecarriedatfairvalue.Gainsandlossesarereportedasprofitorlossunlesstheyqualifyaseffective cashflowhedgesorahedgeofanetinvestmentinaforeignoperationwhengainsandlossesaredeferredinequityand recycledtoincometomatchtheincome/expenseonthehedgedtransaction. Derivative financial instruments:arefinancialinstrumentssuchasfinancialoptions,futuresandforwards,interestrate

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swapsandcurrencyswaps,whichcreaterightsandobligationsthathavetheeffectoftransferringbetweenthepartiestothe instrumentoneormoreofthefinancialrisksinherentinanunderlyingprimaryfinancialinstrument.Oninception, derivativefinancialinstrumentsgiveonepartyacontractualrighttoexchangefinancialassetsorfinancialliabilitieswith anotherpartyunderconditionsthatarepotentiallyfavourable,oracontractualobligationtoexchangefinancialassetsor financialliabilitieswithanotherpartyunderconditionsthatarepotentiallyunfavourable.However,theygenerallydonot resultinatransferoftheunderlyingprimaryfinancialinstrumentonthecontract'sinception,nordoessuchatransfer necessarilytakeplaceonthecontract'smaturity.Someinstrumentsembodybotharightandanobligationtomakean exchange.Becausethetermsoftheexchangearedeterminedonthederivativeinstrument'sinception,aspricesinfinancial marketschangethosetermsmaybecomeeitherfavourableorunfavourable. ImplementationguidancetoIAS39statesthatnon-derivativetransactionsareaggregatedandtreatedasaderivativewhen thetransactionsresult,insubstance,inaderivative.Indicationofthiswouldinclude: Theyareenteredintoatthesametimeandincontemplationofeachother. Theyhavethesamecounterparty. Theyrelatetothesamerisk. Thereisnoapparentneedorsubstantivebusinesspurposeforstructuringthetransactionthatcouldnotalsohave beenaccomplishedinasingletransaction. Dirty price:thisisthetotalpriceofafinancialinstrument,includingaccruedinterest. Discontinuing hedge accounting:ariseswhen: ahedginginstrumentexpiresorissoldterminatedorexercised(forthispurpose,thereplacementorrolloverofa hedginginstrumentintoanotherhedginginstrumentisnotanexpirationorterminationifsuchreplacementor rolloverispartoftheentity'sdocumentedhedgingstrategy); thehedgenolongermeetsthecriteriaforhedgeaccounting(seebelow); aforecasttransactionisnolongerexpectedtooccur(cashflowhedgeonly);or theentityrevokesthedesignation.
Ineachcase,hedgeaccountingceasesprospectively.Forapastcashflowhedge,anygainorlossdeferredremainsinequity whereaforecasttransactionisexpectedtooccurbutisnolonger'highlyprobable'andisrecycledbyadjustingthecostof theitem.Otherwiseanydeferredgainorlossisimmediatelyreportedinprofitorloss. Discount:thisisthedifferencebetweenthestatedparandthemarketpriceofanissueforissuessellingbelowpar,orthe differencebetweenthespotexchangerateandtheforwardexchangeratewhenthelatterisabovetheformer. Acurrencyintheforwardmarketisatadiscountwhenitsinterestrateisabovethatofthecurrencywithwhichitisbeing compared. Discount factor:afuturecashflowcanbediscountedtotakeaccountforthetimevalueofmoney.Thefraction,expressed asadecimal,whichwhenappliedtothefuturecashflowtodiscount,isknownasthediscountfactor.Theformulausesthe interestrateandthenumberofdaysfortheperiodrequired. Dollar-offset:isthenamegiventotheratioanalysisthatcomparesthechangeinthehedgeditem'sfairvaluetothechange inthehedginginstrument'sfairvalue(orvice versa).Itiscommonlyspecifiedasthemethodusedtojudgehedge effectiveness.SeeHedgeeffectiveness. Duration:thesensitivityofthepriceofafixed-incomesecuritytochangesintheinterestrates.Thedurationofaseriesof cashflowsistheprice-weightedaveragetermtomaturityofthezerocouponbondsrepresentedbyeachcashflowinthe
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series.Durationismeasuredinyearsandforallbonds,otherthanzerocouponbonds,thedurationisshorterthanthetime tomaturity(forzerocouponbondstheseareequal). Dual currency bond (Dual option bond):thisisabondwheretheredemptionproceedsareexpressedintwocurrencies. Theinvestormaychoosethecurrencyinwhichtoreceivepaymentofcouponsandredemption. Top Effective interest method:isamethodofcalculatingtheamortisedcostofafinancialassetorafinancialliability(or groupoffinancialassetsorfinancialliabilities)andofallocatingtheinterestincomeorexpenseovertherelevantperiod. Effective interest rate:istheratethatexactlydiscountsestimatedfuturecashpaymentsorreceiptsthroughtheexpected lifeofthefinancialinstrumentor,whenappropriate,ashorterperiodtothenetcarryingamountofthefinancialassetor financialliability.Whencalculatingtheeffectiveinterestrate,anentityshallestimatecashflowsconsideringallofthe financialinstrument'scontractualterms(forexample,prepayment,callandsimilaroptions)butshallnotconsiderfuture creditlosses.Thecalculationincludesallfeesandpointspaidorreceivedbetweenpartiestothecontractthatareanintegral partoftheeffectiveinterestrate,transactioncostsandallotherpremiumsordiscounts.Thereisapresumptionthatthecash flowsandtheexpectedlifeofagroupofsimilarfinancialinstrumentscanbeestimatedreliably.However,inthoserare caseswhenitisnotpossibletoestimatereliablythecashflowsortheexpectedlifeofafinancialinstrument(orgroupof financialinstruments),theentityshouldusethecontractualcashflowsoverthefinancialinstrument'sfullcontractualterm (orgroupoffinancialinstruments). Embedded derivative:acomponentofahybrid(combined)instrumentthatalsoincludesanon-derivativehostcontract withtheeffectthatsomeofthecashflowsofthecombinedinstrumentvaryinawaysimilartoastand-alonederivative.An embeddedderivativecausessomeorallofthecashflowsthatotherwisewouldberequiredbythecontracttobemodified accordingto:aspecifiedinterestrate;financialinstrumentprice;commodityprice;foreignexchangerate;indexofpricesor rates;creditratingorcreditindex;orothervariable,providedinthecaseofanon-financialvariablethatthevariableisnot specifictoapartytothecontract.Aderivativethatisattachedtoafinancialinstrumentbutiscontractuallytransferable independentlyofthatinstrument,orhasadifferentcounterpartyfromthatinstrument,isnotanembeddedderivative,buta separatefinancialinstrument. AnembeddedderivativeisseparatedfromthehostcontractandaccountedforasaderivativeunderIAS39if,andonlyif: theembeddedderivative'seconomiccharacteristicsandrisksarenotcloselyrelatedtothehostcontract'seconomic characteristicsandrisks; aseparateinstrumentwiththesametermsastheembeddedderivativewouldmeetthedefinitionofaderivative;and thehybrid(combined)instrumentisnotmeasuredatfairvaluewithchangesinfairvaluerecognisedinprofitorloss (thatis,aderivativethatisembeddedinafinancialassetsorfinancialliabilityatfairvaluethroughprofitorlossis notseparated).
Embedded option:thisisanoption(oftenaninterestrateoption)thatisembeddedinadebtinstrumentthataffectsits redemption. Examplesincludemortgagebackedsecuritiesandcallableandputtablebonds. Equity:anentity'sownequityinstruments,includingcertainoptionsandwarrantsissuedandpurchasedandownshares (treasuryshares),arenotfinancialinstruments.However,afinancialliabilityincludesanyliabilitythatisacontractthatis tobe,ormaybe,settledintheentity'sownequityinstrumentsandis: anon-derivativeforwhichtheentityis,ormaybe,obligedtodeliveravariablenumberoftheentity'sownequity instruments;or ifthecontractisaderivativethatwillormaybesettledotherthanbyexchangeofafixedamountofcashoranother financialassetforafixednumberoftheentity'sownequityinstruments.Forthispurposetheentity'sownequity instrumentsdonotincludeinstrumentsthatarethemselvescontractsforthefuturereceiptordeliveryoftheentity's ownequityinstruments.
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Derivativecontractssuchasforwardcontractstobuyanentity'sownequitysharesandwrittenputoptionsoveranentity's ownequityshares,arefinancialliabilitiesandnotequityinstrumentseventhoughsettlementisbywayofafixedamountof cashforafixednumberofshares. Thisisbecauseacontractthatcontainsanobligationforanentitytopurchaseitsownequityinstrumentsforcashoranother financialassetgivesrisetoafinancialliabilityforthepresentvalueoftheredemptionamount(forexample,thepresent valueoftheforwardrepurchaseprice,optionexercisepriceorotherredemptionamount). Anentity'scontractualobligationtopurchaseitsownequityinstrumentsgivesrisetoafinancialliabilityevenifthe obligationtorepurchaseisconditionalonthecounterpartyexercisingarighttoredeem(forexample,awrittenputoption givesthecounterpartytherighttosellanentity'sownequityinstrumentstotheentityforafixedprice). Equity instrument:isanycontractthatevidencesaresidualinterestintheentity'sassetsafterdeductingallofits liabilities. Aninvestmentinanequityinstrumentofanotherentityiscarriedatfairvalueasafinancialassetatfairvaluethrough profitorlossorasafinancialassetheldasavailable-for-sale(throughequityunlessimpairmentlossesorforeignexchange gainsandlosses)unlessitsvaluecannotbereliablymeasured,whencostlessimpairmentisused.Currencyelements presentinforeigncurrencydenominatedequityinvestmentsmaynotbeseparatedunlesshedgedinafairvaluecurrency hedge. Eurobond:eurobondisageneraltermforanylong-dateddebtsecurityissuedthroughtheeuromarkets.Thegeneral characteristicssharedbymosteurobondissuesareasfollows: Eurobondsareissuedinbearerform.Inotherwords,investorsdonothavetoberegistered(asinthedomesticUnited Statesbondmarket),andownershipisevidencedbyphysicalpossession.Interestispayabletotheholderpresenting thecoupontothepayingagentforthatparticularissue.Thecouponisdetachablefromthebearerbond.Thiscanbe anadvantagetoinvestorswhowishtoretainanonymity. Interestisquotedonthe30/360basis(thisishowtheinterestaccruesovertime,thisassumes30dayspermonthand 360daysperyear). Eurobondissuespayinterestgrossandtheeffectofanywithholdingtaxesisbournebytheissuer. Eurobondsarelong-terminstrumentswithmaturitiesinexcessoffive,andupto30,years. Eurobondsareusuallyissuedinsmalldenominations(often$1,000). Borrowersaretypicallysovereignstates,government-basedinstitutions,supranationalentities(suchastheWorld Bank)andthelargermulti-nationalcorporations.Assuch,issuerstendtobehouseholdnameswithhighcredit ratings. Theissuesareusuallyunsecured,reflectingthequalityoftheborrowers. Eurobondswillnormallybelistedonastockexchange,althoughthisisnotarequirement.Thelistingwillusuallybe oneithertheLuxembourgStockExchangeorTheLondonStockExchange.Listingsareundertakentomakeissues morepopularwithinvestors,bothbecauseofthedisclosureandreportingrequirementsofthestockexchangesand becausesomecountriesdonotallowtheirresidentstopurchaseunlistedforeignsecurities.Onlyaverysmall percentageofthetradinginlistedeurobondstakesplaceontheseexchanges. Thestandardtermsoftradeareforsevendaysettlementandthemajorityoftransactionsaresettledthroughtwo clearinghouses(EuroclearandCedel).
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Eurodollar:theseareUSdollarsdepositedinaforeignbankorUSbankbranchlocatedoutsidetheUnitedStates. European option:aEuropeanoptionisonethatcanbeexercisedbytheholderonlyatthefixeddateatwhichtheoption expires. Exchange gains and losses:arerecognisedinprofitorlossastheyariseexceptforqualifyingcashflowhedgesandnet investmenthedgeswheretheyaredeferredinequitytotheextentthattheyarisefromaneffectivehedgerelationship. TheapplicationguidanceincludedinIAS39confirmsthatexchangegainsandlossesonmonetaryavailable-for-saleassets arerecognisedinprofitorlossevenifotherchangesinvaluearedeferredinequity. Exchange traded options:areoptionswhosetermsarestandardisedandaretradedonarecognisedexchange,forexample, ChicagoBoardOptionsExchange,NYFuturesExchangeandEuronextLIFFEinLondon. Exercise period:theperiodduringwhichanoptionmaybeexercised. Exercise price: see Strikeprice. Exotic option:thisisanyoptionwithamorecomplicatedpay-outstructurethanasimpleputorcalloption. Extendable swap:isaswapthatgrantsoneoftheconterpartiestheoptiontoextendtheinstrument'slife. Top Factored debts:thisiswhereanentitysellsitsreceivablesforcashinordertoimproveitscashflowposition.Factored debtscanbederecognisedprovidedthatthecriteriaforderecognitionhavebeenmet.See Derecognition. Fair value:istheamountforwhichanassetcouldbeexchanged,oraliabilitysettled,betweenknowledgeable,willing partiesinanarm'slengthtransaction.Forassetsthemarketbidpriceshouldbeusedandnotmid-marketorasking(oroffer) price.Forliabilities,themarketaskingpriceshouldbeused.Mid-marketpricescanonlybeusedwhereanentityhasassets andliabilitieswithoffsettingmarketrisks(thisisexpectedtoberare).Thefairvalueofafinancialliabilitywithademand feature(forexample,ademanddeposit)isnotlessthantheamountpayableondemand,discountedfromthefirstdatethat theamountcouldberequiredtobepaid. TheapplicationguidanceincludedinIAS39confirmsthatmarketvaluereflectsfairvalueexceptinrarecircumstances. Noadjustmentshouldbemadetomarketvalue,forthoseinstrumentswithaquotedprice,toreflectlargeholdingsof shares.However,adjustmentmayberequiredforcreditriskorotherfactorsthatmarketparticipantswouldincludein valuingtheinstrument. Fair value hedge:ahedgeoftheexposuretochangesinfairvalueofarecognisedassetorliabilityoranunrecognisedfirm commitment,oranidentifiedportionofsuchanasset,liabilityorfirmcommitment,thatisattributabletoaparticularrisk andcouldaffectprofitorloss. Fairvaluehedges(whichmeettheconditionswithinIAS39forhedgeaccounting)shouldbeaccountedforasfollows: thegainorlossfromremeasuringthehedginginstrumentatfairvalue(foraderivativehedginginstrument)orthe foreigncurrencycomponentofitscarryingamountmeasuredinaccordancewithIAS21(foranon-derivative hedginginstrument)shouldberecognisedinprofitorloss;and thegainorlossonthehedgeditemattributabletothehedgedriskshouldadjustthecarryingamountofthehedged itemandberecognisedinprofitorloss.Thisappliesifthehedgeditemisotherwisemeasuredatcost.Recognition ofthegainorlossattributabletothehedgedriskinprofitorlossappliesifthehedgeditemisanavailable-for-sale financialasset.
Fair value interest rate risk:isamarketrisktherisksthatthevalueofafinancialinstrumentwillfluctuatebecauseof

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changesinmarketinterestrates. Financial asset:isanyassetthatis: cash; anequityinstrumentofanotherentity; acontractualright: toreceivecashoranotherfinancialassetfromanotherentity;or toexchangefinancialassetsorfinancialliabilitieswithanotherentityunderconditionsthatarepotentially favourabletotheentity;or acontractthatwillormaybesettledintheentity'sownequityinstrumentsandis: anon-derivativeforwhichtheentityisormaybeobligedtoreceiveavariablenumberoftheentity'sown equityinstruments;or aderivativethatwillormaybesettledotherthanbytheexchangeofafixedamountofcashoranother financialassetforafixednumberoftheentity'sownequityinstruments.Forthispurposetheentity'sown equityinstrumentsdonotincludeinstrumentsthatarethemselvescontractsforthefuturereceiptordelivery oftheentity'sownequityinstruments.
Financial asset or financial liability at fair value through profit or loss:isafinancialassetorfinancialliabilitythat meetseitherofthefollowingconditions. Itisclassifiedasheldfortrading.Afinancialassetorfinancialliabilityisclassifiedasheldfortradingifitis: acquiredorincurredprincipallyforthepurposeofsellingorrepurchasingitinthenear-term; partofaportfolioofidentifiedfinancialinstrumentsthataremanagedtogetherandforwhichthereis evidenceofarecentactualpatternofshort-termprofittaking;or aderivative(exceptforaderivativethatisadesignatedandeffectivehedginginstrument). Uponinitialrecognitionitisdesignatedbytheentityasatfairvaluethroughprofitorloss.Anentitymayusethis designationonlywhenthecontractcontainsoneormoreembeddedderivativesandtherelevantcriteriaarenotmet (para11A),orwhendoingsoresultsinmorerelevantinformation,becauseeither i) iteliminatesorsignificantlyreducesameasurementorrecognitioninconsistency(sometimesreferredtoas'an accountingmismatch')thatwouldotherwisearisefrommeasuringassetsorliabilitiesorrecognisingthegains andlossesonthemondifferentbases;or ii) agroupoffinancialassets,financialliabilitiesorbothismanagedanditsperformanceisevaluatedonafair valuebasis,inaccordancewithadocumentedriskmanagementorinvestmentstrategy,andinformationabout thegroupisprovidedinternallyonthatbasistotheentity'skeymanagementpersonnel.
Financial guarantee:isacontractthatrequirestheissuertomakespecifiedpaymentstoreimbursetheholderforalossit incursbecauseaspecifieddebtorfailstomakeapaymentwhendueinaccordancewiththedebtinstrument'soriginalor modifiedterms. Financial instrument:isanycontractthatgivesrisetoafinancialassetofoneentityandafinancialliabilityorequity instrumentofanotherentity. Financial liability:isanyliabilitythatis: acontractualobligation: todelivercashoranotherfinancialassettoanotherentity;or toexchangefinancialassetsorfinancialliabilitieswithanotherentityunderconditionsthatarepotentially unfavourabletotheentity;or
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acontractthatwillormaybesettledintheentity'sownequityinstrumentsandis: anon-derivativeforwhichtheentityisormaybeobligedtodeliveravariablenumberoftheentity'sown equityinstruments;or aderivativethatwillormaybesettledotherthanbytheexchangeofafixedamountofcashoranother financialassetforafixednumberoftheentity'sownequityinstruments.Forthispurposetheentity'sown equityinstrumentsdonotincludeinstrumentsthatarethemselvescontractsforthefuturereceiptordelivery oftheentity'sownequityinstruments.
Financial risks:risksarisingfromexposurestointerest,currency,credit,liquidity,marketandcommodities. Firm commitment:isabindingagreementfortheexchangeofaspecifiedquantityofresourcesataspecifiedpriceona specifiedfuturedateordates. Fixed rate bond:fixedratebondsaredebtsecuritiesonwhichthecoupon(interest)paymentsarefixedatthedateofissue asaspecifiedpercentageofparvalue.Thesebondswillusuallybeissuedandredeemedatpar,althoughbothpremiums anddiscountsarepossible. Flat yield curve:aflat(or'spot')yieldcurveshowsthemarketdoesnothaveastrongexpectationofinterestratesgoingup anddown.See also: Yieldcurve. Floor:thisisanoptioncontractthatgivesthebuyeraminimumrateofinterestonagivenprincipaloveradesignated period.See also: Capandflooroptions. Floortion: see Captionsandfloortions. Forecast transaction:isanuncommittedbutanticipatedfuturetransaction. Foreign operation:isanentitythatisasubsidiary,associate,jointventureorbranchofareportingentity,theactivitiesof whicharebasedorconductedinacountryorcurrencyotherthanthoseofthereportingentity. Forward foreign exchange contracts:arebindingcontractstopurchaseorsellaspecifiedforeigncurrencyatanexchange ratedeterminedonthedatethatthecontractismade,butwithpaymentanddeliveryataspecifiedfuturedateorbetween twospecifiedfuturedates.Theseinstrumentsaremarked-to-marketthroughincome,unlesstheyqualifyeitherascashflow hedges,wheretheeffectiveportionisreportedinequity,oranetinvestmenthedge,wheretheeffectiveportionisalso reportedinequity,orafairvaluehedge,withgainsandlossesonrevaluingtheassetorliabilityandtheforwardcontract beingrecognisedintheincomestatement. Forward points:arethepremiumordiscountaddedorsubtractedfromthespotrateattheinceptionoftheforward exchangecontracttocalculatetheforwardrate(orprice). Theforwardrate(orprice)isnotanestimateofthespotrateatadateinthefuture,butisafunctionoftherelativeinterest ratesofthecountrieswhosecurrenciesareinvolvedintheexchange.Consequently,theforwardpointsrepresentthetime valueofmoneyinherentintheforwardcontractfortheperioditisoutstanding. Forward rate of interest:theforwardrateofinterestistheinterestrateforaperiodstartinginthefuture.Forwardratesof interestareusedbyfinancialinstitutionswhenhedgingortradinginterestratepositions.Forwardratesarederivedfromthe 'forwardyieldcurve.See also: Impliedforwardrateofinterest. Forward/forward:isadepositfromonepointinthefuturetoanother,forexample,fromthreemonthsinthefuturetosix monthsinthefuture. Forward-to-forward:isatermusedwhendesignatingthehedgeeffectivenesstestingmethodologyinrelationtoforeign exchangehedgingrelationships.Itreferstothecomparisonofthechangesinthevalueofthehedgeditemandthehedging instrumentcausedbythechangeinforwardforeignexchangerates.See also: Spot-to-spot.
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Forward yield curve:aforwardyieldcurveisayieldcurvethathasbeenconstructedusingimpliedforwardratesof interest.Itisusedinforwardrateagreement(FRA)andswapvaluations. FRA (forward rate agreement):issimilartoaninterestratefutureinthatitisacontractinwhichtwopartiesagreethe interestratetobepaidonanotionaldepositofspecifiedmaturityonaspecificfuturedate.Thedepositispurelynotional andnoborrowingorlendingtakesplace.Thecontractenablesthepurchasertofixinterestcostsforaspecific(usually short)futureperiod.Atthesettlementdate,whichoccursattheinceptionoftheperiodofthenotionaldepositsforsterling, andtwodayslaterforUSdollars,thesellerpaysthepurchaserforanyincreaseinratesovertheagreedrate.Iftherates havefallen,thepurchaserpaystheseller. FRN (floating rate note):FRNsarefloatingratebonds.Theyaredebtsecuritieswherethecouponisrefixedperiodically onthe'refixdate'byreferencetosomeindependentinterestrateindex.Intheeuromarketsthisisusuallysomefixed marginoverLondonInter-bankofferRate(LIBOR)usuallysixmonthLIBOR.FRNstradedintheeuromarketsofferthe followingfeatures: Theyarelongdatedbondswithinterestrateslinkedtoshort-termmoneymarketindices. Thecouponsarerefixedandcouponpaymentsareusuallymadeeverysixmonths,whereasfixedratebondswill morecommonlypayinterestannually.
Forward swap:areswapsarrangedtorunfromsomefuturedate,forexample,fromthreemonth'stime.Theseservea similarpurposetofuturesorFRAsbutarelongerterminstruments. Fully hedged:anexposureorpositionisfullyhedgedwhenallthehedginginstrument'scriticaltermsexactlymatchthose oftheexposure,suchthatthereisnoabilitytomakeagainorlossshouldratesorpricesmove. Functional currency:isthecurrencyoftheprimaryeconomicenvironmentinwhichtheentityoperates.Theprimary economicenvironmentinwhichanentityoperatesisnormallytheoneinwhichitprimarilygeneratesandexpendscash. UnderIAS21anentitydoesnothaveafreechoiceoffunctionalcurrency,buthastoconsidertheindicatorsprovidedinthe standardwithgreateremphasisplacedonthosefactorsthatdeterminethepricingoftransactionsasopposedtothecurrency inwhichtransactionsaredenominated. Alltransactionsaremeasuredinthefunctionalcurrency.Sinceanentity'sfunctionalcurrencyreflectstheunderlying transactions,eventsandconditionsthatarerelevanttoit,afunctionalcurrency,oncedeterminedisnotchanged,unless thereisachangeinthosetransactions,eventsandconditions. Futures:Afutureisaderivativecontractthatprovidesforthefuturedelivery(oracceptanceofdelivery)ofastandard quantityofaspecifiedgradeortypeoffinancialinstrument,currencyorcommodityataspecifiedfuturedateandin accordancewiththetermsspecifiedbyaregulatedfuturesexchange. Futuresdifferfromforwardcontractsinthattheyaretradedonrecognisedexchangesandrarelyresultinactualdelivery. Instead,mostcontractsareclosedoutpriortomaturitybyacquisitionofanoffsettingposition. Top Gilts or gilt-edged securities:UKandIrishgovernmentsecurities. Global depositary receipt:fundscollecteddenotingownershipofforeign-basedcompanysharesthatareboughtandsold innumerouscapitalmarketsaroundtheworld.See Americandepositoryreceipts. Guarantees:contractssolelyagainstnon-paymentofaspecifiedinstrument.Financialguaranteecontractsthatprovidefor aspecifiedpaymenttobemadetoreimbursetheholderforloss,areinsurancecontractsasdefinedinIFRS4.Howeverthey alsomeetthedefinitionofafinancialguaranteecontractinIAS39andarewithinthescopeofIAS32andIAS39andnot IFRS4.HoweverIFRS4statesthatwhereanentityhaspreviouslyassertedexplicitlythatitregardssuchcontractsas insurancecontracts,itcanelecttoapplyeitherIAS39orIFRS4tothosecontracts.Otherfinancialguaranteecontracts(or
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sometypesoflettersofcredit,creditdefaultcontractsorcreditinsurancecontracts)thatrequirepaymentstobemadeeven iftheholderhasnotincurredalossonthefailureofthedebtortomakepaymentswhendue,arenotinsurancecontracts and,therefore,areincludedinIAS39'sscopeand,hence,mustbecarriedatfairvaluethroughprofitorloss,unlessthey qualifyaseffectivecashflowhedgeswhentheeffectivepartofsuchgainsandlossesarereportedinequity. Top Hedge accounting:isanaccountingtreatmentthatalterstheaccountingthatwouldotherwiseapplysothatgainsand lossesonthehedginginstrumentarerecognisedintheprofitandlossaccountinthesameperiodasoffsettinggainsand lossesonthehedgeditem.Thetypesofriskthatcanbehedgedincludeforeigncurrencyrisk;interestraterisk;equityprice risk;commodityrisk;andcreditrisk.Ineachcase,theexposuretoriskcanarisefromchangesinthefairvalueofan existingassetorliability(thatis,anequityinvestment),changesinthefuturecashflowsarisingfromanexistingassetor liability(thatis,variablefutureinterestpayments)orchangesinfuturecashflowsfromatransactionthatisnotyet recognised,butiseithercommittedoranticipated(thatis,highlyprobablefuturesalesinaforeigncurrency). Hedge criteria:thatmustbemetbeforehedgeaccountingcanbeusedincludethefollowing: Atinceptionofthehedgethereisformaldesignationanddocumentationofthehedgingrelationshipandtheentity's riskmanagementobjectiveandstrategyforundertakingthehedge.Thedocumentationshouldincludeidentification ofthehedginginstrument,thehedgeditemortransaction,thenatureoftheriskbeinghedgedandhowtheentity willassessthehedginginstrument'seffectivenessinoffsettingtheexposuretochangesinthehedgeditem'sfair valueorcashflowsattributabletothehedgedrisk. Thehedgeisexpectedtobehighlyeffectiveinachievingoffsettingchangesinfairvalueorcashflowsattributable tothehedgedrisk,consistentlywiththeoriginallydocumentedriskmanagementstrategyforthatparticularhedging relationship. Forcashflowhedges,aforecasttransactionthatisthesubjectofthehedgemustbehighlyprobableandmust presentanexposuretovariationsincashflowsthatcouldultimatelyaffectprofitorloss. Theeffectivenessofthehedgecanbereliablymeasured,thatis,thefairvalueorcashflowsofthehedgeditemthat areattributabletothehedgedriskandthefairvalueofthehedginginstrumentcanbereliablymeasured. Thehedgeisassessedonanongoingbasisanddeterminedactuallytohavebeenhighlyeffectivethroughoutthe financialreportingperiodsforwhichthehedgewasdesignated.
Hedge effectiveness:hedgeaccountingcanonlybeusedifthehedgeiseffective.Hedgeeffectivenessisthedegreeto whichchangesinthefairvalueorcashflowsofthehedgeditemthatareattributabletoahedgedriskareoffsetbychanges inthefairvalueorcashflowsofthehedginginstrument.Forahedgetobehighlyeffectivetheactualresultsofthehedge mustbesuchthatthechangeinfairvalueofthefullhedginginstrumentwhenexpressedasapercentageofthechangein fairvalueofthehedgedriskoritemiswithinarangeof80-125percentforthepurposeofretrospectivetesting.For prospectivetestingitmustbeexpectedthatthehedgingrelationshipiseffectiveinoffsettingtheexposuretochangesinthe hedgeditem'sfairvalueorcashflowsatinceptionandinsubsequentperiods.Thehedgemustbeexpectedtobehighly effectiveinachievingoffsettingchangesinfairvalueorcashflowsattributabletothehedgedrisk(thisisalsoconsideredto bewithintherangeof80-125percent). Hedged items:areassets,liabilities,unrecognisedfirmcommitments,highlyprobableforecasttransactionsornet investmentsinaforeignoperationthat(a)exposetheentitytoriskofchangesinfairvalueorfuturecashflowsand(b)are designatedasbeinghedged. Aninvestmentaccountedforusingtheequitymethod(forexample,anassociate)cannotbeahedgediteminafairvalue hedgebecausetheequitymethodrecognisesinprofitorlosstheinvestor'sshareoftheassociate'sprofitorloss,ratherthan changesintheinvestment'sfairvalue.Forasimilarreason,aninvestmentinaconsolidatedsubsidiarycannotbeahedged iteminafairvaluehedge,becauseconsolidationrecognisesinprofitorlossthesubsidiary'sprofitorloss,ratherthan changesintheinvestment'sfairvalue.Ahedgeofanetinvestmentinaforeignoperationisdifferentbecauseitisahedge oftheforeigncurrencyexposure,notafairvaluehedgeofthechangeinthevalueoftheinvestment. Onlyassets,liabilities,firmcommitmentsorhighlyprobableforecasttransactionsthatinvolveapartyexternaltotheentity canbedesignatedashedgeditems.
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IAS39statesthatanitemcanbedesignatedinahedgingrelationshipforonlypartofitslife.Forexample,afiveyear interestrateswapcouldbedesignatedasahedgeofinterest-relatedchangesinfairvalueorcashflowsoverthefirstfive yearsofatenyearborrowing,aslongaseffectivenesscanbedemonstrated.Also,IAS39confirmsthatacomponentof financialrisk,suchasarisk-freeinterestrate,canbedesignatedasthehedgedrisk. Hedges of net investment in a foreign operation:isaformofhedgeaccountingthatiscarriedoutinconsolidated accountsonly.Itisahedgeoftheriskofachangeinthevalueofthenetassetsoftheforeignoperationsatthebeginningof theaccountingperiodduetoamovementintheexchangeratesbetweenthegroup'spresentationalcurrencyandthe functionalcurrencyoftheforeignoperationduringtheaccountingperiod.Theyincludehedgesofmonetaryitemsthatare treatedaspartofthenetinvestmentandareaccountedforinasimilarwaytocashflowhedges.Anexchangedifferenceon aborrowingoraderivativethatiseffectiveasahedgeofthenetinvestmentinaforeignentityshouldbedeferredinequity untildisposaloftheinvestment,whenitisrecycledtoincomeaspartofthegainorlossondisposal.Theamounttakento equityonanetinvestmenthedgecannotincludeineffectivenessonanon-derivative,forexample,thatresultsfromusing differentbutcloselyrelatedcurrencies. Hedging instrument:isadesignatedderivativeor(forahedgeoftheriskofchangesinforeigncurrencyexchangerates only)adesignatednon-derivativefinancialassetornon-derivativefinancialliabilitywhosefairvalueorcashflowsare expectedtooffsetchangesinthefairvalueorcashflowsofadesignatedhedgeditem.Ahedginginstrumentwillreducean exposuretochangesinvalueorcashflowsthatwillaffecttheincomestatement.Onlyderivativeinstrumentsandthe currencycomponentofaforeigncurrencynon-derivativefinancialassetornon-derivativefinancialliabilitycanqualifyasa hedginginstrument.Ahedginginstrumentcannotbedesignatedaspartofahedgingrelationshipforonlypartofitslife. Gainsandlossesonallhedginginstrumentsarereportedinincome,unlesstheyqualifywholly(orinpart)ascashflow hedgesornetinvestmenthedgeswhensuchgainsandlosses(orpartthereof)aredeferredinequity. GuidanceontheimplementationofIAS39confirmsthathedgeaccountingispermittedatthegrouplevelforhedgesof currencyriskifeachsubsidiarytransactsindividualinternalhedgingtransactionswithatreasurycentreandthetreasury centrenetsthesepositionsandentersintoasingleexternalderivativetransaction.Hedgingisonlyallowedtotheextent thattheexternalderivativeisdesignatedasanoffsetofcashinflowsorcashoutflowsonagrossbasis. Forgrouppurposestheoperatingunitwiththeriskneednotbeapartytothehedgingtransaction.Thereforeaparent companyortreasurycentrecanundertakehedgingtransactionsonbehalfofgroupcompanieswithouttheneedforinternal derivativetransactions.Hedgeaccountingcanonlybeachievedif,atthegrouplevel,eachexternalderivativetransaction isproperlydocumentedasahedgeofoneormoregrosspositionselsewherewithinthegroup. IAS39confirmsthattwoormorederivativesmaybeusedincombinationasthehedginginstrumentinahedging relationship.Forexample,twointerestrateswapswhereoneoffsetstheeffectoftheotherforadiscreteperiodinthelife ofthehedge.Acombinationofapurchasedoptionandawrittenoption(acollar)canqualifyasasinglehedging instrumentaslongasthecriticaltermsandconditionsofthetwooptionsarethesame(exceptthestrikeprice),thenotional amountofthewrittenoptionisnotgreaterthanthatofthepurchasedoptionandthereisnonetpremiumreceived(thatis, theinstrumentisineffectnotanetwrittenoption).Furthermore,asinglederivativesuchasacross-currencyinterestrate swapcanbeseparatedintoitsinterestrateandforeignexchangecomponentsandeachpartcanbedesignatedseparatelyas ahedginginstrumentforthesemultiplerisksbutthewholefairvalueoftheswapmustbeusedineffectivenesstests. Held-to-maturity investments:arenon-derivativefinancialassetswithfixedordeterminablepaymentsandfixedmaturity thatanentityhasthepositiveintentionandabilitytoholdtomaturityotherthan: thosethattheentityuponinitialrecognitiondesignatesasatfairvaluethroughprofitorloss; thosethattheentitydesignatesasavailableforsale;and thosethatmeetthedefinitionofloansandreceivables.
Held-to-maturityassetsarecarriedatamortisedcost.Held-to-maturityassetsmaynotbehedgedforinterestraterisk. GuidanceontheimplementationofIAS39confirmsthattheprohibitiononhedginginterestrateriskofaheld-to-maturity
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assetappliestobothfixed-to-floatingandfloating-to-fixedinterestrateswaps.However,theguidancestatesthatahighly probablepurchaseofaheld-to-maturityassetcanbedesignatedasahedgediteminacashflowhedge. Transfersoutofthe'held-to-maturity'categoryareverytightlycontrolled.See Tainting. Highly probable:significantlymorethanprobable. Host contract:isanon-derivativecontractthatformspartofahybrid(combined)instrument,whichalsoincludesan embeddedderivative.Commonexamplesofhostcontractsareleasecontracts,supplycontractsanddebtcontracts. Hybrid instrument:isatermusedfromtheperspectiveoftheholderofacombinedinstrumentthatcomprisesanonderivativehostcontractwithanembeddedderivative.See also: Compoundinstrument. Hypothetical derivative method:isaformofhedgeeffectivenesstestingforacashflowhedgeofaforecasttransactionin adebtinstrumentdescribedintheimplementationguidancetoIAS39. Top Impairment:forfinancialinstruments,itistherequirementtoprovideforshortfallsinexpectedreceiptsofinterestand capital,thatis,itistheamountbywhichanasset'scarryingamountexceedsitsrecoverableamount.Anentityshouldassess ateachbalancesheetdatewhetherthereisanyobjectiveevidencethatafinancialassetorgroupofassetsmaybeimpaired. Therecoverableamountiscalculatedbydiscountingtheexpectedcashflowstobereceivedfromtheassetoverthe estimatedperiodofrecoverybytheoriginaleffectiveinterestrate.Futurecreditlossesthathavenotbeenincurredmustbe excludedfromthecalculation. Impairment indicators (or loss events):include,butarenotlimitedto: significantfinancialdifficultyoftheissuerorobligor; abreachofcontract,suchasadefaultordelinquencyininterestorprincipalpayments; thelender,foreconomicorlegalreasonsrelatingtotheborrower'sfinancialdifficulty,grantingtotheborrowera concessionthatthelenderwouldnototherwiseconsider; itbecomingprobablethattheborrowerwillenterbankruptcyorotherfinancialreorganisation; thedisappearanceofanactivemarketforthatfinancialassetbecauseoffinancialdifficulties;or observabledataindicatingthatthereisameasurabledecreaseintheestimatedfuturecashflowsfromagroupof financialassetssinceinitiallyrecognisingthoseassets,althoughthedecreasecannotyetbeidentifiedwiththe individualfinancialassetsinthegroup,including: adversechangesinthepaymentstatusofborrowersinthegroup(forexample,anincreasednumberofdelayed paymentsoranincreasednumberofcreditcardborrowerswhohavereachedtheircreditlimitandarepayingthe minimummonthlyamount);or nationalorlocaleconomicconditionsthatcorrelatewithdefaultsontheassetsinthegroup(forexample,an increaseintheunemploymentrateinthegeographicalareaoftheborrowers,adecreaseinthepropertyprices formortgagesintherelevantarea,adecreaseintheoilpricesfortheloanassetstooilproducers,oradverse changesintheindustryconditionsthataffecttheborrowersinthegroup).
Adeclineinmarketvalue,thedisappearanceofamarketthatisnotaccompaniedbyadeclineincreditworthinessoranyof
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theotherfactorsaboveisnotautomaticallyevidenceofimpairment. Impairment amount:thedifferencebetweencarryingamountandrecoverableamount(seeImpairment). Financial assets carried at amortised cost:theimpairmentamountisthedifferencebetweentheasset'scarrying amountandthepresentvalueofexpectedfuturecashflows(excludingfuturecreditlossesthathavenotbeen incurred),discountedatthefinancialasset'soriginaleffectiveinterestrate(thatis,theeffectiveinterestratecomputed atinitialrecognition).Theamountofthelossshouldberecognisedinprofitorloss. Financial assets carried at cost:theimpairmentamountisthedifferencebetweenthefinancialasset'scarrying amountandthepresentvalueofestimatedfuturecashflowsdiscountedatthecurrentmarketrateofreturnfora similarfinancialasset.Suchimpairmentlossesarenotallowedtobereversed. Available for sale financial assets:theimpairmentlossisthedifferencebetweentheacquisitioncost(netofany principalrepaymentandamortisation)andcurrentfairvalue,lessanyimpairmentlossonthatfinancialasset previouslyrecognisedinprofitorloss.
Whereadeclineinvalueofanavailable-for-salefinancialassethasbeenrecogniseddirectlyinequityandthereisobjective evidencethattheassetisimpaired,thecumulativelossthathadbeenrecogniseddirectlyinequityshouldberemovedfrom equityandrecognisedinprofitorlosseventhoughthefinancialassethasnotbeenderecognised. Impairmentlossesrecognisedinprofitorlossforaninvestmentinanequityinstrumentclassifiedasavailable-for-saleare notallowedtobereversedthroughprofitorlossevenwherethemarketvalueofthatequityinstrumentrecoversina subsequentperiod. However,inthecaseofadebtinstrumentclassifiedasavailable-for-salewhere,inasubsequentperiod,itsfairvalue increasesandtheincreasecanbeobjectivelyrelatedtoaneventoccurringaftertheimpairmentlosswasrecognisedinprofit orloss,theimpairmentlossmustbereversed,withtheamountofthereversalrecognisedinprofitorloss. GuidanceontheimplementationofIAS39clarifiesthatareductionineithertheamount,oradelayinthetimingsofthe expectedcashflows(interestorprincipal)onaloanorotherdebtsecuritywillgiverisetoanimpairmentloss.Theonly exceptionisifadelayinexpectedpaymentwillbefullycompensatedbyadditionalinterest. Theguidancealsoconfirmsthatimpairmentlossesarelimitedtothosearisingwherethereisobjectiveevidence(suchas pastdefaultrates)ofimpairmentinasingleassetorinaportfolio.Additional'possible'or'anticipated'lossesshouldnotbe providedforexceptasamountssetasidewithinshareholders'equity. Implied forward rate:iftheinterestratesareknownforthreemonthscashandsixmonthscash,thenaratemaybe interpolatedfortheperiodfrommonththreetomonthsix.Thisisknownasanimpliedforwardrateofinterest.Theyarethe ratesofinterestimpliedbycurrentspotratesforperiodsoftimeinthefuture.Ayieldcurvecanbeconstructedwith forwardinterestratesandusedforcomputingfuturecashflowsandthefairvalueofsuchcashflows.See also: Yieldcurve. Incremental cost:isacostthatwouldnothavebeenincurrediftheentityhadnotacquired,issuedordisposedofthe financialinstrument. Index linked bonds:indexlinkedbondsattempttoofferaninvestoraformofcapitalmaintenancebyadjustingthe redemptionvalue,andinsomecasestheinterest,forthemovementsinaspecificindex.Anexampleisaninflationlinked bond.Theindexorinflationlinkingisanembeddedderivativeandconsiderationhastobegiventowhetheritneedstobe splitout,whichwouldbenecessaryiftheeconomiccharacteristicsarenotcloselyrelatedtothoseofthehostcontract.See: Embeddedderivatives. Corporateissueshaveusuallybeenlinkedtotheperformanceofspecificindices(particularlystockexchangeindices) ratherthangeneralpriceindices.Wherethereisalinktoapriceindex,theinterestrateisusuallyadjustedtoprovidea specificrealrateofreturn.Inothertypesofissuestheinterestrateispredetermined,butatahigherthannormalrateto
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compensatetheinvestorfortheriskinherentintheredemptionvaluebeingunknown(andmaybeevenlessthanparif indicesmoveunfavourably). Initial recognition:allfinancialinstrumentsareinitiallymeasuredatfairvalueplustransactionscoststhatareincremental anddirectlyattributabletotheacquisitionforthosefinancialassetsandfinancialliabilitiesthatarenotatfairvaluethrough profitorlossandthereafterat:costlessimpairment;amortisedcostlessimpairment;or,atfairvalue. Insurance contracts:aredefinedwithinIFRS4ascontractsunderwhichoneparty(theinsurer)acceptssignificant insuranceriskfromanotherparty(thepolicyholder)byagreeingtocompensatethepolicyholderifaspecifieduncertain futureevent(theinsuredevent)adverselyaffectsthepolicyholder.Insurancecontractsmaycontainembeddedderivatives (whichthemselvesdonotmeetthedefinitionofaninsurancecontract)thatwillneedtobeseparatedandfairvalued throughprofitorloss,unlesstheembeddedderivativecannotbereliablyfairvaluedinwhichcasethewholecontractisfair valuedthroughprofitorloss. Interest rate collar:Aninterestratecollarisacombinationofacapandafloor.Ifinterestratesriseabovethelevel stipulatedinaparticularcontract,thesellerofthecollarwillpaythepurchaseranamountequaltotheadditionalcosttothe nextreferencedate.However,ifinterestratesfallbelowanotherstipulatedlevel,thepurchaserwillpaytheseller. Thepurchaseofacollarisanattractivealternativetoacapifthepurchaserbelievesthatinterestratesaregoingtorise,as thefeereceivedfortheflooroffsetsthepricepaidforthecap.Zerocostcollarscanbeconstructedwherebythefeepaidto thebankforthecapisoffsetbythefeereceivedforthefloor,enablingthepurchasertousethecombinedderivativeasa hedginginstrumentagainstariseininterestrates,atnilcost,butwithanexposureifinterestratesfallbelowthefloorprice. See: Hedginginstrument.Theratesatwhichthepremiumscanceloutarereferredtoastheforwardband.Insucha transaction,thecapratewilltypicallybehigherthanthemarketleveloffixedinterestrates. Interest rate differential:thisdelineatesthedifferenceintherateofinterestofferedintwocurrenciesforinvestmentsof identicalmaturities.Thedifferenceisnotasimplearithmeticalone.Itmustbeappliedtotherelevantmaturity. Interest rate future:isacontractthatprovidesforthefuturedelivery(oracceptanceofdelivery)ofastandardquantityof aspecifiedtypeoffinancialinstrument.Theinstrument'spriceisbasedoninterestratelevelsonaspecifiedfuturedatein accordancewiththetermsspecifiedbyaregulatedfuturesexchange. Interest rate swaps:atransactioninwhichtwocounterpartiesexchangeinterestpaymentstreamsofdifferingcharacter basedonanunderlyingnotionalamountinthesamecurrency.Forexampleapayfixedreceivefloatinginterestswapora payfloatingreceivefixedinterestrateswap.Theseswapsarefairvaluedthroughprofitorloss,unlesstheyqualifyforcash flowhedgeaccountingwheretheeffectiveproportionisdeferredinequityuntilthehedgeditemaffectsprofitorloss. In-the-money:isatermusedtodescribeanoptionwithastrikepricethatismoreadvantageousthanthecurrentmarket priceoftheunderlying.Anin-the-moneyoptionhasintrinsicvalue. Themoreanoptionisin-the-money,thehigheritsintrinsicvalueandthemoreexpensiveitbecomes.Asanoption becomesmorein-the-money,itbehavesmoreliketheunderlyingintermsofprofitandloss(thatis,itisdeepin-themoney). Intrinsic value:isthedifferencebetweenthefairvalueoftheunderlying,whichthecounterpartyhasthe(conditionalor unconditional)righttoreceive,andthepricethecounterpartywillberequiredtopayforthatunderlying(thatis,thestrike orexercisepriceoftheoption).Anin-the-moneyoptionhasintrinsicvalue.Thisvalueistheamountofprofitthatwouldbe realisediftheoptionwasimmediatelyexercised. Inthecaseofacurrencycalloptionthisisthedifferencebetweentheexerciserateandthehigher(orforaputoptionthe lower)ofthespotexchangerateortheforwardrate.Ifthatvalueisnegativetheintrinsicvalueisnil. Inventories used for hedging:physicalinventory(suchasfinishedgoods)canqualifyasahedgeditem,butonlyforeither currencyriskortheriskofchangesinfairvalueoftheentireitem(althoughinventoriesaregenerallyheldatthelowerof costandnetrealisablevalueunderIAS2).However,inpracticethelatterwillberareduetothedifficultyofdemonstrating hedgeeffectiveness.
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Inverted (negative) yield curve:thisistheyieldcurvegeneratedwhenshort-terminterestratesarehigherthanlong-term rates.Anegativeorinverseyieldcurveresultswheninvestorsexpectshort-terminterestratestofallandtheysellshorttermsecuritiesandbuylonger-termones.Thiscausestheyieldsonthelattertoreducewhencomparedwiththeshort-term. Top LIBOR:istheabbreviationofthe'LondonInterBankOfferedRate'.Thisistheinterestratequotedamonglarge,highly creditworthybankstoandfromeachother.Itvariesconstantlyandisarecognisedbasisforcalculatingafloatinginterest rate,usuallyagreedasLIBORplusx%,wherex%increasesasthecreditworthinessoftheborrowerdecreases. DifferentLIBORratesarequotedforanumberofmajorcurrencies.LIBORistherateatwhichbanksoffertolendfunds. LIBID(LondonInterBankBidRate)isthebank'sdepositrate.LIMEANisthemeanofLIBORandLIBID. Liquidity risk:istheriskthatanentitywillencounterdifficultyinraisingfundstomeetcommitmentsassociatedwith financialinstruments.Liquidityriskmayresultfromaninabilitytosellafinancialassetquicklyatclosetoitsfairvalue. Liquid market:aliquidmarketisonewherebuyingandsellingcanbeaccomplishedwithease,duetothepresenceofa largenumberofinterestedbuyersandsellerspreparedtotradesubstantialquantitiesatsmallpricedifferences.See: Active market. Loan commitments:arefirmcommitmentsgenerallybyabankorfinancialinstitutiontoprovidecredit(forexample,a loan)underpre-specifiedtermsandconditions.Exceptasnotedbelow,loancommitmentsthatcannotbesettlednetincash oranotherfinancialinstrumentareexcludedfromthescopeofIAS39.Aloancommitmentisnotregardedassettlednet merelybecausetheloanispaidoutininstalments(forexample,amortgageconstructionloanthatispaidoutininstalments inlinewiththeprogressofconstruction).Anissuerofacommitmenttoprovidealoanatabelow-marketinterestratemust initiallyrecogniseitatfairvalueandsubsequentlymeasureitatthehigherof(i)theamountrecognisedunderIAS37and (ii)theamountinitiallyrecognisedless,whereappropriate,cumulativeamortisationrecognisedinaccordancewithIAS18. AnissuerofloancommitmentsshouldapplyIAS37tootherloancommitmentsthatarenotwithinIAS39'sscope.Loan commitmentsaresubjecttoIAS39'sderecognitionprovisions. LoancommitmentsthattheentitydesignatesasfinancialliabilitiesatfairvaluethroughprofitorlossarewithinIAS39's scope.Anentitythathasapastpracticeofsellingtheassetsresultingfromitsloancommitmentsshortlyafterorigination shouldapplyIAS39toallitsloancommitmentsinthesameclass. Loans and receivables:arenon-derivativefinancialassetswithfixedordeterminablepaymentsthatarenotquotedinan activemarket,otherthan: thosethattheentityintendstosellimmediatelyorinthenearterm,whichshouldbeclassifiedasheldfortrading andthosethattheentityuponinitialrecognitiondesignatesasatfairvaluethroughprofitorloss; thosethattheentityuponinitialrecognitiondesignatesasavailableforsale;or thoseforwhichtheholdermaynotrecoversubstantiallyallofitsinitialinvestment,otherthanbecauseofcredit deterioration,whichshouldbeclassifiedasavailableforsale.
Aninterestacquiredinapoolofassetsthatarenotloansorreceivables(forexample,aninterestinamutualfundora similarfund)isnotaloanorreceivable. Allloansandreceivablesshouldbecarriedatamortisedcostusingtheeffectiveinterestmethod,unlesstheyaredesignated ashedgeditemsandthussubjecttomeasurementunderthehedgeaccountingrequirements.Allloansandreceivables shouldbesubjecttoreviewforimpairment. Lognormal distribution:thisisamathematicalterm,referringtoaparticularstatisticaldistributionoftenappliedtoshare prices,inwhichinstanceitdemonstratesthatthecorrespondingsharepricescanriseinfinitelybutcannotfallbelowzero. Long position:tobelongistohaveboughtandbeholdingafinancialinstrument,forexample,equityshares,debt securities,afuture,anFRAoranoption.
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Itisoftenusedtorefertoapositionwherethenumberofcontractsboughtisgreaterthanthenumbersold.Thetradeis, therefore,anetbuyandthebuyerissaidtohavealongposition.Theexpressionisusedwhenthereisananticipationof pricesrising,inwhichcasethebuyercancloseoutthepositionbysellingtheinstrumentbacktothemarketandlockingin aprofit. Longisalsousedtoexpresswhichpartoftheyieldcurveisbeingreferredtoandisgenerallysaidtocoverfromfiveyears to20years.Therefore,itispossibletobelongofthelongendoftheyieldcurve. Top Macro hedging:atechniqueofaggregatingaportfolioofassetsandliabilitiesandfairvaluehedgingthenetamountfor interestraterisk.IAS39referstothisasaportfoliohedgeofinterestraterisk.Inparticular,forsuchahedge,itallows: thehedgeditemtobedesignatedasanamountofacurrency(forexample,anamountofdollars,euro,poundsor rand)ratherthanasindividualassets(orliabilities). thegainorlossattributabletothehedgeditemtobepresentedeither: inasingleseparatelineitemwithinassets,forthoserepricingtimeperiodsforwhichthehedgeditemisan asset;or inasingleseparatelineitemwithinliabilities,forthoserepricingtimeperiodsforwhichthehedgeditemisa liability. prepaymentrisktobeincorporatedbyschedulingprepayableitemsintorepricingtimeperiodsbasedonexpected, ratherthancontractual,repricingdates.However,whentheportionhedgedisbasedonexpectedrepricingdates,the effectthatchangesinthehedgedinterestratehaveonthoseexpectedrepricingdatesareincludedwhendetermining thechangeinthefairvalueofthehedgeditem.Consequently,ifaportfoliothatcontainsprepayableitemsishedged withanon-prepayablederivative,ineffectivenessarisesifthedatesonwhichitemsinthehedgedportfolioare expectedtoprepayarerevised,oractualprepaymentdatesdifferfromthoseexpected.
Maintenance margin:theleveltowhichamarginaccountmayfallbeforetheholderofthecontractisrequiredtobring thebalancebackuptotheinitialmarginlevel.See: Margin. Making a market:dealerswhostandreadytobuyandsellcertainfinancialinstrumentsandquotebidandofferpricesare saidtobe'makingamarket'. Margin:theinitialfunds(cashorothercollateral)placedbythewriterofanoptionwithabrokerordepositedtoopena futurescontract.Theamountvariesdependinguponwhetherthecontractisahedgeorspeculationaccordingtotherulesof therelevantexchange. Margin call:thisisademandforadditionalfunds(cashorothercollateral)fromacustomer,whichafuturesbrokermay makeonaccountofanadversepricemovementonanopenfuturesposition. Market risk:includesthreetypesofrisk:currencyrisk,fairvalueinterestrateriskandpricerisk.Marketriskembodiesnot onlythepotentialforloss,butalsothepotentialforgain. Mark-to-market:referstothevaluationofpositionsorexposureatcurrentmarketvalueasopposedtocost.Themark-tomarketisthedailyadjustmentofopenpositionstoreflectprofitsandlossesresultingfrompricemovementsoccurring duringthelasttradingsession. Market maker:thisisthenamegiventoanytradingfirmmakingpricesinfinancialinstrumentsatwhichitispreparedto deal.Amarketmakeroffersconstanttwo-waypricesabidandanofferinspecifiedinstruments,amountsand maturities. Market taker:thisisanentitythatisrequestingadealratefromthemarketmaker. Master netting agreement:isanarrangementprovidingforanentitythatundertakesanumberoffinancialinstrument
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transactionswithasinglecounterpartytomakeasinglenetsettlementofallfinancialinstrumentscoveredbytheagreement intheeventofdefaulton,orterminationof,anyonecontract.IAS32statesthatsuchanagreementdoesnotprovideabasis foroffsetting,unlessboththeagreementislegallyenforceableandtheentityintendseithertosettleonanetbasis,orto realisetheassetandsettletheliabilitysimultaneously. Top Natural hedge:anaturalhedgereducesanentity'sfinancialriskorexposuresimplythroughcarefulplanninginthat entity'snormalbusinessactivities(forexample,offsettingforeigncurrencypurchasesandsales). Naked call option:thewritingofacalloptionforwhichthewriterdoesnotcurrentlyownaninstrumentorcommodity thatcouldbedeliverediftheoptionisexercised. Naked put option:thewritingofaputoptionforwhichthewriterdoesnotcurrentlyhaveashortpositioninthe commodityunderlyingtheoption. Negative (inverse) yield curve:anegative(or'inverse')yieldcurveshowsthatshortterminterestratesarehigherthanlong terminterestrates.Thistypeofyieldcurveoccursattimeswhenthemarketexpectsinterestrateswillfall.Playerstendto borrowshort-termandinvestlong-term.Inthelongterm,thisforcesyieldsdown. Net written option:isanoptionthattheentityhasissuedtoacounterparty.Thisexposestheentitytoriskand,therefore, aninterestratecollarorotherderivativeinstrumentthatcombinesawrittenoptionandapurchasedoptiondonotqualifyas ahedginginstrumentiftheyare,ineffect,anetwrittenoption(forwhichanetpremiumisreceived).Similarly,twoor moreinstruments(orproportionsofthem)maybedesignatedasthehedginginstrumentonlyifnoneofthemisawritten optionoranetwrittenoption.See: Hedginginstrument. Normal (positive) yield curve:anormalyieldcurveshowsshort-terminterestratesarelowerthanlong-termrates. Investorsarerewardedfortheperceivedrisksofinvestingforlongerperiods,thegreatervolatilityandthesmallernumber ofinvestors. Nominal rate of return:istherateofreturnonthefacevalueoftheinstrument.See: Realrateofreturn. Novation:therightsandobligationsunderaloanagreementarecancelledandreplacedbynewoneswhosemaineffectis tochangetheidentityofthelender.Althoughrightscanbetransferedbyothermeans,novationistheonlymethodof transferringobligations(forexample,tosupplyfundsunderanundrawnloanfacility)withtheconsequentreleaseofthe lender. Novationisalsoalegalprocessthatwillresultinthederecognitionofafinancialliabilityforaborrower.Similarly, novationcanbeusedwithotherfinancialinstrumentssuchasswaps,options,futuresetctochangeoneofthe counterparties. Top Offer:thisistherateatwhichamarketmakerborrowsfromamarkettaker;thepriceoryieldonasecurityatwhichthe vendoriswillingtosell. Offer price: see: Askoraskedprice. Option:anoptionisacontractthatgivesthebuyertheright,butnottheobligation,tobuy/sellanunderlyingassetata determinedprice(thestrikeprice)atanytimeuptotheoption'smaturity(inthecaseofanAmericanoption),or(inthecase ofEuropeanoptions)onitsmaturitydate.SeeAmerican,AsianandEuropeanoptions. Theselleroftheoptionisknownastheoption's'writer'. Option premium:thisisthevalueoftheoptionatinceptionofthecontract.
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OTC (Over-the-counter) market:thisisamarketinwhichsecuritiesaretradedbydirectdealercommunication.Such directcommunicationisnotpermittedinformalmarkets,suchastheNewYorkorLondonStockExchanges. Out-of-the-money:out-of-the-moneyisatermusedtodescribeanoptionwithastrikepricethatislessadvantageousthan theunderlyinginstrument'scurrentmarketprice.Ifanoptionisout-of-the-moneythenitsintrinsicvalueiszero. Overhedge:occurswherethenotionalprincipalamountofthehedginginstrumentisgreaterthanthatofthehedgeditem. Top Paper:thisreferstosecurities,commercialpaperormarketinstrumentsthataregenerallyshort-term. Par:paris100percentofasecurity'sfacevalue.Itistheprincipalamountatwhichanissuerofbondsagreestoredeemits bondsatmaturity. Perfect hedge:thisisahedgeinwhichachangeinthefairvalueofaderivativeexactlyoffsetsanychangeinthefairvalue oftheunderlyinghedgeditem. Perpetual bonds:arebondsthatareissuedwithnofixedredemptiondate. Perpetualspayinginterestatfixedrateshavebeenissuedinthepast(particularlybygovernmentsforexampletheBritish government'swarloanissues),butmostrecentperpetualshavebeenFRNs. Pip:1/100ofonepercentofthenominalvalueofasecurity,forexample,0.10per1,000. Point:onepercentofthenominalvalueofaninstrument,forexample,onehundredbasispoints. Portion:isthetermusedinhedgeaccountingforanamountofthehedgeditemorriskthatisdesignatedinthehedge relationship. Portfolio hedging: see Macrohedging. Preference shares:aresharesintheissuerwhosetermsandconditionsconveysomepreferentialtreatmentcomparedto thoseoftheordinaryshares.Forexample,arighttoreceiveafixeddividendbeforedividendsarepaidontheordinary sharesorarighttohavetheircapitalamountrepaidbeforeanydistributiontoordinaryshareholders.Thetermofa preferencesharemaycontainacontractualobligation:(i)todelivercashoranotherfinancialassettoanotherentity;or(ii) toexchangefinancialassetsorfinancialliabilitieswithanotherentityunderconditionsthatarepotentiallyunfavourableto theentity,inwhichcasetheyaretreatedasliabilities.Preferencesharesthatdonotcontaincontractualobligationsare treatedasequityinstruments.Preferencesharesmayalsobecompoundinstruments. Presentational currency:isthecurrencyinwhichthefinancialstatementsarepresentedandforanentity'sindividual financialstatementsmaybedifferentfromtheentity'sfunctionalcurrency. Price risk:isamarketrisktheriskthatthevalueofafinancialinstrumentwillfluctuateasaresultofchangesinmarket priceswhetherthosechangesarecausedbyfactorsspecifictotheindividualinstrumentoritsissuerorfactorsaffectingall securitiestradedinthemarket. Primary financial instruments:arefinancialinstrumentssuchasreceivables,payablesandequitysecurities,thatarenot derivativefinancialinstruments. Principal:istheparvalue(orfaceamount)ofafinancialinstrument,whichisexclusiveofanypremiumorinterest. Promissory note:awrittenpromisetopayorrepayaspecifiedsumofmoneyatastatedtimeorondemand. Property, plant and equipment:aretangibleitemsthat:
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areheldforuseintheproductionorsupplyofgoodsorservices,forrentaltoothers,orforadministrativepurposes; and areexpectedtobeusedduringmorethanoneperiod.
Property,plantandequipmentinthebalancesheetcanonlybehedgedforforeignexchangerisk,orinitsentiretyforall risks,becauseofthedifficultyofisolatingandmeasuringtheappropriateportionofthecashflowsorfairvaluechanges attributabletospecificrisksotherthanforeigncurrencyrisks. Proportion:isatermusedinhedgeaccountingfortheamountofthehedginginstrumentthatisdesignatedinthehedge relationship.IAS39allowsaproportionoftheentirehedginginstrumenttobedesignatedbutdoesnotpermitahedging instrumenttobedesignatedforonlyaportionofthetimeperiodforwhichitisoutstanding. Purchases of inventory, property, plant and equipment:thatarehighlyprobablecanqualifyashedgeditems,butonly inrelationtocurrencyriskand,withcertainrestrictions,commoditypricerisk.Gainsandlossesonsucheffectivecashflow hedgesareinitiallydeferredinequityandthenmaybeaddedtoordeductedfromtheactualpurchasecostuponsubsequent recognitionorrecognisedinprofitorlossinthesameperiodinwhichtheassetacquiredaffectsprofitorloss(thatis, periodsofdepreciationorcostofsalerecognised).See also: Basisadjustment.Unrecognisedfirmcommitmentsto purchaseinventory,property,plantorequipmentmayqualifyashedgeditemsforfairvaluehedgeaccountingforparticular risksthatcouldaffectprofitorloss. Purchased option:isanoptionthatanentitybuys(thatis,theentityhastakenalongposition). Purchases of subsidiaries, associates and joint ventures:thatarehighlyprobablecanqualifyashedgeditemsbutonlyin relationtocurrencyriskand,forlistedshares,thesharepriceitself.Gainsandlossesonsucheffectivecashflowhedgesare initiallydeferredinequityandthenrecognisedinprofitorlossinthesameperiodinwhichtheassetacquiredaffectsprofit orloss(thatis,uponsubsequentdisposalorimpairment).Unrecognisedfirmcommitmentstopurchasesubsidiaries, associatesandjointventuresmayqualifyashedgeditemsforfairvaluehedgeaccountingforparticularrisksthatcould affectprofitorloss. Put:isanoptioncontractthatallowstheholdertosellagivennumberofsecuritiesbacktotheissueratafixedpricefora givenperiodoftime(thatis,wheretheoptionisAmerican)oratafixeddate(wheretheoptionisEuropean). Puttable instrument:isaninstrumentthatgivestheholdertherighttoputitbacktotheissuerforcashoranotherfinancial asset.Forexample,aninstrumentthatcanberedeemedatanytimebyaholderforcashequaltoitsproportionateshareof theassetvalueoftheissuer.See'Put'. Top Range:isa'space'or'gap'definedbythehighestandlowestprices,orhighestandlowestbidsandoffers,recordedduring aspecifiedperiod. Real rate of return:isthetermusedtodescribetherateofreturncalculatedbysubtractingtherateofinflationfromthe nominalrateofreturn. Recognition:meansrecordingafinancialassetorfinancialliabilitywhen,andonlywhen,anenterprisebecomesapartyto theinstrument'scontractualprovisions.A'regularway'purchasesofsecuritiesmayberecognisedusingeithertradedateor settlementdateaccounting,butthemethodusedshouldbeappliedconsistentlywithineachofthefourcategoriesof financialassets.Forthispurposeassetsheldfortradingformaseparatecategoryfromassetsdesignatedatfairvalue throughprofitandloss.Acontractthatrequiresorpermitsnetsettlementofthechangeinthecontract'svalueisnota regularwaycontract.Instead,suchacontractisaccountedforasaderivativeintheperiodbetweenthetradedateandthe settlementdate. GuidanceontheimplementingIAS39statesthattheregularwayexceptioncanapplyevenwhenthereisnoformal regulatedmarket,aslongasanormalsettlementperiodisestablishedbycustominthatbusinessenvironment.
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Recycled from equity:inahedgeofaforecasttransaction,wherethattransactionsubsequentlyresultsinrecognisinga financialassetorafinancialliability,theassociatedgainsandlossesonthecashflowhedgethathavebeenrecognised directlyinequityarerecycledtoincome(thatis,reclassifiedtoprofitorloss)inthesameperiodduringwhichtheasset acquired,orliabilityassumedaffectsprofitorloss(otherthanlossesthatarenotexpectedtoberecovered,whichare reclassifiedintoprofitorloss).Forahedgeofaforecasttransactionwherethattransactionsubsequentlyresultsin recognisinganon-financialassetoranon-financialliability,orwhereaforecasttransactionforsuchassetsorliabilities becomesafirmcommitmentforwhichfairvaluehedgeaccountingisapplied,thentheentityeitherreclassifiesthegainsor lossestoprofitorlossinthesameperiodthattheassetsacquiredorliabilityassumedaffectsprofitorloss,orincludesthem intheinitialcostorothercarryingamountoftheassetorliabilitySeeBasisadjustments. Gainsandlossesonnetinvestmenthedgesarerecycledtoincomeontheforeignoperation'sdisposal,ordeemeddisposal. Gainsandlosses,exceptforimpairmentlossesandforeignexchangegainsandlosses,onavailable-for-salefinancialassets shouldberecogniseddirectlyinequityuntilthefinancialassetisderecognised. Regression analysis:isatechniquethattakesagroupofvariablesandexpressesatendencyofthedependentvariableto varywiththeindependentvariableinasystematicfashion.Inthecontextofahedgeeffectivenesstest,theprimary objectiveistodetermineifchangestothehedgeditemandhedginginstrumentarehighlycorrelatedand,thus,supportive oftheassertionthattherewillbeahighdegreeofoffsetinfairvaluesorcashflowsachievedbythehedge.Itisusedfor morecomplexrelationshipswhereitisknownattheoutsetofthehedgerelationshipthatitisnotperfect,butstatistically (thisis,inthevastmajorityofcases)itisexpectedthattheratioofthechangeinfairvalueofhedgeditemtothechangein thefairvalueofhedginginstrumentwillfallintherangeof80-125%.Regressionanalysiscanbeusedforprospective and/orretrospectivehedgeeffectivenesstesting.Forthepurposesofthehedgeeffectivenesstest,theanalysisusually involvesasimplelinearregression.Forexample,onevariablecouldbethepriceofaderivativeonthefirstdayofeach monthforaparticularyearandtheothervariablecouldbethepriceofthehedgedinstrumentonthesamedates.Multiple linearregressionanalysisexaminestherelationshipbetweenadependentvariableandtwoormoreindependentvariables. Inagraphicalsense,thevaluesofthevariablesareplottedandalineof'bestfit'drawn. Keyfactorsinaregressionanalysisapproachtoprovinghedgeeffectivenessare: numberofdatapoints,methodofselectionandfrequency; theslopeorgradientofthelineof'bestfit'; thecoefficientofdetermination(R2 )-theexplanatorypowerofcorrelation;and the'F'statistic-theadjustmentforrandomerror,whichiskeytothestrengthofthestatisticalrelationship.
Regular way:purchasesorsalesoffinancialassetsunderacontractwhosetermsrequiretheasset'sdeliverywithinthe timeframeestablishedgenerallybyregulationorconventioninthemarketplaceconcerned.Thesemayberecognisedor derecognisedusingtradedateaccountingorsettlementdateaccounting;providedthataconsistentpolicyisappliedwithin eachofthefourclassesofasset.(See also: recognition.)Itavoidstheneedtoaccountforaderivativebetweentradedate andsettlementdateforafinancialasset,butcanonlybeappliedto'normal'marketsettlementarrangements. GuidanceintheimplementationofIAS39confirmsthatthestandardhasnospecificrequirementsabouttradedate accountingandsettlementdateaccountinginthecaseoftransactionsinfinancialinstrumentsthatareclassifiedas financialliabilities.Consequently,thestandard'sgeneralrecognitionandderecognitionrequirementsapplyandthusitis possiblethatacontractthatresultsinafinancialliabilitywillbeaccountedforasaderivativebetweentradedateand settlementdate,unlessthecontractisanexecutorycontract.Thelatterarenotrecogniseduntiloneofthepartiestothe contracthasperformed. Reinsurance contracts:arecontractsissuedbyoneinsurer(thereinsurer)tocompensateanotherinsurer(thecedant)for lossesononeormorecontractsissuedbythecedant.Thesemaycontainembeddedderivativesthatwillneedtobe separatedandfairvaluedthroughprofitorloss(providingtheembeddedderivativeisnotacontractwithintheIFRS4's
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scope),unlessthederivativecannotbereliablyfairvaluedinwhichcasethewholecontractisfairvaluedthroughprofitor loss. Repos and reverse repos:repoagreements(saleandrepurchaseagreements)aretransactionsinvolvingthesaleofa securitywithasimultaneousagreementtorepurchasethesameorasubstantiallyidenticalsecurityataspecifiedfuture date.Theseareaccountedforassecuredborrowingsandloans,unlesstherepurchaseisatfairvalueandthetransfereeis freetosellorpledgetheasset.Anentity'sintentionandabilitytoholddebtinstrumentstomaturityisnotnecessarily constrainedifthoseinstrumentshavebeenpledgedascollateraloraresubjecttoarepurchaseagreementorsecurities lendingagreement.However,anentitydoesnothavethepositiveintentionandabilitytoholdthedebtinstrumentsuntil maturityifitdoesnotexpecttobeabletomaintainorrecoveraccesstotheinstruments. Risk-free interest rate:therateearnedonarisklessasset,suchasaUKgovernmentgiltorUStreasurybill. Top Secondary market:isavailabletotradesecuritiesaftertheirinitialpublicoffering. Securitisation:Theprocessofcreatingafinancialinstrumentbypoolingotherfinancialassetstobacktheinstrument. Thesearethenmarketedtoinvestors(forexample,mortgagebackedsecurities). Selling short:isthenamegiventothepracticeofsellinganinstrumentorcommoditythatisnotownedandthenborrowing anequivalentinstrumentorcommoditytosatisfydeliveryofthesalewiththeintentofreplacingthatborrowedinstrument orcommodityatalowerpricethanatwhichitwasborrowed.Theshorttraderisspeculatingthatthepriceofthesecurity willgodown. Senority:Theorderinwhichholdersofdebtsgetpaidafterbankruptcyofanentity.Forexample,seniorunsecureddebtis 'senior'tosubordinateddebt. Set-off, legal right of:isadebtor'slegalright,bycontractorotherwise,tosettleorotherwiseeliminateallofaportionof anamountduetoacreditorbyapplyingagainstthatamountanamountduefromthecreditor. Settlement date:isthedatethatanassetisdeliveredtoorbyanentity. Settlement date accounting:refersto:(a)therecognitionofafinancialassetonthedateitisreceivedbytheentity;and (b)thederecognitionofafinancialassetandrecognitionofanygainorlossondisposalonthedaythatitisdeliveredbythe entity.Whensettlementdateaccountingisappliedanentityaccountsforthechangeinthefairvalueofthefinancialassetto bereceivedduringtheperiodbetweenthetradedateandthesettlementdate,inthesamewayasitaccountsfortheacquired asset.Inotherwords,thechangeinvalueisnotrecognisedforfinancialassetscarriedatcostoramortisedcost;itis recognisedinprofitorlossforassetsclassifiedasfinancialassetsatfairvaluethroughprofitorloss;anditisrecognisedin equityforfinancialassetsclassifiedasavailable-for-sale.Thenormalrecognitionandderecognitionrulesapplytofinancial liabilities.See: Regularway. Settlement option:iswhereaderivativefinancialinstrumentgivesonepartyachoiceoverhowitissettled(forexample, theissuerortheholdercanchoosesettlementnetincashorbyexchangingsharesforcash).Suchaderivativeisafinancial assetorafinancialliability,unlessallofthesettlementalternativeswouldresultinitbeinganequityinstrument. Settlement price (futures):isafiguredeterminedbytheclosingrange,whichisusedtocalculategainsandlossesin futuresmarketaccounts.Settlementpricesareusedtodeterminegains,losses,margincallsandinvoicepricesfor derivatives. Short position:tobeshortistohavesoldafinancialinstrumentthattheentitydoesnotown,forexample,anequityshare, debtsecurity,afuture,anFRAoranoption. Itisoftenusedtorefertoapositionwherethenumberofcontractssoldisgreaterthanthenumberbought.Thetradeis, therefore,anetsellandthesellerissaidtohaveashortposition.Theexpressionisusedwhenthereisananticipationof pricesfalling,inwhichcasethesellercancloseoutthepositionbybuyingtheinstrumentbackandlockinginaprofit.
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Shortisalsousedtoexpresswhichpartoftheyieldcurveisbeingreferredto,andisgenerallysaidtocoverfromtodayto twoyears.Therefore,itispossibletobeshortoftheshortendoftheyieldcurve. Short seller:isanentitythatsellssecuritiesthatithasborrowedordoesnotyetown. Special purpose entities:areentitiescreatedtoaccomplishanarrowandwelldefinedobjective(forexample,toeffecta lease,researchanddevelopmentactivitiesorasecuritisationoffinancialassets).Ifassetsaresoldtoaspecialpurpose entityandderecognised,consolidationoftheSPEmaybenecessarywherethegroupisexposedtothemajorityoftheSPE's risksand/orrewardsorthemajorityofitsassets;thatis,wherethesubstanceoftherelationshipbetweenanentityandthe SPEindicatesthattheSPEiscontrolledbythatentity. Speculator:issomeonewhotakesariskforanappropriatereturn. Spot price:(alsoreferredtoas'cash'or'current')referstosomething'simmediatecashprice.Hencethespotmarketisthe marketforcurrenttransactions. Spot rate:isthecurrentexchangeratebetweentwocurrencies. Spot-to-spot:isatermusedwhendesignatingahedgeeffectivenesstestingmethodologyinrelationtoforeignexchange hedgingrelationships.Itreferstothecomparisonofthechangesinthemeasurementofthehedgeditemandthehedging instrumentcausedbythechangeinspotforeignexchangerates.See:forward-to-forward. Spread:intrading,orinthequotationoffinancialinstruments,isthedifferencebetweenthebidandtheoffer/askedprices. Spread (combination) of options:aspreadcombinesputorcalloptionsonthesameunderlyinginstrumentbutwith differentexpirationdatesorstrikeprices,wheresomeareboughtandothersarewritten.Threecommonspreadsarebull, bearandbutterfly. Straddle:acombinationofoptionsthatcombinesaputandcallonthesameunderlyinginstrument,withthesamestrike priceandthesameexpirationdate. Strangle:acombinationofoptionsthatissimilartoastraddle,exceptthattheputsandcallsonthesameunderlying instrumentsareboughtatdifferentprices. Strike price: see: Option. Strip:aseriesofconsecutivefuturesisknownasastripoffutures.Forexample,tradingMarch,JuneandSeptember interestratefutures. Strip bond:abondwhereboththeprincipalandinterestelementsaresoldseparately.See: Zero-couponbond. Structured note:canbeeither: amedium-termnotewithembeddedoptionsthatadjusttherisk/returnprofile;or anotewhosevalueisdeterminedbyfluctuationsinthepriceoftheunderlyingasset.
Astructurednoteisahybridinstrumentthatchangesitsprofilebyincludingembeddedderivatives.Asimpleexample wouldbeafiveyearbondwithanembeddedoptionforincreasingreturns. Subordinated debt:areloans,debtsecuritiesorbondswheretheclaimsoftheholdersontheissuer'sassetsorearningsare subordinatedtotheclaimsoftheholdersofseniordebtsecurities. Sub-participation:rightsandobligationstoprincipalandinterestonaloan(financialasset)arenotformallytransferred, butthelenderentersintoanon-recoverableback-to-backagreementwithathirdparty,the'sub-participant',underwhich

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thelatterdepositswiththelenderanamountequaltothewholeorpartoftheloanandinreturnreceivesfromthelendera shareofthecashflowsarisingontheloan.Asub-participationwillneedtobeassessedunderthepass-throughprovisions ofIAS39onderecognitionoffinancialassets. Subprime loan:aloanthatisofferedatarateabovecurrentmarketlevelstoindividualswhodonotqualifyformarketrate loans. Swaps:areagreementsbetweentwopartiestoexchangeonesetofcashflowsforanother.Theyaresimplyahighly structuredseriesofcashflows.Theyweredevelopedtoenablecompaniestovarythetermsoftheirloansand,therefore, managetheirliabilitiesmoreeffectively.Swapsresultintheeconomicexchangeofinterestrates,currencies,basisratesor anycombinationthereof.Thetwobasictypesofswapare: Interestrateswaps:herethetwopartiestothetransactionexchangethetermsunderwhichtheypayinterestontheir liabilities.Typically,theywillexchangeinterestpaidatafixedrateforinterestpaidatafloatingrate,andvice versa. Noexchangeofprincipaltakesplace,theinterestpaymentsundertheswaparemadeonanationalprincipalamount. Currencyswaps:thetwopartiestothetransactionexchangeliabilitiesdenominatedindifferentcurrenciesaswell. Theprincipalsumsmaybeexchangedeitheratthestartoftheswapperiod,orattheendoftheswapperiodorby somecombinationthereof,orpossiblyneither.
Swaptions:(oranoptiononaswap)isanoptiontoenterintoaninterestrateswapatafuturedateatafixedinterestrate determinedbyreferencetocurrentmarketrates.Aswithoptions,swaptionscanbeforAmericanexercise(atanytimeuntil expiry)orEuropeanexercise(atexpiry). Theholderofaswaptionisabletolimittheriskinswitchingfromfloatinginterestratestofixedinterestrates(orvice versa )withreferencetothecostofthepremium,whilststillbeingabletobenefitfromfavourableinterestratemovements.This providesagreaterflexibilityorliability(orasset)managementthantheswapmarket.Swaptionsmaybeusedbyissuersof callabledebtthathasbeenswappedsothattheswapcanbereducedifthedebtiscalled. SwaptionsareavailableontheOTCfrombanksandintermediarieswhohedgetherisksusingexchangetradedoptionson interestrates.Swaptions,beingacombinationofaswapandanoptiononinterestrates,arepricedusingtraditionaloption pricingtheories. Synthetic future:asyntheticfuturesstrategycreatesacombinationofoptions,whichisequivalenttoapositioninthe underlyingtransaction.Syntheticpositionsaresonamedbecausetheyarenotactualpositions.Theygiveapositioninthe underlying,whichisequivalenttoafuturesposition. Top Tainting (of a held-to-maturity investment portfolio):IAS39doesnotpermitanyfinancialassetstobeclassifiedas held-to-maturityinvestmentsiftheentityhas,duringthecurrentfinancialyearorduringthetwoprecedingfinancialyears, soldorreclassifiedmorethananinsignificantamountofheld-to-maturityinvestmentsbeforematurityotherthansalesor reclassificationsthat: aresoclosetomaturityorthefinancialasset'scalldate(forexample,lessthanthreemonthsbeforematurity)that changesinthemarketrateofinterestwouldnothaveasignificanteffectonthefinancialasset'sfairvalue; occuraftertheentityhascollectedsubstantiallyallofthefinancialasset'soriginalprincipalthroughscheduled paymentsorprepayments;or areattributabletoanisolatedeventthatisbeyondtheentity'scontrol,isnon-recurringandcouldnothavebeen reasonablyanticipatedbytheentity.
'Insignificant'isassessedinrelationtothetotalamountofheld-to-maturityinvestments. Take position:atakepositionexistswhenapunt(speculate)hasbeentakenonfuturechangesinthefinancialinstrument's

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value(forexample,changesininterestrates,exchangerates,orchangesinassetprices). Time value option:thevalueofanoptioncontractlessitsintrinsicvalue. Time value of money:theconceptthataspecificsumofmoneyismorevaluablethesooneritisreceived.Thisisbasedon theprinciplethatanamountwillbeworthmoreinthefuturebecauseitcanbeinvested.Ifitisreceivedearlieritwill generateagreaterreturn Total return swap:isacontractunderwhichoneparty('thetotalreturnpayer')transferstheeconomicrisksandrewards associatedwithanunderlyingassettoanothercounterparty('thetotalreturnreceiver').Thetransferofriskandrewardis effectedbywayofanexchangeofcashflowsthatmirrorchangesintheunderlyingasset'svalueandanyincomederived therefrom. Trade date:isthedatethatanentitycommitsitselftopurchaseorsellanasset. Trade date accounting:refersto:(a)therecognitionofafinancialassettobereceivedandtheliabilitytopayforitonthe tradedate;and(b)derecognitionofanassetthatissold,recognitionofanygainorlossondisposalandtherecognitionofa receivablefromthebuyerforpaymentonthetradedate.Generally,interestdoesnotstarttoaccrueontheassetand correspondingliabilityuntilthesettlementdatewhentitlepasses.Thenormalrecognitionandderecognitionrulesapplyto financialliabilities.SeeRegularway. Trade loans:areclassifiedasoriginatedloansandcarriedatamortisedcostlessimpairment,unlesspurchasedfromathird partywhentheyarecategorisedastrading,held-to-maturity,available-for-saleorloansandreceivables(providedtheyare notquotedinanactivemarket). Trade payables:arefinancialliabilitiescarriedeitheratamortisedcostorfairvaluethroughprofitorloss.Payablesheldat amortisedcostarecalculatedusingtheeffectiveinterestmethod. Trade receivables:arefinancialassetscarriedatamortisedcostlessimpairment,unlesspurchasedordesignatedasatfair valuethroughprofitorloss.Receivablesheldatamortisedcostarecalculatedusingtheeffectiveinterestmethod. Trading financial assets and financial liabilities:arethosepurchasedwiththeintentionofmakingshort-termprofits fromdealingorthosewhicharepartofaportfoliowithapatternofshort-termprofittaking.Thecategoryforfinancial assetsorfinancialliabilities'atfairvaluethroughprofitorloss'cannotbeusedforassetsnotmeetingtheserequirements, unlessthefinancialassetorfinancialliabilityisdesignatedassuchuponinitialrecognition.Anentityisnotallowedto reclassifyafinancialinstrumentintooroutofthefairvaluethroughprofitorlossclassificationwhileitisheldorissued. Tradingfinancialliabilitiesincludeallshortpositionsinsecurities(securitiessoldbutnotyetsettled)andallderivatives withnegativefairvalues.Anentityshoulddefinetheperiodthatitregardsasshort-termandapplythatconsistently,butit wouldnotexceedoneyear. Alltradingfinancialassetsandfinancialliabilitiesarecarriedatfairvaluewithgainsandlossesimmediatelyrecognisedin profitorloss.Atradingfinancialassetcannotbetransferredtoanothercategoryeveniftheintentionchanges.Afinancial assetclassifiedasheld-to-maturiyistransferredintotheavailable-for-salecategorywhenthereisachangeintheintention orabilitytohold-to-maturity. Transaction costs:areincrementalcoststhataredirectlyattributabletotheacquisition,issueordisposalofafinancial assetorfinancialliabilitysuchasbrokercommissions,settlementfees,legalandotherexpensesthatareaddedto,or deductedfrom,costoninitiallyrecognisingafinancialinstrument.Anincrementalcostisonethatwouldnothavebeen incurrediftheentityhadnotacquired,issuedordisposedofthefinancialinstrument. Top Uncommitted facility:acredit(loan)facilitywheretherearenorestrictionsplaceduponthelenderregardingtheamount tobelent.Undersuchanagreement,thelenderhasnoobligationtoprovidespecificamountstotheborrower.Furthermore, theborrowerisnotsubjecttoconditionssetbythelenderinrelationtothefacility.
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Underhedge:occurswherethenotionalprincipalamountofthehedginginstrumentislessthanthatofthehedgeditem. Underwater option: see: Out-of-the-money. Underwater swap:anunprofitableswapposition(fromtheperspectiveofonecounterparty)causedbyadversemovement ininterestratessincetheswap'sinception.Thelosingcounterpartyismakingnetpaymentstotheothercounterpartyand wouldhavetopaythefairvalueoftheswaptoterminatetheagreement. Unsubordinated debt:aloan,debtsecurityorbondwheretheclaimoftheholderontheissuer'sassetsorearningsranks aboveotherloansorsecurities.Alsoknownasaseniorsecurity.Inthecaseofdefault,creditorswithunsubordinateddebt wouldgetpaidoutinfullbeforejuniordebtholders. Top Vanilla (or plain-vanilla) swap:isasimpleinterestrateswap,wherefloatinginterestcashflowsareswappedforfixed interestcashflows,overafixedperiodoftime,basedonaknownnotionalprincipalamount. Volatility:isthesusceptibilityofapricetorapidchangesinexchangeand/orinterestrates.Volatilityisoftenmeasuredin standarddeviationsorpercentagesperannum. Top Wash sales:comprisefinancialassetssoldandpurchasedwithashorttime-frame(butnotatthesametime)suchthat realisedgainsorlossesarereportedinincome.Thesearealsoknownasbedandbreakfasttransactions. GuidanceontheimplementationofIAS39statesthatsucharepurchasedoesnotprecludederecognition,providedthatthe originaltransactionmetthederecognitionrequirements.However,ifanagreementtosellafinancialassetisenteredinto concurrentlywithanagreementtorepurchasethesameassetatafixedpriceorthesalepriceplusalender'sreturn,then theassetisnotderecognised. Written options:areoptionsthatanentitysells(thatis,theentityhastakenashortposition).Thesemustbefairvalued withgainsandlossesreportedinprofitorloss.Theycannotbeusedforhedgeaccountingpurposesastheyexposethe writer(seller)tounlimitedlossandthustheyincreaseratherthanreducepotentialvolatilityintheincomestatement.The exceptioniswherethewrittenoptionisdesignatedasanoffsettoapurchasedoption,includingonethatisembeddedin anotherfinancialinstrument(forexample,awrittencalloptionusedtohedgeacallableliability). Top Yield:istherateofreturnonanfinancialassetorsecurity(thatis,itsinterestrate),asdeterminedbyitscouponandother characteristics.Theyieldisgenerallyexpressedasapercentagereturnandannualised. Yield curve:isagraphicalrepresentationoftherelationshipbetweenthereturn(thatis,theinterestrate)onafinancial assetplottedagainstitstimetomaturity.Yieldsfordifferentmaturitiesareplottedandalineisdrawnpassingthroughthe points.Theshapeofthecurvewillusuallychangeovertimeandtheshapeshowsthecurrentstructureofinterestrates. Therearemanydifferentshapesofyieldcurves,forexample,normal(positive),linearandinverted(negative). Itisalsoknownasthetermstructureofinterestrates. Therearemanyyieldcurvesbothfordifferentassetsanddifferentcurrencies. Aparallelshiftintheyieldcurveoccurswhenthereisasteppedchangeinmarketinterestrates,suchaswhentheBankof EnglandchangestheMinimumLendingRate. GuidanceontheimplementationofIAS39statesthattheyieldcurveprovidesthefoundationforcomputingfuturecash flowsandthefairvalueofsuchcashflowsbothatinceptionof,andduring,ahedgingrelationship.Itisbasedoncurrent
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marketyieldsonapplicablereferencebondsthataretradedinthemarketplace.Marketyieldsareconvertedtospotinterest rates('spotrates'or'zerocouponrates')byeliminatingtheeffectofcouponpaymentsonthemarketyield.Spotratesare usedtodiscountfuturecashflows,suchasprincipalandinterestpayments,toarriveattheirfairvalue.Spotratesalsoused tocomputeforwardinterestratesthatareusedtocomputevariableandestimatedfuturecashflows. Top Zero coupon bond:isabondwherenoperiodicinterestpaymentsaremadeduringthebond'slife.Theinterestispaidat theendofthebond'slife.Itisissued,andtrades,atadiscounttoitsnominalamount,becausetheonlycashflowisthe redemptionpayment.See also Deepdiscountedbonds. Zero coupon interest rate swap:Thistypeofswapenablesaborrowertoissueazerocouponbondandswaptheinterest forfloatingrate.Thustheborrowerpaysafloatingrateandreceivesafixedrate.However,thefixedratepaymentispaidat theterminationoftheswap.
A B C D E F G H I J K L M N O P Q R S T U V W X Y Z
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A-Z Financial Instruments

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Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Fair value interest rate risk:isamarketrisktherisksthatthevalueofafinancialinstrumentwillfluctuatebecauseof

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

areheldforuseintheproductionorsupplyofgoodsorservices,forrentaltoothers,orforadministrativepurposes; and areexpectedtobeusedduringmorethanoneperiod.

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

'Insignificant'isassessedinrelationtothetotalamountofheld-to-maturityinvestments. Take position:atakepositionexistswhenapunt(speculate)hasbeentakenonfuturechangesinthefinancialinstrument's

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

Questions and answers Financial instruments A-Z of financial instruments

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