Green Book Glossary Terms
Green Book Glossary Terms
American-Style Option (also American Option): an option which may be exercised at any time
up to and including the expiration date.
Basis Point: one one-hundredth of one percentage point, most often used in quotation of spreads
between interest rates or to describe changes in yields on securities.
Break-Even Point: the price of the underlying instrument at which an option buyer just recovers
the initial outlay or premium. For a call option, the break-even point is the exercise price plus the
premium; a put option's break-even point is the exercise price minus the premium.
Commercial Paper: a short-term unsecured promise to repay a fixed amount (representing
borrowed funds plus interest) on a certain future date and at a specific place. The note stands on
the general creditworthiness of the issuer or on the standing of a third party that is obligated to
repay if the original borrower defaults. The most active commercial-paper market is in the
United States. (See also Letter of Credit.)
Country Risk: the risk that most or all economic agents (including the government) in a
particular country will for some common reason become unable or unwilling to fulfill
international financial obligations.
Covered Writing: generally refers to selling call options "covered" by an equal or larger long
position in the security underlying the option. It is a strategy intended to augment overall returns
by earning fee income on the options written against securities held for normal investment
Currency Swap: a transaction in which two counterparties exchange specific amounts of two
different currencies at the outset and repay over time according to a predetermined rule which
reflects interest payments and possibly amortization of principal. The payment flows in currency
swaps (in which payments are based on fixed interest rates in each currency) are generally like
those of spot and forward currency transactions.
Duration: a measure of a security's maturity which takes into account the periodic coupon
payments. Specifically, it is the weighted average maturity of all payments of a security, coupons
plus principal, where the weights are the discounted present values of the payments. As such the
duration is shorter than the stated term to maturity on all securities except for zero coupon bonds,
for which they are equal because the zero coupon bond is a single-payment security
European-Style Option (also European Option): an option which may be exercised only on the
expiration date. It is an alternative to an American option, which can be exercised on any
business day prior to expiration, or on the expiration date. Green Book Glossary Terms
Exercise Price (also Strike Price): the fixed price at which an option holder has the right to buy,
in the case of a call option, or to sell, in the case of a put option, the financial instrument covered
by the option.
Federal Funds Market: a market for unsecured loans between depository institutions in the
United States in immediately available funds, essentially reserves held at Federal Reserve Banks.
Most activity is for next-day maturity. Term Federal funds refers to longer maturities which can
be up to several weeks or months.
Forward Rate Agreement (FRA): an agreement between two parties wishing to protect
themselves against a future movement in interest rates. The two parties agree an interest rate for
a specified period from a specified future settlement date based on an agreed principal amount.
No commitment is made by either party to lend or borrow the principal amount; their exposure is
only the interest difference between the agreed and actual rates at settlement.
Futures Contract: an exchange-traded contract generally calling for delivery of a specified
amount of a particular grade of commodity or financial instrument at a fixed date in the future.
Contracts are highly standardized and traders need only agree on the price and number of
contracts traded. Traders' positions are maintained at the exchange's clearing house, which
becomes a counterparty to each trader once the trade has been cleared at the end of each day's
trading session. Members holding positions at the clearing house must post margin which is
marked to market daily. Most trades are unwound before delivery. The interposition of the
clearing house facilitates the unwinding since a trader need not find his original counterparty, but
may arrange an offsetting position with any trader on the exchange. (See Margin and Marking to
In-The-Money: option contracts are in the money when there is a net financial benefit to be
derived from exercising the option immediately. A call option is in the money when the price of
the underlying instrument is above the exercise price and a put option is in the money when the
price of the underlying is below the exercise price.
Interest Rate Swap: a transaction in interest payment streams of underlying notional principal
which two counterparties exchange differing character based on an amount. The three main types
are coupon swaps (fixed rate to floating rate in the same currency), basis swaps (one floating rate
index to another floating rate index in the same currency), and cross-currency interest rate swaps
(fixed rate in one currency to floating rate in another).
Intrinsic Value: the net benefit to be derived from exercising an option contract immediately. It is
the difference between the price of the underlying and the option's exercise price. An opt