Derivatives Dictionary^TM (D-F) Last revised: August 03, 2001

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 #

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DAXâ: A stock performance index (dividends added in) composed of the 30 most actively traded German blue chip stocks on the Frankfurt Stock Exchange. (Source: http://www.exchange.de/fwb/indices.html#dax)

DAXâ Futures: A cash-settled Futures contract based on the DAXâ (q.v.) stock performance index. (Source: http://www.exchange.de/dtb/daxfuture.html)

DAXâ Futures Option: An American option that settles into a DAXâ Futures (q.v.) contract. Payment of the option premium is "futures-style", which means none of it occurs immediately, and a piece of it occurs with each daily mark-to-market. An implication of this is that the "buyer" (really, the "long") may pay no premium and the "seller" (really, the "short") may pay all the premium! (Source: http://www.exchange.de/dtb/daxfuture-option.html)

DAXâ Option: A cash-settled, European option on the DAXâ (q.v.) stock performance index. (Source: http://www.exchange.de/dtb/daxoption.html)

DCS: Direct Credit Substitute (q.v.).

deck: A floor broker's (q.v.) stack of customer orders.

Degree-Day: A unit of measure for the deviation of a day's average temperature from the arbitrary standard of 65 degrees Fahrenheit. The U.S. Energy Information Administration publishes indexes of accumulated Degree Days. If the average temperature one day is 75 (55) degrees, then the index increases (decreases) ten Degree-Days on that day. Degree-days come in two varieties – Heating Degree-Days and Cooling Degree-Days. When the average temperature is above (below) 65 degrees, then the number of cooling (heating) Degree-Days increases.; (Source: Victor Kremer, "Utility to Make First Use of Degree-Day Swaps, Derivatives Week, 5/5/97.)

Degree-Day Swaps: A Swap (q.v.) that receives (pays) a floating payment proportional to the change in Degree-Days (q.v.) over the accrual period, and pays (receives) a fixed payment. Dealers of such swaps claim that they are good hedges of heating costs, because (1) a negative number of Degree-Days over the accrual period results in (2) a positive number of Heating Degree-Days, which leads to (3) a negative floating payoff, which is (4) a hedge for the resulting positive heating costs, because (5) a large number of Heating Degree-Days translates into both a large volume of energy and a high price for it. (Source: Victor Kremer, "Utility to Make First Use of Degree-Day Swaps, Derivatives Week, 5/5/97.); However, this argument has some problems. First, energy cost is a U- or V-shaped function of Degree-Days. Heating Degree-Days lead to heating costs, and Cooling Degree-Days lead to cooling costs. Second, nobody knows what that function is. Consequently, Degree-Days Swaps will have some Basis Risk (q.v.).

Delivery Point: In a Futures Contract (q.v.) the location where the short must deliver the underlying "commodity" to the long. This can be crucial in the case of physical products, transportation bottlenecks can make it easier for the longs to squeeze the shorts. In April, 1996, the CBOT tried to eliminate Toledo, Ohio as a delivery point. Farmers and processors who favored delivery there complained to the CFTC, which delayed approval of the change in the contract. (Source: "CBOT Gets Warning Concerning Changes in Certain Contracts, WSJ, 5/6/97.)

derivative: 1. Not original, secondary, originating in or transformed from something else.
2. fin. A short form of "derivative product" (q.v.).
3. chem. A substance or compound obtained from or derived from another substance or compound.
4. math. The instantaneous rate of change of a function with respect to a change in an argument: df(x)/dx. For example, acceleration is the first derivative of velocity with respect to time. In a financial context, we call some such derivatives, with respect to time or market risk factors, "sensitivitites" or Greeks. For example, the Greek, delta, is the first derivative of option value with respect to underlying price.

derivative product: A financial contract whose value depends on a risk factor, such as
· the price of a bond, commodity, currency, share, etc.
· a yield or rate of interest
· an index of prices or yields
· weather data, such as inches of rainful or heating-degree-days,
· insurance data, such as claims paid for a disastrous earthquake or flood,
etc. Also known as "derivative", for short.

Derivative Products Company (DPC): A subsidiary that exists solely as a secure home for some of its parent’s financial transactions, contracts, and derivative products (q.v.). The DPC’s credit rating typically exceeds the parent’s, because the parent infuses it with a large amount of capital, compared to the credit exposure that that DPC counterparties have to it. In case the parent is insolvent or bankrupt, the DPC might either continue (continuation structure, q.v.) or terminate (termination structure, q.v.).

Digital Option: A Binary Option (q.v.).

Direct Credit Substitute: The Federal Reserve Board's term for a credit enhancement, that is, a means of improving the credit quality of a loan or a bond.

dirty price: Definition: The quoted bond price, including the accrued interest. (Cf. clean price.)
Application: In certain non-U.S. bond markets, if you ask your broker a bond's price, he quotes the dirty price. Thus, your check for that amount would be sufficient to buy the bond.

Discount rate: The rate of interest that the Bundesbank (Buba) charges for granting "rediscount credit". Typically, the discount rate is the lowest rate at which the Buba lends.

domestic market: The securities market in a country where securities of that country’s companies and governments trade.; Example: Bank of America securities that trade in the U.S. trade in the domestic market.; Source: http://www.jobs.washingtonpost.com/wp-srv/business/longterm/glossary/a_m/domestic_market.htm

DPC: Derivative Products Company (q.v.).

DTB: Deutsche Terminbörse. The Futures and Options Exchange associated with the Frankfurt Stock Exchange (Frankfurter Wertpapierbörse, FWB) in Frankfurt, Germany.

Duration: 1. A weighted average of the number of years until a financial instrument's cash flows (e.g., a bond's principal and each of its coupons) arrives.; 2. A measure of the sensitivity of the value of a financial instrument (i.e., a sequence of cash flows) to a change in its yield to maturity. The two main variants of Duration are Macaulay Duration (q.v.) and Modified Duration (q.v.).

DV01: The change in the dollar value of a bond (conventionally, one with a Par Value of 100) when its yield falls one basis point. Also known as PV01, PVBP, DVBP.

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ECB: European Central Bank (q.v.).

ECN: An acronym for either electronic communications network or electronic crossing network. An electronic market place. Examples are Island and Archipelago. At least one ECN is able to submit orders directly to NASDAQ and some may be applying to the SEC to qualify as stock markets.

Edge Act Corporation, Edge Corporation: Definition: A bank subsidiary corporation with a federal or state charter, created under the Edge Act (1919) to engage in international banking and investing. FRB Regulation K defines the equivalent "Edge Corporation" as a corporation formed under section 25(a) of the Federal Reserve Act (12 USC 611-631). (Source: Federal Reserve System Regulation K, 12 CFR 211; as amended effective October 8, 1993.)
Application: Unlike its U.S. parent bank, the subsidiary can own a bank outside the U.S. and can invest in foreign commercial and industrial corporations.
Comment: The motivation of the act was to allow U.S. firms more flexibility in competing with foreign firms.

ELKS: Equity Linked Securities (sm). Salomon Brothers Inc's proprietary Equity Linked Debt Security (q.v.). A debt obligation of Corporation A, equivalent to a buy-write on one share of Corporation B. The ELKS is like a PERCS (q.v.), except that the company that issues the stock issues the PERCS, and another company issues the ELKS. Salomon Brothers Inc issued the first ELKS in 1993.

Embeddo: An Embedded Option.

Endowment Warrant: A Call Options on shares, where the strike price grows at the rate of interest, but shrinks by the amount of the dividends that the share pays. In essence, the buyer of an Endowment Call Warrant uses the dividends from the shares to pay off the strike price, but is not obligated to complete the transaction. If at expiration the balance reaches zero, then the buyer may take delivery without further payment. If the balance reaches a positive amount, then the buyer may pay that amount and take delivery. If the balance reaches a negative amount, then the buyer may settle in cash for the value of the shares plus the absolute value of the balance.; (Source: Australian Financial Review Dictionary of Investment Terms.)

Equity-Linked Debt Security: Fixed-income, equity-linked debt securities of corporation A, that participate in the change in price of the "linked" common stock of corporation B.; Four main examples, listed on the American Stock Exchange, include Salomon Brothers' ELKS (sm) (q.v.), Bear Stearns' CHIPS (sm) (q.v.), Lehman Brother's YEELDS (sm) (q.v.), and Morgan Stanley's PERQ's (sm) (q.v.). These four pay quarterly interest at a fixed percentage rate.
(Source: http://www.amex.com)

Equity Swap: A Swap (q.v.) in which one of the payment streams derives from an equity instrument. For example, in one sort of ordinary Equity Swap, each period, Party A receives (and Party B pays) the capital gains on an equity investment of a given notional amount, while Party B receives (and Party A pays) a floating interest payment based on LIBOR and the same notional amount. This swap is practically equivalent to buying the underlying equity with 100% borrowing (zero margin) and realizing the gain or loss each period.; Equity Swaps are useful for obtaining leverage, avoiding withholding taxes, and enjoying the returns from ownership without legally owning anything.
7/28/00 equivalent: A concept in probability theory that means that two probability measures (q.v.) assign a probability of zero to precisely the same sets.
Example: If the probability space corresponding to two flips of a fair coin is W = {HH, HT, TH, TT}, and two probability measures, P(.) and Q(.), both assign a probability of zero to the empty set, P(Æ) = Q(Æ) = 0, and to no other set, then they are equivalent probability measures.
7/28/00 equivalent martingale measure: Any probability measure (q.v.) that is "equivalent" (q.v.) to the true probability measure, and under which a random variable (q.v.) -- such as an asset price or the ratio of two asset prices -- is a martingale (q.v.).
Application: In Arrow-Debreu equilibrium, there exists an equivalent martingale measure, under which the ratio of two asset prices is a martingale.
Euribor: Euro Interbank Offered Rate. The Brussels-based European Banking Federation’s Euro-denominated counterpart to LIBOR. As of January, 1999, Euribor seems to be winning its battle for acceptance over the British Bankers Association’s Euro LIBOR (q.v.), but London still hopes to win the war for the financial business. On 1/7/99 LIFFE announced plans for new contracts, based on five- and ten-year Euribor swaps.

Euroclear: A major system settling securities trades.

Eurojunk: High-yield corporate bonds of European companies. Of course, the high yield is compensation for a high probability of default.
For example, Richard Branson’s Virgin Group financed its new, V2 Music Holdings PLC label with L74 million in high yield bonds, rather than using a venture capitalist.

Euro LIBOR: The British Bankers Association’s Euro-denominated analog to dollar LIBOR. As of January, 1999, the European Banking Federation’s Euribor (q.v.) seems to be winning its battle for acceptance over Euro LIBOR, but London still hopes to win the war for the financial business. On 1/7/99 LIFFE announced plans for new contracts, based on five- and ten-year Euribor swaps.

European Central Bank: The institution that the European Monetary Union has put in charge of maintaining the value of its currency, the euro. (Dagmar Aalund, "What's the Euro?", The Wall Street Journal, 9/28/98.)

EX: One of J.P. Morgan's SPVs (q.v.). Source: http://emwl.oyster.co.uk/contents/publications/euromoney/em.96/em.96.04/em.96.04.12.html)

Exchange Option: An option to exchange one asset for another. A Margrabe Option (q.v.).

Exotic Option: Any Option that is well out of the ordinary, hence not a "Plain Vanilla" Option. The list of Exotic Options changes over time. It grows as dealers innovate new and marvelous options, and shrinks as a jaded market grows accustomed to products that once thrilled it.

external market: The market outside a country’s borders for securities that its companies governments issue. The Eurosecurities market. Example: Bank of America debt that trades in Asia and Europe trades in the external market for securities of U.S. companies. Source: http://www.jobs.washingtonpost.com/wp-srv/business/longterm/glossary/a_m/external_market.htm

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fading a big dog: Buying (selling) when a big dog (q.v.) is selling (buying).

Fairway Bond or Note

Another name for Accrual Note (q.v.), Corridor Note (q.v.), or Range Note (q.v.). It accrues interest if and only if the index rate stays within a range (analogous to a golf ball staying on the fairway).

Fannie Mae: Federal National Mortgage Association. The largest player in the secondary mortgage market.

Fiona: Frankfurt Interbank Overnight Average (q.v.).

Flex Option: An exchange-traded options that does not have the standard terms of listed options. The customer and the market maker can negotiate various terms, such as strike price and expiration date.

Floor: A strip of Floorlets (q.v.). Cf. Cap.

floor broker: A local (q.v.) who trades for customer accounts, on commission.

Floorlet: An Interest Rate Option to receive fixed in an FRA (q.v.). Its payoff is proportional that to that of a Put Option on a floating rate of interest.

Floortion: An option on a Floor (q.v.).

floor trader: A local (q.v.) who trades for his own account, trying to buy low and sell high.

foreign market: The securities market inside a country’s borders for securities of foreign companies and governments. Example: Bank of America securities trade in Tokyo in the Japanese foreign market (the Samurai market). Nomura securities trade in New York in the U.S. foreign market (the Yankee market). Further examples are the Bulldog (q.v.), Matador (q.v.), and Rembrandt (q.v.) markets. Source: http://www.jobs.washingtonpost.com/wp-srv/business/longterm/glossary/a_m/foreign_market.htm
Forward Contract: A contract to exchange (buy or sell) an underlying instrument for a fixed forward price at a specific, future delivery date. In certain cases – but not always – the Forward Price exceeds the spot price by the cost of carrying the underlying asset from the spot delivery date to the forward delivery date. The cost of carry is an increasing function of the rate of interest and storage costs, and a decreasing function of the rate of dividends, interest, or other cash flows from the underlying instrument. Cf. Futures Contract.

Forward Forward Curve: The Forward Curve at a specific future date, based on today's Forward Curve.

Forward Rate Agreement: A contract calling for one counterparty to receive the fixed FRA rate and pay the floating rate (e.g., LIBOR) for a particular accrual period in the future, and for the other counterparty to do the reverse. Settlement is at the beginning of the accrual period, when the markets resolve the uncertainty about the floating rate, mainly because that reduces the credit risk associated with the contract. Cf. Swaplet.

Frankfurt Interbank Overnight Average: An average of overnight DEM interest rates that uses the Frankfurt market's fixing system. (Source: IFR's online version of "Derivatives: Action in Japan," IFR, 5/3/97, http://www.ifrpub.com/ifrstart.htm)

Freddie Mac: Federal Home Loan Mortgage Association. The second largest player in the secondary mortgage market.

front months: Futures contracts with delivery dates in the nearer future.

Futures Contract: An exchange-traded contract that on its last trading day settles into a Forward Contract (q.v.). The Futures Price and the corresponding Forward Price differ systematically in a world where interest rates are stochastic, and the difference depends on the correlation between the underlying spot price and the price of the zero coupon bond that matures on the last trading day.

Futures Option: A listed option that settles into a Futures Contract (q.v.).

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Derivatives DictionaryTM (D-F) Last revised: August 03, 2001

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Derivatives Dictionary^TM (D-F) Last revised: August 03, 2001