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Financial glossary

C

C-VaR

Conditional value at risk (C-VaR) is a measure of risk that gives an amount of potential loss a portfolio can suffer should the VaR be exceeded. It is associated with a confidence level (x %) and a time horizon (number of days) and is calculated as the weighted average between the value at risk and losses exceeding that value at risk. For instance, a C-VaR (95%, 5 days) of EUR 1 mn means that in 5% of the cases, the portfolio could lose an average amount of EUR 1 mn over a period of 5 days. C-VaR is also known as “expected shortfall” or “tail VaR”.

Call option

A call option is a financial contract between two parties where the buyer of the option pays a fee (premium) to have the right, but not the obligation, to buy an agreed quantity of a particular commodity or financial instrument (the underlying) from the seller of the option at a certain time (the expiration date) for a certain price (the strike price). The seller of the option is then obliged to sell the commodity or financial instrument should the buyer so decide.

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Cap

An interest rate cap is a derivative contract in which the buyer pays a fee (premium) to receive payments at the end of each defined period when the interest rate used as a reference exceeds a pre-agreed level (the strike price). For instance, an agreement to receive a payment every six months for the next three years when the six-month EURIBOR rate exceeds 1% is a three year cap strike of 1% on 6 month EURIBOR.

Carry

The carry of a bond is the return derived from holding it. For instance, the three month carry of a bond corresponds to the gain or loss an investor will record by carrying the bond for three months. The carry is usually expressed in basis points.

Cash and carry

A cash and carry trade is a transaction usually considered to be a type of arbitrage. In this transaction, an investor buys an asset while selling the future contract on the same asset for a given forward expiry date. Taking into account the cost associated with purchasing and keeping the asset until the expiry date of the future (borrowing the asset, storage for a commodity etc.), the investor will perform this arbitrage if the forward price of the asset derived from the spot price and the costs associated is lower than the future price of the asset.

Central Bank Market Operations

Operations made by central banks on financial markets to implement monetary policy. As central banks have unlimited ability to inject funds into (or withdraw funds from) the money market, the aim of these operations is to influence the interest rate on overnight funds in the money market. Several types of intervention are possible, the most famous one being the open market operation (OMO) where the central bank buys or sells government bonds in the open market.

Cheapest to deliver

The cheapest to deliver (CTD) terminology is used in futures markets and corresponds to the least expensive underlying product that can be delivered on the expiry date of the futures contract. In most futures contracts, sellers (investors who are “short” on the future) have the right to deliver different types of underlying and therefore will always want to deliver the cheapest available underlying. The price of the derivative contract will then take into account the CTD price of the underlying.

Closed-ended fund

A closed-end fund (or closed-ended fund) is a mutual fund with a fixed number of units, as opposed to open-ended funds where additional units can be created by fund managers to meet investor demand. The units of closed-end funds can be bought or sold in the market.

Collar

A collar is a combination of the purchase (sale) of a cap and the sale (purchase) of a floor. It protects a floating rate borrower (lender) from an increase (decrease) in interest rates. For instance, a floating rate borrower will buy a cap and sell a floor (at a lower strike price). The cost of the collar will then be lower than the cost of a cap due to the proceeds of the sale of the floor (it can even be a zero cost collar when the cap and the floor trade at the same price). In exchange for the reduced price, the borrower’s gain will be limited if there is a decrease in interest rates.

Collateralised Debt Obligation (CDO)

A collateralised debt obligation is a type of asset backed security backed by bonds, loans or other debts. Returns on these products are paid in tranches (see tranching definition for further details) and then adapted to different investors’ risk/return profiles. In the early 1990s CDOs were largely created by financial institutions to move debt off their balance sheets.

Commodities

A basic good used in commerce that is interchangeable with other commodities of the same type. Commodities are most often used as inputs in the production of other goods. Examples include gold, oil, wheat

 

Constant Proportion Portfolio Insurance (CPPI)

A Constant Proportion Portfolio Insurance (CPPI) is a trading strategy or portfolio construction technique which allows an investor to maintain exposure to the upside potential of a risky asset while providing protection (or a capital guarantee) against downside risk.


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Consumer Price Index (CPI)

The Consumer Price Index (CPI) is an index measuring the price of a basket of goods representative of actual consumption. The variation in CPI is a measure of the rate of inflation.

Contango

Contango refers to a market condition where the forward price of a contract trades above its spot price. In other words, contango is a situation where the tradeable price curve of an instrument is normal (the short term price is lower than the forward price). The opposite market condition to contango is backwardation.

Convertible bond

A convertible bond is a bond which gives its holder the right to convert it into the issuer company’s shares according to a conversion ratio. With both features of bonds and equities, convertible bonds are classified as hybrid instruments.

Convexity

The convexity is a measure of change in duration when interest rates move. In general, bonds have a positive convexity.

Counterparty risk

Counterparty risk refers to the risk that a counterparty of a financial transaction will not honour its contractual obligation. For a counterparty of an OTC transaction who is recording a gain (positive market value of the OTC transaction in its book), this represents the risk that the other counterparty defaults before the transaction matures.

Covered bond

A covered bond is a bond backed by a pool of loans. If there is a default by the covered bond issuer, this pool of assets is used to repay the covered bond. By definition, this type of bond is safer than a senior unsecured bond.

Credit default swap (CDS)

A CDS is a swap between two counterparties, the buyer and the seller of credit protection referencing a debt issuer (either a company or a country). In exchange for a stream of payments, the buyer of protection will be compensated in case theissuer defaults. The CDS is like an insurance contract against the default of a debt issuer. The CDS default settlement is triggered by the occurrence of a credit event that requires the seller of protection to pay the buyer a compensation for the issuer’s unrecovered amount.

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Credit event

A credit event is an event whose occurrence triggers the default settlement of CDS. The three main eligible credit events are failure to pay, bankruptcy and restructuring. The ISDA is in charge of defining, watching and ascertaining the occurrence of credit events.

Credit spread

A credit spread measures the credit risk premium of a debt issuer:

  • It is the spread over the risk-free rate that investors require to purchase a bond (see Z-spread).
  • Alternatively, it is the premium required by CDS sellers of protection to bear the credit risk on the reference entity.

Custodian

A custodian is a financial institution responsible for holding and safeguarding financial assets for a third party. It provides an investor with a place to store assets with little risk in exchange for a fee (custodial services) and is legally responsible for maintaining electronic records of financial assets. Other services such as settlements, corporate action administration and accounting can also be offered by custodians.

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