Financial Derivative Terms - M

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

Macaulay Duration: An approximate measure of the weighted-average term to maturity of the cash flows from a bond. The weight of each cash flow is determined by dividing the present value of the cash flow by the price.
Mark to Market: The process of daily adjustment of a financial instrumentâ€™s value to reflect its current market value as the prices go up and down in the market.
Market Model: A model that states that the return on a security is related to the return on a market portfolio and the extent of the securityâ€™s responsiveness as measured by beta.
Market Risk: The potential loss of an investment which is related to the moves in the market portfolio and, therefore, cannot be lessened by diversification.
Market Value: The current value of a financial instrument based upon the price at which the financial instrument can be bought or sold in the financial market immediately. For equities, multiply the number of shares times the market price and for bonds, multiply the par or current face value times the market price.
Married Put: An option strategy whereby an investor, having purchased a stock, purchases a put on the same stock to protect (hedge) against a depreciation in the stockâ€™s price.
Martingale: A form of stochastic (random) process with zero drift (break even).
Maturity Date: The date that a contract term is ended or expires. For bonds, this is the date that the bond issuer repays investors the principal of the bond.
Maturity Status: Indicates whether the transaction is expired or active.
Mean Reversion: A model that explains the tendency of a stochastic process such as interest rates or stock returns to remain at or return over a long period of time to an average value. This average value can be based on the historical average of a return or another relevant average such as growth in the economy.
Model: An abstraction of reality, generally referring in investments to a mathematical formula designed to determine security values. Economists also use models to project trends in economic variables such as interest rates, economic activity, and inflation rates.
Modified Duration: A formula that measures the percentage change in the value of a security in response for each one percentage point change in current interest rates. (primary basis for comparing the effect of interest rate changes on prices).

Equal to the Macaulay Duration divided by (1+ (bond YTM/n)) where n is the number of coupon periods per year.
Modified Convexity: Convexity adjusted for the time value of money by using a simple discount factor based on average yield.
Money Market Instruments: Short-term interest rate securities (usually with maturities less than one year) which are classed as follows: interest bearing securities such as Certificates of Deposits (CD) or some types of commercial paper (CP); or discount securities such as T-Bills or Banker Acceptances (BAâ€™s).
Money Market Rate Basis: The yield to maturity for a discount security where the fair price is calculated by discounting the face amount at the yield to maturity.
Monte Carlo Simulation: A problem solving technique used to approximate the probability of certain outcomes by using a large number of repeated calculations, called simulations (a formal trial and error), using random variables thus creating a large number of scenarios. Monte Carlo simulation uses historical interest rate volatilities to generate the large number of interest rate paths needed to simulate (imitate) interest rate sensitivity. Monte Carlo simulation is one of the best tools to measure interest rate risk in particular for option valuation.
Mortgage Backed Securities (MBS): Debt obligations that represent claims to the cash flows in a group (pool) of mortgages (loans on real estate) most commonly on residential property. These investments are created when a mortgage provider sells the residential loans to a federally sponsored credit agency or a private institution that in turn pools the mortgages together and securitizes it. Principal and interest payments made from individual mortgage payments are used to pay investorsâ€™ return of principal and interest income on the investment. The security returns the principal to the investor periodically over the term of the security rather than all at once at maturity.
Mortgage Backed Securities-Accrual Bonds: A type of Collateralized Mortgage Obligation (CMO bond), accrual bonds, or Z-bonds, receive no payments of interest or principal until all prior classes have been satisfied. The interest due to the accrual bond in each period accretes and is added to the existing principal balance of the bond due for payment at a later date. The interest payment is then used to pay down prior classes.
Mortgage Backed Securities-Fixed Rate Passthroughs: A portfolio of similar fixed rate mortgages are pooled together and securitized. Investors can purchase units of these fixed rate passthrough securities and will receive principal and interest payments from the underlying pool of fixed rate mortgages each period. Generally, the mortgages pooled together will be approximately the same age, have approximately the same mortgage rate, and have approximately the same amount of time remaining to maturity. Homeowners generally have the option to prepay their mortgage in part or in full at any time prior to maturity which differ these securities from other regular fixed income securities because of their underlying prepayment options.
Mortgage Backed Securities-IO/PO Bonds: When stripped mortgage-backed securities are created, principal and interest cash flows from the underlying collateral are redistributed creating two new classes of bonds. These bonds have an Interest-Only (IO) class that receives only interest payments based on a notional principal amount, and a Principal-Only (PO) class that receives only the principal payments from the underlying collateral.
Mortgage Backed Securities-Planned Amortization Class: A type of Collateralized Mortgage Obligation (CMO bond) designed to reduce the effects of prepayment risk. A PAC bond pays to a predetermined principal balance schedule that can be maintained over a range of prepayment speeds. A principal payment schedule is established as the minimum amount of principal payments produced by the underlying collateral at two prepayment speeds, known as the PAC bands.
Mortgage Backed Securities-Pro Rata Bonds: Pro-Rata bonds pay down concurrently based on the proportion of the total pro-rata class balance the bond accounts for. Interest payments are made on pro-rata bonds while prior classes are being paid down. Once all prior classes have been paid down, the pro-rata bonds will receive interest and principal payments until the bonds are retired.
Mortgage Backed Securities-Sequential Bonds: Sequential bonds pay down in chronological order with no concurrent pay components. Interest payments are made on a sequential bond while prior sequential classes are being paid down. Once all prior classes have been paid down, the sequential bond will receive interest and principal from the underlying collateral each period until the bond is retired.
Mortgage Backed Securities-Targeted Amortization Classes: A type of CMO bond designed to reduce the effects of prepayment risk. Like a Planned Amortization Class (PAC), a TAC bond pays to a predetermined principal balance schedule, but the schedule is determined using a single prepayment speed instead of bands of prepayment speeds. TACs offer reasonable call protection when prepayment speeds rise above the TAC PSA speed, but unlike PACs, do not offer protection against extension of weighted average life when prepayments slow. For this reason, TACs offer higher yields than PACs.
Mortgage Swap: A structured transaction attached to mortgage payments where the notional principal amortizes in parallel with the mortgage principal. The payments and prepayments on a pool of fixed rate mortgages are exchanged for fixed rate cash flow payments.
Multi-Asset Option: An option whose payoff is based on two (or more) assets.
Multi-Average Options: Any number of average price options (Asian) and / or any number of average strike options. The options involve any number of underlyings with any strike price and may be calls or puts.
Multi-factor Short Rate Model: A mathematical model using two or more factors that predicts future interest rates by predicting the future evolution of the short rate. The short rate is the (annualized) interest rate at which an entity can borrow money for a very short period of time.

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