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Questions and answers » Financial instruments

A-Z of financial instruments

A-Z of financial instruments

Publication date: 30 Nov 2005

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

Note – The glossary below is based on the requirements of the revised version of IAS 39 as at 31 March 2004 and

incorporates the following amendments made by the IASB to IAS 39.

● Transition and initial recognition of financial assets and financial liabilities

● Cash flow hedge accounting of forecast intra-group transactions

● The fair value option

● Financial guarantee contracts

Although the summary has been written in the context of international financial reporting standards, most of the terms are

relevant for UK GAAP reporters.

AAA/aaa rating: is the highest credit rating given by the two main agencies (Standard & Poor's and Moody's).

Arbitrage: is the simultaneous purchase and sale of similar financial instruments in order to profit from distortions caused

by price relationships.

Absolute rate: a bid made at an absolute rate is one which is not expressed in relation to a particular funding base such as

LIBOR or US treasury rates.

Accreting: occurs when the notional or actual amount of a financial instrument increases successively over the life of the

instrument. It is applicable to a number of instruments.

Accreting (or drawdown) swap: is an interest rate or currency swap with a notional or actual principal amount, which

increases in steps over the life of the swap. Such an arrangement would be structured to mirror the drawing down of funds

under a borrowing facility.

Accrued interest: is the interest earned but not yet due and payable. The buyer of a bond, for instance, pays the seller the

bond's agreed price plus interest accrued since the last interest date, up to and including the value date.

Active market: a market is considered active if quoted prices are readily and regularly available from an exchange, dealer,

broker, industry group, pricing service or regulatory agency, and those prices represent actual and regularly occurring

market transactions on an arm's length basis.

Actual or cash instrument: an actual is a physical financial instrument, such as cash, as distinguished from a futures

contract.

American depositary receipts (ADR): A form of international 'equity' is the depositary receipt. The most widely known

form of the depositary receipt is the ADR or American Depositary Receipt. There are other forms such as international

depositary receipts, but the process is broadly the same.

ADRs may be created as part of a sponsored programme by a company to raise the profile of the company and its products

in the US. At its simplest, however, the creation of an ADR results from the sale of a non US stock to a US shareholder

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who wants to retain that stock in a Dollar denominated form. In this case an intermediary such as a nominee US bank in the

UK would act as a depositary for the stock certificates of a UK company whose shares have been sold to a US investor. The

US office of that bank then issues receipts for those stocks denominated in the US Dollars.

The receipts themselves would then be issued to the investor and would be traded as US Dollar denominated stock, either

listed or unlisted on the US exchanges. The process works in reverse in much the same way; ADRs being transformed

through the depositary banks' systems back into fungible equities in the UK.

American option: is an option that can be exercised by the purchaser/holder at any time prior to its expiration. Generally

American options are more valuable than European options, due to the possibility of early exercise.

Amortised cost of a financial asset or liability: is the:

● amount at which the financial asset or financial liability is measured at initial recognition* ;

● minus: principal repayments;

● plus or minus: the cumulative amortisation using the effective interest method of any difference between the initial

amount and the maturity amount; and

● minus (in the case of a financial asset only): any reduction (directly or through the use of an allowance account) for

impairment or uncollectability.

* being fair value plus, in the case of a financial asset or financial liability not at fair value, transaction costs that are directly attributable to the acquisition or issue of the financial asset or financial

liability. Transaction costs in the case of a financial asset or financial liability held at fair value are expensed immediately.

Amortising swap: These are swaps for which the notional principal alters (for example, reduces or increases) over the term

of the swap. This is particularly useful for borrowers that have issued redeemable debt as it may facilitate their interest rate

hedging with the redemption profile of the debt.

Asian option: is an option where the pay off depends on the average price of the underlying asset during at least some part

of the option's life. Asian options come in two forms:

● Average price options – the pay out is the difference between the agreed strike price and the average asset price for

the period.

● Average strike options – the strike price is set as the average of asset prices over the period and the pay out is the

difference between the strike price and the spot price on the maturity date.

Averaging the underlying asset price reduces volatility, as option prices are largely determined by volatility. The premium

on an Asian option, therefore, tends to be cheaper than on a European option.

Ask (or asked): an ask, or an asked price, denotes the price level at which sellers offer securities to buyers. In some

markets it is used as an alternative to offer price.

Asset backed securities: the distinctive feature of asset backed securities is that the return on the securities is derived fromthe performance of specific assets (although this performance may be supported by various forms of guarantee). In general,

many forms of assets are available for securitisation, providing they have a contractual cash flow. In an issue of asset

backed securities, specific assets both serve as collateral for the securities and generate the payment streams that are used to

finance the payment of interest and principal to the investors in the security. This compares with a corporate bond where

payments to investors are made out of cash flows derived from the entity's operations as a whole (albeit that some bonds

may be secured by charges on assets in the event of a default).

Asset swap: asset swaps are similar to interest rate and currency swaps, except that they are undertaken by holders of assets

rather than liabilities. Asset swap is a general term for any repackaging of a debt instrument paying fixed interest into

floating, or vice versa, or involving a change in currency of interest and/or principal. For example, an investor may be

holding a fixed rate bond and may enter into a swap to convert the cash flows to floating rates.

Assignment: is an exercise notice that is given to an option writer (seller) that obligates him/her to sell (in the case of a




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call) or purchase (in the case of a put) the underlying security at the specified strike price.

Assignment (statutory and equitable): The transfer of rights (to principal and interest) but not obligations, to a third party

(the 'assignee') may be affected by either a statutory or equitable assignment. In a statutory assignment, which must relate to

the whole of the loan (finacial asset), notice must be given in writing to the borrower and other obligors (for example, a

guarantor). An equitable assignment may relate to only part of the loan (financial asset) and does not require notice to the

borrower or other obligors.

At-the-money: is when the current price of the underlying instrument (for example, shares) equals the strike price of an

option. When an option is at the money, its holder does not exercise the option, because there is nothing to gain by doing

so.

Auction market preferred shares (AMPS): AMPS are preference shares that are entitled to dividends determined in

accordance with an auction process in which a panel of investors participates, the shares being transferred at a fixed price to

the investor who will accept the lowest dividend. If the auction process fails - for example because no bids are received -

the shares remain in the ownership of the former holder and the dividend is increased to a rate, known as the default rate,

that is calculated in accordance with a prescribed formula. (This default rate may change if there is any change in the credit

rating of the issuer.) In some cases dividends may be passed at the option of the issuer and in any event will not be paid by

a UK company if there are insufficient distributable profits. If the dividend is not paid the holders of the AMPS do not

obtain any additional rights, for example to demand redemption. AMPS are redeemable at the option of the issuer, usually

at the issue price.

Available-for-sale: are those non-derivative financial assets that are designated as available-for-sale or are not categorised

as; (a) loans and receivables; (b) held-to-maturity investments; or (c) financial assets at fair value through profit or loss.

Available-for-sale does not mean that they are actually being held-for-sale within the meaning in IFRS 5. Available-for-sale

financial assets are carried at fair value (without any deduction for transaction costs it may incur on sale or other disposal),

unless they are investments which cannot be reliably measured and derivatives that are linked to and must be settled by

delivery of such unquoted equity instruments, when they are carried at cost less impairment.

A gain or loss arising from a change in fair value of an available-for-sale financial asset is recognised directly in equity,

through the statement of changes in equity, or the statement of recognised income and expense, except for impairmentlosses and foreign exchange gains and losses. When the financial asset is derecognised, the cumulative gain or loss

previously recognised in equity is recognised in profit or loss.

However, interest calculated using the effective interest method is recognised in profit or loss.

Dividends on available-for-sale equity instruments are recognised in profit or loss when the entity's right to receive payment

is established.

Average strike option: see Asian option.

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Bank deposits: depositors classify them as 'Loans and receivables' that are carried at amortised cost. Note that for

presentation purposes, these may be included in cash and cash equivalents. Banks carry such liabilities at amortised cost.

If a bank depositor intends to sell the instrument immediately or in the near term, the deposit is classified as a financial

asset held for trading and is measured at fair value through profit or loss.

Bank loans: borrowers carry them at amortised cost. If originated, banks generally classify them as 'Loans and receivables'

and carry them at amortised cost. Loans purchased from third parties are classified as 'Loans and receivables' (unless they

are quoted) but may be classified as 'at fair value through profit or loss', held-to-maturity or available-for-sale.

Base currency: is the currency which is quoted first in a foreign exchange rate, for example, the dollar in $/yen. The

exchange rate is the number of the quoted currency that equals one unit of the base currency, for example, $/yen 123, where

123 yen equals 1 dollar.




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Basis: this is the difference between the cash price of a financial instrument and the price of a related financial futures

contract.

Basis adjustment: a basis adjustment arises when an entity hedges the future purchase of an asset or the future issue of a

liability. One example is that of a UK entity that expects to make a highly probable future purchase of a German machine

that it will pay for in euro. The entity enters into a derivative to hedge against possible future changes in the sterling/euro

exchange rate. Provided that the documentation, designation and effectiveness criteria are met, such a hedge may beclassified as a cash flow hedge under IAS 39, with the effect that gains and losses on the hedging instrument (to the extent

that the hedge is effective) are initially recognised in equity.When the forecast transaction has occurred the cumulative

hedging gain or loss may be removed from equity and recognised as part of the initial carrying amount of the asset or

liability (in the example above, the machine). In future periods, the hedging gain or loss is automatically recognised in

profit or loss as part of depreciation expense (for a fixed asset), interest income or expense (for a financial asset or financial

liability), or cost of sales (for inventories). This treatment is commonly referred to as a 'basis adjustment'. This approach is

only appropriate for hedges of forecast transactions that will result in the recognition of a non-financial asset or a non-

financial liability.

Basis convergence: The phenomenon whereby the market value of a futures contract approaches the spot price for the

underlying item as the delivery date nears.

Basis point: is one-hundredth of a per cent (that is, 0.01% or 0.0001), and is typically used in expressing any change in

interest rates. The change from 7.00% to 7.03%, for example, is three basis points.

Basis risk: is the risk of movement between two different interest rate profiles – for example, LIBOR and US treasury

rates. The term can also be used in futures markets to describe the risk that the relationship between the spot rate of the

underlying and its future price will change.

Basis swap: This is a swap where the interest payments exchanged are based on two different floating rate indices. For

example, a US dollar LIBOR versus US Treasury Bill rate swap.

Bear: This is a term for a person who expects prices will move lower.

Bear spread: A bear spread is an option strategy that involves combining two or more positions at different strike prices or

different expiry dates.

An example is the sale of a call option with a low exercise price together with the purchase of a call option with a high

exercise price. The investor thereby profits if prices fall.

Bed and breakfast: see Wash sales.

Bermudan option: is an option which the holder can exercise on one or more possible dates prior to its expiry. It is also

known as a limited exercise, a mid-Atlantic or a semi-American option.

Bid: is the rate at which a market maker borrows from a market taker; the price or yield on a security at which the

purchaser is willing to buy.

Bid-offer (or bid-ask) spread: is the amount that the offer (or ask) price is greater than the bid price of an instrument.

When used in IAS 39 in the context of quoted market prices this term comprises transaction costs only. Other adjustments

to arrive at fair value (for example, for counterparty credit risk) are not included in the 'bid-ask' spread.

Bid price: is the quoted market price that a market marker will pay for an instrument including transaction costs.

Bifurcate: is to split or divide in two. This is the term used when, for example, an issuer of a compound instrument splits

that instrument into its debt and equity elements, or a holder of a hybrid instrument splits it into a host contract and

embedded derivative.




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Black-Scholes: A model for pricing options. The model uses the share price, the risk-free interest rate, the time to

expiration of the option and the expected standard deviation of the share return (distributions).

Bonds: are certificates of debt, generally long-term, where an issuer contracts to pay the holder a fixed principal amount on

a specified future date and, often, a series of interest (fixed or variable) payments during its life.

Bonds held as assets generally should be classified as 'Loans and receivables' (where acquired from the issuer directly or

via a broker or other intermediary and providing that they are not quoted). Bond assets may be classified as held-to-maturity, at fair value through profit or loss or available-for-sale. Bonds classified as 'Loans and receivables' or held-to-

maturity are carried at amortised cost less impairment, whilst those in the other two classifications are carried at fair value.

Bonds issued by an entity are financial liabilities and are carried at amortised cost. Unless the bonds form part of a trading

portfolio or the issuer designates, where permitted, at inception to fair value a bond, the issuer cannot classify the liability

as one to be measured at fair value.

Borrow long: This is a borrowing of long-term cash. This term is also used in comparison with investing short, where the

term for borrowing is greater than the term for the investing.

Borrow short: To borrow short-term cash. This term is also used in comparison with investing long, where the term for the

borrowing is less than the term for the investing.

Bull: This is a term for a person who expects prices will move higher.

Bullet bonds: These are bonds where the whole of the par value of a bond is redeemed by the issuer on a specified maturity

date. A debt security that is redeemed in this way is known as a 'bullet'.

Bull spread: A bull spread involves the purchase of a call option with a relatively low exercise price and the sale of a call

option with a relatively high exercise price.

Butterfly spread: Options strategies that involve combining two or more positions with different strike prices, or different

expiry dates, are called spreads.

By combining a bear spread and a bull spread, an investor can take advantage of a market that he/she expects to remain

relatively stable, whilst limiting the risk of loss from large price movements.

Buy in: This is a purchase made to cover, offset or close a short position.

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Call: The right to acquire the underlying instrument at a predetermined price at a future date.

Call option: A call option is a contract that conveys the right but not the obligation to the purchaser/holder to buy the

underlying at the strike/exercise price at a fixed date (where the option is European) or during a fixed period of time (where

the option is American).

Callable instrument: is an instrument that gives the issuer the right to call it back from the holder (that is, to terminate the

instrument).

Cap and floor options: Caps and floors modify the plain vanilla variety of options with a provision. The seller of a cap is

obliged to reimburse the buyer should the prevailing price/rate on expiry exceed the cap's strike rate. A typical floor seller

agrees to compensate the buyer should the rate fall below the agreed strike price. The seller of either a cap or floor receives

a premium for taking on this risk.

Specifically, an interest rate cap is an agreement by the cap seller to pay the buyer the excess of the prevailing market rate

(for example, three month LIBOR) over a cap rate (for example, 6 per cent) based upon an agreed notional principal

amount. Conversely, an interest rate floor is an agreement by the floor seller to pay the buyer excess of a floor rate over a

prevailing market interest based upon an agreed notional principal amount. Accordingly, buying a cap (long) and selling a




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floor (short) struck at the same rate, based on the same index, notional and maturity, is equivalent to entering into a payer's

interest rate swap with a fixed rate equal to the strike of the cap/floor.

One significant difference between a plain vanilla interest rate option and a cap or floor option is that there are often reset

dates within the contract lives of caps and floors (for example, market rate is three month LIBOR which resets every three

months) on which the seller must pay the buyer an amount by which the prevailing rate exceeds (in the case of caps) or falls

below (in the case of floors) the strike price/rate.

For a cap, payments are only made by the seller if the market rate exceeds the cap rate, therefore, the maximum loss to the

purchaser is the premium. Similarly, for a floor, payments are only made by the seller if the floor rate exceeds the market

rate; therefore, the maximum loss to the purchaser is also the premium. Accordingly, upon receipt of the premium from the

buyer, the seller bears no credit risk for these types of transactions.

Captions and floortions: a caption is an option to buy a cap option in the future. A floortion is an option to buy a floor

option in the future. A caption is useful if a company is uncertain of future interest rates; it might be involved in a major

acquisition and needs to be able to fix borrowing costs. A floortion is useful if a company wants to deposit at a floating rate

while still leaving the potential for upward movements in rates.

Cash flow interest rate risk: is the risk that future cash flows of a monetary financial instrument will fluctuate because of

changes in market interest rates. In the case of a floating rate debt instrument, for example, such fluctuations result in a

change in the effective interest rate of the financial instrument, usually without a corresponding change in its fair value.

Cash flow hedges: a hedge of the exposure to variability in cash flows that:

● is attributable to a particular risk associated with a recognised asset or liability (such as all or some future interest

payments on variable rate debt) or a highly probable forecast transaction; and

● could affect profit or loss.

Guidance on the implementation of IAS 39 states that a hedged forecast transaction must be highly probable, which

indicates a much greater likelihood of it happening than the term 'more likely than not' and is also significantly higher than probable. This assessment should be supported by observable facts and circumstances.

Cash flow hedges are accounted for as follows:

● the portion of the gain or loss on the hedging instrument that is determined to be an effective hedge is recognised

directly in equity through the statement of changes in equity; and

● the ineffective portion of the gain or loss on the hedging instrument is recognised directly in profit or loss.

Cash pooling: this is the name given to a mechanism whereby cash surpluses and overdrafts residing in an entity's or

group's various bank accounts are pooled together at the end of the day to create a net surplus or overdraft. Cash pooling is

used to realise savings, either through minimising interest expense or maximising interest income.

Cash pooling mechanisms are unlikely to meet IAS 32's requirements for offsetting of cash balances and overdrafts for

presentation in the balance sheet.

Certificates of deposit: these are amounts deposited with a bank that it will redeem at a stated maturity date and on which

interest will have accrued. These instruments can be traded. When acquired from the issuer directly or via a broker, they are

classified as loans and receivables (provided they are not quoted) and held at amortised cost, unless they are held for trading

and are thus measured at fair value through profit or loss. Banks carry such liabilities at amortised cost, unless they are held

in the portfolio for trading in which case they are carried at fair value through profit or loss.

Clean price: this is the total price of a financial instrument less accrued interest.

Climatic, geographical or other physical variables: such variables may be found in contracts which can be divided into

two categories:




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● Contracts that require a payment only if a particular level of the underlying climatic, geological, or other physical

variables adversely affects the contract holder. These are insurance contracts as defined in IFRS 4. For example, a

pluvious insurance taken out by a fete organiser against the effect if it rains on the day of the fete.

● Contracts that require a payment based on a specified level of the underlying climate, geological or other physical

variable, regardless of whether there is an adverse effect on the contract holder (for example, a bet that it will snowon Christmas day). These are derivatives and IFRS 4 removes a previous scope exclusion to bring them within IAS

39's scope.

Cliquet (ratchet) option: a cliquet (or 'ratchet') option is a sequential series of forward start options where the strike

price/rate for the next period is reset at each period end up or down to the market price at that time. An example would be

an option that is due to start in three months time and run for a further six months. The initial strike price is not determined

until the start date and is usually the current spot price at that date. This strike price is then reset to match the prevailing

asset price on set predetermined dates. Whenever the strike price is reset the intrinsic value is locked in.

Collar: a collar is the simultaneous purchase of a cap and a floor option. The premium from selling the put (the floor)

reduces the cost of purchasing the call (the cap). The amount saved depends on the strike rate of the two options. If the

premium raised by the sale of the put exactly matches the cost of the call, the strategy is known as a zero cost collar.

Collateral: properties, cash or other assets that are offered to the lender to secure a loan or other credit in case the borrower

fails to pay back the loan. Collateral is thus subject to seizure by the lender on default.

Collateralised bond obligation (CBO): bonds that are assigned one of the top four credit ratings that are backed by bonds

with a speculative rating that is lower (that is, junk or high yield bonds).

Collateralised debt obligation (CDO): a general term that includes collateralised bond obligations, collateralised loan

obligations and collateralised mortgage obligations.

Collateralised loan obligation (CLO): is a security backed by a pool of loans (commercial or personal). These arestructured such that there are several classes (tranches) of bond holders with varying maturities.

Collateralised mortgage obligation (CMO): is a security backed by a pool of mortgages (commercial or home). These are

structured such that there are several classes (tranches) of bond holders with varying maturities. The principal payments

from the underlying mortgages are used to extinguish (that is, pay back) the CMO bonds on a priority basis as specified in

the prospectus for these securities.

Combination options: a combination option combines puts and calls on the same underlying instrument or commodity, so

that they are either both bought or both written options. Two popular combinations are straddles and strangles.

Commercial paper: commercial paper issues are negotiable promissory notes with short-term maturities. Their most

important characteristics are:

● The maturities are flexible and are fixed by the issuer at the time of issue. In most markets they will range from a few

days to a year.

● The notes are usually issued in higher denominations than is the case with longer-dated securities. US dollar euro-

commercial paper issues, for example, are issued in $250,000 denominations, compared with $1,000 for eurobonds.

This reflects the domination of markets by large and professional investors.

The majority of commercial paper issues are unsecured. However, most commercial paper programs are given ratings by

the leading credit rating agencies in a similar way to bonds. Moody's ratings for commercial paper are from P1 to P3, and

Standard and Poor's range from A1 to A3.

Commercial paper can be issued in interest bearing form, analogous to longer dated instruments (with principal amount and




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bearing a stated interest rate). However, it is more usual for the paper to be issued at a discount to its face value. The yield

on the instrument is reflected in the difference between the discounted price and the par value at which it will be redeemed.

Commercial paper is quoted in the secondary markets on a yield basis rather than at a price expressed as percentage of par.

Commercial paper is issued in bearer form. In other words, investors do not have to be registered, and ownership is

evidenced by physical possession.

Commercial paper is a financial asset of the holder and will generally be classified at fair value through profit or loss (if

held for trading) or as available-for-sale. In both cases it will be measured at fair value. Commercial paper issued by an

issuer will generally be measured at amortised cost.

Commitment fee: this is an amount that lending institutions charge their borrowers for credit that is unused or credit that

has been promised by the lender at a specified future date.

Committed facility: a credit (loan) facility whereby the terms and conditions are defined by the lender and imposed upon

the borrower.

Commodity derivatives: contracts to buy or sell a non-financial item (for example, hard commodities (such as metals) andsoft commodities (such as oils, grains, cocoa, pork bellies, coffee, cotton, soya, beans, sugar, gas, electricity etc)) that give

either party the right to settle in cash or some other financial instrument, or by exchanging financial instruments. They are

derivatives and must be carried at fair value, with the exception of those entered into and which continue to be held for the

purpose of receipt or delivery of a non-financial item in accordance with the entity's expected purchase, sale or usage

requirements.

Commodity contracts excluded from IAS 39's scope are not recognised as assets, but, when onerous, may be reported as

liabilities in accordance with IAS 37.

IAS 32 and 39 clarify that this 'normal purchases and sales' exemption depends on the entity's experience with respect to

similar contracts and does not extend to an entity with a practice and history of net cash settlement, even if there is no

contractual or market settlement.

Commodity futures: a commodity future is a contract traded on an exchange that gives the holder the right to buy or sell a

specified amount of a commodity at a stated price and date in the future. Examples of commodities are agricultural products

(wheat, coffee, corn, cocoa, etc), precious metals (gold, platinum, etc) non-ferrous metals (copper, zinc etc) and petroleum

products (crude oil, fuel oil etc). There are also meat and meat product futures (hogs, cattle, etc) and a number of other

products (frozen orange juice, plywood and eggs).

Compound instrument: a compound instrument is a non-derivative financial instrument whose terms determine that, from

the issuer's perspective, it contains both a liability and an equity component. An issuer recognises separately the

components of a financial instrument that: (a) creates a financial liability of the entity; and (b) grants an option to the holder

of the instrument to convert it into an equity instrument of the entity. The equity conversion option is a 'derivative over ownshares' and is subject to the rules under IAS 32 on alternative settlement provisions. From the holder's perspective this

contract is a hybrid instrument.

Compound option: this is an option on an option for a specific currency. It is the currency equivalent of

captions/floortions. The option premium on the initial option is lower than a conventional option, but, if exercised, the

overall cost will be higher than the purchase of an outright currency option.

Contingent settlement provision: this is where a financial instrument may require the issuer to deliver cash or another

financial instrument, or otherwise settle it in such a way that it would be a financial liability in the event of the occurrence

or non-occurrence of uncertain future events (or on the outcome of uncertain circumstances) that are beyond the control of

both the issuer and holder of the instrument, such as change in stock market index, consumer price index, interest rate or

taxation requirements, or the issuer's future revenues, net income or debt-to-equity ratio. The issuer of such an instrumentdoes not have the unconditional right to avoid delivering cash or another financial asset (or otherwise to settle it in such a

way that it would be a financial liability). Therefore, it is a financial liability of the issuer unless:




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● the part of the contingent settlement provision that could require settlement in cash or another financial asset (or

otherwise in such a way that it would be a financial liability) is not genuine; or

● the issuer can be required to settle the obligation in cash or another financial asset (or otherwise to settle it in such a

way that it would be a financial liability) only in the event of liquidation of the issuer.

Continuing involvement: is where an entity neither transfers nor retains substantially all the risks and rewards of ownership of a transferred asset, but retains control of the transferred asset, in which case the entity continues to recognise

the transferred asset to the extent of its continuing involvement. The extent of the entity's continuing involvement in the

transferred asset is the extent to which it is exposed to changes in the value of the transferred asset.

Contract: is an agreement between two or more parties that has clear economic consequences that the parties have little, if

any, discretion to avoid, usually because the agreement is enforceable at law. Contracts may take a variety of forms and

need not be in writing.

Covenant: a promise in a debt agreement that agreed activities will be undertaken (positive) or not done (negative). A

breach of a covenant is a default on the debt.

Convertible bonds: are compound instruments that (for the holder) cannot be held-to-maturity investments, unless theyonly convert at the final maturity date. Instead they are classified as available-for-sale provided they are not purchased for

trading purposes. They contain an embedded derivative – the option to convert into shares. For those classified as available-

for-sale (that is, carried at fair value with gains and losses reported in equity until the bond is sold), the equity conversion

option (the embedded derivative) is separated. The amount paid for the bond is split between the debt instrument without

the conversion option and the equity conversion option. Changes in the fair value of the equity conversion option are

recognised in profit or loss unless the option is part of a cash flow hedging relationship.

If the convertible bond is measured at fair value with changes in fair value recognised in profit or loss, separating the

embedded derivative from the host bond is not permitted.

From the perspective of the issuer, such an instrument comprises two elements: a financial liability (a contractualarrangement to deliver cash or other financial assets) and an equity instrument (a call option granting the holder the right,

for a specified period of time, to convert into issuer's shares). The economic effect of issuing such an instrument is

substantially the same as issuing simultaneously a debt instrument with an early settlement provision and warrants to

purchase equity shares, or issuing a debt instrument with detachable share purchase warrants. Accordingly, in all cases, the

issuer presents the liability and equity elements separately on its balance sheet. The equity element is a 'derivative over own

shares' and is subject to the rules under IAS 32 on alternative settlement provisions. Where there is no cash alternative, the

equity element is included in equity. However, where there is a settlement provision that allows the issuer to settle the

equity element in cash rather than in a fixed number of equity shares, the equity element is a derivative liability, which is

held at fair value with movements taken through profit or loss.

Classification of the liability and equity elements of a convertible instrument is not revised as a result of a change in the

likelihood that a conversion option will be exercised, even when exercise of the option may appear to have becomeeconomically advantageous to some holders. Holders may not always act in the manner that might be expected, because, for

example, the tax consequences resulting from conversion may differ among holders. Furthermore, the likelihood of

conversion will change from time to time. The issuer's obligation to make future payments remains outstanding until it is

extinguished through conversion, the maturity of the instrument or some other transaction.

Coupon: generally, this is the nominal annual rate of interest expressed as a percentage of the principal value, which the

borrower promises to pay the holder of a fixed income security.

Covered call option: the writing of a call option for which the writer owns an instrument or commodity that could be

delivered if the call option is exercised by its holder.

Covered put option: the writing of a put option on an instrument or commodity in which the writer has a short position.




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Credit default swap: this is a credit derivative that transfers credit risk (that is, the risk of default) from the holder of the

swap to the issuer. Income received and the risk assumed by one party extending credit to an entity may be swapped for the

income and risk associated with giving credit to another party. It may be a financial instrument or an insurance contract

depending on whether or not it relates to a specified financial asset owned by the holder of the swap.

Credit derivative: the credit derivative is a relatively new derivative product. The credit derivative seeks either to hedge

against or to assume the risk of default by one or number of counterparties. Option style credit derivatives behave in much

the same way as insurance contracts, as these cannot be exercised unless there is a counterparty default. The contract wouldnormally state the counterparties covered and an absolute level of exposure to the seller of, say $10 million. The pricing and

characteristics are conceptually the same as for a call option.

Credit insurance: is insurance that provides for specified payments to be made to reimburse the holder for the loss it incurs

because a specified debtor fails to make payment when due under the debt instrument's original or modified terms. These

contracts can have various legal forms, such as that of a guarantee, some types of letter of credit, a credit derivative default

contract or insurance contract.

A credit-related guarantee that does not, as a pre-condition for payment, require that the holder is expected to be exposed to,

and has incurred a loss on, the failure of the debtor to make payments on the guaranteed asset when due is a financial

instrument and is not an insurance contract.

Credit rating: this is a letter, or combination of letters and numbers, that signifies a security's investment rating. The main

rating agencies are Moody's and Standard & Poor's.

Credit risk: is the risk that one party to a financial instrument will fail to discharge an obligation and cause the other party

to incur a financial loss.

Critical terms matching: this is a method that, in very limited circumstances, an entity may adopt in order to assess hedge

effectiveness. Critical terms matching can only be used if the entity is certain that critical terms match exactly at the

inception of the hedge and also that they expect this to continue throughout the life of the hedging relationship. If the

principal terms of the hedging instrument and of the hedged asset, liability, firm commitment or highly probable forecast

transaction are identical, the changes in fair value and cash flows attributable to the risk being hedged may be likely tooffset each other fully, both when the hedge is entered into and afterwards. For example, an interest rate swap is likely to be

an effective hedge if the notional and principal amounts, term, repricing dates, dates of interest and principal receipts and

payments, and basis for measuring interest rates are identical for the hedging instrument and the hedged item. In addition, a

hedge of a highly probable forecast purchase of a commodity with a forward contract is likely to be highly effective if:

● the forward contract is for the purchase of the same quantity of the same commodity at the same time and location as

the hedged forecast purchase;

● the fair value of the forward contract at inception is zero; and

● either the change in the discount or premium on the forward contract is excluded from the assessment of effectiveness and recognised in profit or loss or the change in expected cash flows on the highly probable forecast

transaction is based on the forward price for the commodity.

Cross currency interest rate swaps: are instruments that enable an entity to swap both the currency of a principal amount

as well as the interest payments. A fixed to fixed cross currency interest rate swap involves an exchange of interest

liabilities between currencies. It may consist of three stages:

● A spot exchange of principal. This does not always form part of the swap agreement, as a similar effect can be

obtained by using the spot foreign exchange market.

● Continuing exchange of fixed interest payments during the term of the swap, where the timing of the interest flowson both legs in the swap is identified. This in effect reqresents a series of forward foreign exchange contracts during




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the term of the swap contract. This is typically done at the same exchange rate as the spot rate used at the swap's

inception. This is because interest payments are made between the parties during the swap's life based on the interest

rates available in the two currencies at the contract's inception. If any other exchange rate is used on re-exchange, this

is because the bank is building in part of its profit in exchange rate terms rather than as fee or interest spread terms.

Any difference between the initial and final principal exchanges is known as the exchange discount or premium.

● Re-exchange of principal on maturity at the spot rate at inception if there was an exchange of principal at inception.

In essence there is a formalised long-term foreign exchange deal, fully reflecting all inherent differentials and documented

in a legal agreement.

A fixed to floating or a floating to floating cross currency interest rate swap is one that exchanges a fixed or floating interest

payment in one currency for a floating rate payment in another currency. These types of swaps do not represent a series of

forward foreign exchange contracts due to the floating nature of one or both legs.

Currency forwards: these are contracts to buy or sell an amount of currency at an agreed exchange rate with settlement

and delivery at a specified future date.

Currency risk: is a market risk – the risk that the value of a financial instrument will fluctuate due to changes in foreignexchange rates.

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Debt for equity swap: here, one party pays fixed or floating coupons interest and receives interest coupons based upon the

performance of an equity index. If the index falls (for a product with payoff based upon rise in the index) the equity-linked

coupon is not paid.

Deep discounted bonds: deep discounted or zero coupon bonds (ZCB) are bonds that make no periodic interest payments

and are, therefore, sold at a large discount ('deep discount') to their nominal value. Instead of interest payments the buyer of

such a bond receives as a return the difference between the purchase price and the higher redemption proceeds. There are

only two cash flows that arise on a zero coupon bond: the proceeds at the date of issue (which, if the bond is to be redeemed

at par, will be at a substantial discount to par value), and the payment on redemption date.

The issue will be priced at a larger discount to par value the longer the zero coupon bond's life. The bond's price in the

secondary market will gradually accrete as the maturity date approaches.

Default: the failure to pay promptly interest or principal on a debt security or to otherwise comply with the provisions of a

loan agreement such as a breach of a covenant.

Delta: is defined as the relationship between a change in the derivative price and a corresponding change in the price of the

underlying asset. The delta of an option is a most important concept, because it is used in areas such as margining (see

margin) and hedging an options portfolio.

The delta of an option is the prime determinant of the risk factors used by many exchanges in determining the margin funds

that are required to be deposited by sellers and perhaps buyers of options.

The overall delta of a portfolio reveals how much its value will change for a change in the asset price. It is thus a

fundamental measure of the portfolio's risk.

Delta hedging: The concept of delta is used in a method of hedging options. The price or value of an option will move by

an amount equal to the movement in price of delta multiplied by the underlying quantity of the instrument to which the

option relates. Thus at any time the writer of an option can protect himself from the effect of any price movements on the

option by holding an amount, delta, of the underlying instrument. However this is only valid for infinitely small movements

in the option's price and is particularly difficult to apply when an option is at or near the money, as at this point the timevalue of the option reaches its maximum. Transaction costs present problems for 'delta hedgers', for they obstruct the

continued readjustments of the hedge that is assumed by the theory.




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Delta-neutral hedging: is a hedging strategy that involves constantly adjusting the quantity of the hedging instrument in

order to maintain a described hedge ratio to achieve a delta-neutral position insensitive to changes in the fair value of the

hedged item.

Implementation guidance to IAS 39 states that a delta-neutral hedging strategy is possible to qualify for hedge accounting

as it is a form of "dynamic hedging strategy that assesses both the intrinsic value and the time value of a option contract" .For example, a portfolio insurance strategy that seeks to ensure that the fair value of the hedged item does not drop below

a certain level, while allowing the fair value to increase, may qualify for hedge accounting.

To qualify for hedge accounting, the entity must document how it will monitor and update the hedge and measure hedge

effectiveness, be able to track properly all terminations and redesignations of the hedging instrument and demonstrate that

all other criteria for hedge accounting are met. Also, it must be able to demonstrate an expectation that the hedge will be

highly effective for a specified short period of time during which the hedge is not expected to be adjusted.

Depth of the market: this is the amount of a given security that can be dealt in the market at a given time without causing

price fluctuation. Thin markets are usually characterised by wide spreads and substantial price fluctuations during a short

period of time. Strong markets tend to be characterised by relatively narrow spreads and stable prices.

Derecognition of a financial asset: is the removal of a previously recognised financial asset from an entity's balance sheet.

Derecognition occurs only when the seller has transferred the asset's risk and rewards (either substantially or partially) or

control of the contractual rights have been transferred from the seller to the buyer. The evaluation of the transfer of risks

and rewards should precede an evaluation of the transfer of control for all types of transaction. The positions of both the

seller and the buyer should be considered, but the seller's position is seen as more relevant. Thereafter, an enterprise may

achieve partial derecognition where it recognises the components that have been retained, or new assets or liabilities such as

those that arise from issuing a guarantee.

If the entity determines that it has neither retained nor transferred substantially all of an asset's risks and rewards and that it

has retained control, the entity should continue to recognise the asset to the extent of its continuing involvement.

On derecognition, the difference between the amount received and the asset's carrying amount is recognised in profit or

loss. Any fair value adjustment to the asset formerly reported in equity is then recycled to profit or loss.

Derecognition of a financial liability: financial liabilities (or part of a financial liability) are removed from the balance

sheet when, and only when, extinguished that is, when the obligation specified in the contract is discharged, cancelled or

expires. For example, derecognition occurs when a liability is paid or the debtor is released from primary responsibility for

the liability either by process of law or by the creditor.

On derecognition, the difference between the consideration paid and the liability's carrying amount is recognised in profit or

loss.

Derivative: as defined in IAS 39 is a financial instrument or other contract:

● whose value changes in response to changes in a specified interest rate, financial instrument price, commodity price,

foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable, provided in the case of

a non-financial variable that the variable is not specific to a party to the contract (sometimes called the 'underlying');

● that required no initial net investment or an initial net investment that is smaller than would be required for other

types of contracts that would be expected to have a similar response to changes in market factors; and

● that is settled at a future date.

All derivatives must be carried at fair value. Gains and losses are reported as profit or loss unless they qualify as effective

cash flow hedges or a hedge of a net investment in a foreign operation when gains and losses are deferred in equity and

recycled to income to match the income/expense on the hedged transaction.

Derivative financial instruments: are financial instruments such as financial options, futures and forwards, interest rate




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swaps and currency swaps, which create rights and obligations that have the effect of transferring between the parties to the

instrument one or more of the financial risks inherent in an underlying primary financial instrument. On inception,

derivative financial instruments give one party a contractual right to exchange financial assets or financial liabilities with

another party under conditions that are potentially favourable, or a contractual obligation to exchange financial assets or

financial liabilities with another party under conditions that are potentially unfavourable. However, they generally do not

result in a transfer of the underlying primary financial instrument on the contract's inception, nor does such a transfer

necessarily take place on the contract's maturity. Some instruments embody both a right and an obligation to make an

exchange. Because the terms of the exchange are determined on the derivative instrument's inception, as prices in financialmarkets change those terms may become either favourable or unfavourable.

Implementation guidance to IAS 39 states that non-derivative transactions are aggregated and treated as a derivative when

the transactions result, in substance, in a derivative. Indication of this would include:

● They are entered into at the same time and in contemplation of each other.

● They have the same counter party.

● They relate to the same risk.

● There is no apparent need or substantive business purpose for structuring the transaction that could not also have

been accomplished in a single transaction.

Dirty price: this is the total price of a financial instrument, including accrued interest.

Discontinuing hedge accounting: arises when:

● a hedging instrument expires or is sold terminated or exercised (for this purpose, the replacement or rollover of a

hedging instrument into another hedging instrument is not an expiration or termination if such replacement or

rollover is part of the entity's documented hedging strategy);● the hedge no longer meets the criteria for hedge accounting (see below);

● a forecast transaction is no longer expected to occur (cash flow hedge only); or

● the entity revokes the designation.

In each case, hedge accounting ceases prospectively. For a past cash flow hedge, any gain or loss deferred remains in equity

where a forecast transaction is expected to occur but is no longer 'highly probable' and is recycled by adjusting the cost of

the item. Otherwise any deferred gain or loss is immediately reported in profit or loss.

Discount: this is the difference between the stated par and the market price of an issue for issues selling below par, or the

difference between the spot exchange rate and the forward exchange rate when the latter is above the former.

A currency in the forward market is at a discount when its interest rate is above that of the currency with which it is being

compared.

Discount factor: a future cashflow can be discounted to take account for the time value of money. The fraction, expressed

as a decimal, which when applied to the future cashflow to discount, is known as the discount factor. The formula uses the

interest rate and the number of days for the period required.

Dollar-offset: is the name given to the ratio analysis that compares the change in the hedged item's fair value to the change

in the hedging instrument's fair value (or vice versa). It is commonly specified as the method used to judge hedge

effectiveness. See Hedge effectiveness.

Duration: the sensitivity of the price of a fixed-income security to changes in the interest rates. The duration of a series of

cash flows is the price-weighted average term to maturity of the zero coupon bonds represented by each cash flow in the




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series. Duration is measured in years and for all bonds, other than zero coupon bonds, the duration is shorter than the time

to maturity (for zero coupon bonds these are equal).

Dual currency bond (Dual option bond): this is a bond where the redemption proceeds are expressed in two currencies.

The investor may choose the currency in which to receive payment of coupons and redemption.

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Effective interest method: is a method of calculating the amortised cost of a financial asset or a financial liability (or

group of financial assets or financial liabilities) and of allocating the interest income or expense over the relevant period.

Effective interest rate: is the rate that exactly discounts estimated future cash payments or receipts through the expected

life of the financial instrument or, when appropriate, a shorter period to the net carrying amount of the financial asset or

financial liability. When calculating the effective interest rate, an entity shall estimate cash flows considering all of the

financial instrument's contractual terms (for example, prepayment, call and similar options) but shall not consider future

credit losses. The calculation includes all fees and points paid or received between parties to the contract that are an integral

part of the effective interest rate, transaction costs and all other premiums or discounts. There is a presumption that the cash

flows and the expected life of a group of similar financial instruments can be estimated reliably. However, in those rare

cases when it is not possible to estimate reliably the cash flows or the expected life of a financial instrument (or group of

financial instruments), the entity should use the contractual cash flows over the financial instrument's full contractual term

(or group of financial instruments).

Embedded derivative: a component of a hybrid (combined) instrument that also includes a non-derivative host contract –

with the effect that some of the cash flows of the combined instrument vary in a way similar to a stand-alone derivative. An

embedded derivative causes some or all of the cash flows that otherwise would be required by the contract to be modified

according to: a specified interest rate; financial instrument price; commodity price; foreign exchange rate; index of prices or

rates; credit rating or credit index; or other variable, provided in the case of a non-financial variable that the variable is not

specific to a party to the contract. A derivative that is attached to a financial instrument but is contractually transferable

independently of that instrument, or has a different counterparty from that instrument, is not an embedded derivative, but a

separate financial instrument.

An embedded derivative is separated from the host contract and accounted for as a derivative under IAS 39 if, and only if:

● the embedded derivative's economic characteristics and risks are not closely related to the host contract's economic

characteristics and risks;

● a separate instrument with the same terms as the embedded derivative would meet the definition of a derivative; and

● the hybrid (combined) instrument is not measured at fair value with changes in fair value recognised in profit or loss

(that is, a derivative that is embedded in a financial assets or financial liability at fair value through profit or loss is

not separated).

Embedded option: this is an option (often an interest rate option) that is embedded in a debt instrument that affects its

redemption.

Examples include mortgage backed securities and callable and puttable bonds.

Equity: an entity's own equity instruments, including certain options and warrants issued and purchased and own shares

(treasury shares), are not financial instruments. However, a financial liability includes any liability that is a contract that is

to be, or may be, settled in the entity's own equity instruments and is:

● a non-derivative for which the entity is, or may be, obliged to deliver a variable number of the entity's own equity

instruments; or

● if the contract is a derivative that will or may be settled other than by exchange of a fixed amount of cash or another

financial asset for a fixed number of the entity's own equity instruments. For this purpose the entity's own equity

instruments do not include instruments that are themselves contracts for the future receipt or delivery of the entity's

own equity instruments.




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Derivative contracts such as forward contracts to buy an entity's own equity shares and written put options over an entity's

own equity shares, are financial liabilities and not equity instruments even though settlement is by way of a fixed amount of

cash for a fixed number of shares.

This is because a contract that contains an obligation for an entity to purchase its own equity instruments for cash or another

financial asset gives rise to a financial liability for the present value of the redemption amount (for example, the present

value of the forward repurchase price, option exercise price or other redemption amount).

An entity's contractual obligation to purchase its own equity instruments gives rise to a financial liability even if the

obligation to repurchase is conditional on the counterparty exercising a right to redeem (for example, a written put option

gives the counterparty the right to sell an entity's own equity instruments to the entity for a fixed price).

Equity instrument: is any contract that evidences a residual interest in the entity's assets after deducting all of its

liabilities.

An investment in an equity instrument of another entity is carried at fair value as a financial asset at fair value through

profit or loss or as a financial asset held as available-for-sale (through equity unless impairment losses or foreign exchange

gains and losses) unless its value cannot be reliably measured, when cost less impairment is used. Currency elements

present in foreign currency denominated equity investments may not be separated unless hedged in a fair value currency

hedge.

Eurobond: eurobond is a general term for any long-dated debt security issued through the euromarkets. The general

characteristics shared by most eurobond issues are as follows:

● Eurobonds are issued in bearer form. In other words, investors do not have to be registered (as in the domestic United

States bond market), and ownership is evidenced by physical possession. Interest is payable to the holder presenting

the coupon to the paying agent for that particular issue. The coupon is detachable from the bearer bond. This can be

an advantage to investors who wish to retain anonymity.

● Interest is quoted on the 30/360 basis (this is how the interest accrues over time, this assumes 30 days per month and360 days per year).

● Eurobond issues pay interest gross and the effect of any withholding taxes is bourne by the issuer.

● Eurobonds are long-term instruments with maturities in excess of five, and up to 30, years.

● Eurobonds are usually issued in small denominations (often $1,000).

● Borrowers are typically sovereign states, government-based institutions, supranational entities (such as the World

Bank) and the larger multi-national corporations. As such, issuers tend to be household names with high creditratings.

● The issues are usually unsecured, reflecting the quality of the borrowers.

● Eurobonds will normally be listed on a stock exchange, although this is not a requirement. The listing will usually be

on either the Luxembourg Stock Exchange or The London Stock Exchange. Listings are undertaken to make issues

more popular with investors, both because of the disclosure and reporting requirements of the stock exchanges and

because some countries do not allow their residents to purchase unlisted foreign securities. Only a very small

percentage of the trading in listed eurobonds takes place on these exchanges.

● The standard terms of trade are for seven day settlement and the majority of transactions are settled through two

clearing houses (Euroclear and Cedel).




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Eurodollar: these are US dollars deposited in a foreign bank or US bank branch located outside the United States.

European option: a European option is one that can be exercised by the holder only at the fixed date at which the option

expires.

Exchange gains and losses: are recognised in profit or loss as they arise except for qualifying cash flow hedges and net

investment hedges where they are deferred in equity to the extent that they arise from an effective hedge relationship.

The application guidance included in IAS 39 confirms that exchange gains and losses on monetary available-for-sale assets

are recognised in profit or loss even if other changes in value are deferred in equity.

Exchange traded options: are options whose terms are standardised and are traded on a recognised exchange, for example,

Chicago Board Options Exchange, NY Futures Exchange and Euronext LIFFE in London.

Exercise period: the period during which an option may be exercised.

Exercise price: see Strike price.

Exotic option: this is any option with a more complicated pay-out structure than a simple put or call option.

Extendable swap: is a swap that grants one of the conterparties the option to extend the instrument's life.

Top

Factored debts: this is where an entity sells its receivables for cash in order to improve its cash flow position. Factored

debts can be derecognised provided that the criteria for derecognition have been met. See Derecognition.

Fair value: is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing

parties in an arm's length transaction. For assets the market bid price should be used and not mid-market or asking (or offer)

price. For liabilities, the market asking price should be used. Mid-market prices can only be used where an entity has assets

and liabilities with offsetting market risks (this is expected to be rare). The fair value of a financial liability with a demand

feature (for example, a demand deposit) is not less than the amount payable on demand, discounted from the first date that

the amount could be required to be paid.

The application guidance included in IAS 39 confirms that market value reflects fair value except in rare circumstances.

No adjustment should be made to market value, for those instruments with a quoted price, to reflect large holdings of

shares. However, adjustment may be required for credit risk or other factors that market participants would include in

valuing the instrument.

Fair value hedge: a hedge of the exposure to changes in fair value of a recognised asset or liability or an unrecognised firm

commitment, or an identified portion of such an asset, liability or firm commitment, that is attributable to a particular risk and could affect profit or loss.

Fair value hedges (which meet the conditions within IAS 39 for hedge accounting) should be accounted for as follows:

● the gain or loss from remeasuring the hedging instrument at fair value (for a derivative hedging instrument) or the

foreign currency component of its carrying amount measured in accordance with IAS 21 (for a non-derivative

hedging instrument) should be recognised in profit or loss; and

● the gain or loss on the hedged item attributable to the hedged risk should adjust the carrying amount of the hedged

item and be recognised in profit or loss. This applies if the hedged item is otherwise measured at cost. Recognition

of the gain or loss attributable to the hedged risk in profit or loss applies if the hedged item is an available-for-sale

financial asset.

Fair value interest rate risk: is a market risk – the risks that the value of a financial instrument will fluctuate because of




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changes in market interest rates.

Financial asset: is any asset that is:

● cash;

● an equity instrument of another entity;

● a contractual right:● to receive cash or another financial asset from another entity; or

● to exchange financial assets or financial liabilities with another entity under conditions that are potentially

favourable to the entity; or

● a contract that will or may be settled in the entity's own equity instruments and is:

● a non-derivative for which the entity is or may be obliged to receive a variable number of the entity's own

equity instruments; or

● a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another

financial asset for a fixed number of the entity's own equity instruments. For this purpose the entity's own

equity instruments do not include instruments that are themselves contracts for the future receipt or delivery

of the entity's own equity instruments.

Financial asset or financial liability at fair value through profit or loss: is a financial asset or financial liability that

meets either of the following conditions.

● It is classified as held for trading. A financial asset or financial liability is classified as held for trading if it is:

● acquired or incurred principally for the purpose of selling or repurchasing it in the near-term;

● part of a portfolio of identified financial instruments that are managed together and for which there is

evidence of a recent actual pattern of short-term profit taking; or

● a derivative (except for a derivative that is a designated and effective hedging instrument).

● Upon initial recognition it is designated by the entity as at fair value through profit or loss. An entity may use this

designation only when the contract contains one or more embedded derivatives and the relevant criteria are not met(para 11A), or when doing so results in more relevant information, because either

i) it eliminates or significantly reduces a measurement or recognition inconsistency (sometimes referred to as 'an

accounting mismatch') that would otherwise arise from measuring assets or liabilities or recognising the gains

and losses on them on different bases; or

ii) a group of financial assets, financial liabilities or both is managed and its performance is evaluated on a fair

value basis, in accordance with a documented risk management or investment strategy, and information about

the group is provided internally on that basis to the entity's key management personnel.

Financial guarantee: is a contract that requires the issuer to make specified payments to reimburse the holder for a loss itincurs because a specified debtor fails to make a payment when due in accordance with the debt instrument's original or

modified terms.

Financial instrument: is any contract that gives rise to a financial asset of one entity and a financial liability or equity

instrument of another entity.

Financial liability: is any liability that is:

● a contractual obligation:

● to deliver cash or another financial asset to another entity; or

● to exchange financial assets or financial liabilities with another entity under conditions that are potentiallyunfavourable to the entity; or




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● a contract that will or may be settled in the entity's own equity instruments and is:

● a non-derivative for which the entity is or may be obliged to deliver a variable number of the entity's own

equity instruments; or

● a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another

financial asset for a fixed number of the entity's own equity instruments. For this purpose the entity's own

equity instruments do not include instruments that are themselves contracts for the future receipt or delivery

of the entity's own equity instruments.

Financial risks: risks arising from exposures to interest, currency, credit, liquidity, market and commodities.

Firm commitment: is a binding agreement for the exchange of a specified quantity of resources at a specified price on a

specified future date or dates.

Fixed rate bond: fixed rate bonds are debt securities on which the coupon (interest) payments are fixed at the date of issue

as a specified percentage of par value. These bonds will usually be issued and redeemed at par, although both premiums

and discounts are possible.

Flat yield curve: a flat (or 'spot') yield curve shows the market does not have a strong expectation of interest rates going up

and down. See also: Yield curve.

Floor: this is an option contract that gives the buyer a minimum rate of interest on a given principal over a designated

period. See also: Cap and floor options.

Floortion: see Captions and floortions.

Forecast transaction: is an uncommitted but anticipated future transaction.

Foreign operation: is an entity that is a subsidiary, associate, joint venture or branch of a reporting entity, the activities of

which are based or conducted in a country or currency other than those of the reporting entity.

Forward foreign exchange contracts: are binding contracts to purchase or sell a specified foreign currency at an exchange

rate determined on the date that the contract is made, but with payment and delivery at a specified future date or between

two specified future dates. These instruments are marked-to-market through income, unless they qualify either as cash flow

hedges, where the effective portion is reported in equity, or a net investment hedge, where the effective portion is also

reported in equity, or a fair value hedge, with gains and losses on revaluing the asset or liability and the forward contract

being recognised in the income statement.

Forward points: are the premium or discount added or subtracted from the spot rate at the inception of the forward

exchange contract to calculate the forward rate (or price).

The forward rate (or price) is not an estimate of the spot rate at a date in the future, but is a function of the relative interest

rates of the countries whose currencies are involved in the exchange. Consequently, the forward points represent the timevalue of money inherent in the forward contract for the period it is outstanding.

Forward rate of interest: the forward rate of interest is the interest rate for a period starting in the future. Forward rates of

interest are used by financial institutions when hedging or trading interest rate positions. Forward rates are derived from the

'forward yield curve. See also: Implied forward rate of interest.

Forward/forward: is a deposit from one point in the future to another, for example, from three months in the future to six

months in the future.

Forward-to-forward: is a term used when designating the hedge effectiveness testing methodology in relation to foreign

exchange hedging relationships. It refers to the comparison of the changes in the value of the hedged item and the hedging

instrument caused by the change in forward foreign exchange rates. See also: Spot-to-spot.




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Forward yield curve: a forward yield curve is a yield curve that has been constructed using implied forward rates of

interest. It is used in forward rate agreement (FRA) and swap valuations.

FRA (forward rate agreement): is similar to an interest rate future in that it is a contract in which two parties agree the

interest rate to be paid on a notional deposit of specified maturity on a specific future date. The deposit is purely notional

and no borrowing or lending takes place. The contract enables the purchaser to fix interest costs for a specific (usually

short) future period. At the settlement date, which occurs at the inception of the period of the notional deposits for sterling,

and two days later for US dollars, the seller pays the purchaser for any increase in rates over the agreed rate. If the rateshave fallen, the purchaser pays the seller.

FRN (floating rate note): FRNs are floating rate bonds. They are debt securities where the coupon is refixed periodically

on the 'refix date' by reference to some independent interest rate index. In the euro markets this is usually some fixed

margin over London Inter-bank offer Rate (LIBOR) – usually six month LIBOR. FRNs traded in the euro markets offer the

following features:

● They are long dated bonds with interest rates linked to short-term money market indices.

● The coupons are refixed and coupon payments are usually made every six months, whereas fixed rate bonds will

more commonly pay interest annually.

Forward swap: are swaps arranged to run from some future date, for example, from three month's time. These serve a

similar purpose to futures or FRAs but are longer term instruments.

Fully hedged: an exposure or position is fully hedged when all the hedging instrument's critical terms exactly match those

of the exposure, such that there is no ability to make a gain or loss should rates or prices move.

Functional currency: is the currency of the primary economic environment in which the entity operates. The primary

economic environment in which an entity operates is normally the one in which it primarily generates and expends cash.

Under IAS 21 an entity does not have a free choice of functional currency, but has to consider the indicators provided in the

standard with greater emphasis placed on those factors that determine the pricing of transactions as opposed to the currency

in which transactions are denominated.

All transactions are measured in the functional currency. Since an entity's functional currency reflects the underlying

transactions, events and conditions that are relevant to it, a functional currency, once determined is not changed, unless

there is a change in those transactions, events and conditions.

Futures: A future is a derivative contract that provides for the future delivery (or acceptance of delivery) of a standard

quantity of a specified grade or type of financial instrument, currency or commodity at a specified future date and in

accordance with the terms specified by a regulated futures exchange.

Futures differ from forward contracts in that they are traded on recognised exchanges and rarely result in actual delivery.

Instead, most contracts are closed out prior to maturity by acquisition of an offsetting position.

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Gilts or gilt-edged securities: UK and Irish government securities.

Global depositary receipt: funds collected denoting ownership of foreign-based company shares that are bought and sold

in numerous capital markets around the world. See American depository receipts.

Guarantees: contracts solely against non-payment of a specified instrument. Financial guarantee contracts that provide for

a specified payment to be made to reimburse the holder for loss, are insurance contracts as defined in IFRS 4. However they

also meet the definition of a financial guarantee contract in IAS 39 and are within the scope of IAS 32 and IAS 39 and not

IFRS 4. However IFRS 4 states that where an entity has previously asserted explicitly that it regards such contracts asinsurance contracts, it can elect to apply either IAS 39 or IFRS 4 to those contracts. Other financial guarantee contracts (or




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some types of letters of credit, credit default contracts or credit insurance contracts) that require payments to be made even

if the holder has not incurred a loss on the failure of the debtor to make payments when due, are not insurance contracts

and, therefore, are included in IAS 39's scope and, hence, must be carried at fair value through profit or loss, unless they

qualify as effective cash flow hedges when the effective part of such gains and losses are reported in equity.

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Hedge accounting: is an accounting treatment that alters the accounting that would otherwise apply so that gains andlosses on the hedging instrument are recognised in the profit and loss account in the same period as offsetting gains and

losses on the hedged item. The types of risk that can be hedged include foreign currency risk; interest rate risk; equity price

risk; commodity risk; and credit risk. In each case, the exposure to risk can arise from changes in the fair value of an

existing asset or liability (that is, an equity investment), changes in the future cash flows arising from an existing asset or

liability (that is, variable future interest payments) or changes in future cash flows from a transaction that is not yet

recognised, but is either committed or anticipated (that is, highly probable future sales in a foreign currency).

Hedge criteria: that must be met before hedge accounting can be used include the following:

● At inception of the hedge there is formal designation and documentation of the hedging relationship and the entity's

risk management objective and strategy for undertaking the hedge. The documentation should include identificationof the hedging instrument, the hedged item or transaction, the nature of the risk being hedged and how the entity

will assess the hedging instrument's effectiveness in offsetting the exposure to changes in the hedged item's fair

value or cash flows attributable to the hedged risk.

● The hedge is expected to be highly effective in achieving offsetting changes in fair value or cash flows attributable

to the hedged risk, consistently with the originally documented risk management strategy for that particular hedging

relationship.

● For cash flow hedges, a forecast transaction that is the subject of the hedge must be highly probable and must

present an exposure to variations in cash flows that could ultimately affect profit or loss.

● The effectiveness of the hedge can be reliably measured, that is, the fair value or cash flows of the hedged item that

are attributable to the hedged risk and the fair value of the hedging instrument can be reliably measured.

● The hedge is assessed on an ongoing basis and determined actually to have been highly effective throughout thefinancial reporting periods for which the hedge was designated.

Hedge effectiveness: hedge accounting can only be used if the hedge is effective. Hedge effectiveness is the degree to

which changes in the fair value or cash flows of the hedged item that are attributable to a hedged risk are offset by changes

in the fair value or cash flows of the hedging instrument. For a hedge to be highly effective the actual results of the hedge

must be such that the change in fair value of the full hedging instrument when expressed as a percentage of the change in

fair value of the hedged risk or item is within a range of 80-125 per cent for the purpose of retrospective testing. For

prospective testing it must be expected that the hedging relationship is effective in offsetting the exposure to changes in the

hedged item's fair value or cash flows at inception and in subsequent periods. The hedge must be expected to be highly

effective in achieving offsetting changes in fair value or cash flows attributable to the hedged risk (this is also considered to

be within the range of 80-125 per cent).

Hedged items: are assets, liabilities, unrecognised firm commitments, highly probable forecast transactions or net

investments in a foreign operation that (a) expose the entity to risk of changes in fair value or future cash flows and (b) are

designated as being hedged.

An investment accounted for using the equity method (for example, an associate) cannot be a hedged item in a fair value

hedge because the equity method recognises in profit or loss the investor's share of the associate's profit or loss, rather than

changes in the investment's fair value. For a similar reason, an investment in a consolidated subsidiary cannot be a hedged

item in a fair value hedge, because consolidation recognises in profit or loss the subsidiary's profit or loss, rather than

changes in the investment's fair value. A hedge of a net investment in a foreign operation is different because it is a hedge

of the foreign currency exposure, not a fair value hedge of the change in the value of the investment.

Only assets, liabilities, firm commitments or highly probable forecast transactions that involve a party external to the entity

can be designated as hedged items.




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IAS 39 states that an item can be designated in a hedging relationship for only part of its life. For example, a five year

interest rate swap could be designated as a hedge of interest-related changes in fair value or cash flows over the first five

years of a ten year borrowing, as long as effectiveness can be demonstrated. Also, IAS 39 confirms that a component of

financial risk, such as a risk-free interest rate, can be designated as the hedged risk.

Hedges of net investment in a foreign operation: is a form of hedge accounting that is carried out in consolidated

accounts only. It is a hedge of the risk of a change in the value of the net assets of the foreign operations at the beginning of

the accounting period due to a movement in the exchange rates between the group's presentational currency and the

functional currency of the foreign operation during the accounting period. They include hedges of monetary items that are

treated as part of the net investment and are accounted for in a similar way to cash flow hedges. An exchange difference on

a borrowing or a derivative that is effective as a hedge of the net investment in a foreign entity should be deferred in equity

until disposal of the investment, when it is recycled to income as part of the gain or loss on disposal. The amount taken to

equity on a net investment hedge cannot include ineffectiveness on a non-derivative, for example, that results from using

different but closely related currencies.

Hedging instrument: is a designated derivative or (for a hedge of the risk of changes in foreign currency exchange rates

only) a designated non-derivative financial asset or non-derivative financial liability whose fair value or cash flows are

expected to offset changes in the fair value or cash flows of a designated hedged item. A hedging instrument will reduce anexposure to changes in value or cash flows that will affect the income statement. Only derivative instruments and the

currency component of a foreign currency non-derivative financial asset or non-derivative financial liability can qualify as a

hedging instrument. A hedging instrument cannot be designated as part of a hedging relationship for only part of its life.

Gains and losses on all hedging instruments are reported in income, unless they qualify wholly (or in part) as cash flow

hedges or net investment hedges when such gains and losses (or part thereof) are deferred in equity.

Guidance on the implementation of IAS 39 confirms that hedge accounting is permitted at the group level for hedges of

currency risk if each subsidiary transacts individual internal hedging transactions with a treasury centre and the treasury

centre nets these positions and enters into a single external derivative transaction. Hedging is only allowed to the extent

that the external derivative is designated as an offset of cash inflows or cash outflows on a gross basis.

For group purposes the operating unit with the risk need not be a party to the hedging transaction. Therefore a parent

company or treasury centre can undertake hedging transactions on behalf of group companies without the need for internal

derivative transactions. Hedge accounting can only be achieved if, at the group level, each external derivative transaction

is properly documented as a hedge of one or more gross positions elsewhere within the group.

IAS 39 confirms that two or more derivatives may be used in combination as the hedging instrument in a hedging

relationship. For example, two interest rate swaps where one offsets the effect of the other for a discrete period in the life

of the hedge. A combination of a purchased option and a written option (a collar) can qualify as a single hedging

instrument as long as the critical terms and conditions of the two options are the same (except the strike price), the notional

amount of the written option is not greater than that of the purchased option and there is no net premium received (that is,

the instrument is in effect not a net written option). Furthermore, a single derivative such as a cross-currency interest rate

swap can be separated into its interest rate and foreign exchange components and each part can be designated separately as

a hedging instrument for these multiple risks but the whole fair value of the swap must be used in effectiveness tests.

Held-to-maturity investments: are non-derivative financial assets with fixed or determinable payments and fixed maturity

that an entity has the positive intention and ability to hold to maturity other than:

● those that the entity upon initial recognition designates as at fair value through profit or loss;

● those that the entity designates as available for sale; and

● those that meet the definition of loans and receivables.

Held-to-maturity assets are carried at amortised cost. Held-to-maturity assets may not be hedged for interest rate risk.

Guidance on the implementation of IAS 39 confirms that the prohibition on hedging interest rate risk of a held-to-maturity




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asset applies to both fixed-to-floating and floating-to-fixed interest rate swaps. However, the guidance states that a highly

probable purchase of a held-to-maturity asset can be designated as a hedged item in a cash flow hedge.

Transfers out of the 'held-to-maturity' category are very tightly controlled. See Tainting.

Highly probable: significantly more than probable.

Host contract: is a non-derivative contract that forms part of a hybrid (combined) instrument, which also includes an

embedded derivative. Common examples of host contracts are lease contracts, supply contracts and debt contracts.

Hybrid instrument: is a term used from the perspective of the holder of a combined instrument that comprises a non-

derivative host contract with an embedded derivative. See also: Compound instrument.

Hypothetical derivative method: is a form of hedge effectiveness testing for a cash flow hedge of a forecast transaction in

a debt instrument described in the implementation guidance to IAS 39.

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Impairment: for financial instruments, it is the requirement to provide for shortfalls in expected receipts of interest andcapital, that is, it is the amount by which an asset's carrying amount exceeds its recoverable amount. An entity should assess

at each balance sheet date whether there is any objective evidence that a financial asset or group of assets may be impaired.

The recoverable amount is calculated by discounting the expected cash flows to be received from the asset over the

estimated period of recovery by the original effective interest rate. Future credit losses that have not been incurred must be

excluded from the calculation.

Impairment indicators (or loss events): include, but are not limited to:

● significant financial difficulty of the issuer or obligor;

● a breach of contract, such as a default or delinquency in interest or principal payments;

● the lender, for economic or legal reasons relating to the borrower's financial difficulty, granting to the borrower a

concession that the lender would not otherwise consider;

● it becoming probable that the borrower will enter bankruptcy or other financial reorganisation;

● the disappearance of an active market for that financial asset because of financial difficulties; or

● observable data indicating that there is a measurable decrease in the estimated future cash flows from a group of financial assets since initially recognising those assets, although the decrease cannot yet be identified with the

individual financial assets in the group, including:

● adverse changes in the payment status of borrowers in the group (for example, an increased number of delayed

payments or an increased number of credit card borrowers who have reached their credit limit and are paying the

minimum monthly amount); or

● national or local economic conditions that correlate with defaults on the assets in the group (for example, an

increase in the unemployment rate in the geographical area of the borrowers, a decrease in the property prices

for mortgages in the relevant area, a decrease in the oil prices for the loan assets to oil producers, or adverse

changes in the industry conditions that affect the borrowers in the group).

A decline in market value, the disappearance of a market that is not accompanied by a decline in creditworthiness or any of




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the other factors above is not automatically evidence of impairment.

Impairment amount: the difference between carrying amount and recoverable amount (see Impairment).

● Financial assets carried at amortised cost: the impairment amount is the difference between the asset's carrying

amount and the present value of expected future cash flows (excluding future credit losses that have not been

incurred), discounted at the financial asset's original effective interest rate (that is, the effective interest rate computedat initial recognition). The amount of the loss should be recognised in profit or loss.

● Financial assets carried at cost: the impairment amount is the difference between the financial asset's carrying

amount and the present value of estimated future cash flows discounted at the current market rate of return for a

similar financial asset. Such impairment losses are not allowed to be reversed.

● Available for sale financial assets: the impairment loss is the difference between the acquisition cost (net of any

principal repayment and amortisation) and current fair value, less any impairment loss on that financial asset

previously recognised in profit or loss.

Where a decline in value of an available-for-sale financial asset has been recognised directly in equity and there is objectiveevidence that the asset is impaired, the cumulative loss that had been recognised directly in equity should be removed from

equity and recognised in profit or loss even though the financial asset has not been derecognised.

Impairment losses recognised in profit or loss for an investment in an equity instrument classified as available-for-sale are

not allowed to be reversed through profit or loss even where the market value of that equity instrument recovers in a

subsequent period.

However, in the case of a debt instrument classified as available-for-sale where, in a subsequent period, its fair value

increases and the increase can be objectively related to an event occurring after the impairment loss was recognised in profit

or loss, the impairment loss must be reversed, with the amount of the reversal recognised in profit or loss.

Guidance on the implementation of IAS 39 clarifies that a reduction in either the amount, or a delay in the timings of the

expected cash flows (interest or principal) on a loan or other debt security will give rise to an impairment loss. The only

exception is if a delay in expected payment will be fully compensated by additional interest.

The guidance also confirms that impairment losses are limited to those arising where there is objective evidence (such as

past default rates) of impairment in a single asset or in a portfolio. Additional 'possible' or 'anticipated' losses should not be

provided for except as amounts set aside within shareholders' equity.

Implied forward rate: if the interest rates are known for three months cash and six months cash, then a rate may be

interpolated for the period from month three to month six. This is known as an implied forward rate of interest. They are the

rates of interest implied by current spot rates for periods of time in the future. A yield curve can be constructed with

forward interest rates and used for computing future cash flows and the fair value of such cash flows. See also: Yield curve.

Incremental cost: is a cost that would not have been incurred if the entity had not acquired, issued or disposed of the

financial instrument.

Index linked bonds: index linked bonds attempt to offer an investor a form of capital maintenance by adjusting the

redemption value, and in some cases the interest, for the movements in a specific index. An example is an inflation linked

bond. The index or inflation linking is an embedded derivative and consideration has to be given to whether it needs to be

split out, which would be necessary if the economic characteristics are not closely related to those of the host contract. See:

Embedded derivatives.

Corporate issues have usually been linked to the performance of specific indices (particularly stock exchange indices)

rather than general price indices. Where there is a link to a price index, the interest rate is usually adjusted to provide aspecific real rate of return. In other types of issues the interest rate is predetermined, but at a higher than normal rate to




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compensate the investor for the risk inherent in the redemption value being unknown (and maybe even less than par if

indices move unfavourably).

Initial recognition: all financial instruments are initially measured at fair value plus transactions costs that are incremental

and directly attributable to the acquisition for those financial assets and financial liabilities that are not at fair value through

profit or loss and thereafter at: cost less impairment; amortised cost less impairment; or, at fair value.

Insurance contracts: are defined within IFRS 4 as contracts under which one party (the insurer) accepts significantinsurance risk from another party (the policyholder) by agreeing to compensate the policy holder if a specified uncertain

future event (the insured event) adversely affects the policy holder. Insurance contracts may contain embedded derivatives

(which themselves do not meet the definition of an insurance contract) that will need to be separated and fair valued

through profit or loss, unless the embedded derivative cannot be reliably fair valued in which case the whole contract is fair

valued through profit or loss.

Interest rate collar: An interest rate collar is a combination of a cap and a floor. If interest rates rise above the level

stipulated in a particular contract, the seller of the collar will pay the purchaser an amount equal to the additional cost to the

next reference date. However, if interest rates fall below another stipulated level, the purchaser will pay the seller.

The purchase of a collar is an attractive alternative to a cap if the purchaser believes that interest rates are going to rise, as

the fee received for the floor offsets the price paid for the cap. Zero cost collars can be constructed whereby the fee paid to

the bank for the cap is offset by the fee received for the floor, enabling the purchaser to use the combined derivative as a

hedging instrument against a rise in interest rates, at nil cost, but with an exposure if interest rates fall below the floor price.

See: Hedging instrument. The rates at which the premiums cancel out are referred to as the forward band. In such a

transaction, the cap rate will typically be higher than the market level of fixed interest rates.

Interest rate differential: this delineates the difference in the rate of interest offered in two currencies for investments of

identical maturities. The difference is not a simple arithmetical one. It must be applied to the relevant maturity.

Interest rate future: is a contract that provides for the future delivery (or acceptance of delivery) of a standard quantity of

a specified type of financial instrument. The instrument's price is based on interest rate levels on a specified future date in

accordance with the terms specified by a regulated futures exchange.

Interest rate swaps: a transaction in which two counterparties exchange interest payment streams of differing character

based on an underlying notional amount in the same currency. For example a pay fixed receive floating interest swap or a

pay floating receive fixed interest rate swap. These swaps are fair valued through profit or loss, unless they qualify for cash

flow hedge accounting where the effective proportion is deferred in equity until the hedged item affects profit or loss.

In-the-money: is a term used to describe an option with a strike price that is more advantageous than the current market

price of the underlying. An in-the-money option has intrinsic value.

The more an option is in-the-money, the higher its intrinsic value and the more expensive it becomes. As an option

becomes more in-the-money, it behaves more like the underlying in terms of profit and loss (that is, it is deep in-the-

money).

Intrinsic value: is the difference between the fair value of the underlying, which the counterparty has the (conditional or

unconditional) right to receive, and the price the counterparty will be required to pay for that underlying (that is, the strike

or exercise price of the option). An in-the-money option has intrinsic value. This value is the amount of profit that would be

realised if the option was immediately exercised.

In the case of a currency call option this is the difference between the exercise rate and the higher (or for a put option the

lower) of the spot exchange rate or the forward rate. If that value is negative the intrinsic value is nil.

Inventories used for hedging: physical inventory (such as finished goods) can qualify as a hedged item, but only for either

currency risk or the risk of changes in fair value of the entire item (although inventories are generally held at the lower of

cost and net realisable value under IAS 2). However, in practice the latter will be rare due to the difficulty of demonstrating

hedge effectiveness.




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Inverted (negative) yield curve: this is the yield curve generated when short-term interest rates are higher than long-term

rates. A negative or inverse yield curve results when investors expect short-term interest rates to fall and they sell short-

term securities and buy longer-term ones. This causes the yields on the latter to reduce when compared with the short-term.

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LIBOR: is the abbreviation of the 'London Inter Bank Offered Rate'. This is the interest rate quoted among large, highlycredit worthy banks to and from each other. It varies constantly and is a recognised basis for calculating a floating interest

rate, usually agreed as LIBOR plus x%, where x% increases as the creditworthiness of the borrower decreases.

Different LIBOR rates are quoted for a number of major currencies. LIBOR is the rate at which banks offer to lend funds.

LIBID (London Inter Bank Bid Rate) is the bank's deposit rate. LIMEAN is the mean of LIBOR and LIBID.

Liquidity risk: is the risk that an entity will encounter difficulty in raising funds to meet commitments associated with

financial instruments. Liquidity risk may result from an inability to sell a financial asset quickly at close to its fair value.

Liquid market: a liquid market is one where buying and selling can be accomplished with ease, due to the presence of a

large number of interested buyers and sellers prepared to trade substantial quantities at small price differences. See: Active

market.

Loan commitments: are firm commitments generally by a bank or financial institution to provide credit (for example, a

loan) under pre-specified terms and conditions. Except as noted below, loan commitments that cannot be settled net in cash

or another financial instrument are excluded from the scope of IAS 39. A loan commitment is not regarded as settled net

merely because the loan is paid out in instalments (for example, a mortgage construction loan that is paid out in instalments

in line with the progress of construction). An issuer of a commitment to provide a loan at a below-market interest rate must

initially recognise it at fair value and subsequently measure it at the higher of (i) the amount recognised under IAS 37 and

(ii) the amount initially recognised less, where appropriate, cumulative amortisation recognised in accordance with IAS 18.

An issuer of loan commitments should apply IAS 37 to other loan commitments that are not within IAS 39's scope. Loan

commitments are subject to IAS 39's derecognition provisions.

Loan commitments that the entity designates as financial liabilities at fair value through profit or loss are within IAS 39's

scope. An entity that has a past practice of selling the assets resulting from its loan commitments shortly after origination

should apply IAS 39 to all its loan commitments in the same class.

Loans and receivables: are non-derivative financial assets with fixed or determinable payments that are not quoted in an

active market, other than:

● those that the entity intends to sell immediately or in the near term, which should be classified as held for trading

and those that the entity upon initial recognition designates as at fair value through profit or loss;

● those that the entity upon initial recognition designates as available for sale; or

● those for which the holder may not recover substantially all of its initial investment, other than because of credit

deterioration, which should be classified as available for sale.

An interest acquired in a pool of assets that are not loans or receivables (for example, an interest in a mutual fund or a

similar fund) is not a loan or receivable.

All loans and receivables should be carried at amortised cost using the effective interest method, unless they are designated

as hedged items and thus subject to measurement under the hedge accounting requirements. All loans and receivables

should be subject to review for impairment.

Lognormal distribution: this is a mathematical term, referring to a particular statistical distribution often applied to share

prices, in which instance it demonstrates that the corresponding share prices can rise infinitely but cannot fall below zero.

Long position: to be long is to have bought and be holding a financial instrument, for example, equity shares, debt

securities, a future, an FRA or an option.




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It is often used to refer to a position where the number of contracts bought is greater than the number sold. The trade is,

therefore, a net buy and the buyer is said to have a long position. The expression is used when there is an anticipation of

prices rising, in which case the buyer can close out the position by selling the instrument back to the market and locking in

a profit.

Long is also used to express which part of the yield curve is being referred to and is generally said to cover from five years

to 20 years. Therefore, it is possible to be long of the long end of the yield curve.

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Macro hedging: a technique of aggregating a portfolio of assets and liabilities and fair value hedging the net amount for

interest rate risk. IAS 39 refers to this as a portfolio hedge of interest rate risk. In particular, for such a hedge, it allows:

● the hedged item to be designated as an amount of a currency (for example, an amount of dollars, euro, pounds or

rand) rather than as individual assets (or liabilities).

● the gain or loss attributable to the hedged item to be presented either:

● in a single separate line item within assets, for those repricing time periods for which the hedged item is an

asset; or

● in a single separate line item within liabilities, for those repricing time periods for which the hedged item is a

liability.

● prepayment risk to be incorporated by scheduling prepayable items into repricing time periods based on expected,

rather than contractual, repricing dates. However, when the portion hedged is based on expected repricing dates, the

effect that changes in the hedged interest rate have on those expected repricing dates are included when determining

the change in the fair value of the hedged item. Consequently, if a portfolio that contains prepayable items is hedged

with a non-prepayable derivative, ineffectiveness arises if the dates on which items in the hedged portfolio are

expected to prepay are revised, or actual prepayment dates differ from those expected.

Maintenance margin: the level to which a margin account may fall before the holder of the contract is required to bring

the balance back up to the initial margin level. See: Margin.

Making a market: dealers who stand ready to buy and sell certain financial instruments and quote bid and offer prices are

said to be 'making a market'.

Margin: the initial funds (cash or other collateral) placed by the writer of an option with a broker or deposited to open a

futures contract. The amount varies depending upon whether the contract is a hedge or speculation according to the rules of

the relevant exchange.

Margin call: this is a demand for additional funds (cash or other collateral) from a customer, which a futures broker may

make on account of an adverse price movement on an open futures position.

Market risk: includes three types of risk: currency risk, fair value interest rate risk and price risk. Market risk embodies not

only the potential for loss, but also the potential for gain.

Mark-to-market: refers to the valuation of positions or exposure at current market value as opposed to cost. The mark-to-

market is the daily adjustment of open positions to reflect profits and losses resulting from price movements occurring

during the last trading session.

Market maker: this is the name given to any trading firm making prices in financial instruments at which it is prepared to

deal. A market maker offers constant two-way prices – a bid and an offer – in specified instruments, amounts and

maturities.

Market taker: this is an entity that is requesting a deal rate from the market maker.

Master netting agreement: is an arrangement providing for an entity that undertakes a number of financial instrument




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transactions with a single counterparty to make a single net settlement of all financial instruments covered by the agreement

in the event of default on, or termination of, any one contract. IAS 32 states that such an agreement does not provide a basis

for offsetting, unless both the agreement is legally enforceable and the entity intends either to settle on a net basis, or to

realise the asset and settle the liability simultaneously.

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Natural hedge: a natural hedge reduces an entity's financial risk or exposure simply through careful planning in that

entity's normal business activities (for example, offsetting foreign currency purchases and sales).

Naked call option: the writing of a call option for which the writer does not currently own an instrument or commodity

that could be delivered if the option is exercised.

Naked put option: the writing of a put option for which the writer does not currently have a short position in the

commodity underlying the option.

Negative (inverse) yield curve: a negative (or 'inverse') yield curve shows that short term interest rates are higher than long

term interest rates. This type of yield curve occurs at times when the market expects interest rates will fall. Players tend to

borrow short-term and invest long-term. In the long term, this forces yields down.

Net written option: is an option that the entity has issued to a counterparty. This exposes the entity to risk and, therefore,

an interest rate collar or other derivative instrument that combines a written option and a purchased option do not qualify as

a hedging instrument if they are, in effect, a net written option (for which a net premium is received). Similarly, two or

more instruments (or proportions of them) may be designated as the hedging instrument only if none of them is a written

option or a net written option. See: Hedging instrument.

Normal (positive) yield curve: a normal yield curve shows short-term interest rates are lower than long-term rates.

Investors are rewarded for the perceived risks of investing for longer periods, the greater volatility and the smaller number

of investors.

Nominal rate of return: is the rate of return on the face value of the instrument. See: Real rate of return.

Novation: the rights and obligations under a loan agreement are cancelled and replaced by new ones whose main effect is

to change the identity of the lender. Although rights can be transfered by other means, novation is the only method of

transferring obligations (for example, to supply funds under an undrawn loan facility) with the consequent release of the

lender.

Novation is also a legal process that will result in the derecognition of a financial liability for a borrower. Similarly,

novation can be used with other financial instruments such as swaps, options, futures etc to change one of the

counterparties.

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Offer: this is the rate at which a market maker borrows from a market taker; the price or yield on a security at which the

vendor is willing to sell.

Offer price: see: Ask or asked price.

Option: an option is a contract that gives the buyer the right, but not the obligation, to buy/sell an underlying asset at a

determined price (the strike price) at any time up to the option's maturity (in the case of an American option), or (in the case

of European options) on its maturity date. See American, Asian and European options.

The seller of the option is known as the option's 'writer'.

Option premium: this is the value of the option at inception of the contract.




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OTC (Over-the-counter) market: this is a market in which securities are traded by direct dealer communication. Such

direct communication is not permitted in formal markets, such as the New York or London Stock Exchanges.

Out-of-the-money: out-of-the-money is a term used to describe an option with a strike price that is less advantageous than

the underlying instrument's current market price. If an option is out-of-the-money then its intrinsic value is zero.

Overhedge: occurs where the notional principal amount of the hedging instrument is greater than that of the hedged item.

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Paper: this refers to securities, commercial paper or market instruments that are generally short-term.

Par: par is 100 per cent of a security's face value. It is the principal amount at which an issuer of bonds agrees to redeem its

bonds at maturity.

Perfect hedge: this is a hedge in which a change in the fair value of a derivative exactly offsets any change in the fair value

of the underlying hedged item.

Perpetual bonds: are bonds that are issued with no fixed redemption date.

Perpetuals paying interest at fixed rates have been issued in the past (particularly by governments – for example the British

government's war loan issues), but most recent perpetuals have been FRNs.

Pip: 1/100 of one per cent of the nominal value of a security, for example, ₤0.10 per ₤1,000.

Point: one per cent of the nominal value of an instrument, for example, one hundred basis points.

Portion: is the term used in hedge accounting for an amount of the hedged item or risk that is designated in the hedge

relationship.

Portfolio hedging: see Macro hedging.

Preference shares: are shares in the issuer whose terms and conditions convey some preferential treatment compared to

those of the ordinary shares. For example, a right to receive a fixed dividend before dividends are paid on the ordinary

shares or a right to have their capital amount repaid before any distribution to ordinary shareholders. The term of a

preference share may contain a contractual obligation: (i) to deliver cash or another financial asset to another entity; or (ii)

to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to

the entity, in which case they are treated as liabilities. Preference shares that do not contain contractual obligations are

treated as equity instruments. Preference shares may also be compound instruments.

Presentational currency: is the currency in which the financial statements are presented and for an entity's individual

financial statements may be different from the entity's functional currency.

Price risk: is a market risk – the risk that the value of a financial instrument will fluctuate as a result of changes in market

prices whether those changes are caused by factors specific to the individual instrument or its issuer or factors affecting all

securities traded in the market.

Primary financial instruments: are financial instruments such as receivables, payables and equity securities, that are not

derivative financial instruments.

Principal: is the par value (or face amount) of a financial instrument, which is exclusive of any premium or interest.

Promissory note: a written promise to pay or repay a specified sum of money at a stated time or on demand.

Property, plant and equipment: are tangible items that:




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● are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes;

and

● are expected to be used during more than one period.

Property, plant and equipment in the balance sheet can only be hedged for foreign exchange risk, or in its entirety for all

risks, because of the difficulty of isolating and measuring the appropriate portion of the cash flows or fair value changesattributable to specific risks other than foreign currency risks.

Proportion: is a term used in hedge accounting for the amount of the hedging instrument that is designated in the hedge

relationship. IAS 39 allows a proportion of the entire hedging instrument to be designated but does not permit a hedging

instrument to be designated for only a portion of the time period for which it is outstanding.

Purchases of inventory, property, plant and equipment: that are highly probable can qualify as hedged items, but only

in relation to currency risk and, with certain restrictions, commodity price risk. Gains and losses on such effective cash flow

hedges are initially deferred in equity and then may be added to or deducted from the actual purchase cost upon subsequent

recognition or recognised in profit or loss in the same period in which the asset acquired affects profit or loss (that is,

periods of depreciation or cost of sale recognised). See also: Basis adjustment. Unrecognised firm commitments to

purchase inventory, property, plant or equipment may qualify as hedged items for fair value hedge accounting for particular risks that could affect profit or loss.

Purchased option: is an option that an entity buys (that is, the entity has taken a long position).

Purchases of subsidiaries, associates and joint ventures: that are highly probable can qualify as hedged items but only in

relation to currency risk and, for listed shares, the share price itself. Gains and losses on such effective cash flow hedges are

initially deferred in equity and then recognised in profit or loss in the same period in which the asset acquired affects profit

or loss (that is, upon subsequent disposal or impairment). Unrecognised firm commitments to purchase subsidiaries,

associates and joint ventures may qualify as hedged items for fair value hedge accounting for particular risks that could

affect profit or loss.

Put: is an option contract that allows the holder to sell a given number of securities back to the issuer at a fixed price for a

given period of time (that is, where the option is American) or at a fixed date (where the option is European).

Puttable instrument: is an instrument that gives the holder the right to put it back to the issuer for cash or another financial

asset. For example, an instrument that can be redeemed at any time by a holder for cash equal to its proportionate share of

the asset value of the issuer. See 'Put'.

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Range: is a 'space' or 'gap' defined by the highest and lowest prices, or highest and lowest bids and offers, recorded during

a specified period.

Real rate of return: is the term used to describe the rate of return calculated by subtracting the rate of inflation from the

nominal rate of return.

Recognition: means recording a financial asset or financial liability when, and only when, an enterprise becomes a party to

the instrument's contractual provisions. A 'regular way' purchases of securities may be recognised using either trade date or

settlement date accounting, but the method used should be applied consistently within each of the four categories of

financial assets. For this purpose assets held for trading form a separate category from assets designated at fair value

through profit and loss. A contract that requires or permits net settlement of the change in the contract's value is not a

regular way contract. Instead, such a contract is accounted for as a derivative in the period between the trade date and the

settlement date.

Guidance on the implementing IAS 39 states that the regular way exception can apply even when there is no formalregulated market, as long as a normal settlement period is established by custom in that business environment.




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Recycled from equity: in a hedge of a forecast transaction, where that transaction subsequently results in recognising a

financial asset or a financial liability, the associated gains and losses on the cash flow hedge that have been recognised

directly in equity are recycled to income (that is, reclassified to profit or loss) in the same period during which the asset

acquired, or liability assumed affects profit or loss (other than losses that are not expected to be recovered, which are

reclassified into profit or loss). For a hedge of a forecast transaction where that transaction subsequently results in

recognising a non-financial asset or a non-financial liability, or where a forecast transaction for such assets or liabilities

becomes a firm commitment for which fair value hedge accounting is applied, then the entity either reclassifies the gains or losses to profit or loss in the same period that the assets acquired or liability assumed affects profit or loss, or includes them

in the initial cost or other carrying amount of the asset or liability See Basis adjustments.

Gains and losses on net investment hedges are recycled to income on the foreign operation's disposal, or deemed disposal.

Gains and losses, except for impairment losses and foreign exchange gains and losses, on available-for-sale financial assets

should be recognised directly in equity until the financial asset is derecognised.

Regression analysis: is a technique that takes a group of variables and expresses a tendency of the dependent variable to

vary with the independent variable in a systematic fashion. In the context of a hedge effectiveness test, the primary

objective is to determine if changes to the hedged item and hedging instrument are highly correlated and, thus, supportive

of the assertion that there will be a high degree of offset in fair values or cash flows achieved by the hedge. It is used for

more complex relationships where it is known at the outset of the hedge relationship that it is not perfect, but statistically(this is, in the vast majority of cases) it is expected that the ratio of the change in fair value of hedged item to the change in

the fair value of hedging instrument will fall in the range of 80-125%. Regression analysis can be used for prospective

and/or retrospective hedge effectiveness testing. For the purposes of the hedge effectiveness test, the analysis usually

involves a simple linear regression. For example, one variable could be the price of a derivative on the first day of each

month for a particular year and the other variable could be the price of the hedged instrument on the same dates. Multiple

linear regression analysis examines the relationship between a dependent variable and two or more independent variables.

In a graphical sense, the values of the variables are plotted and a line of 'best fit' drawn.

Key factors in a regression analysis approach to proving hedge effectiveness are:

● number of data points, method of selection and frequency;

● the slope or gradient of the line of 'best fit';

● the coefficient of determination (R 2) - the explanatory power of correlation; and

● the 'F' statistic - the adjustment for random error, which is key to the strength of the statistical relationship.

Regular way: purchases or sales of financial assets under a contract whose terms require the asset's delivery within the

time frame established generally by regulation or convention in the marketplace concerned. These may be recognised or

derecognised using trade date accounting or settlement date accounting; provided that a consistent policy is applied within

each of the four classes of asset. (See also: recognition.) It avoids the need to account for a derivative between trade date

and settlement date for a financial asset, but can only be applied to 'normal' market settlement arrangements.

Guidance in the implementation of IAS 39 confirms that the standard has no specific requirements about trade date

accounting and settlement date accounting in the case of transactions in financial instruments that are classified as

financial liabilities. Consequently, the standard's general recognition and derecognition requirements apply and thus it is

possible that a contract that results in a financial liability will be accounted for as a derivative between trade date and

settlement date, unless the contract is an executory contract. The latter are not recognised until one of the parties to the

contract has performed.

Reinsurance contracts: are contracts issued by one insurer (the reinsurer) to compensate another insurer (the cedant) for

losses on one or more contracts issued by the cedant. These may contain embedded derivatives that will need to beseparated and fair valued through profit or loss (providing the embedded derivative is not a contract within the IFRS 4's




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scope), unless the derivative cannot be reliably fair valued in which case the whole contract is fair valued through profit or

loss.

Repos and reverse repos: repo agreements (sale and repurchase agreements) are transactions involving the sale of a

security with a simultaneous agreement to repurchase the same or a substantially identical security at a specified future

date. These are accounted for as secured borrowings and loans, unless the repurchase is at fair value and the transferee is

free to sell or pledge the asset. An entity's intention and ability to hold debt instruments to maturity is not necessarily

constrained if those instruments have been pledged as collateral or are subject to a repurchase agreement or securitieslending agreement. However, an entity does not have the positive intention and ability to hold the debt instruments until

maturity if it does not expect to be able to maintain or recover access to the instruments.

Risk-free interest rate: the rate earned on a riskless asset, such as a UK government gilt or US treasury bill.

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Secondary market: is available to trade securities after their initial public offering.

Securitisation: The process of creating a financial instrument by pooling other financial assets to back the instrument.

These are then marketed to investors (for example, mortgage backed securities).

Selling short: is the name given to the practice of selling an instrument or commodity that is not owned and then borrowing

an equivalent instrument or commodity to satisfy delivery of the sale with the intent of replacing that borrowed instrument

or commodity at a lower price than at which it was borrowed. The short trader is speculating that the price of the security

will go down.

Senority: The order in which holders of debts get paid after bankruptcy of an entity. For example, senior unsecured debt is

'senior' to subordinated debt.

Set-off, legal right of: is a debtor's legal right, by contract or otherwise, to settle or otherwise eliminate all of a portion of

an amount due to a creditor by applying against that amount an amount due from the creditor.

Settlement date: is the date that an asset is delivered to or by an entity.

Settlement date accounting: refers to: (a) the recognition of a financial asset on the date it is received by the entity; and

(b) the derecognition of a financial asset and recognition of any gain or loss on disposal on the day that it is delivered by the

entity. When settlement date accounting is applied an entity accounts for the change in the fair value of the financial asset to

be received during the period between the trade date and the settlement date, in the same way as it accounts for the acquired

asset. In other words, the change in value is not recognised for financial assets carried at cost or amortised cost; it is

recognised in profit or loss for assets classified as financial assets at fair value through profit or loss; and it is recognised in

equity for financial assets classified as available-for-sale. The normal recognition and derecognition rules apply to financial

liabilities. See: Regular way.

Settlement option: is where a derivative financial instrument gives one party a choice over how it is settled (for example,the issuer or the holder can choose settlement net in cash or by exchanging shares for cash). Such a derivative is a financial

asset or a financial liability, unless all of the settlement alternatives would result in it being an equity instrument.

Settlement price (futures): is a figure determined by the closing range, which is used to calculate gains and losses in

futures market accounts. Settlement prices are used to determine gains, losses, margin calls and invoice prices for

derivatives.

Short position: to be short is to have sold a financial instrument that the entity does not own, for example, an equity share,

debt security, a future, an FRA or an option.

It is often used to refer to a position where the number of contracts sold is greater than the number bought. The trade is,

therefore, a net sell and the seller is said to have a short position. The expression is used when there is an anticipation of

prices falling, in which case the seller can close out the position by buying the instrument back and locking in a profit.




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Short is also used to express which part of the yield curve is being referred to, and is generally said to cover from today to

two years. Therefore, it is possible to be short of the short end of the yield curve.

Short seller: is an entity that sells securities that it has borrowed or does not yet own.

Special purpose entities: are entities created to accomplish a narrow and well defined objective (for example, to effect a

lease, research and development activities or a securitisation of financial assets). If assets are sold to a special purposeentity and derecognised, consolidation of the SPE may be necessary where the group is exposed to the majority of the SPE's

risks and/or rewards or the majority of its assets; that is, where the substance of the relationship between an entity and the

SPE indicates that the SPE is controlled by that entity.

Speculator: is someone who takes a risk for an appropriate return.

Spot price: (also referred to as 'cash' or 'current') refers to something's immediate cash price. Hence the spot market is the

market for current transactions.

Spot rate: is the current exchange rate between two currencies.

Spot-to-spot: is a term used when designating a hedge effectiveness testing methodology in relation to foreign exchangehedging relationships. It refers to the comparison of the changes in the measurement of the hedged item and the hedging

instrument caused by the change in spot foreign exchange rates. See: forward-to-forward.

Spread: in trading, or in the quotation of financial instruments, is the difference between the bid and the offer/asked prices.

Spread (combination) of options: a spread combines put or call options on the same underlying instrument but with

different expiration dates or strike prices, where some are bought and others are written. Three common spreads are bull,

bear and butterfly.

Straddle: a combination of options that combines a put and call on the same underlying instrument, with the same strike

price and the same expiration date.

Strangle: a combination of options that is similar to a straddle, except that the puts and calls on the same underlying

instruments are bought at different prices.

Strike price: see: Option.

Strip: a series of consecutive futures is known as a strip of futures. For example, trading March, June and September

interest rate futures.

Strip bond: a bond where both the principal and interest elements are sold separately. See: Zero-coupon bond.

Structured note: can be either:

● a medium-term note with embedded options that adjust the risk/return profile; or

● a note whose value is determined by fluctuations in the price of the underlying asset.

A structured note is a hybrid instrument that changes its profile by including embedded derivatives. A simple example

would be a five year bond with an embedded option for increasing returns.

Subordinated debt: are loans, debt securities or bonds where the claims of the holders on the issuer's assets or earnings are

subordinated to the claims of the holders of senior debt securities.

Sub-participation: rights and obligations to principal and interest on a loan (financial asset) are not formally transferred,

but the lender enters into a non-recoverable back-to-back agreement with a third party, the 'sub-participant', under which




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the latter deposits with the lender an amount equal to the whole or part of the loan and in return receives from the lender a

share of the cash flows arising on the loan. A sub-participation will need to be assessed under the pass-through provisions

of IAS 39 on derecognition of financial assets.

Subprime loan: a loan that is offered at a rate above current market levels to individuals who do not qualify for market rate

loans.

Swaps: are agreements between two parties to exchange one set of cash flows for another. They are simply a highly

structured series of cash flows. They were developed to enable companies to vary the terms of their loans and, therefore,

manage their liabilities more effectively. Swaps result in the economic exchange of interest rates, currencies, basis rates or

any combination thereof. The two basic types of swap are:

● Interest rate swaps: here the two parties to the transaction exchange the terms under which they pay interest on their

liabilities. Typically, they will exchange interest paid at a fixed rate for interest paid at a floating rate, and vice versa.

No exchange of principal takes place, the interest payments under the swap are made on a national principal amount.

● Currency swaps: the two parties to the transaction exchange liabilities denominated in different currencies as well.

The principal sums may be exchanged either at the start of the swap period, or at the end of the swap period or by

some combination thereof, or possibly neither.

Swaptions: (or an option on a swap) is an option to enter into an interest rate swap at a future date at a fixed interest rate

determined by reference to current market rates. As with options, swaptions can be for American exercise (at any time until

expiry) or European exercise (at expiry).

The holder of a swaption is able to limit the risk in switching from floating interest rates to fixed interest rates (or vice versa

) with reference to the cost of the premium, whilst still being able to benefit from favourable interest rate movements. This

provides a greater flexibility or liability (or asset) management than the swap market. Swaptions may be used by issuers of

callable debt that has been swapped so that the swap can be reduced if the debt is called.

Swaptions are available on the OTC from banks and intermediaries who hedge the risks using exchange traded options oninterest rates. Swaptions, being a combination of a swap and an option on interest rates, are priced using traditional option

pricing theories.

Synthetic future: a synthetic futures strategy creates a combination of options, which is equivalent to a position in the

underlying transaction. Synthetic positions are so named because they are not actual positions. They give a position in the

underlying, which is equivalent to a futures position.

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Tainting (of a held-to-maturity investment portfolio): IAS 39 does not permit any financial assets to be classified as

held-to-maturity investments if the entity has, during the current financial year or during the two preceding financial years,

sold or reclassified more than an insignificant amount of held-to-maturity investments before maturity other than sales or reclassifications that:

● are so close to maturity or the financial asset's call date (for example, less than three months before maturity) that

changes in the market rate of interest would not have a significant effect on the financial asset's fair value;

● occur after the entity has collected substantially all of the financial asset's original principal through scheduled

payments or prepayments; or

● are attributable to an isolated event that is beyond the entity's control, is non-recurring and could not have been

reasonably anticipated by the entity.

'Insignificant' is assessed in relation to the total amount of held-to-maturity investments.

Take position: a take position exists when a punt (speculate) has been taken on future changes in the financial instrument's




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value (for example, changes in interest rates, exchange rates, or changes in asset prices).

Time value option: the value of an option contract less its intrinsic value.

Time value of money: the concept that a specific sum of money is more valuable the sooner it is received. This is based on

the principle that an amount will be worth more in the future because it can be invested. If it is received earlier it will

generate a greater return

Total return swap: is a contract under which one party ('the total return payer') transfers the economic risks and rewards

associated with an underlying asset to another counterparty ('the total return receiver'). The transfer of risk and reward is

effected by way of an exchange of cash flows that mirror changes in the underlying asset's value and any income derived

therefrom.

Trade date: is the date that an entity commits itself to purchase or sell an asset.

Trade date accounting: refers to: (a) the recognition of a financial asset to be received and the liability to pay for it on the

trade date; and (b) derecognition of an asset that is sold, recognition of any gain or loss on disposal and the recognition of a

receivable from the buyer for payment on the trade date. Generally, interest does not start to accrue on the asset and

corresponding liability until the settlement date when title passes. The normal recognition and derecognition rules apply to

financial liabilities. See Regular way.

Trade loans: are classified as originated loans and carried at amortised cost less impairment, unless purchased from a third

party when they are categorised as trading, held-to-maturity, available-for-sale or loans and receivables (provided they are

not quoted in an active market).

Trade payables: are financial liabilities carried either at amortised cost or fair value through profit or loss. Payables held at

amortised cost are calculated using the effective interest method.

Trade receivables: are financial assets carried at amortised cost less impairment, unless purchased or designated as at fair

value through profit or loss. Receivables held at amortised cost are calculated using the effective interest method.

Trading financial assets and financial liabilities: are those purchased with the intention of making short-term profits

from dealing or those which are part of a portfolio with a pattern of short-term profit taking. The category for financial

assets or financial liabilities 'at fair value through profit or loss' cannot be used for assets not meeting these requirements,

unless the financial asset or financial liability is designated as such upon initial recognition. An entity is not allowed to

reclassify a financial instrument into or out of the fair value through profit or loss classification while it is held or issued.

Trading financial liabilities include all short positions in securities (securities sold but not yet settled) and all derivatives

with negative fair values. An entity should define the period that it regards as short-term and apply that consistently, but it

would not exceed one year.

All trading financial assets and financial liabilities are carried at fair value with gains and losses immediately recognised in

profit or loss. A trading financial asset cannot be transferred to another category even if the intention changes. A financialasset classified as held-to-maturiy is transferred into the available-for-sale category when there is a change in the intention

or ability to hold-to-maturity.

Transaction costs: are incremental costs that are directly attributable to the acquisition, issue or disposal of a financial

asset or financial liability such as broker commissions, settlement fees, legal and other expenses that are added to, or

deducted from, cost on initially recognising a financial instrument. An incremental cost is one that would not have been

incurred if the entity had not acquired, issued or disposed of the financial instrument.

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Uncommitted facility: a credit (loan) facility where there are no restrictions placed upon the lender regarding the amount

to be lent. Under such an agreement, the lender has no obligation to provide specific amounts to the borrower. Furthermore,

the borrower is not subject to conditions set by the lender in relation to the facility.




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Underhedge: occurs where the notional principal amount of the hedging instrument is less than that of the hedged item.

Underwater option: see: Out-of-the-money.

Underwater swap: an unprofitable swap position (from the perspective of one counter party) caused by adverse movement

in interest rates since the swap's inception. The losing counterparty is making net payments to the other counter party and

would have to pay the fair value of the swap to terminate the agreement.

Unsubordinated debt: a loan, debt security or bond where the claim of the holder on the issuer's assets or earnings ranks

above other loans or securities. Also known as a senior security. In the case of default, creditors with unsubordinated debt

would get paid out in full before junior debt holders.

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Vanilla (or plain-vanilla) swap: is a simple interest rate swap, where floating interest cashflows are swapped for fixed

interest cash flows, over a fixed period of time, based on a known notional principal amount.

Volatility: is the susceptibility of a price to rapid changes in exchange and/or interest rates. Volatility is often measured in

standard deviations or percentages per annum.

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Wash sales: comprise financial assets sold and purchased with a short time-frame (but not at the same time) such that

realised gains or losses are reported in income. These are also known as bed and breakfast transactions.

Guidance on the implementation of IAS 39 states that such a repurchase does not preclude derecognition, provided that the

original transaction met the derecognition requirements. However, if an agreement to sell a financial asset is entered into

concurrently with an agreement to repurchase the same asset at a fixed price or the sale price plus a lender's return, then

the asset is not derecognised.

Written options: are options that an entity sells (that is, the entity has taken a short position). These must be fair valued

with gains and losses reported in profit or loss. They cannot be used for hedge accounting purposes as they expose the

writer (seller) to unlimited loss and thus they increase rather than reduce potential volatility in the income statement. The

exception is where the written option is designated as an offset to a purchased option, including one that is embedded in

another financial instrument (for example, a written call option used to hedge a callable liability).

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Yield: is the rate of return on an financial asset or security (that is, its interest rate), as determined by its coupon and other

characteristics. The yield is generally expressed as a percentage return and annualised.

Yield curve: is a graphical representation of the relationship between the return (that is, the interest rate) on a financialasset plotted against its time to maturity. Yields for different maturities are plotted and a line is drawn passing through the

points. The shape of the curve will usually change over time and the shape shows the current structure of interest rates.

There are many different shapes of yield curves, for example, normal (positive), linear and inverted (negative).

It is also known as the term structure of interest rates.

There are many yield curves – both for different assets and different currencies.

A parallel shift in the yield curve occurs when there is a stepped change in market interest rates, such as when the Bank of

England changes the Minimum Lending Rate.

Guidance on the implementation of IAS 39 states that the yield curve provides the foundation for computing future cash

flows and the fair value of such cash flows both at inception of, and during, a hedging relationship. It is based on current




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market yields on applicable reference bonds that are traded in the market place. Market yields are converted to spot interest

rates ('spot rates' or 'zero coupon rates') by eliminating the effect of coupon payments on the market yield. Spot rates are

used to discount future cash flows, such as principal and interest payments, to arrive at their fair value. Spot rates also used

to compute forward interest rates that are used to compute variable and estimated future cash flows.

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Zero coupon bond: is a bond where no periodic interest payments are made during the bond's life. The interest is paid at

the end of the bond's life. It is issued, and trades, at a discount to its nominal amount, because the only cash flow is the

redemption payment. See also Deep discounted bonds.

Zero coupon interest rate swap: This type of swap enables a borrower to issue a zero coupon bond and swap the interest

for floating rate. Thus the borrower pays a floating rate and receives a fixed rate. However, the fixed rate payment is paid at

the termination of the swap.

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