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Underlying asset
The security or property or loan agreement that an option gives the option holder the right to buy or to sell.

Underlying Asset
In a derivative or warrant, the security, property, or other asset that gives value to the derivative or warrant. For example, in an optiongiving one the right to buy stock in Johnson and Johnson, the underlying asset is the stock in Johnson and Johnson. An underlying asset may many things, such as a physical commodity, a security, a piece of land, or part of a business.

Futures Contract
An agreement to buy or sell an asset at a certain date at a certain price. That is, Investor A may make a contract with Farmer B in which A agrees to buy a certain number of bushels of B's corn at $15 per bushel. This contract must be honored whether the priceof corn goes to $1 or $100 per bushel. Futures contracts can help reduce volatility in certain markets, but they contain the risks inherent to all speculative investing. These contracts may be sold on the secondary market, but the person holding the contract at its end must take delivery of the underlying asset. Futures contract are standard instruments; that is, unlike forward contracts, their provisions are standardized. As such, they may be traded on an exchange.

Futures
What Does Futures Mean? Futures involve a financial contract that requires the buyer to purchase an asset (or the seller to sell an asset), such as a physical commodity or a financial instrument, at a specific price on a predetermined date in the future. Futures contracts detail the quality and quantity of the underlying asset; they are standardized to facilitate trading on a futures exchange. Some futures contracts may call for physical delivery of the asset, and others are settled in cash. The futures markets are characterized by the ability to use very high leverage relative to stock markets. Futures can be used either to hedge or to speculate on the price movement of the underlying asset. For example, a producer of corn could use futures to lock in a certain price and reduce risk (hedge). However, anybody could speculate on the price movement of corn by going long or short using futures. Investopedia explains Futures

The primary difference between options and futures is that options give the holder the right, not the obligation, to buy or sell the underlying asset until expiration, whereas the holder of a futures contract is obligated to fulfill the terms of the contract. In reality, most futures contract holders do not hold the contract to expiration. In addition, if an investor were long in a futures contract, that investor could go short the same type of contract to offset his or her position. This serves to exit the position, much like selling a stock in the equity markets would close a trade. Related Terms: Commodity Hedge Leverage Option Short (or Short Position)

Forward Contract
An agreement to buy or sell an asset at a certain date at a certain price. That is, Investor A may make a contract with Farmer B in which A agrees to buy a certain number of bushels of B's corn at $15 per bushel. This contract must be honored whether the price of corn goes to $1 or $100 per bushel. Forward contracts can help reduce volatility in certain markets, but they contain the risks inherent to all speculative investing. These contracts may be sold on the secondary market, but the person holding the contract at its end must take delivery of the underlying asset. Forward contracts are identical to futures contracts except that their provisions are not standardized. That is, forwards may be written with any provisions the parties desire. While this allows for greater flexibility, this makes the contracts less liquid on the secondary market and prevents them from being traded on an exchange.

Option
Gives the buyer the right, but not the obligation, to buy or sell an asset at a set price on or before a given date. Investors, notcompanies, issue options. Buyers of call options bet that a stock will be worth more than the price set by the option (the strike price), plus the price they pay for the option itself. Buyers of put options bet that the stock's price will drop below the price set by the option. An option is part of a class of securities called derivatives, which means these securities derive their value from the worth of an underlyinginvestment.

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Option
Gives the buyer the right, but not the obligation, to buy or sell an asset at a set price on or before a given date. Investors, notcompanies, issue options. Buyers of call options bet that a stock will be worth more than the price set by the option (the strike price), plus the price they pay for the option itself. Buyers of put options bet that the stock's price will drop below the price set by the option. An option is part of a class of securities called derivatives, which means these securities derive their value from the worth of an underlyinginvestment.
Copyright 2012, Campbell R. Harvey. All Rights Reserved.

Option
A contract in which the writer (seller) promises that the contract buyer has the right, but not the obligation, to buy or sell a certainsecurity at a certain price (the strike price) on or before a certain expiration date, or exercise date. The asset in the contract is referred to as the underlying asset, or simply the underlying. An option giving the buyer the right to buy at a certain price is called a call, while one that gives him/her the right to sell is called a put.

Options contracts are used both in speculative investments, in which the option holder believes he/she can secure a price much higher (or lower) than the fair market value of the underlying on the expiration date. For example, one may purchase a call option to buy corn at a low price, expecting the price of corn to rise significantly by the time the option is exercised. The investors may then buy the corn at the agreed-upon low price and instantly resell it for a tidy profit. Cases in which the option holder is correct are called in the moneyoptions, while cases in which the market moves in the opposite direction of the speculation are called out of the money. Like allspeculative investing, this is a risky venture. Other investors use option contracts for a completely different purpose: to hedge against market movements that would cause their other investments to lose money. For example, the same corn investor may buy the commodity at fair market value with the hope of the price rising. He/she may then buy a put contract at a high price in case the price of corn declines. This will limit his/her risk: if the price of corn falls, the investor has the option to sell at a high price, and, if the price of corn rises (especially higher than the strike price of the option), then he/she will choose not to exercise the option. See also: Futures, Forward Sales.

Farlex Financial Dictionary. 2012 Farlex, Inc. All Rights Reserved

option
1. A contract that permits the owner, depending on the type of option held, to purchase or sell an asset at a fixed price until a specific date. An option to purchase an asset is a call and an option to sell an asset is a put. Depending on how an investor uses options, the risks can be quite high. Investors in options must be correct on timing as well as on valuation of the underlying asset to be successful. See also Asian option, chooser option, combination option, conventional option, European option, exercise price, exotic option,expiration date, knock-out option, lapsed option, long-term equity anticipation securities, restricted option, stock option. 2. See incentive stock option.
Wall Street Words: An A to Z Guide to Investment Terms for Today's Investor by David L. Scott. Copyright 2003 by Houghton Mifflin Company. Published by Houghton Mifflin Company. All rights reserved.

Option. Buying an option gives you the right to buy or sell a specific financial instrument
at a specific price, called the strike price, during a preset period of time. In the United States, you can buy or sell listed options on individual stocks, stock indexes, futures contracts, currencies, and debt securities. If you buy an option to buy, which is known as a call, you pay a one-time premium that's a fraction of the cost of buying the underlying instrument. For example, when a particular stock is trading at $75 a share, you might buy a call option giving you the right to buy 100 shares of that stock at a strike price of $80 a share. If the price goes higher than the strike price, you can exercise the option and buy the stock at the strike price, or sell the option, potentially at a net profit.

If the stock price doesn't go higher than the strike price before the option expires, you don't exercise. Your only cost is the money that you paid for the premium. Similarly, you may buy a put option, which gives you the right to sell the underlying instrument at the strike price. In this case, you may exercise the option or sell it at a potential profit if the market price drops below the strike price. In contrast, if you sell a put or call option, you collect a premium and must be prepared to deliver (in the case of a call) or purchase (in the case of a put) the underlying instrument. That will happen if the investor who holds the option decides to exercise it and you're assigned to fulfill the obligation. To neutralize your obligation to fulfill the terms of the contract before an option you sold is exercised, you may choose to buy an offsetting option.
Dictionary of Financial Terms. Copyright 2008 Lightbulb Press, Inc. All Rights Reserved.

option
The right to purchase or lease property for an agreed-upon price.The person who owns the property is called the optionor and is the one who grants the option.The recipient is called the optionee.The optionee has the right to take advantage of the opportunity, but does not have the obligation to do so.

Securities
Paper certificates (definitive securities) or electronic records (book-entry securities) evidencing ownership of equity (stocks) or debt obligations (bonds).
Copyright 2012, Campbell R. Harvey. All Rights Reserved.

Security
A document; historically, a physical certificate but increasingly electronic, showing that one owns a portion of a publicly-traded companyor is owed a portion of a debt issue. Securities are tradable. At their most basic, securities refer to stocks and bonds, but the term sometimes also refers to derivatives such as futures and options.

Farlex Financial Dictionary. 2012 Farlex, Inc. All Rights Reserved

Securities
In general, any evidence of an interest in corporate stock or stock rights or an interest in any note, bond, debenture or other evidence of indebtedness issued by a government or corporation. For certain tax purposes, however, the definition is more limited.

Stock
Ownership of a corporation indicated by shares, which represent a piece of the corporation's assets and earnings.

Stock
A portion of ownership in a corporation. The holder of a stock is entitled to the company's earnings and is responsible for its risk for the portion of the company that each stock represents. There are two main classes of stock: common stock and preferred stock. Common stock holders have the right to vote on major company decisions, such as whether or not to merge with another corporation, and receivedividends determined by management. Preferred stock holders do not usually have voting rights, but receive a minimum dividend. Stock may be bought or sold, usually, though not always, in the context of a securities exchange. It is important to note that a single share of a stock usually represents only a tiny amount of ownership, and, therefore, most stocks are traded in batches of 100.

Bond
Bonds are debt and are issued for a period of more than one year. The US government, local governments, water districts, companiesand many other types of institutions sell bonds. When an investor buys bonds, he or she is lending money. The seller of the bond agrees to repay the principal amount of the loan at a specified time. Interest-bearing bonds pay interest periodically.

Bond
A security representing the debt of the company or government issuing it. When a company or government issues a bond, it borrowsmoney from the bondholders; it then uses the money to invest in its operations. In exchange, the bondholder receives the principal amount back on a maturity date stated in the indenture, which is the agreement governing a bond's terms. In addition, the bondholder usually has the right to receive coupons or payments on the bond's interest. Generally speaking, a bond is tradable though some, such as savings bonds, are not. The interest rates on Treasury securities are considered a benchmark for interest rates on other debt in the United States. The higher the interest rate on a bond is, the more risky it is likely to be. There are several different kinds of bonds. The most basic division is the one between corporate bonds, which are issued by private companies, and government bonds such as Treasuries or municipal bonds. Other common types include callable bonds, which allow the issuer to repay the principal prior to maturity, depriving the bondholder of future coupons, and floating rate notes, which carry an interest rate that changes from time to time according to some benchmark. Along with cash and stocks, bonds are one of the basic types ofassets.

bond
1. A long-term promissory note. Bonds vary widely in maturity, security, and type of issuer, although most are sold in $1,000 denominations or, if a municipal bond, $5,000 denominations. 2. A written obligation that makes a person or an institution responsible for the actions of another.
Wall Street Words: An A to Z Guide to Investment Terms for Today's Investor by David L. Scott. Copyright 2003 by Houghton Mifflin Company. Published by Houghton Mifflin Company. All rights reserved.

Bond. Bonds are debt securities issued by corporations and governments.

Bonds are, in fact, loans that you and other investors make to the issuers in return for the promise of being paid interest, usually but not always at a fixed rate, over the loan term. The issuer also promises to repay the loan principal at maturity, on time and in full.

Because most bonds pay interest on a regular basis, they are also described as fixed-income investments. While the term bond is used generically to describe all debt securities, bonds are specifically long-term investments, with maturities longer than ten years.
Dictionary of Financial Terms. Copyright 2008 Lightbulb Press, Inc. All Rights Reserved.

bond
A certificate that provides evidence of a debt or obligation.
The Complete Real Estate Encyclopedia by Denise L. Evans, JD & O. William Evans, JD. Copyright 2007 by The McGraw-Hill Companies, Inc.

Bond
What Does Bond Mean? A debt investment in which an investor lends money to an entity (corporate or government) that borrows the funds for a defined period at a fixed interest rate. Bonds are used by companies, municipalities, states, and U.S. and foreign governments to finance a variety of projects and activities. Bonds commonly are referred to as fixedincome securities and are one of the three main asset classes, along with stocks and cash equivalents. Investopedia explains Bond The indebted entity (issuer) issues a bond stipulating the stated interest rate (coupon) to be paid and a date when the loaned funds (bond principal) are to be returned (maturity date). Interest on bonds usually is paid every six months (semiannually); bond categories include corporate bonds, municipal bonds, and U.S. Treasury bonds, notes, and bills (Treasuries). Two features of a bondcredit quality and maturityare the principal determinants of the interest rate of a bond. Bond maturities can range from a 90-day Treasury bill to a 30-year government bond. Corporate and municipal bonds typically go out 3 to 10 years. Related Terms: Callable Bond Convertible Bond Corporate Bond Junk Bond Yield to Maturity
Investopedia's Guide To Wall Speak, Edited by Jack Guinan. Copyright 2009 by Investopedia. Used with permission of The McGraw-Hill Companies, Inc.

Bond

A note obliging a corporation or governmental unit to repay, on a specified date, money loaned to it by the bondholder. The holder receives interest for the life of the bond. If a bond is backed by collateral, it is called a mortgage bond. If it is backed only by the good faith and credit rating of the issuing company, it is called a debenture.

Swap market[edit]
Most swaps are traded over-the-counter (OTC), "tailor-made" for the counterparties. Some types of swaps are also exchanged on futures markets such as the Chicago Mercantile Exchange, the largest U.S. futures market, the Chicago Board Options Exchange, IntercontinentalExchange and Frankfurtbased Eurex AG. The Bank for International Settlements (BIS) publishes statistics on the notional amounts outstanding in the OTC derivatives market. At the end of 2006, this was USD 415.2 trillion, more than 8.5 times the 2006 gross world product. However, since the cash flow generated by a swap is equal to an interest rate times that notional amount, the cash flow generated from swaps is a substantial fraction of but much less than the gross world productwhich is also a cash-flow measure. The majority of this (USD 292.0 trillion) was due to interest rate swaps. These split by currency as:

The CDS and currency swap markets are dwarfed by the interest rate swap market. All three markets peaked in mid-2008. Source: BIS Semiannual OTC derivatives statistics at end-December 2008

Notional outstanding
in USD trillion

Currency

End 2000 End 2001 End 2002 End 2003 End 2004 End 2005 End 2006

Euro

16.6

20.9

31.5

44.7

59.3

81.4

112.1

US dollar

13.0

18.9

23.7

33.4

44.8

74.4

97.6

Japanese yen 11.1

10.1

12.8

17.4

21.5

25.6

38.0

Pound sterling 4.0

5.0

6.2

7.9

11.6

15.1

22.3

Swiss franc

1.1

1.2

1.5

2.0

2.7

3.3

3.5

Total

48.8

58.9

79.2

111.2

147.4

212.0

292.0

Source: "The Global OTC Derivatives Market at end-December 2004", BIS, [1], "OTC Derivatives Market Activity in the Second Half of 2006", BIS, [2]

Usually, at least one of the legs has a rate that is variable. It can depend on a reference rate, the total return of a swap, an economic statistic, etc. The most important criterion is that it comes from an independent third party, to avoid any conflict of interest. For instance, LIBOR is published by the British Bankers Association, an independent trade body but this rate is known to be rigged (Barclays and others banks have been convicted in the 2010-2012 LIBOR scandal).

Types of swaps[edit]
The five generic types of swaps, in order of their quantitative importance, are: interest rate swaps, currency swaps, credit swaps, commodity swaps and equity swaps. There are also many other types of swaps.

Interest rate swaps[edit]

Main article: Interest rate swap

A is currently paying floating, but wants to pay fixed. B is currently paying fixed but wants to pay floating. By entering into an interest rate swap, the net result is that each party can 'swap' their existing obligation for their desired obligation. Normally, the parties do not swap payments directly, but rather each sets up a separate swap with a financial intermediary such as a bank. In return for matching the two parties together, the bank takes a spread from the swap payments.

The most common type of swap is a plain Vanilla interest rate swap. It is the exchange of a fixed rate loan to a floating rate loan. The life of the swap can range from 2 years to over 15 years. The reason for this exchange is to take benefit from comparative advantage. Some companies may have comparative advantage in fixed rate markets, while other companies have a comparative advantage in floating rate markets. When companies want to borrow, they look for cheap borrowing, i.e. from the market where they have comparative advantage. However, this may lead to a company borrowing fixed when it wants floating or borrowing floating when it wants fixed. This is where a swap comes in. A swap has the effect of transforming a fixed rate loan into a floating rate loan or vice versa. For example, party B makes periodic interest payments to party A based on a variable interest rate of LIBOR +70 basis points. Party A in return makes periodic interest payments based on a fixed rate of 8.65%. The payments are calculated over the notional amount. The first rate is called variable because it is reset at the beginning of each interest calculation period to the then current reference rate, such as LIBOR. In reality, the actual rate received by A and B is slightly lower due to a bank taking a spread.

Currency swaps[edit]
Main article: Currency swap A currency swap involves exchanging principal and fixed rate interest payments on a loan in one currency for principal and fixed rate interest payments on an equal loan in another currency. Just like interest rate swaps, the currency swaps are also motivated by comparative advantage. Currency swaps entail swapping both principal and interest between the parties, with the cashflows in one direction being in a different currency than those in the opposite direction. It is also a very crucial uniform pattern in individuals and customers.

Commodity swaps[edit]

Main article: Commodity swap A commodity swap is an agreement whereby a floating (or market or spot) price is exchanged for a fixed price over a specified period. The vast majority of commodity swaps involve crude oil.

Credit default swaps[edit]

Main article: Credit default swap A credit default swap (CDS) is a contract in which the buyer of the CDS makes a series of payments to the seller and, in exchange, receives a payoff if an instrument, typically a bond or loan, goes into default (fails to pay). Less commonly, the credit event that triggers the payoff can be a company undergoing restructuring, bankruptcy or even just having its credit rating downgraded. CDS contracts have been compared with insurance, because the buyer pays a premium and, in return, receives a sum of money if one of the events specified in the contract occur. Unlike an actual insurance contract the buyer is allowed to profit from the contract and may also cover an asset to which the buyer has no direct exposure.

Subordinated risk swaps[edit]

A subordinated risk swap (SRS), or equity risk swap, is a contract in which the buyer (or equity holder) pays a premium to the seller (or silent holder) for the option to transfer certain risks. These can include any form of equity, management or legal risk of the underlying (for example a company). Through execution the equity holder can (for example) transfer shares, management responsibilities or else. Thus, general and special entrepreneurial risks can be managed, assigned or prematurely hedged. Those instruments are traded over-the-counter (OTC) and there are only a few specialized investors worldwide.

Speculation
From Wikipedia, the free encyclopedia

"Speculator" redirects here. For the Montana mining incident, see Speculator Mine disaster. This article is about the financial term. For other uses, see Speculation (disambiguation).

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Speculation is the practice of engaging in risky financial transactions in an attempt to profit from short or medium term fluctuations in the market value of a tradable good such as a financial instrument, rather than attempting to profit from the underlying financial attributes embodied in the instrument such as capital gains, interest, or dividends. Many speculators pay little attention to the fundamental value of a security and instead focus purely on price movements. Speculation can in principle involve any tradable good or financial instrument. Speculators are particularly common in the markets for stocks, bonds, commodity futures, currencies, fine art, collectibles, real estate, and derivatives. Speculators play one of four primary roles in financial markets, along with hedgers who engage in transactions to offset some other pre-existing risk,arbitrageurs who seek to profit from situations where fungible instruments trade at different prices in different market segments, and investors who seek profit through long-term ownership of an instrument's underlying attributes. The role of speculators is to absorb excess risk that other participants do not want, and to provide liquidity in the marketplace by buying or selling when no participants from the other categories are available. Successful speculation entails collecting an adequate level of monetary compensation in return for providing immediate liquidity and assuming additional risk so that, over time, the inevitable losses are offset by larger profits