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Glossary of Financial Terms

Asset-Backed (ABS): Financial security backed by a or a lease against other than . An ABS is essentially the same thing as a mortgage- backed security (MBS), except that the securities backing it are assets such as auto- mobile and leases, card , royalties, etc. : Along with equity bonds are the oldest debt securities or assets and today the principal used by . The issuer (a government, a local public authority or a corporation) owes bond-holders a debt and, depending on the terms of the bond, is obliged to pay them interest and to repay the principal at a determined date. Interest is payable at fixed intervals. Government bonds (also named sovereign bonds) are classified in three main categories: bills, debt secu- rities maturing in less than one year; notes, debt securities maturing in one to 10 years; and bonds, debt securities maturing in more than 10 years. Both corporate and government bonds are issued in primary markets held by underwriting groups (investment and in Europe of large universal banks) and are negotiable in secondary markets. Brokerage: The financial function of mediating between sellers and buyers of securi- ties. For its services, a broking firm, today generally a department or affiliate of an investment or in Europe of a universal bank, charges fees. When a broking firm buys or sells securities for itself and not a client, it is said to be undertaking principal or proprietary trade. Capital gain: A gain made by an in an market through successful specu- lation. When its current exceeds the price at which it was bought the investor may choose to realise the gain by trading the asset, or keep the gains unrealised by holding on to the asset, typically in the hope of further price-increases. Capital gains are one component of financial profits. Collateralised Debt Obligation (CDO): A structured financial product that pools together flow-generating assets and repackages this asset pool into tranches that can be sold to investors. A collateralised debt obligation (CDO) is so-called because the pooled assets – such as mortgages, bonds and loans – are essentially debt obligations that serve as collateral for the CDO. Protection against depends on a prioritised ranking. Holders of more senior tranches of the CDO are paid first, followed by holders of mezzanine-tranches, and finally equity-tranches. As a result, the senior tranches of a CDO generally have a higher credit rating and offer lower coupon rates than the junior tranches, which offer higher coupon rates to compensate for their higher default . Collateralised Debt Obligation Squared: This is identical to a CDO except for the assets securing the obligation. Unlike the CDO, which is backed by a pool of bonds, 298 Glossary of Financial Terms

loans and other credit instruments, CDO-squared arrangements are backed by CDO tranches. CDO-squared allows banks to resell the that they have taken in CDOs. They are ‘CDOs once removed’. Credit Default (CDS): A contract between two parties in which the buyer makes regular payments to the seller in exchange for a payoff in the event that an underly- ing credit instrument (such as a loan) defaults. The buyer of the CDS makes a series of payments (the CDS ‘fee’ or ‘spread’) to the seller and, in exchange, receives a pay- off if the loan defaults. In essence, it is a form of against default on debt. A CDS is said to be ‘naked’ when the holder is not required to own the insured asset. It means that an investor can take out insurance on bonds without actually owning them. It is taken to its highest degree. Practised on a large scale it exerts very strong pressure on the loan as with Greek debt in 2011. : A whose directly derives from the value of under- lying entities such as a , a (oil), an index, or an . Derivatives have no intrinsic value. They were created to against risk. The two main initial forms were futures (see below) and options and the first main underly- ing assets were and . Derivative transactions now include a variety of financial contracts, including CDOs. Equity: An ownership-claim on a corporation and along with bonds the oldest form of asset or security. Holders of corporate equity own a of the corporation and are entitled to proportional shares of dividend payments made by the corporation to equity holders. Equity, also named shares, is traded in markets. Equity Buyback: Capital-market operation through which a corporation buys back some of its own shares from shareholders, leaving fewer shares outstanding. Financial Intermediation: Activity whereby economic agents with funds who want to lend and those who want to borrow are brought together. In the case of banks, the theory or view of financial intermediation denies or relegates to a secondary role the money creation function through the granting of credit. With regards to specialised non-bank financial corporations, the view claims that they offer lenders and borrowers the benefits of maturity and risk transformation. : A standardised, exchange-traded contract to buy or sell a speci- fied quantity of a particular commodity or asset at a certain future date. Examples include oil futures, through which trading parties agree to buy or sell oil for delivery at future dates. Most trading in futures does not involve parties seeking to obtain or sell the actual commodity or asset in the future. They involve parties either seeking to speculate on particular price movements between the present and the contract’s maturity, or to build a particular risk-profile for their asset-portfolio. : Generally a privately owned investment fund, administered by profes- sional investment managers and open to a limited range of investors. Hedge funds are unregulated as opposed to banks, pension funds and mutual funds. They engage