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
Funds at risk in an enterprise:
Regulatory Capital: Set by the BIS, the amount of Tier I and Tier II long term funding that commercial banks are compelled to hold based upon the Basel Accord" regulations for risk adjustment.
- Risk Capital: Bank Management's view of how much buffer should be prudently held to protect the institution from volatility of value in its assets and liabilities.
A risk management concept which requires that the capital of a financial organization be sufficient to protect its counterparties and depositors from on- and off-balance sheet market risks, credit risk, etc. Capital requirements are often simple mechanical rules, but are growing to be more sophisticated risk management technology. The test of a securities business's ability to meet its financial obligation.
Capital adequacy rules outline the money that is necessary to support the risks of trading; the possibility of reduced revenue from weak trading conditions; the danger that book debts may not be fully realized, etc.
- Stringent rules governing capital adequacy for US brokers have been laid down by the Securities & Futures Association. Commercial banks also face a raft of capital adequacy rules established by international regulators.
Also called "Market Capitalization": The total value of the company in the stock market. The sum of a corporation's long-term debt, stock and surpluses (i.e., the invested capital).
- This value is arrived at by multiplying the number of shares in issue by the company's share price. This market capitalization obviously fluctuates as the share price moves up and down.
- The British term for clearing corporation. An organization associated with a futures/options exchange that guarantees the performance of both parties to a contract, collects margin and maintains records of the parties to the transactions.
An obligation or security linked to another obligation or security to secure its performance. For example, an option writer may deposit with his bank or broker common stock in the company on which an option is written as collateral to guarantee performance on the option. He may also deposit securities convertible into the underlying stock or completely unrelated securities with an appropriate market value. Collateral is also posted as a performance bond to guarantee performance on listed futures contracts and on various over-the-counter contracts.
- Something of value given or pledged as security for payment of a loan. Collateral consists usually of financial instruments, such as stocks, bonds, and negotiable paper, rather than physical goods, although the latter may also be accepted as such. In case of default, the creditor may sell the collateral and apply the money thus acquired to payment of the debt, charging the debtor with any deficiency or crediting him with any surplus. The borrower may usually substitute other collateral for that held by the lender if it is acceptable to the latter. Such a privilege is particularly useful to borrowers who buy and sell securities. Merchandise collateral--such as negotiable warehouse receipts, bills of lading, and trust receipts--is also used, as is personal collateral, including deeds, mortgages, leases, and other rights in real estate. Other collateral may include bills of sale of movable goods, such as crops, machinery, furniture, and livestock, and savings-bank passbooks.
This is extra security provided by a borrower to back up his/her intention to repay a loan.
- Such security might be: Cash/Marketable Securities, Inventory, Accounts Receivable, Fixed Assets or Real Estate. It would likely include documentation (such as deeds) giving right of title to property, which the lender could take over and sell to repay the debt if the borrower defaults.
collateralized bond obligation (CBO)
Definition: An ABS (q.v.) structure similar to a CMO (q.v.), but with a portfolio of bonds as collateral, instead of a portfolio of Mortgage Backed Securities (q.v.) and/or mortgage loans. A sponsor transfers the collateral into a Special Purpose Vehicle (SPV), such as a trust or corporation, which has no other assets and which issues claims. A typical CBO has more than one "tranche" or "tier", and a more junior tranche has more risk of default.
- Example: A CBO might have senior, junior (or mezzanine), and subordinated (or equity) tranches. The senior tranche, like senior debt, has first claim on the collateral's cash flows to cover its interest and principal payments. The junior tranche has second claim. The equity tranche claims the residual.
collateralized debt obligation (CDO)
- An inclusive term that refers to any of: CBOs , CMOs or CLOs.
collateralized loan obligation (CLO)
Definition: An ABS (q.v.) structure similar to a CMO (q.v.), but with a portfolio of commercial or personal loans as collateral, instead of a portfolio of Mortgage Backed Securities (q.v.) and/or mortgage loans. A sponsor transfers the collateral into a Special Purpose Vehicle (SPV), such as a trust or corporation, which has no other assets and which issues claims. A typical CLO has more than one "tranche" or "tier", and a more junior tranche has more risk of default.
- Example: A CLO might have senior, junior (or mezzanine), and subordinated (or equity) tranches. The senior tranche, like senior debt, has first claim on the collateral's cash flows to cover its interest and principal payments. The junior tranche has second claim. The equity tranche claims the residual. For example, National Westminster transferred $5 billion of loans from its balance sheet to an asset-backed trust October 1996 and created an early and large CLO.
- A legally binding bank obligation to provide loans up to a specified amount for a specified period. The lender commonly writes this type of lending agreement with protective covenants that would limit/terminate the commitment upon specified signs of adverse changes in credit quality or loan use. However, even during publicly known credit distress, a commitment can be legally binding (US law) if drawn before the lender withdraws it.
- According to "Risk Concentrations Principles," which the BIS released in 12/99, risk concentrations in financial conglomerates come in seven categories of exposures, to: individual counterparties, groups of individual counterparties, counterparties in specified geographical locations, counterparties in industries, counterparties in products, key business services (such as back-office services), and natural disasters. (ref. BIS Examines Concentration Risk, 2/2000, p. 11.)
- A bond which the holder can convert into a specified number of shares issued by the company.
- A corporate bond is an IOU issued by a public company, such as British Telecom, ICI or Marks & Spencer. When you invest in a corporate bond, you are lending money to the company. In return you will receive interest at a fixed rate and the promise that your capital will be repaid at a certain date in the future. The guarantee that our capital will be returned is only as good as the company you are lending money to. While BT, ICI or Marks & Spencer are considered 'good risks' by investment pundits because they are blue chip companies, other smaller companies are likely to be a less good risk. Following the Chancellor's decision to permit corporate bonds to be included in a Personal Equity Plan (PEP), leading financial service providers have launched schemes encouraging investment in Corporate Bond Peps. Preference shares , convertibles and Euro sterling bonds are also permitted to be included in Peps as of July 1995.
A correlation coefficient is a number between -1 and 1 which measures the degree to which two variables are linearly related. If there is perfect linear relationship with positive slope between the two variables, we have a correlation coefficient of 1; if there is positive correlation, whenever one variable has a high (low) value, so does the other. If there is a perfect linear relationship with negative slope between the two variables, we have a correlation coefficient of -1; if there is negative correlation, whenever one variable has a high (low) value, the other has a low (high) value. A correlation coefficient of 0 means that there is no linear relationship between the variables. There are a number of different correlation coefficients that might be appropriate depending on the kinds of variables being studied (e.g., Pearson's Product Moment Correlation Coefficient and Spearman Rank Correlation Coefficient).
Given a pair of related measures (X and Y) on each of a set of items, the correlation coefficient (r) provides an index of the degree to which the paired measures co-vary in a linear fashion. In general r will be positive when items with large values of X also tend to have large values of Y whereas items with small values of X tend to have small values of Y. Correspondingly, r will be negative when Items with large values of X tend to have small values of Y whereas items with small values of X tend to have large values of Y. The value of r is calculated by first converting the Xs and Ys into their respective Z Scores and, keeping track of which Z Score goes with which item, determining the value of the mean Z Score product. Numerically, r can assume any value between -1 and +1 depending upon the degree of the relationship. Plus and minus one indicate perfect positive and negative relationships whereas zero indicates that the X and Y values do not co-vary in any linear fashion.
- "The partner in a credit facility or transaction in which each side takes broadly comparable credit risk to the other. When a bank lends a company money, the borrower (not Counterpary) has no meaningful credit risk to the bank. hen the same two agree on an at-the-money forward exchange contract or swap, the company is at risk if the bank fails just as much as the bank is at risk if the counterparty fails ( although for the opposite movement in exchange or interest rates). After inception, swap positions often move in/out-of the money and the relative risk changes accordingly."
This term is often used interchangeably with interest, but coupon actually has two distinct meanings:
- In the case of Bearer Bonds, the coupon is the warrant attached to the certificate, i.e. a physically detachable coupon, which you are required to present to a paying agent in order to receive the interest payment due. The coupon will state the amount of interest due at each payment date.
- As a result of the definition above, coupon has also come to be accepted as a name for the nominal interest a bond pays. Remember not to confuse the nominal interest being offered with the yield. The latter is the actual rate of return you are getting and it relates to the market price you paid for the investment.
- A debt obligation with coupons representing semiannual interest payments attached; the coupons are submitted to the trustee by the holder to receive the interest payments. No record of the purchaser is kept by the issuer, and the purchaser's name is not printed on the certificate. Syn. bearer bond.
- This is an agreement or promise in the form of a deed binding the person or persons signing the covenant to do certain things or not to do them, including make specified payments of money.
- Procedures in bankruptcy litigation that allow the bankruptcy court to implement a reorganization plan over the objections of a class of creditors. Specifically, these rules provide that secured claimants must retain their liens on the debtor's property, and their liens must be satisfied if the property is sold. The claims of unsecured claimants must receive full value, or no junior claimants will receive anything. Actual practice may deviate from these rules. See also Absolute Priority Rule (APR).
credit default swap
- A Swap in which A pays B the periodic fee, and B pays A the floating payment that depends on whether a predefined credit even has occurred, or not. The fee might be quarterly, semiannual, or annual. The floating payment would likely occur only once, and might be proportional to the discount of the reference loan below par. The credit event might be a declaration of bankruptcy or violation of a bond indenture or loan agreement.
Derivative Products with payoffs that depend on risk factors related to credit quality, such as yield spread over Treasuries, price discount from par, or a "credit event." A credit event might be a drop in credit rating or some sort of failure, such as occurrence of default, insolvency or bankruptcy.
One goal of Credit Derivatives is to split credit risk from market risk. The key concept here is that credit risk is an undesirable element, akin to pollution. When you allow a market for pollution, people who don't want it sell it at market price to the parties who mind it the least or handle it the best.
- Credit Derivatives already come in a variety of flavors, and infinitely many types are possible. However, nearly all current structures are variations on Call or Put Options (q.v.) on Credit Spreads (q.v.), Binary Options (q.v.), or Knockout Options (q.v.). In the last two cases the trigger is a "credit event". Typically, the payoff depends on the state of the world some time - as much as months - after the event. Here are some examples of Credit Derivatives:
- Notes that Bankers Trust and CSFP issued in 1993, which promised large coupons if the reference asset didn't suffer a "credit event" - namely, default or sufficient deterioration in its credit rating - and small coupons if it did. The spread of the large coupon over ordinary debt depended on the reference asset's credit quality, and was sometimes 80 - 100 b.p. (over LIBOR). This is a sort of Binary Option that is a function of the credit event.
- A Binary Option that Bankers Trust offered, with a payoff that depended on the credit performance of a basket of bonds. If any of the bonds defaulted, then a counterparty paid Bankers Trust a fee.
- A Call or Put Option on a credit spread over Treasuries.
- A One-Touch (q.v.) Knock-in Put (q.v.) Option on the value of a corporate bond.
- A One-Touch (q.v.) Knock-in Put Option (q.v.) on the lowest value of n corporate bonds in a portfolio.
- A firm can have many types of credit obligations outstanding. These may be of all manner of seniority, security and instrument type. In bankruptcy proceeding, it is not uncommon for different obligations to realize different recovery rates including perhaps 100% recovery - zero loss. It is the obligor that encounters credit distress carrying all of his obligations with him. Thus individual obligations will be exposed to credit distress even though some may not realize an actual default (i.e., some may have zero loss).
- See, " exposure".
- This is payment protection so that if you take out a loan and then fall sick or lose your job, your monthly loan repayments will be covered. Credit Insurance is a safety net but it is not cheap, it can increase the cost of a personal loans substantially. Consider very carefully before signing up for these policies and of course read the policy wording closely.
credit linked note
Definition: A note that pays interest and repays principal that depends on a credit event, such as bankruptcy and default.
- Example: Swiss Bank Corporation issued global floating rate notes, which it would redeem for 51% of par value or 100% of the value of a reference security (a similar bond from the same issuer, less the credit exposure), if a particular credit event occurs.
- Generally meant to refer to an obligor's relative chance of default, usually expressed in alphanumeric terms (e.g., Aaa, Aa1, Aa2, Aa3, A1, A2, A3, Baa1, Baa2, Baa3, Ba1, Ba2, Ba3, B1, B2, B3, Caa1, Caa2, Caa3, Ca, C). More commonly, with the every increasing capability and acceptance of quantitative credit scoring systems, this is express directly as the probability of default within some specified horizon.
- The risk of loss from not receiving one's reward for being on the right side of a bet about a market move, due to the losing counterparty's failure to meet his obligations.
A system used by lenders to calculate the statistical probability that a loan they grant to you will be repaid. Different lenders have slightly different rules for assessing risk. Each lender works out the characteristics of 'good' and 'bad' customers, based on its past experience. Homeowners or borrowers with steady incomes may be considered less likely to default.
- Each answer you give on your application form will be given a rating. If the total 'score' is above a certain figure, your application is accepted. Because credit scoring is the key to different lenders risk management they do not easily reveal the precise details of how it works.
- An option spread trade - long one option, short another - that generates cash.
- The excess of the yield on a note with credit risk over a comparable note without credit risk.
credit spread swap
- A Swap with a payoff that depends on a Credit Spread. For instance, a Swap with a Floating Leg that depends on the Credit Spread.
Definition: A Swap whose value depends on underlying credit quality, preferably without bearing ordinary interest-rate risk.
- Examples: A Total Return Swap (q.v.) with underlying risky debt might qualify, although this has a heavy dose of interest rate risk. An Outperformance Swap, with a payoff proportional to the excess of the rate of return on the risky debt over the rate of return on a comparable Treasury bond, would be a clearer example. A Total Return Swap plus an ordinary Interest Rate Swap () that offsets the interest rate risk. The exchange of a constant fee per period versus a binary floating payment of either zero or a Credit Event Payment. A Credit Spread Swap.
- The annual rate of return on a security, calculated by dividing the interest or dividends paid by the security's current market price.