Industry’s Most Important Terms Explained
The financial trading industry is made up of so many definitions that it’s easy to forget a few along the way. Take the time to get to grips with financial trading jargon because understanding trading vocabulary is an important step in a trader’s journey.
Total amount of exposure a bank has with a customer for both spot and forward contracts.
An option which may be exercised at any valid business date throughout the life of the option.
Describes a currency strengthening in response to market demand rather than by official action.
A type of trading where the same instrument is bought and sold simultaneously in two different markets in order to cash in on the difference in these markets.
Used in quoting forward “premium / discount”.
Ask is the lowest price acceptable to the buyer.
In the context of foreign exchange it is the right to receive from a counterparty an amount of currency either in respect of a balance sheet asset (e.g. a loan) or at a specified future date in respect of an unmatched forward or spot deal.
An instruction given to a dealer to buy or sell at the best rate that is currently available in the market.
At Par Forward Spread
When the forward price is equivalent to the spot price.
At or Better
An order to deal at a specific rate or better.
At the Price Stop Loss Order
A stop loss order that must be executed at the requested level regardless of market conditions.
An option whose strike/exercise price is equal to or near the current market price of the underlying instrument.
Sale of an item to the highest bidder. (1) A method commonly used in exchange control regimes for the allocation of foreign exchange. (2) A method for allocating government paper, such as US Treasury Bills. Small investors are given preferential access to the bills. The average issuing price is then computed on the basis of the competitive bids accepted. In some circumstances for government auctions it is the yield rather than the price which is bid.
Average Rate Option
A contract where the exercise price is based on the difference between the strike price and the average spot rate over the contract period. Sometimes called an “Asian option”.
Balance of Trade
The value of exports less imports. Invisibles are normally excluded, and is otherwise referred to as mercantile or physical trade. Figures can be quoted on FoB/ FaS, customs cleared, or FoB export.
The range in which a currency is permitted to move. A system used in the ERM.
Bank notes are paper issued by the central or issuing bank and are legal tender, but are not usually considered to be part of the FX market. However bank notes can be converted, in some counties, into FX. Bank notes are normally priced at a premium to the current spot rate for a currency.
The rate at which a central bank is prepared to lend money to its domestic banking system.
Bank of England
Central Bank of the United Kingdom.
A family of path dependent options whose pay-off pattern and survival to the expiration date depend not only on the final price of the underlying currency but also on whether or not the underlying currency breaks a predetermined price level at any time during the life of the option.
The currency in which the operating results of the bank or institution are reported.
A term used in the UK for the rate used by banks to calculate the interest rate to borrowers. Top quality borrowers will pay a small amount over base.
The process whereby the basis tends towards zero as the contract expiry approaches.
One per cent of one per cent.
The price expressed in terms of yield maturity or annual rate of return.
Taking opposite positions in the cash and futures market with the intention of profiting from favourable movements in the basis.
The difference between the cash price and futures price.
A group of currencies normally used to manage the exchange rate of a currency. Sometimes referred to as a unit of account.
A market in which prices decline sharply against a background of widespread pessimism (opposite of Bull Market).
A person who believes that prices will decline.
Bid is the highest price that the seller is offering for the particular currency/commodity at the moment; the difference between the ask and the bid price is the spread. Together, the two prices constitute a quotation; the difference between the two is the spread. The bid-ask spread is stated as a percentage cost of transacting in foreign exchange.
Refers normally to the first three digits of an exchange rate that dealers treat as understood in quoting. For example a quote of “30/40” on dollar mark could indicate a price of 1.5530/40BIS: Bank of International Settlement.
A system used where foreign currency is limited. Payments are usually routed through the central banks, and sometimes require that the trade balance is equaled every year.
A type of option in which the payoff is structured to be either a fixed amount of compensation if the option expires in the money, or nothing at all if the option expires out of the money.
An option pricing formula initially derived by Fisher Black and Myron Scholes for securities options and later refined by Black for options on futures. It is widely used in the currency markets.
The recording of a transaction outside the country where the transaction is itself negotiated.
Break Even Point
The price of a financial instrument at which the option buyer recovers the premium, meaning that they make neither a loss nor a gain. In the case of a call option, the break even point is the exercise price plus the premium.
In the options market, undoing a conversion or a reversal to restore the option buyer’s original position.
An agent, who executes orders to buy and sell currencies and related instruments either for a commission or on a spread. Brokers are agents working on commission and not principals or agents acting on their own account. In the foreign exchange market brokers tend to act as intermediaries between banks bringing buyers and sellers together for a commission paid by the initiator or by both parties. There are four or five major global brokers operating through subsidiaries affiliates and partners in many countries.
A market characterised by rising prices.
A person who believes that prices will rise.
Sterling bonds issued in the UK by foreign institutions.
(1) A futures butterfly spread is a spread trade in which multiple futures months are traded simultaneously at a differential. The trade basically consists of two futures spread transactions with either three or four different futures months at one differential.
(2) An options butterfly spread is a combination of a bear and bull spread trade in which multiple options months and strike prices are traded simultaneously at a differential. The trade basically consists of two options spread transactions with either three or four different options months and strikes at one differential
Chicago Board Options Exchange.
CBOT or CBT
Chicago Board of Trade.
Certificate of Deposit.
The Commodity Futures Trading Commission, the US Federal regulatory agency for futures traded on commodity markets, including financial futures.
Clearing House Automated Payment System.
The New York clearing house clearing system. (Clearing House Interbank Payment System). Most Euro transactions are cleared and settled through this system.
Chicago Mercantile Exchange.
Contracts for Difference (CFD)
An arrangement made in a futures contract whereby differences in settlement are made through cash payments, rather than the delivery of physical goods or securities.
Consumer Price Index. Monthly measure of the change in the prices of a defined basket of consumer goods including food, clothing, and transport. Countries vary in their approach to rents and mortgages.
Committee on Payment and Settlement Systems.
Telegraphic transfer of funds from one centre to another. Now synonymous with interbank electronic fund transfer.
A term used in the foreign exchange market for the British Pound / US Dollar rate.
A call option confers the right but not the obligation to buy stock, shares or futures at a specified price.
An option that gives the holder the right to buy the underlying instrument at a specified price during a fixed period.
A national account that shows the net change in asset ownership for a nation. The capital account is the net result of public and private international investments flowing in and out of a country.
A finance charge associated with the storing of commodities (or foreign exchange contracts) from one delivery date to another.
The interest cost of financing securities or other financial instruments held.
A procedure for settling futures contract where the cash difference between the future and the market price is paid instead of physical delivery.
Cash and Carry
The buying of an asset today and selling a future contract on the asset. A reverse cash and carry is possible by selling an asset and buying a future.
Normally refers to an exchange transaction contracted for settlement on the day the deal is struck. This term is mainly used in the North American markets and those countries which rely for foreign exchange services on these markets because of time zone preference i.e. Latin America. In Europe and Asia, cash transactions are often referred to as value same day deals.
A central bank provides financial and banking services for a country’s government and commercial banks. It implements the government’s monetary policy, as well, by changing interest rates.
Exchange rates against the ECU adopted for each currency within the EMS. Currencies have limited movement from the central rate according to the relevant band.
Certificate of Deposit (CD)
A negotiable certificate in bearer form issued by a commercial bank as evidence of a deposit with that bank which states the maturity value, maturity rate and interest rate payable. CDs vary in size with maturities ranging from a few weeks to several years. CDs may normally be redeemed before maturity only by sale on the secondary market but may also be redeemed back to issuing bank through payment of a penalty.
An individual who studies graphs and charts of historic data to find trends and predict trend reversals which include the observance of certain patterns and characteristics of the charts to derive resistance levels, head and shoulders patterns, and double bottom or double top patterns which are thought to indicate trend reversals.
Executing a security transaction that is the exact opposite of an open position, thereby nullifying it and eliminating the initial exposure. Closing a long position in a security would entail selling it, while closing a short position in a security would involve buying it back.
Closing Purchase Transaction
The purchase of an option identical to one already sold to liquidate a position.
An economic indicator that generally moves in line with the general business cycle such as industrial production.
Commodity Exchange of New York.
The fee that a broker may charge clients for dealing on their behalf.
An option on an option, the dates and price of such option being fixed.
A memorandum to the other party describing all the relevant details of the transaction.
Contract Expiration Date
The date on which a currency must be delivered to fulfill the terms of the contract. For options, the last day on which the option holder can exercise his right to buy or sell the underlying instrument or currency.
The month in which a futures contract matures or becomes deliverable if not liquidated or traded out before the date specified.
An agreement to buy or sell a specified amount of a particular currency or option for a specified month in the future (See Futures contract).
The foreign banks representative who regularly performs services for a bank which has no branch in the relevant centre, e.g. to facilitate the transfer of funds. In the US this often occurs domestically due to inter state banking restrictions.
Cost of Carry
The interest rate parity, where the forward price is determined by the cost of borrowing money in order to hold the position.
The customer or bank with which a foreign exchange deal is executed.
The risk to each party of a contract, that the counterparty will not live up to its contractual obligations. Counterparty risk as a risk to both parties and should be considered when evaluating a contract.
Factors that affect currency trading unique to the specific country include political, regulatory, legal and holiday risks.
The annual rate of interest of a bond.
(1) On bearer stocks, the detachable part of the hide behind nominee status. A certificate exchangeable for dividends.
(2) Denotes the rate of interest on a fixed interest security.
(1) To take out a forward foreign exchange contract.
(2) To close out a short position by buying currency or securities which have been sold.
Covered Interest Rate Arbitrage
An arbitrage approach which consists of borrowing currency A, exchanging it for currency B, investing currency B for the duration of the loan, and, after taking off the forward cover on maturity, showing a profit on the entire set of deals. It is based on the theorem of interest rate parity (one of the key theoretical economic relationships) which says that the return on a hedged foreign investment will just equal the domestic interest rate on investments of identical risk. When the covered interest rate differential between the two money markets is zero, there is no arbitrage incentive to move funds from one market to another.
Crawling Peg (Adjustable Peg)
An exchange rate system where a country’s exchange rate is “pegged” (i.e. fixed) in relation to another currency. The official rate may be changed from time to time.
The risk that a debtor will not repay; more specifically the risk that the counterparty does not have the currency promised to be delivered.
A foreign exchange deal entered into involving two currencies, neither of which is the base currency.
A technique using financial futures to hedge different but related cash instruments based on the view that the price movements between the instruments move in concert.
An exchange rate between two currencies, usually constructed from the individual exchange rates of the two currencies, as most currencies are quoted against the dollar.
A cross-trade transaction is a transaction where either the buy broker and the sell broker are the same, or the buy broker and the sell broker belong to the same firm.
Various weightings of other currencies grouped together in relation to a basket currency (e.g. ECU or SDR). Sometimes used by currencies to fix their rate often on a trade weighted basket.
The type of money that a country uses. It can be traded for other currencies on the foreign exchange market, so each currency has a value relative to another.
The net balance of a country’s international payment arising from exports and imports together with unilateral transfers such as aid and migrant remittances. It excludes capital flows.
The value of all exports (goods plus services) less all imports of a country over a specific period of time, equal to the sum of trade and invisible balances plus net receipt of interest, profits and dividends from abroad.
The set of expiration dates applicable to different classes of options.
An order that if not executed on the specific day is automatically canceled.
A Day Trading deal is a currency exchange deal which renews automatically every night at 22:00 (GMT time) starting the day the deal was made and until it ends. The deal ends in one of the following events:
Termination initiated by you.
The day trading rate has reached the Stop-Loss or Take Profit rate you predefined.
The deal end date.
As long as the deal is open, it is charged a renewal fee every night at 22:00 (GMT time).
The date on which a transaction is agreed upon.
The primary method of recording the basic information relating to a transaction.
An individual or firm acting as a principal, rather than as an agent, in the purchase and /or sale of securities. Dealers trade for their own account and risk in contrast to the brokers who trade only on behalf of their clients.
The latest day or time by which the buyer of an option must intimate to the seller his willingness or unwillingness to exercise the option.
Shortfall in the balance of trade, balance of payments, or government budgets.
The date of maturity of the contract, when the final settlement of transaction is made by exchanging the currencies. This date is more commonly known as the value date.
The settlement of a transaction by receipt or tender of a financial instrument or currency.
A method used by option writers to hedge risk exposure of written options by purchase or sale of the underlying instrument in proportion to the delta.
A ratio spread of options established as a neutral position by using the deltas of the options concerned to determine the hedge ratio.
The ratio comparing the change in the price of the underlying asset to the corresponding change in the price of a derivative. Also referred as the “hedge ratio”.
A security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterised by high leverage.
Term referring to a group dealing with a specific currency or currencies.
All the information required to finalise a foreign exchange transaction, i.e. name, rate, dates, and point of delivery.
Deliberate downward adjustment of a currency against its fixed parities or bands which is normally accompanied by formal announcement.
Quoting in fixed units of foreign currency against variable amounts of the domestic currency.
Less than the spot price. For example, forward discount.
The interest rates applicable to deposits domiciled in the country of origin. Value may vary from Euro deposits due to taxation and varying market practices.
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