Financial Derivative Terms - C


Used for models to produce an accurate price or risk statistic of a financial derivative, calibration involves calculating values of the parameters such that the model is able to reproduce (as closely as possible) the prices of “calibration instruments" such as market-quoted Black volatilities of caps and European-style swaptions.
Call Ladder
An option strategy comprised of a long call, a short call having a strike price higher than the long call as well as a short call having a higher strike price than the long call.
Call Option
An option whereby the purchaser pays a premium to the seller (writer) for the right to buy the underlying security at a predetermined strike price. The seller must sell the security to the purchaser if the option is exercised.
Call Premium
  1. The amount that the purchaser of a call option pays to the seller (writer) to buy (purchase price) a call option.
  2. The difference between the call price of a bond and the par value of the bond.
Call Spread
An option strategy designed to limit costs and losses (and lower returns) which involves purchasing a call option and selling another call option (at a higher strike price), with both options having the same expiry date.
Call Spread vs. Put
An option strategy comprised of a long call, a short call having a higher strike price than the long call as well as a short put having a strike price usually, but not always the lowest.
Callable Bond
A bond in which the issuer has the right to call the bond away from the investor for a price determined at the time that the bond is issued.
Callable Capped Floaters
A capped floater is similar to a regular floating rate note, except that the floating rate is capped. In addition, the rate may be floored, may be multiplied by a scaling factor, and may have a spread added.
Callable Inverse Floaters
An inverse floater is similar to a regular fixed rate bond, except that a floating rate is subtracted from the fixed rate. This floating rate may be floored, capped, multiplied by a scaling factor, and have a spread added. In addition, the value of (fixed rate – floating rate) may be floored.
Callable/Puttable Range Accrual Notes
A type of structured note similar to a fixed rate bond, except that interest (usually higher than market rate) only accrues on days when its reference rate (such as the 3 month LIBOR) falls between specified levels. If it is possible for the issuer to call, and the call price is less than the note price, then the call option is exercised and the price of the option on that exercise date is the difference between the call price and the note price. If the note is not called and it is possible for the holder to put, and the put price is greater than the note price, then the put option is exercised and the price of the option is the difference between the put price and the note price.
Cancelable Forward
See Break Forward Contract.
Cancelable Swap
A cancelable swap provides the right to cancel the swap at a given point in the future. An example would be a swap with a tenor of 5 years that can cancelled after year three. This can be broken into two components. The first is a vanilla five year swap paying floating and receiving fixed. The econd component is a payer swaption exercisable into a two year swap three years from today. The result is that when the original bond is called, the swaption is exercised and the cash flows for the original swap and that from the swaption offset one another. If the bond isn’t called, the swaption is left to expire.
One of the interim dates of caps each with an expiry date generally on the date which the forward rate is set in a multiple period cap agreement. A cap is not a continuous guarantee which means claims can only be made on specified dates selected by the purchaser.
Capped Swap
A swap with a cap in which the floating payments of a swap are capped at a certain level. A floating-rate counterparty can thereby limit its exposure to rising interest rates above a certain level.
Cash CDO
A credit default option which is backed by “true" assets, such as bonds or loans. Its payoffs, either coupons or principals, come from the actual cash flows of the assets in the pool.
Cash Flow
The amount of payment expected on a particular date.
Cash Flow Hedge
A hedge that includes a derivative with a periodic settlement based upon cash flows such as interest rate changes on variable rate debt (FRNs) which are swapped for a fixed rate to offset the variability of the cash flow of a balance sheet item.
CDS Spread
Commonly quoted rates used to create a default probability curve. The default probability curve is used in pricing many types of credit derivatives.
Cheapest to Deliver Bond
Given the list of deliverable securities into the futures contract, the cheapest to deliver bond has the lowest delivery-adjusted spot price (spot price divided by conversion factor).
Chooser Option
An option where the investor has the opportunity to choose whether the option is a put or call at a certain point in time during the life of the option. The underlying options are assumed to be European options on the same asset. At the expiry date of the chooser option, it is assumed that a rational holder of the chooser option will choose the more valuable of the put or call option. In doing so, the less valuable option, not chosen, will die.
Clean Price
The value of a transaction at any given date excluding accrued interest.
Cliquet Options
Options that provide a guaranteed minimum return in exchange for capping the maximum return over the life of the contract.
A type of spread option strategy where an investor purchases (or sells) a call option while at the same time sells (or purchases) a put option both of which are out of the money with the same expiry date. If the strikes are chosen so that the purchase price of the call option and the sale price of the put option exactly match, then this is called a costless collar.
Collar Swap
A collar on a swap. The transaction is zero-cost – the purchase of the cap is financed by the sale of the floor. The collar allows the floating-rate receiver to gain slightly if rates go down.
Collateralized Debt Obligation (CDO)
A security that is linked to a diversified pool of credits which are mostly backed by corporate bonds or other corporate debt. The credits can be assets, such as bonds or loans, or simply defaultable names, such as companies or countries. There are two categories of CDOs: Cash CDOs and Synthetic CDOs.
Collateralized Mortgage Obligations
A type of mortgage backed security that gives investors the right to receive cash flows from an underlying pool of mortgages in a predetermined order based on priority.
Any raw material or food that can be bought and sold, which includes goods traded on a commodity exchange. Examples of commonly traded commodities include oil, natural gas, gold, beef and grains.
Commodity Forward
A forward contract which is very similar to a futures contract, except that the terms and conditions can be specified to meet the particular needs of the counterparty. These contracts are primarily on agricultural or precious metal commodities and can be used for hedging, arbitraging and speculating against the future price of the underlying asset.
Commodity Forward Strip
A simultaneous purchase or sale of a series of commodity forwards. The fair value of a commodity strip is the sum of the fair values of each of the commodity forwards.
Commodity Futures
A futures contract is an agreement between two counterparties that commits one party to sell a standardized quantity of a commodity at a given price on a specified future date. These contracts are primarily on agricultural or precious metal commodities and can be used for hedging, arbitraging and speculating against the future price of the underlying asset. These contracts are standardized and traded on an exchange, in contrast to a forward.
Commodity Option
A commodity call option gives the holder the right to buy a commodity at a specified price (the exercise or strike price) for a certain time. The seller of a call option assumes a corresponding obligation to sell the commodity if and when the call option holder decides to exercise his right to buy. A put option gives the holder the right to sell a commodity at a specified price for a certain time. The seller of a put option assumes a corresponding obligation to buy the commodity if the put option holder decides to exercise his right to sell.
Commodity Option Strip
A simultaneous purchase or sale of a series of call or put options. The fair value of a commodity option strip is the sum of fair values of the individual options.
Commodity Swap
A swap in which one of the payment streams for a commodity is fixed and the other is floating. The cash flows are dependent on the price of an underlying commodity. Usually only the payment streams, not the principal, are exchanged, although physical delivery is becoming increasingly common.
Compensation Payment
The undiscounted interest differential for a Forward Rate Agreement (FRA).
Compound Interest
Interest that is earned on both the initial deposit and on any interest that has already been earned but left on deposit. When a deposit earns compound interest, its value grows exponentially with time.
Compound Option
An option on an underlying which is itself an option; therefore, there are two strike prices and two expiry dates (where the underlying option’s expiry date is equal to or greater than the compound option’s expiry date). The underlying option is assumed to be a European Style option on an asset which follows a lognormal random walk (such as a basic Black-Scholes call or put option).
Compounding Frequency
The number of times per year that interest is credited to a deposit. Annual compounding is once per year, semi-annual is twice per year, quarterly is four times per year and monthly is 12 times per year.
An options strategy comprised of a long call (or put) and another long call (or put) having different strike prices as well as two short calls (or puts) having their strike prices equally spaced between the two long options.
Constant Maturity Derivatives
A derivative where the payoffs are based on swap rates or bond yields (multiple payments) but the payoffs are calculated as if the rates or yields were zero coupon rates. The term constant maturity swap (CMS) is used when the derivative is based on swap rates and the term constant maturity treasury (CMT) is used when the derivative is based on bond yields.
Constant Maturity Swap
A derivative with a payoff that is based on a swap rate of a specific maturity. For example, while a regular floating rate note might pay semi-annual coupons based on semi-annual fixings of 6-month USD LIBOR, a CMS note might pay semi-annual coupons based on semi-annual fixings of the 10-year semi-annual swap rate. Note, however, that the coupon frequency need not match that of the underlying swap rate: the note might pay semi-annual coupons based on fixings of the 10-year annual swap rate, for example.
Contingent Swap
Generic term for a swap that is activated when rates reach a certain level or a specific event occurs. Swaptions are often considered to be contingent swaps – the specific event in this case being the exercise of the option. Other types of swaps, e.g., droplock or spreadlock swaps, are activated only if rates drop to a certain level or if a specified level over a benchmark is achieved.
Contract Rate
The percentage amount of the principal amount used to determine cashflow amounts.
The time of delivery at which the cash price and the futures price are finally equal because the cost of carry decreases over time.
Conversion Factor
The price ($1 par value) of a convertible bond divided by the conversion price to yield a fixed rate.
Conversion Price
The price per share of a convertible security can be converted into common stock.
Convertible Bond
A bond that can be converted into a predetermined amount of the entity’s (issuer) equity at certain times during its life; giving the bondholder the option to exchange the bond for shares in the entity. Basically, this is a bond with an embedded call option. By including the call option, issuers can issue the debt at much lower interest rates
A measure of the degree of curvature between bond prices and bond yields that are inversely related in a non-linear manner. The size of the rise in a bond’s price associated with a given decrease in its yield is greater than the drop in the bond’s price for a similar sized increase in the bond’s yield resulting in a graphical representation that shows a convex curve. The degree of curvature is not the same for all bonds as it depends on the size of the coupon payments, the sensitivity of duration to changes in interest rate, the life of the bonds as well as its current market price.
Convexity Adjustment
The amount that must be added to the forward rate yield to give the expected future rate (yield) in order to calculate the expected payoff.
From the Latin word, meaning “to bond", a copula is a statistical measure that links many variables together and has been applied to option pricing and portfolio value-at-risk to help identify various risks to deal with skewed distributions in finance.
Correlation Coefficient
A statistical measure that determines the degree to which two random variables movements are associated and is expressed on a scale of -1 to +1. -1 indicates perfect negative correlation, and +1 indicates perfect positive correlation.
Cost of Carry
The amount of money spent during the course of owning an investment such as interest expenses plus the amount of money that could have been made otherwise (opportunity costs) had the investment not been purchased.
The other party involved in the transaction or trade.
Counterparty Risk
The risk posed by the possibility the other party with which an investor has entered into a financial arrangement may fail to make their required payments.
The agreed upon interest rate (usually semiannually) that the issuer must pay the purchaser of a bond during the life of the bond.
Coupon Payments
The periodic interest payments on a bond
Coupon Rate
The percentage of the annual dollar amount of coupon payments to the bond’s par value
A measure of the extent by which two random variables, for example, annual returns on two risky assets move as a pair. A positive covariance means that asset returns move together. A negative covariance means returns move oppositely
Covered Call Option
An option strategy where the investor owns a stock and writes a call option on the same amount of the stock. If the holder exercises the option, the stock owner must deliver the stock. This strategy is used if the stock owner believes that the stock price may decline in which case the holder will not exercise and he or she keeps the premium. If the price of the stock goes up and the option is exercised, the risk is minimal as the writer already owns the stock.
Credit Default Index Swap(CDIS)
A portfolio of single-entity credit default swaps where the premium notional is variable. The most popular CDISs are the so-called standardized CDISs. In these standardized contracts the reference entity pool is homogeneous, that is, all the reference entities have the same notional and the same recovery rate. Typical examples of standardized CDISs are the CDX index and the ITRAXX index
Credit Default Index Swap Option
An option to buy or sell the underlying CDIS at a specified date.
Credit Default Risk
The possibility that the debt issuer will fail to make payments (either interest or principal) in a timely manner
Credit Default Swap (CDS)
A credit derivative where the seller agrees, for an upfront or continuing premium or fee, to compensate the buyer when a specified event, such as default, restructuring of the issuer of the reference entity, or failure to pay, occurs. The value of the swap depends on two default probabilities and the correlation between them: that of the reference entity and that of the counterparty
Credit Default Swap on a Basket of Entities
A basket default swap is similar to a single entity default swap except that the underlying is made up of more than one entity rather than one single entity.
Credit Default Swap on a Single Entity
A credit swap where the reference entity is a single entity. With a single entity, a credit event is usually a default of the entity
Credit Default Swap Options
Also known as a credit default swaption, it is an option on a credit default swap (CDS). A CDS option gives its holder the right, but not the obligation, to buy (call) or sell (put) protection on a specified reference entity for a specified future time period for a certain spread. The option is knocked out if the reference entity defaults during the life of the option. This knock-out feature marks the fundamental difference between a CDS option and a vanilla option. Most commonly traded CDS options are European style options.
Credit Derivative
A trade that transfers credit risk related to an underlying entity or a portfolio of underlying entities from one party with the credit risk to another party while maintaining its investment in the underlying asset.
Credit Event
Usually a default or, possibly, a credit downgrade by a rating agency of an entity. The reference entity may be a name, a bond, a loan, a trade receivable or some other type of liability.
Credit Exposure
A credit exposure of a financial instrument to a counterparty is the amount lost when the counterparty defaults. There are two types of potential credit exposures, worst credit exposures and expected credit exposures. A worst credit exposure at a given time is the largest possible loss of the instrument at certain confidence level when the counterparty defaults. An expected exposure is the expected loss of the instrument at a given time.
Credit Risk
The risk that one of the parties to a financial transaction will fail to fulfill its obligation to pay.
Credit Spread
The difference between Treasury securities or some other given benchmark curve and non-Treasury securities (for example, corporate bonds) that are similar except for quality rating
Credit Spread Option
Options where the payoffs are dependent on changes to credit spreads, that is, an option whose payoff is based on the credit spread between the debt of a particular borrower and a Treasury security having similar maturity
Credit-linked Note (CLN)
Also called a credit default note, it is a fixed or floating rate note where the coupon and principal payments are referenced to a reference credit, which can be a single name or multiple names. It pays interest and repays principal that depend on a credit event. At maturity, the investors receive par unless the referenced credit defaults or declares bankruptcy, in which case they receive an amount equal to the recovery rate
Cross Currency Basis Spread
Used in the valuation of cross currency basis swaps, this is the liquidity premium of one currency over the other that is added to the floating rate of one of the legs of the swap
Cross Currency Bermudan Swaption
An embedded Bermudan option in a cross currency swap. It is a contract in which the holder of a cross currency swap is long or short an option to put the swap at certain cash flow payment dates. For example, suppose a fixed leg cross-currency swap payer is long a Bermudan swaption. Then he makes periodic payments based on a fixed rate in a certain currency and receives floating rate payments based on the interest rate of another currency. At certain payment dates he can cancel the swap, or equivalently, he can switch to pay the floating rate and receive the fixed rate. Most cross currency swaptions are fixed-for-floating swaptions. Typical swaptions have fixed notionals for both receive and pay legs, and a single fixed coupon rate for the fixed leg and a single spread for the floating leg
Cross Currency Swap
An interest rate swap that consists of each leg dominated in a different currency and two notional principal amounts also in different currencies. The two parties agree to exchange principal and interest payments in one currency for the principal and interest payments in the other currency. The principal amounts must be paid out at maturity
Money that is issued by a national government
Currency Forward
An agreement to exchange a specified amount of one currency for another at a future date at a certain rate. The exchange of currencies is priced on an arbitrage-free basis according to the interest rates in the two jurisdictions
Currency Translated Options
Options on foreign assets where the payoff is exchanged into the domestic currency. For example, a US investor may be interested in buying an option on a British equity which is priced in sterling. Two types of risk must be considered when pricing the option: exchange rate changes and price changes
The simultaneous purchase of a currency put option and sale of a currency call option at different strike prices. Both options are out of the money. This strategy enables purchasers to hedge their downside risk at a reduced cost. This is at the expense of forgoing upside beyond a certain level since the purchase of the put is financed by the selling of the call (or vice versa). See also Range Forward
Cycling Dates
Dates that are generated backwards from the terminating date, based on the user-defined frequency.


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