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Glossary
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The earliest form of duration measurement. Developed in 1938 by
Professor Frederick Macaulay, this simple form of duration provides
only an approximate measure of the true price volatility and interest
rate sensitivity of an instrument. See convexity, duration, effective
duration, and modified duration.
Hedging the net risk exposure of an entity’s entire portfolio
or balance sheet. As opposed to micro hedging a single instrument.
In interest rate risk management, macro hedging involves hedging
the net mismatch or the net duration for the entire entity.
A description comprising numbers and symbols printed in magnetic
ink on documents for automated processing. For checks, this MICR
line appears at the bottom of the check.
See Member Appraisal Institute.
The time it takes a remittance to move from the remitter to the
recipient through the mail. This period can range from one to several
days. Also called remittance float; however, remittance float can
also result from electronic rather than mail delivery.
See writer.
The conduct of a dealer who buys or sells at his or her bid and
offered prices to ensure that there is a secondary market for other
buyers or sellers. See market maker.
A document prepared by a firm’s auditors in conjunction with
its annual audit.
Term used to describe financial reports prepared by the borrower
with no assistance from independent, outside parties.
Types of convertible bonds that have required conversion or redemption
features. One type of mandatory convertible requires the holder
to exchange the bonds for common stock at maturity. Often used by
banks seeking to meet regulatory capital requirements without issuing
common stock until a later date. Often called equity-linked securities.
These securities provide investors with higher yields to compensate
holders for the mandatory conversion structure. They also typically
have caps on the amount of upside potential that the security can
achieve. For moderate stock increases, they will outperform the
common stock due to the yield advantage, but the cap on the upside
means that they lag stock performance for high stock returns.
(1) An amount of cash or collateral that a buyer or borrower must
provide in excess of value owed to that buyer or borrower by a seller,
lender or depositor. Ensures performance by the buyer or borrower.
Initial margin is posted at inception. Variation margin is the amount
of any additional margin needed to correct deficiencies in the currently
posted margin.
(2) The amount by which the coupon rate for a floating-
or variable- rate financial instrument differs from the defined
index for that coupon rate. For example, if a floating-rate note
requires that the coupon rate be set at 250 basis points above 30-day
LIBOR, the gross margin is 250 basis points. Can also be the amount
added to, or subtracted from, the index in determining the instrument's
fully indexed rate. Investors in adjustable rate mortgage-backed
securities (MBSs) receive a coupon rate that is lower than the fully
indexed rate because the cost of servicing, the servicing spread,
is deducted. The gross spread minus the servicing spread is called
the net margin or the security margin. See index and servicing.
(3) In a firm’s profit and loss statement,
margin is the difference between sales price and the cost of goods
sold. It may be expressed as a dollar quantity or as a percentage
of the cost of goods sold.
Loans acquired from brokers or financial institutions for the purpose
of acquiring margin stock.
A term defined by the Federal Reserve Board of Governors in Regulations
T and U. Any stock listed on a national securities exchange, any
over-the-counter security approved by the SEC for trading in the
national market system, or any security appearing on the Board's
list of over-the-counter margin stock and most mutual funds. There
are certain requirements a stock must meet before it can be margined.
The most important of which is that the price must be greater than
five dollars.
The incremental rate or return realized by making just one change,
adding a single additional unit, or deleting a single unit. For
example, if one more new loan is added to an existing portfolio,
and the yield on that loan is 10%, the marginal yield for the portfolio
is 10%. Not the same as the average.
The process of restating the carrying value of an asset or liability
to equal its current market value. Under FAS 115, financial instruments
held in trading accounts must be marked to market by increasing
income to reflect unrealized gains or by decreasing income to reflect
unrealized losses. Financial instruments categorized as available-for-sale
(AFS) under FAS 115 must also be marked to market but receive different
accounting treatment.
A term used to describe the characteristic of a secondary market
for a financial instrument evidenced by more than a minimal amount
of active daily trading. One of the requirements for readily marketable
assets.
The potential that an institution cannot easily unwind or offset
specific exposures, such as investments held as liquidity reserves,
without incurring a loss because of inadequate market depth or market
disruptions. One of the three primary components of liquidity risk
along with mismatch liquidity risk and liquidity contingency risk.
An individual or entity that stands ready to buy or sell financial
instruments at all times. Market makers quote both a bid and an
offer price to the market. Market makers provide liquidity to markets.
They profit from the spread between bid and offer prices as well
as from changes in market prices. Market makers adjust their bid
or offer prices depending upon positions that they hold and/or upon
their outlook for changes in prices.
One of six risks defined by the Federal Reserve. The risk of an
increase or decrease in the market value/price of a financial instrument.
Market values for debt instruments are affected by actual and anticipated
changes in prevailing interest rates. Market values for all financial
instruments, except direct obligations of the U.S. Treasury, are
affected by either actual or perceived changes in credit quality.
Market risk includes reinvestment risk - that is, the risk that
all or part of the principal may be received when interest rates
are lower than when the security was originally purchased. In that
case, the principal must be reinvested at a lower rate than that
originally received. Sometimes called market value risk. Also see
interest rate risk and price risk.
See market depth.
The value of a financial instrument based upon the price at which
a financial instrument is purchased or sold or the price at which
it could presumably be purchased or sold. For an equity instrument,
the product of the number of shares times the market price. For
a debt instrument, the product of the par or current face times
the market price.
The difference between the sum of the present values of all cash
flows from assets and the sum of the present values of all cash
flows from liabilities. In other words, the market value of the
institution’s capital account. Defined by the Office of Thrift
Supervision (OTS) to represent the difference between the market
value of a financial institution’s assets and liabilities
plus or minus the value of any off-balancesheet positions. This
is a proxy or estimate used for capital when the sensitivity of
capital to changes in prevailing interest rates is calculated. As
used by thrift institutions and the OTS, the term has been replaced
by "net portfolio value" or NPV. As used by bankers and
banking regulators, the term is slowly being replaced by "economic
value of equity" or EVE. See net economic value and value at
risk.
The process of generating multiple forecasts for future interest
rate scenarios and then discounting the estimated cash flows anticipated
under those rate scenarios. The results of market value simulation
are a range of forecasted market values of equity for both current
and potential rate risk exposures. Comparisons of these forecasted
MVPE values reveal the sensitivity of MVPE to changes in rates.
An attribute that may or may not be associated with a security.
A security is considered to be marketable if it is readily salable
to buyers in an active secondary market. As defined by the Office
of the Comptroller of the Currency (OCC) (12 CFR 1), marketable
means that the security:
(1) Is registered under the Securities Act of 1933,15
USC 77a et seq.;
(2) Is a municipal revenue bond exempt from registration
under the Securities Act of 1933, 15 USC 77c(a)(2);
(3) Is offered and sold pursuant to Securities
and Exchange Commission Rule 144A,17 CFR 230.144, and rated investment
grade or is the credit equivalent of investment grade; or
(4) Can be sold with reasonable promptness at a
price that corresponds reasonably to its fair value.
A written contract covering all future transactions between the
parties to repurchase/reverse repurchase agreements and establishing
each party’s rights in the transactions. A master agreement
often will specify, among other things, the right of the buyer-lender
to liquidate the underlying securities in the event of default by
the seller-borrower.
or
An entity is said to match fund a loan or investment when it acquires
a liability in equal amount for the same maturity. However it is
not perfectly match funded unless all of the interest and principal
cash flows and any prepayment options are also the same for the
asset as they are for the liability.
A funds transfer pricing system or methodology that assigns a cost
of funds to assets and a credit for funds to liabilities that reflect
the interest rate risk - especially the rate risk associated with
the time remaining to maturity - in those assets or liabilities.
See funds transfer pricing.
A trade that is mirrored by an equal and offsetting trade with a
different counterparty. In a matched trade, the interest rate, market,
and price risks are offset but not the credit risk. The trading
entity incurs credit risk for the counterparties on each side of
the trade.
A lien against real property created under state laws that give
a person who supplies materials used to repair or improve real estate
the right to place a lien against the property if that person is
not paid.
The date a financial instrument's contractual term expires. The
date on which the principal or last principal payment on a debt
is due and payable. For mortgage-related securities, see final distribution
date and final maturity.
See laddered maturities.
The term economists use to describe the activity of a financial
intermediary that accepts deposits or investments of one term (usually
short) and places those funds with a debtor in another term (usually
intermediate or long term).
An alternative yield curve smoothing technique. The most accurate
yield curve smoothing method for forward rates. The yield curve
with the smoothest possible forward rate function, consistent with
observable data, is closely related to but significantly different
from the popular cubic spline approach to the smoothing of both
yields and discount bond prices. The yield curve which produces
the smoothest possible forward rates consistent with given zero
coupon bond prices has a quartic forward rate function which spans
each time interval between observable data points. This contrasts
with the cubic polynomial that is used to fit either yields or discount
bond prices in the cubic spline approach. This method produces the
smoothest possible forward rate curve (with f’=0 at the longest
maturity) that causes the interpolated yield curve to be totally
consistent with the observable data. See smoothing.
See mortgage-backed security.
The behavior of a variable in which the values for that variable
move towards the long-run average value for that variable.
A lien against real property created under state laws that give
a person who makes repairs or improvements to real estate the right
to place a lien against the property if that person is not paid.
Debt instruments with maturities ranging from 9 months to 30 years
that are offered on a continuous basis. Offered on a continuous
basis means that they are issued and sold as buyers request them
rather than on a single issue date. MTNs have features similar to
corporate bonds. Bank deposit notes are a form of MTNs.
FNMA MBSs created when older pools that have been reduced to small
outstanding balances (i.e., low current face) as a result of cumulative
prepayments are combined to create new securities with larger remaining
balances.
A designation earned by qualifying commercial real estate appraisers.
It is awarded by the Appraisal Institute.
Data about data. A term used in database management and data warehousing.
A name for a type of property description used to identify parcels
of land for which the legal identification is expressed in surveying
terms. "Metes" means measurements and "bounds"
means boundaries. A metes and bounds description gives the length
and direction of the boundaries of a property.
Financing wherein the junior debt in a leveraged buyout comes from
a lender willing to take a subordinate position. See leveraged buy
out.
See magnetic ink character recognition.
Hedging the interest rate risk exposure of a single asset or liability.
See macro hedging, its converse.
Government National Mortgage Association (GNMA) issued pools of
fixed-rate mortgages with original maturities of 15 years.
A term used to describe a liability for underfunded pension obligations
that FAS 87 required firms to recognize as an actual balance sheet
liability. The minimum pension liability is the excess of accumulated
vested and nonvested plan benefits over plan assets. FAS 130 establishes
accounting requirements for adjustments to minimum pension liability.
Used in asset/liability management to describe the difference between
rate-sensitive assets and rate-sensitive liabilities in rate gaps
or between cash inflows and outflows in liquidity gaps. See gap.
(1) The risk that a financial institution will suffer either a decline
in income or capital because future changes in prevailing interest
rates impact assets more or less than they impact liabilities. The
component of interest rate risk arising from differences in the
timing of asset and liability repricing. Also called gap or repricing
risk.
(2) The risk that a financial institution will
suffer either a decline in income or capital because of future funding
problems. The component of liquidity risk arising from differences
in the timing of cash inflows and outflows. Also called liquidity
gap or liquidity mismatch risk.
See money market deposit account.
See matched maturity funds transfer price.
The risk that incorrect or sub-optimal interest rate risk management
decisions will be made because of errors in the model used to measure
risk exposure. Errors may arise from inaccurate data input into
the model, from inaccurate assumptions used in the simulation, and/or
from errors in model logic or programming.
See Bermuda option.
Macaulay duration adjusted for compounding. The figure for Macaulay
duration is divided by the sum of one plus the rate divided by the
number of compounding periods per year. A more accurate measure
of the weighted average time remaining until receipt of a series
of cash flows. In essence, modified duration is a measurement of
price and interest rate sensitivity. (Economists refer to this as
price elasticity.) Modified duration expresses the percentage change
in the value of an instrument for each one percentage point change
in prevailing interest rates. See convexity, duration, effective
duration, Macaulay duration, negative duration, and positive duration.
A term used to describe a variety of gap analysis methodologies
that make modifications to contractual gap analysis in an effort
to improve the accuracy of the gap analysis. See beta adjusted gap
and dynamic gap.
The conversion or transfer of property derived from a criminal offense
for the purpose of concealing, or disguising, the illicit origin
of the property, or of assissting any person who is involved in
the commission of such an offense, to evade the legal consequences
of the action; the concealment or disguise of the true nature, source,
location, disposition, movement, rights with respect to, or ownership
of property, knowing that such property is derived from a criminal
offense.
The aggregation of buyers and sellers actively trading money market
instruments.
A bank deposit account designed to pay a higher rate of interest
to depositors than might otherwise be earned in checking or savings
accounts. Money market deposit accounts do not have specified maturities.
Their rates are administered by the bank although they are influenced
by prevailing rates for money market instruments traded in capital
markets. Some banks index the rates that they pay on MMDAs to rates
paid for traded money market instruments such as U.S. Treasury bill
rates. Federal regulations limit the number of transactions that
can be made from these accounts.
A form of mutual fund that restricts investments to relatively safe,
relatively short-term instruments. Typical money market funds may
invest in short-term U.S. government obligations, commercial paper,
and banker’s acceptances. Average maturities of fund assets
are typically 14 to 28 days. The income, less costs, is paid out
every day so that the share value is always the same. However, shareholders
are not protected against loss from the fund's investments.
The broadest definition of a money market instrument is a short-term
debt instrument that is purchased from a broker, dealer, or bank.
Sometimes the term "money market" is used more restrictively
by further defining short-term to mean an instrument with no more
than 12 months remaining from the purchase date until the maturity
date. (The remaining life of the instrument is the basis for the
definition rather than the its original term.) Sometimes money market
is used more restrictively to mean only those instruments that have
active secondary markets. Definitions of money market instruments
that only include instruments with active secondary markets exclude
non-negotiable investments such as most bank certificates of deposit.
See money market fund.
In asset/liability management, the phrase money market rate is used
to distinguish a rate set in actively traded markets from a rate
that is administratively set by banks or other financial institutions.
Rates on short-term U.S. Treasury notes and the London Interbank
Offered Rate (LIBOR) are the most common money market rates. However,
any actively traded, short-term, high-quality instrument might be
considered to be a money market instrument.
A statistical technique that involves using a large number of repeated
calculations. A methodical and formalized version of trial and error.
A statistical technique that involves using a large number of repeated
calculations. A methodical and formalized version of trial and error.
Monte Carlo simulation uses historically known interest rate volatilities
to scientifically generate the large number of interest rate paths
needed to simulate the interest rate sensitivity of bank products
with embedded options. Monte Carlo simulation is one of the best
tools for dealing with many of the option-related problems in interest
rate risk measurement.
Revenue bonds issued by state agencies, government commissions,
or other special purpose municipal entities that purport to have
the added backing of a moral obligation of the city or state government.
Since there is no legal obligation for the state or city to back
the principal or interest due on these bonds, the moral obligation
provides limited, if not dubious, support.
(1) noun — A legal instrument that creates a lien upon real
estate for the purpose of securing a debt. The instrument is executed
by a lender and a borrower or guarantor as collateral for the payment
of a debt that creates a lien on real estate owned by the borrower
or guarantor. The borrower or guarantor is called the mortgagor
and the lender is called the mortgagee. In some states, a different
legal instrument called a deed of trust fulfills a similar function
even though it is not legally the same. See chattel mortgage.
(2) verb — The action of granting a lien
to pledge real property as security for the repayment of a debt.
A common type of secured corporate bond. The bond indenture for
mortgage bonds, along with associated documents executed by the
issuer, provides for the bondholders to have, through the trustee,
an interest in real property collateral. For example, the bonds
may be secured by a mortgage on real estate used by the company.
This may be the case when the bond proceeds are used to finance
the construction of a factory or plant. (Many pollution control
and utility bonds are mortgage bonds.) It is important to understand
that the mortgage is not the sole, or even the primary, backing
for the repayment of these bonds. These debts are still financial
obligations that the firm must repay even if the value of the collateral
falls.
Percentages that are an expression of the total interest and principal
payments that must be made each year to fully amortize a loan over
a specified number of years using level payments.
A loan secured by a mortgage. In the mortgage-backed securities
industry, loans secured through deeds of trust are also referred
to as mortgage loans.
A name used to describe a promissory note that is secured by an
interest in real property. Mortgage notes generally, but not always,
call for mostly regular, periodic payments of principal and interest.
The simplest and oldest type of MBS. A pass-through is a security
that provides its owners with a pro rata claim to all of the cash
flow generated from a pool of mortgage loans.
or
Securities composed of, or collateralized by, loans that are themselves
collateralized by liens on real property. MBSs can be categorized
into two major types. Pass-through pools are mortgage-backed bonds
created by assembling a pool of similar mortgage loans into a single
security. Investors in a pass-through pool receive a portion of
every interest and principal payment (less serving charges) that
is equivalent to the investor’s pro rata ownership share in
the pool. The other major type is collateralized mortgage obligations
(CMOs), usually real estate mortgage investment conduits (REMICs).
Investors in a CMO own the rights to receive cash flow from an underlying
pool of mortgages in a predetermined order based on priority. CMO
securities are secured by pass-through pools. Both types of MBSs
may be backed by either liens on residential or commercial properties;
however, residential mortgages are more common. Both types of MBSs
may be issued by either government agencies or private issuers;
however, those issued by government agencies are more common. See
pass-through collateralized mortgage obligation and real estate
mortgage investment conduit.
A secured party to whom insurance proceeds are paid as stipulated
in a mortgagee payee clause of an insurance policy obtained by a
debtor and covering property owned by a debtor and pledged to the
secured party. Generally applies to real property.
A provision in a hazard insurance contract stipulating that in the
event of a loss, proceeds will be paid to a secured party. Usually
used when the insured property is real property. Includes personal
property that is insured as contents of the insured real property.
The term mortgagee clause may be used to refer to all such insurance
policy stipulations. However mortgagee clauses are technically not
as broad as a similar insurance policy stipulation called a standard
mortgagee clause. See standard mortgagee clause.
A document obtained by some secured lenders with a collateral interest
in property covered or potentially covered by a mortgage granted
to a different lender. For example, if Bank B is taking a security
interest in large equipment that might be deemed to be fixtures
covered by a mortgage held by Bank A, Bank B may request a mortgagee
waiver from Bank A. May also be used when a tenant is granting its
lender a security interest in property that might be deemed to be
fixtures subject to a mortgage granted by the landlord to its lender.
See medium-term notes.
Synthetic securities created from municipal securities. Variable-rate,
short-term securities are, for example, created from long-term,
taxable municipals when remarketing agents add a series of put options,
the backing of a letter of credit, and an agreement to pay interest
at rates that vary weekly, monthly, quarterly, or semiannually.
See market value of portfolio equity.
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