financial terminology guide from A-Z
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List of included financial terms
Introduction: Towards a Common Risk Management Language
In recent years, the worlds of banking, insurance and investment management have become increasingly intermingled, and for good reason – investment is, after all, a form of insurance, albeit one in which the parameters of risk and reward are generally broader.
That process of convergence has been visible at a regulatory and corporate level, with the passage of a series of financial reforms – such as the Gramm-Leach-Bliley Act in the US in 1990 – opening the way for consolidation between banks, insurance companies and investment management firms. The consequence has been a number of high profile mergers within the financial services sector – many of them negotiated on a cross-border basis – that have created global groups whose fields of expertise extend across all areas of business.
This is a logical development, given that one of the most important disciplines common to all three businesses is risk management: the proactive identification and measurement of financial risks and the timely implementation of measures designed to minimize or eliminate those risks. Over the past two decades, the risk management capabilities of the financial services sector have taken giant strides towards ensuring that the chances of a system-wide failure are minimized.
As risk management techniques have become more sophisticated and more efficient, innovations developed in banking and investment management have increasingly used the nomenclature of the insurance industry to describe the processes used to address the issue of risk.
An obvious example of this process has been the contribution made to the evolution of the structured finance market by monoline insurance companies, the specialists that started out by providing insurance in the market for municipal bonds, but that now also play a key role in providing protection for investors in areas ranging from project finance to the market for collateralized debt obligations (CDOs). Less obvious but equally important examples are to be observed in the growing importance of capital market products that go by different names, but which also effectively act as insurance policies.
Credit default swaps (CDS), for example, have been a key building block in the development of a new class of hedging and investment products that have transformed the fixed-income markets, although CDS themselves are essentially just insurance policies allowing for credit protection to be bought and sold among participants in the capital market.
In other words, the cross-fertilization of banking and insurance products and their closer integration with investment management is bringing with it a range of by-products from new hedging mechanisms to entirely new asset classes. These products allow investment managers to better manage their portfolios by enabling them to customize risk/return payoffs in a way that was, until recently, impossible.
On one level, this process has underpinned the development of a number of innovations that have improved efficiencies for retail and institutional investors alike – with the emergence of capital-guaranteed products such as constant proportion portfolio insurance (CPPI) one notable example. At another, it has helped in the evolution of products insuring a range of risks that were previously thought of as uninsurable, with the growing popularity of catastrophe bonds (or cat-bonds) one example of an innovation that will become more important as weather patterns become increasingly unpredictable.
Against this background, a degree of blurring and overlapping in the terminology of the banking, insurance and investment management industries has been inevitable. This guide aims to demystify many of those terms, bringing some of the more frequently used technical expressions in all three disciplines into a concise, single volume. We hope it will serve as a useful guide for market participants in all three areas of the financial services sector.
Simon Brady
List of financial terms:
* you may click on any of the linked topics to view Euromoney's coverage related to the term.
A
Accrued Interest & Accrued Interest Bonds
Actuary
Algorithmic Trading
Alpha (see also ‘Greeks’)
Alternative Assets
Alternative Risk Transfer
Amortization
Annuity (see also ‘Deferred Annuity’)
Apportionment
Arbitrage & Arbitrage Pricing
Asset-Backed Security (ABS)
Asset-Liability Management (ALM)
B
Barbell Investment Strategy
Basel I & Basel II (see also ‘Capital Adequacy’)
Basis Point
Basis Risk
Basis Trading
Bell Curve (see also ‘Normal Distribution’)
Beta (see also ‘Greeks’)
Binary Options
Black-Scholes
Bootstrapping
Bullet Bond
C
Callable Security
Capital – Economic & Regulatory
Capital Adequacy (see also ‘Basel I & Basel II')
Capital Asset Pricing Model (CAPM)
Captive Insurance
Catastrophe Bond
Catastrophe Model
Collateral (see also ‘Asset- Backed Security’)
Collateralized Obligations
(CDOs, CLOs, CBOs)
Combined Ratio
Commercial Paper
Conduit
Catastrophe Bond
Constant Proportion
Portfolio Insurance (CPPI)
Contractual Trust Arrangement (CTA)
Convertible Bond
Convexity
Correlation & Correlation Risk (see also ‘Variance’)
Credit Crunch
Credit Default Swap (CDS)
Credit Derivatives
Cost of Carry
Cost-to-Income Ratio
Counterparty Risk
Coupon
Covered Bond
Credit Enhancement
Credit Rating
Credit-Linked Note (CLN)
Currency Overlay
D
Dedicated Long & Dedicated
Short Investing (Long Only & Short Only strategies)
Default & Default Rates
Deferred Annuity (see also ‘Annuity’)
Defined Benefit Plan
Defined Contribution Plan
Delta & Delta Hedging (see also ‘Greeks’)
Derivatives
Dispersion
Diversification
Dividends & Dividend Cover
Duration Management, Duration Matching & Duration Risk
E
Efficient Frontier (see also ‘Markowitz, Markowitz Diversification’)
Equity-Linked Annuity
Event Risk
Excess of loss (reinsurance)
Expected Value, Expected Loss & Expected Return
Exposure
F
Facultative reinsurance
Financial Guarantee Insurance (see also ‘Monoline Insurance’)
Financial reinsurance
Fixed Annuity
Floating Rate Note
Forwards (see also ‘Options’)
Fronting
Futures
G
Generally Accepted Accounting Principles (GAAP)
Gamma (see also ‘Greeks’)
Gearing
Gramm-Leach-Bliley Act
Greeks
Gross Redemption Yield (see also ‘Delta’, ‘Gamma’)
H
Hedge Funds
Hedging & Dynamic Hedging
High-Yield Bond
Hurdle Rates
Hybrid Security
I
IFRS
Illiquidity Premium
Immediate Annuity (see also ‘Annuity’)
Immunization
Implied Volatility
Incurred but not reported (IBNR)
Inflation-Linked Bonds
inflation (CPI or RPI)
Internal Rate of Return (IRR)
Internal Ratings-Based Approach (IRB)
Investment Income
iTraxx
J
Junior debt (see also ‘Subordinated Debt’)
Junk bond
K
Knockout Options
Kurtosis
L
Layer
Leverage & Leveraged Loan
Liquidity, Liquidity Risk & Liquidity Premium
Loan Loss Provision
Long Tail Event
Long/Short Positions & Long/Short Strategies
Loss Given Default (LGD)
Loss Portfolio Transfer
M
Mark-to-Market
Markets in Financial
Instruments Directive (MiFID)
Markowitz, Markowitz Diversification
Mezzanine
Minimum Variance Frontier
Monoline Insurance (see also ‘Wraps’)
Monte Carlo & Monte Carlo Simulation
Moral Hazard
Mortgage-Backed Securities
Net Asset Value (NAV)
Normal Probability Distribution
O
Option
Over-the-Counter
P
Pairs Trading (see also ‘Correlation & Correlation Risk')
Political Risk Insurance
Portable Alpha
Present Value
Price to Earnings (P/E) Ratio
Primary Market (see also ‘Secondary Market’)
Prime Broker & Prime Brokerage
Private Placement
Product recall (insurance)
Probability of Default (PD)
Q
Qualifi ed Institutional Buyer (QIB)
Quantitative Analysis & Quantitative Management
(Quant)
Quota Share
R
Random Walk Theory
Ratings Agencies
Recovery
Recovery Rate
Reinsurance
Repurchase Agreement (Repo)
Return on Assets (ROA)
Return on Invested Capital (ROIC)
Return on Equity (ROE)
Rho (see also ‘Greeks’)
Risk Management
Risk Premium
Risk Weightings (see also ‘Basel I & Basel II')
Run-off
S
Secondary Market (see also ‘Primary Market’)
Securitization
Semi-Variance
Sharpe Ratio
Solvency II
Special Purpose Vehicle (SPV)
Standard Deviation
Standardized Approach (see also ‘Basel I & Basel II')
Statistical Arbitrage
Stochastic Analysis
Structured Investment Vehicle (SIV)
Subordinated Debt
Super Senior Tranche
Systemic Risk
T
Tier I Capital
Tier II Capital
Tier III Capital
Tobin Q
Total Return
Total Return Swap
Tracking Error
Tranches & Tranching
U
Uninsurable Risk
V
Value at Risk (VAR)
Vanilla
Variable Annuity
Variance
VIX
Volatility
W
Weather Derivatives
Wraps
Y
Yen Carry Trade
Z
Zero-Beta Portfolio
Zero-Coupon Bond
Zero-Sum Game
