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accreting swaps, 177
accumulation swaps, 177
actively managed certificate (AMC), 67
All Ordinaries index, 258
“all or none” transactions, 143–44
American Petroleum Institute No. 4 index (API 4), 148
American Society for Testing and Materials, 147
anonymity, need for, 176
appreciating swaps, 177
Argentina Stock Exchange, 259
asset-backed securities, 208
asset swaps, 178–79
associated persons (APs), 139
“at the money,” definition of, 77
Australian Stock Exchange, 258
authorized participants, 50, 52
banks, see investment banks; mortgage bankers
Barclays Global Investors, 49, 52
barrier options, 110–12
basis price, 19
basis spread, 24
basis swaps, 179, 180–81, 188–89
bear spreads, 90–91
beta, 95–96
binary options, 108–9
BlackRock, 49
convexity of, 32
corporate vs. municipal, 20–21
covered, 216–17
fixed-income, 19
interest only/principal only, 33–35
pricing of, 29–33
put, 17–18
ratings of, 24–25
serial form of, 21
sinking fund provision for, 15–16, 18–19
zero-coupon, 228
see also callable bonds
Bovespa (Bolsa de Valores do Estado de São Paulo) index, 259
Brent crude oil, 146–47
BRIC (Brazil, Russia, India, China) countries, 219
broker-dealers, 5–6, 13, 104, 213, 234, 235, 241
bull spreads, 87–90
buyer, definition of, 70
buy/write strategies, 5, 83–85, 113–15, 219–20
CAC 40 (Cotation Assistée en Continu) index, 258
callable bonds, 12–18
as beneficial to issuer, 13
partial, 13
refunding of, 16–17
rule-of-thumb method for, 14–15
sinking fund provision for, 15–16
callable/putable swaps, 180
capital requirements, 238
capped options, 105–6
capped swaps, 180–81
carbon dioxide emissions, 148–49
cash settlers, 80
CBOE Futures Exchange (CFE), 136
Central Appalachian Coal Future, 147
central clearing parties (CCPs), 27, 243
certificate of deposit (CD) rate, 179
Chicago Board of Trade (CBOT), 136, 249
Chicago Board Options Exchange (CBOE), 105, 136, 239, 240–42, 262
Chicago Climate Exchange (CCE), 136
Chicago Mercantile Exchange (CME), 127–28, 136
circus swaps, 181–82
class, definition of, 72–73
clearing corporations, 27, 51, 64, 73, 104–5, 107, 142, 143, 156, 161–62, 163, 164, 166, 209, 210, 222, 233, 239, 242, 245–49, 272
benefits of using, 254–55
CME Clearing, 144
CME Group, 136, 142–44, 146, 164, 233
coal futures, 147–48
coffee futures, 145–46, 150–51, 166
collateral, 23
collateralized bond obligations (CBOs), 206–7, 214–15
collateralized debt obligations (CDOs), 4, 206–17
risk and, 206
collateralized loan obligations (CLOs), 206–7, 215–16
collateralized mortgage obligations (CMOs), 8, 178, 206–14
GNMA-backed, 207–11
nongovernment-backed, 213
REMICs and, 211–12
TBA pools of, 209–10
commercial paper, 11
commodities, 63, 177, 219, 230, 233, 262
exchange-traded (ETC), 48, 63–64
swaps, 182–84
see also futures products
Commodity Exchange Act (1936), 127, 232, 233
Commodity Exchange Authority, 232
Commodity Futures Trading Commission (CFTC), 127, 137, 232, 237, 247
divisions of, 233–34
Dodd-Frank and, 239
commodity pool operators (CPOs), 137–38, 233
Commodity Price Index, 262
Commodity Research Board (CRB), 262
commodity trading advisors (CTAs), 138, 233
compound options, 112–13
confirmation (terms) sheet, 72
constant maturity swaps, 184
Consumer Confidence Index (CCI), 261
Consumer Price Index (CPI), 261–62
cost of carry, 152
cost of funds index (COFI) rate, 179
coupon rates, see interest rates
covered bonds, 216–17
covered call, definition of, 83
CRB BLS indexes, 262–63
CRB Futures Price Index, 262
credit, 5
credit default swaps (CDSs), 144, 194–201
assessing risk in, 195–97
counterparties in, 194–95, 198
ISDA master agreement for, 199–201
marketability of, 196–97
negotiation of, 197–98
credit events, 194
Creditex, 144
credit scores, 23
credit swaps, 178
fluctuation in, 25
CSX coal future, 147
currency transactions, 246–47
exchange-traded (ETC), 48
swaps, 177, 179, 181, 184, 187–88
current (spot) market indexes, 262–63
current (spot) market price, 123, 126
CUSIP number, 20–21
customized (one-off) transactions, 26, 27, 44, 105, 166, 225, 239–40
DAX (Deutscher Aktien IndeX), 258, 260
day orders, 140
debt instruments:
bellwether, 25–26
investment-grade, 23
pricing of, 29–33
trading of, 19–20
debt markets:
global economy and, 8–10
interest rates and, 28–35
liquidity of, 11, 26, 176, 242
overview of, 8–21
risk in, 22–27
see also specific markets
default, definition of, 198
delivery versus payment (DVP) rule, 52
Depository Trust & Clearing Corporation (DTCC), 51–52, 222
Mortgage-Backed Securities Division of, 209, 210, 239
Depository Trust Company (DTC), 13, 51–52
derivatives:
of benefit to issuer of underlying product, 3–4
capital requirements and, 238
definition of, 3
indexes and, 262–63
investment banks and, 6–7
of no benefit to issuer of underlying product, 4
processing of, see transaction processing
types of, 3–4
see also specific derivative products
Deutsche Bank, 67–68
diagonal spreads, 92
“discount,” meaning of term, 19
dividends, 112
Dodd-Frank Wall Street Reform and Consumer Protection Act (2010), 10, 11, 236, 238, 263–64
Commodities Futures Trading Commission and, 239
OTC derivatives and, 238–39
processing and transparency issues addressed by, 238, 242–44, 245
SEC and, 239
Dow Jones Industrial Average, 50, 256, 257
down-and-out call option, 110
down-and-out put option, 110
DownREIT, 45
duration, Macaulay vs. modified, 32–33
EDGAR (Electronic Data Gathering, Analysis, and Retrieval), 231
electronic commerce networks (ECNs), 49, 54
electronic trading platforms, 141–42, 143, 239, 243
EMIR (European Market Infrastructure Regulation), 10, 238, 264
emissions contract futures, 148–49
Equifax, 23
equity-linked notes, 227–28
Euribor (Euro Interbank Offered Rate), 34, 35
Euronext, 258
European Central Bank, 10
European Market Infrastructure Regulation (EMIR), 10, 238, 264
“Ex by EX,” 108
excess return trackers, 67
exchange rates, 168
exchange-traded commodities (ETC), 48, 63–64
exchange-traded currencies (ETC), 48, 65
exchange-traded funds (ETFs), 39, 45–46, 48–62, 95
creation of, 50–53
definition and types of, 49–50
global, 56–58
grantor trusts, 58–59
indexes and, 262
inverse, 59
margining of, 60–62
mutual funds vs., 53
open-end, 55
redemption of, 51
strategies for, 53–55
trading of, 51–53
UIT vs. mutual fund form of, 54–55
exchange-traded notes (ETN), 48, 65–67
risk in, 66–67
exchange-traded products, 39, 48–68, 239, 249
exercise capabilities, for options, 77–79
exercise price, 78–79
Experian, 23
expiration dates, of options, 73–74
Fannie Mae (Federal National Mortgage Association), 211–12, 213
Federal Home Loan Mortgage Corporation (Freddie Mac), 20, 211–12, 213
Federal National Mortgage Association (Fannie Mae), 211–12, 213
Federal Reserve Board (FRB), 231, 234–35
fiduciary responsibility, 13
financial crisis (2008), 10–11, 228
Financial Industry Regulatory Authority (FINRA), 45, 62, 66, 231, 234–35, 236
Financial Times London Stock Exchange (FTSE 100; “Footsie”) index, 258
Fitch, 23
fixed-for-fixed swaps, 181, 186–88
fixed-for-floating swaps, 179, 180–82, 185–86
Fixed Income Clearing Corporation (FICC), 105
fixed return options (FROs), 108
fixed- vs. floating-rate debt instruments, 11–12
flex options, 107
floating-for-floating (basis) swaps, 179, 180–81, 188–89
foreign exchange, 116–17
forward contracts, 165–68
forward currency market, 166–68
forward rate agreements (FRAs), 165, 168–70
Frankfurt Stock Exchange, 258
Freddie Mac (Federal Home Loan Mortgage Corporation), 20, 211–12, 213
FTSE 100 (Financial Times London Stock Exchange; “Footsie”) index, 258
fuel futures, 146–47
Fund Analyzer, 235
funds, availability of, 9, 10–11
futures commission merchants (FCMs), 138, 142, 144, 152–53, 161–62, 233, 247
futures margins, 152–64
initial, 152–53
leverage in, 159–61
SPAN, 161–63
futures market, 137–51
associated persons (APs), in, 139
bids in, 139
commodity pool operators (CPOs) in, 137–38
commodity trading advisors (CTAs) in, 138
electronic trading platforms in, 141–42
futures commission merchants (FCMs) in, see futures commission merchants (FCMs)
hedgers in, 123–24, 125, 126, 137, 139, 149, 164
leverage transaction merchants (LTMs) in, 138–39
limit orders in, 140
list of U.S. exchanges, 136
“market if touched” orders in, 141
offers in, 139
order and report requirements for, 149–51
orders in, 140–41
producer-user relationship in, 123–24
speculators in, 124–25, 139, 149
stop orders and stop limit orders in, 141
time constraint orders in, 140
traders in, 137
trading floors in, 141–45
futures products, 72, 82, 121–36
contracts for, 129–32
definition of, 121–22
delivery months for, 128
exchange for physical (EFP) in, 163–64
exchange for related positions (EFRPs) in, 164
liquidity and, 124–25
list of, 132–35
market risk and, 123–28
market value volatility and, 125–27
options on, 161
quality requirements for, 150–51
and volatility of underlying issues, 92–93, 99, 125, 153
Ginnie Mae, see Government National Mortgage Association (GNMA; Ginnie Mae)
global economy, debt markets and, 8–10
global warming, 126
GNMA, see Government National Mortgage Association (GNMA; Ginnie Mae)
Goldman Sachs, 263
good till canceled (GTC) orders, 51, 140
Government National Mortgage Association (GNMA; Ginnie Mae), 20
future product of, 128
grantor, definition of, 70, 71
grantor trusts, exchange-traded, 58–59
Hang Seng index, 258
hedgers, hedging, 22
futures and, 123–24, 125, 126, 137, 139, 149, 164
Hedge Street, 136
holder, definition of, 70, 71, 241
Hong Kong Stock Exchange, 258
horizontal spreads, 92
Housing and Urban Development Department, U.S., 207
housing market, 10
income writing strategy, 109
see also buy/write strategies
indexes, 256–63
capitalization-weighted, 256–57
derivative products and, 262–63
economic, 261–62
floating adjusted weighting, 257
formulas for, 260
general market, by country, 257–60
price-weighted, 256
index-linked notes, 227–28
index options, 80–81
inflation swaps, 184
initial margin, 152–53
initial public offering (IPO), 6, 7
Intercontinental Exchange (ICE), 136, 144–45, 146, 147–48
interdealer brokers (IDBs), 144, 176
interest:
as expense, 9
taxes on, 20
interest rates:
debt markets and, 28–35
fixed vs. floating, 11–12, 185
forward contracts on, 167
forward rate agreements and, 168–70
long-term vs. short-term, 185
rho and, 98–99
risk-free (Treasury bill), 112
interest rate swaps, 184–89
fixed-for-fixed, 186–87
fixed-for-floating, 185–86
scheduling payment in, 189
International Securities Exchange, 117, 249
International Swaps and Derivatives Association (ISDA), 198, 235–36
master agreement of, 199–201, 236
“in the money,” definition of, 76
intrinsic value, 76–77, 80, 85, 91, 97, 98–99, 100, 101, 112, 117, 204, 284
inverse floater structured products, 226–27
Invesco PowerShares, 50
Investment Advisors Act (1940), 231, 232
investment banks:
capital requirements of, 238
role of, 5–7
Investment Company Act (1940), 40, 55, 231, 232
investment-grade securities, 23
IPC index (Índice de Precios y Cotizaciones), 257
IPSA (Índice de Precios Selectivo de Acciones), 259
ISE (Istanbul Stock Exchange) 100 index, 259
iShares, 49
joint ventures, 41
Kansas City Board of Trade (KCBT), 136
knock-in, knock-out options, 109–12
KOSPI Composite Index, 259
Laspeyres Index, 260
Lehman Brothers, 66
leverage transaction merchants (LTMs), 138–39
LIBOR (London Interbank Offered Rate), 24, 34, 35, 179, 188, 203
LIFFE CONNECT, 142
liquidity, 11, 26, 66, 107, 108, 124–25, 176, 242
London Stock Exchange, 63–64, 258
longevity of loans, interest rates and, 9, 28
Long-term Equity AnticiPation Securities (LEAPS), 75, 106
“long the option,” definition of, 70
Macaulay duration, 32–33
Madrid Stock Exchange, 258
Dodd-Frank and, 243–44
spreads and, 86, 88–89, 118–20
straddle position and, 120
market-linked products, see structured products
market makers, 50, 52, 176, 242
futures and, 123–28
swaps and, 175
markets:
see also debt markets
Markets in Financial Instruments Directive (MiFID), 238
matching facilities, 249
mergers and acquisitions, 6
Merrill Lynch HOLDRS, 59
MerVal (Mercado de Valores) index, 259
Minneapolis Grain Exchange (MGEX), 136
modified duration, 32–33
monetary policy, 9
Moody’s, 23
mortgage-backed securities, 10, 43–44, 178
see also collateralized mortgage obligations (CMOs)
Mortgage-Backed Security Division (MBSD), 209, 210, 239
mortgage bankers, 208
REITs and, 43
mother and daughter options, 112–13
corporate bonds vs., 20–21
mutual funds, 36–42
closed-end, 39–41
exchange-traded products vs., 39, 43
REITs and, 45
unit investment trusts, 41–42
mutual funds, open-end, 36–39
break-point sales charges for, 37–38
closed-end funds vs., 40–41
no-load, 37
Nadex, 136
NASDAQ Composite index, 257, 258
NASDAQ OMX Futures Exchange (NFX), 136
National Exchange of India, 259
National Futures Association (NFA), 137, 233, 237
National Securities Clearing Corporation (NSCC), 51, 105
net asset value (NAV), 38–39, 40, 53
netting:
nonnetting vs., 249
unilateral, 243, 246, 250, 251–52
Newcastle coal futures, 148
New York Board of Trade (NYBOT), 136
New York Mercantile Exchange (NYMEX; COMEX), 136
New York Stock Exchange (NYSE), 105
see also NYSE Amex; NYSE Liffe US
Nifty index (“Nifty Fifty”), 259
no-load funds, 37
nonnetting, 249
North American Securities Administrators Association (NASAA), 45
notes, 11
exchange-traded (ETN), 48
structured, see structured notes
principal amount vs., 193
NYSE Amex, 108
NYSE Liffe US, 136
OEX options, 262
Office of the Comptroller of the Currency (OCC), 230–31
oil contracts, 125
OneChicago, LLC, 136
one-off (customized) transactions, 26, 27, 44, 105, 166, 225, 239–40
operational risk, 27
Options Clearing Corporation (OCC), 73, 104, 107–8, 222, 239, 242, 243
options dealers, 104
Options Price Reporting Authority (OPRA), 242
options products, 69–82
barrier, 110–12
binary, 108–9
call, defined, 69–70
capped, 105–6
class of, defined, 72–73
compound, 112–13
European form of, 78, 117, 222, 228
exercise capabilities for, 77–79
expiration date of, 73–74
fixed return (FROs), 108–9
flex, 107
on futures, see futures products
intrinsic value of, 76–77
knock-in, knock-out, 109–12
orderly issue of, 242
over-the-counter (OTC), 73, 104–5, 107, 108, 241
position terminology in, 70–71
premium of, 76–77, 96–97, 99–100, 112
privately placed, 4
put, defined, 69–70
rainbow, 115–16
series of, defined, 73–74
standardization of, 242
strike (exercise) price of, 73–74, 78–79, 104
structure of, 72–74
symbology of, 75–76
synthetic, 113–15
type of, defined, 72–73
uncovered, 89
underlying issues of, 71–72, 96–97
options products, strategies for, 79–80, 83–94
beta and, 95–96
buy/writes and, 5, 83–85, 113–15, 219–20
multiple options and, 88–89
option premium and, 96–97, 99–100
rho and, 98–99
spreads and, see spreads
straddle and, 92–94, 99, 113, 120
tau and, 99
theta and, 99
“out of the money,” definition of, 77
over-the-counter (OTC) markets, 40, 44, 45–46, 144, 176
Dodd-Frank and, 238–39
forward contracts in, 165–68
options in, 73, 104–5, 107, 108, 241
packaged products, see structured products
pass-through securities, 128, 207–8, 239
Paulson, Henry, 216
Philadelphia Board of Trade (PBOT), 136
PHLX, 117
Platts CAPP Rail (CSX) OTC assessment, 147–48
portfolios, indexing of, 262, 263
precious metals, forward contracts on, 167
premium, definition of, 19, 71, 76
premium reducers, 85–86
present value, formula for, 29–30
pricing:
current (spot), 123
of debt instruments, 29–33
of futures, 123–25
principal amount, notional value vs., 193
proprietary trading, 11, 107–8
put bonds, 17–18
rainbow options, 115–16
rating agencies, 23
real estate investment trusts (REITs), 43–47
equity, 43
as global product, 46
investing in, 44–45
mortgage, 43–44
mutual funds and, 45
popularity of, 43
qualifications for, 46–47
registered vs. privately placed, 44–45
taxes on, 46
termination of, 47
REMICs (real estate mortgage investment conduits), 211–12
reporting authorities, 242, 248
repositories, 253–54
reserves, 10–11
Retirement Calculator, 235
retirement plans, 37
reverse convertible products, 228–29
rho, 98–99
Richards Bay coal futures, 148
rights, 4
in binary options, 108
of buy/write strategies, 84–85
in credit default swaps, 195–97
ETNs and, 66–67
futures margins and, 161–63
hedging of, 22
market, see market risk
operational, 27
systemic, 236
roller-coaster swaps, 189–90
rule-of-thumb (ROT) method, 14–15, 29
Sallie Mae (SLM Corporation), 215
S&P 500 index, 49, 52, 95, 127, 257, 262
S&P Global 1200 index, 260
S&P GSCI index, 263
S&P TSX Composite index, 257
Sarbanes-Oxley Act (2002), 231
scalpers, 125
Securities Act (Truth in Securities Act, 1933), 218, 231
Securities and Exchange Commission (SEC), 6, 40, 44, 50, 218, 230–31, 234–35, 236, 242
divisions of, 231–32
Securities Exchange Act (1934), 59, 231
Securities Industry and Financial Markets Association (SIFMA), 236
seller, definition of, 70
senior debt, 65
series, definition of, 73–74
settlement, 255
Shanghai Stock Exchange, 258
short-term paper, 11
“short the option,” definition of, 70–71
Singapore Stock Exchange, 259
sinking fund provisions, 15–16, 18–19
SLM Corporation (Sallie Mae), 215
Société d’Investissement à Capita (SICAV), 68
South Korean Stock Exchange, 259
soybean futures, 125–26
sample contract for, 130–32
special interest vehicle (SIV), 215
special purpose vehicle (SPV), special purpose entity (SPE), 215, 217
speculators, futures and, 124–25, 139, 149
Spiders (Spyders; SPDRs), 49, 55
spot (current) market indexes, 262–63
spot (current) market price, 123, 126
bear, 90–91
bull, 87–90
diagonal, 92
horizontal, 92
as premium reducers, 85–86
vertical, 92
SSE (Shanghai Stock Exchange Composite Index), 258
Standard & Poor’s, 23
see also OEX (S&P 100 index); S&P 500 index; S&P Global 1200 index; S&P GSCI index; S&P TSX Composite index
standardized portfolio analysis of risk (SPAN) margin, 181–83
State Street Global Advisors (SSGA), 49, 50
step-up swaps, 177
straddle positions, 92–94, 99, 113, 120
Straits Times index, 259
strike price, definition of, 73
structured notes, 223–26
equity-linked, 227–28
index-linked, 227–28
inverse floater, 226–27
structured products, 218–29
investment banks and, 6–7
objective of, 219
reverse convertible, 228–29
subindexes, 260
SunGuard, 142
swap brokers, 173–74, 175, 182, 244
swap execution facility (SEF), 238
swaps, 171–93
accreting, 177
amortizing, 177
asset, 178–79
callable/putable, 180
capped, 180–81
circus, 181–82
commodity, 182–84
constant maturity, 184
credit, 178
credit default, see credit default swaps (CDSs)
currency, 177, 179, 181, 184, 187–88
fixed-for-floating, 179, 180–82, 185–86
floating-for-floating (basis), 179, 180–81, 188–89
inflation, 184
interest rate, see interest rate swaps
notional value in, 177–78, 185, 193
options on, see swaptions
overview of, 171–73
participants in, 173–76
roller-coaster, 189–90
total rate of return (TROR), 190–92
yield curve, 192–93
zero-coupon, 193
swaptions, 202–5
call vs. put, 204
receiver vs. payer in, 203–4
types of, 203
synthetic options, 113–15
systemic risk, 236
tau, 99
taxes:
on interest, 20
on REITs, 46
TBA (to be announced) pools, 209–10
theta, 99
Thomson Reuters, 142
time value, 76, 79–80, 93–94, 96, 97, 98–99, 100, 102, 103, 112
Tokyo Stock Exchange, 259
Topix index, 259
total rate of return (TROR) swaps, 190–92
total return trackers, 67
trackers, 67–68
trade date plus three (T + 3) rule, 52
transaction guarantee, 255
transaction processing, 238–55
customized vs. noncustomized products in, 239–40
evolution of, 240–44
nonsystemized, 244–45
Dodd-Frank and, 238, 242–43, 245
TransUnion, 23
Treasury bill interest rate, 112
Treasury bond future, 128
Treasury bonds, 20–21, 105, 128
as interest only/principal only instruments, 34–35
Treasury debt instruments, 8
Treasury Department, U.S., 17
Trust Indenture Act (1939), 231
Truth in Securities Act (Securities Act, 1933), 218, 231
type, definition of, 72–73
Undertakings for Collective Investment in Transferable Securities (UCITS), 67–68
unilateral netting, 243, 246, 250, 251–52
unit investment trusts (UITs), 41–42, 49
units, 4
unsecured debt, 65–66
up-and-out call option, 110
up-and-out put option, 110
UPREIT, 45
U.S. Treasury rate, 34, 35, 179, 188
value at risk (VAR), 153
venture capitalists, 41
vertical spreads, 92
VIPERs, 50
volatility:
of currencies, 65
futures products and, 125–27
of indexes, 95–96
of underlying issues, 92–93, 99, 125, 153
Volcker Rule, 11
warrants, 4
Washington Post, 198
weighted average coupon (WAC), 211
weighted average maturity (WAM), 211
West Texas Intermediate (WTI) oil, 146–47
writer, definition of, 70, 71, 241
yield, credit risk and, 23–24
yield curve swaps, 192–93
zero-coupon bonds, 228
zero-coupon swaps, 193
Z tranches, 214