172 Glossary cheapness a term used to describe the least expensive cash security that can be delivered against a short futures position contango an ex

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1 Glossary arbitrage the process of buying and selling securities simultaneously in different markets to take advantage of price differentials backwardation a state of price deterioration where the next offered price is lower than the previous bid on the same instrument basis the difference in price (or yield) between a cash market instrument and its futures counterpart bid the quoted price at which a security or future may be sold call an option to buy, at a specific price, for a specific period of time covering the act of buying a financial instrument in order to deliver against a short sale CD certificate delivery, one of the two methods of delivery for GNMA futures contracts; this method calls for actual delivery of GNMA certificates themselves, determined by a yield-maintenance formula CD a certificate of deposit, issued by banks in both the domestic and euromarkets; unlike a normal term deposit it is a liquid instrument supported by an active secondary market CDR collateralised depository receipt, the second of the two methods used in delivering against a GNMA contract; this method calls for delivery of a receipt backed by actual securities themselves and is determined by a principalmaintenance formula CFfC the Commodity Futures Trading Commission, empowered by an act of Congress in 1974 with the duty to regulate all commodity futures trading in the USA 171

2 172 Glossary cheapness a term used to describe the least expensive cash security that can be delivered against a short futures position contango an expected state of security price rise when investors sometimes leverage themselves to buy coupon the amount of stated interest paid on a bond, GNMA, or certificate of deposit CPI consumer price index, a composite index of goods purchased by individuals intended to measure the rate of inflation delivery month the specific month in which a futures contract closes discount the amount below par (100) at which a low coupon bond or ordinary Treasury bill is quoted; it is normally stated in full percentage points and fractions thereof fill or kill an order placed with a futures broker meaning that it must be executed in its entirety at the stipulated place or immediately discarded forward the price of a contract in the traditional foreign exchange market, dated for delivery in the near future GTC good till cancelled order; placed with a broker by an investor who signifies a specific price for his order with no specific period of time in mind LIBOR the London Interbank Offered Rate for eurodollars; sometimes also used to describe sterling limit an order placed with a broker setting strict price restrictions upon execution locals those speculators and market makers drawn from the indigenous population who make up the trading backbone of floorbrokers on a futures exchange long hedge a strategy whereby one purchases futures for intended delivery in order to lock in today's interest rates margin the amount of money actually needed to open a futures position nearby the price of a future in the delivery month closest to the spot month offer the quoted price at which a security or future may be purchased open interest the amount of contracts outstanding on any type of futures contract or listed option

3 Glossary 173 par cap a stipulation found in the GNMA certificate delivery contract stating that no cash securities priced above par can be delivered against a short position partly paid a method used in the British gilt market and in the eurobond market where a new issue is initially offered at a fraction of par, the balance being due on a specific date premium the amount above par (100) that a high coupon bond or high-yielding Treasury bill is quoted; it is normally stated in full percentage points and fractions thereof principal maintenance a method of determining how many cash Treasury bonds, gilts or GNMAs are to be delivered against a futures contract; it uses a factor to determine the amount of securities to be delivered, based upon the notional yield of the futures contract price limit the amount of market price movement allowed a particular futures contract in any one trading day put an option to sell, at a specific price, for a specific period of time roll-over a technique whereby a futures position is closed out and immediately extended by opening another farther into the future scalpers those floorbrokers on an exchange whose major function is to take advantage of minor price discrepancies short hedge a strategy whereby one sells (short) futures in order to profit from ensuing interest-rate rises spot month the closest delivery month on a particular futures contract spot price the price of the spot month on a particular futures contract spread the differential between the bid and ask quotes on a cash or futures price stagging a British term referring to the purchase and quick sale of a security without the intention of paying for it in full straddle a trading strategy involving both long and short positions on the same futures contract or option; usually done at a similar price in the same delivery month yield maintenance a method of determining how many bonds are to be delivered against a futures position; in antithesis to the principal-maintenance contract, it uses price of a bond as the crucial factor in calculating delivery amount rather than principal equivalent.

4 Index Accounting exposure, 90, 91 Aliber, R. Z., 67n American Stock Exchange, 159 AMEX, see American Stock Exchange Arbitrage and banks, 56-7 banks and CDs, in CME, 150 between forward and futures markets, 54-9 inimm, 54-9,78-9 between interest-rate futures and cash markets, between interest-rate futures and commodity futures, 82-5 between options, 160 in stock-index futures, and Treasury bills, 71, 77-9 triangular, 78, 84, 85, 99n Auction process, 19, 32,40 and new issues, 1 06 see also Open outcry Backwardation, Banks and arbitrage, 56-7, for currencies, 39 in foreign exchange market, 48 and forward exchange, 43-5, 49 andimm,47-8, 50,56 and interest-rate risk, 90-1, 92 Basis points, 11 Basis risk, 10-11, 28, 83-4, 130, Beta coefficient, 155, 157 Bid-ask spread, Bid-offer spread, 35, 44, 46, 47 Bond futures options, Bond market, hedging in, 86 Bonds fixed-rate, 87 'flower', 138n long, 12, 15-17, 102, 107 see also Treasury bonds Brokers, 19-20, 33-4 in UK 119 see also Commission brokers; Market-makers; Scalpers Brown, B. D., 67n, 99n Burns, J. M., 67n Butterfly,see Yield curve Call provisions, Calls (and interest-rate options), 158, 159, 162 Cash markets, 4, 20 and futures markets, 25, 26, and stock index futures, 152, 153, 154 US Treasury bond market, CBOE, see Chicago Board Options Exchange CBT, see Chicago Board of Trade CDs, see Certificate delivery or Certificates of deposit CDR, see Collateralised depository receipt Certificate delivery, 116 Certificates of deposit, 72-5, 98n arbitrage and, eurodollar, 76 forward market, 81 futures market, 79-81, 89, 91-2,

5 176 Index Certificateless trading, 5, 7 Certificates trading, 5 Chartism, 155 Chicago Board Options Exchange, 159 Chicago Board of Trade, 15, 18, 23, 70, 75, 113, 133, 166, 167, 168 and bond futures options, 163 and CME, Chicago Clearing Corporation, 39 Chicago Mercantile Exchange, 165, 167 arbitrage in, 150 balance sheet of, 147 and CBT, and IMM, 141-2, 146 income of, Membership Rights Programme, 146 Class B member (of IMM), 54-6, 81 Clearing Corporation, Clearing fees, 39 Clearing house, 4-5, 18, 43 and eurodollar futures, 76 Clearing members, 40, 42, 43 Collateralised depository receipt, 116 Collusion (between brokers), 32, 36, 47 Commission brokers, 32, 36,47 Commission costs, 24 Commodity futures contract, 5 Commodity futures market, 3, 59 and arbitrage, 82-5 development of, 14-15, 19 Consumer price index, Contango, Convenience rent, 98n, 99n Convertible issue (UK), Cost of carry, 134 Covering, 7 CPI, see Consumer price index Credit risk, 4, 10, 28, 39, 48, 89, 130 Cross-hedging, 117, 130, 132 and early call provisions, 131 and sinking fund provisions, Currency, speculation in, 93-4 Currency-forward markets and credit risk, 48 decentralisation, 43, 46 and futures markets compared, and role of banks, 43-5, 46 Currency-futures contracts and banks, 39 delivery dates, profits and losses on, 40 sizes, 38--9, 49 Currency-futures markets arbitrage and, 82 and forward markets compared, limitations, Currency zone, 67n Debt markets, 3 Delivery Commitments, 43 Deliverable grade of futures, 8, 10 of options, 161 Delivery months, 7, 20, 71 Deposit margin, 2~ Deposit market, 49 Disintermediation, 126 Dollar, floating of, 32, 165 Dollar bonds, 104 Dutch options market, 159 Early call provisions, 131 Economic exposure, 9~1 Einzig, P., 66n Eurodollar futures, 75-6, 165-6, 169 Euromarket, 25 Exchange risk, 60-6, 67n and private corporations, 65 Federal Reserve Bank, 69, 95, 97 'Fill or kill' order, 22, 33 Fixed exchange rate (breakdown), 69 'Flower bonds', 138n Foreign exchange, 4-5 Foreign-exchange risk and accounting exposure, 90, 91 and economic exposure, 9~1 hedging, 90 Forward exchange markets, see Currency-forward markets Forward-forward contracts, 94-5 Forward markets, 4 see also Currency-foward markets

6 Index 177 Futures markets, 4, 6, 10 and cash markets, 25, 26 development of, 15-18, and forward markets compared, 4, 48-9 functions of, 3 innovations in, membership of, organisation of, and physical markets, 7 trading mechanics of, volatility of, 9, 15 see also Currency-futures markets Futures pricing, Futures trading transactions, 5 and deliverable grade. 8 economics of and regulation of size. 7-8 Geisst, C. R.. 29n Gilt contract (UK) and LIFFE Gilt market and US government market. 119 Gilts(UK).l convertible issues, current yield, 128 index-linked issues real rate of return of running yield, 128 yield to maturity. 128 see also New issues; Tap stock Ginnie Maes. see Government National Mortgage Association futures GNMA. Jee Government National Mortgage Association Government National Mortgage Association futures Ill GNP deflator Gold boom 'Grey' market. I 06 Hicks. J n Hedging in bond markets. 86 and call provisions. 131 in currency-futures markets in financial futures, in S&P futures, in stock-index futures, and purchase and sinking fund provisions, 131 IMM, see International Monetary Market (Chicago) Index and Option Market, 146, 148 Index-linked issue, 121 Inflation and interest rates, 125 measures of Inflation risk, 60, 61-2, 64, 86, 87-8, 92,94 Information-trading, 37-8 Interbank money markets, 79 Interest rate, 9, ex ante and ex post, 60, 6 1, 63, 64 volatility of. 104 Interest-rate futures arbitrage with cash markets, CDs eurodollar futures. 75-6, 165-6, 169 long-term, short-term, speculation in Treasury bills, Interest-rate options, arbitrage between. 160 calls, 158, 159 and deliverable grades, 161 puts and spreading strategies. 162 striking price Interest-rate risk , and banks International Monetary Market (Chicago). 31-2, , 40, ,46.4~50.55, , and banks and broken month trading. 51 and CDs, 73, class B members of, 54-6 and CME , and contract maturities, 51-2

7 178 Index International Monetary Market -cont. development of, and eurodollar futures, 75, 76 and forward-futures market arbitrage, 54-6 liquidity in, 50--1, 55 and margin requirements, 47-8 market-makers in, 4Cr7 membership of, Membership Rights Programme, 146 seat prices in, 144 and stock-index futures, 150, 151 and Treasury bills, 78-9, 70 Inventory risk, M, see Index and Option Market Jobbers (UK), 119 Keynes, J. M., 13, 28n Laddering, 89 LIBOR, see London interbank market LIFFE, see London International Financial Futures Exchange Limit-order, 33, 37-8, 43-4, 45, 48-9 for spread transaction, 53 Limit prices, 21, 34, 41-2 London interbank market, 75 London International Financial Futures Exchange, 17, 70, 76, 102, 164, 167 and arbitrage, 84 development of gilt contract, London Metal Exchange, 83 London Stock Exchange, 18, 118, 119 Margin, see Deposit margin; Margin collection Margin collection (in currency futures) Market-makers, 43 in currency-futures market, 45-6, 49 in forward market, 45, 4Cr 7 and IMM. 4Cr7 and spread transactions, 53 Market-orders, , 45, 53 'Naked' option writing, 159 New issues UK, USA, New York Financial Futures Exchange, 149, 164, 165, 167 New York Futures Exchange, 70, 113 and stock futures contracts, 150, 151 New York Stock Exchange, 151, 157 Composite Index, 151 NYFE, see New York Futures Exchange NYFFE, see New York Financial Futures Exchange NYSE, see New York Stock Exchange Open interest, Open outcry, 19,32-8,40, 45,47 'Par cap' stipulation, 116 Partly paid issues (UK), 'Pass-through' certificates, 108, 109 Portfolio horizon date, 85-7 minimum risk, 60-4, 87-8 Pound (UK), floating of, 32 Premium in option markets, 169n Price curve, Principal maintenance, , 116 and LIFFE gilt contract, 122 Purchase and sinking fund provisions, Puts (and interest-rate options), 158, 159, 162 Real exchange-rate risk, 60--1, 63 Repurchase agreement, 139n Re-po, see Repurchase agreement Risk, see Basis risk; Credit risk Roll-over strategy, 87, 88 Roll-over transaction, 50 S&P Stock Index, Sale and repurchase agreements, 77-9 Scalpers, 19, 35-6, 37, 54 and arbitrage, 84-5 in currency-futures markets, 49 and Treasury bill futures, 79

8 Index 179 Scalpers- cont. on IMM, 167 Short maturity contracts (in IMM), 50 Short sales, shorts, 7, 127 and CD futures contracts, 73, 74 Smithsonian Agreement, 31 Speculation in currency, 93-4 in interest-rate futures, 93-8 and yield curve, 96 Spot interest rates, 97 Spot markets, 49 illiquidity, 72 for Treasury bills, 69 Spot month, 7, 12-14, 132 Spot price, 13-14,133-4 Spread orders, 54 Spread trader, 71-2 Spreads bear, 162 bid-ask, bid-offer, 35, 44, 46, 47 bull, 162 and market orders, 53 yield, Stock Exchange, see London Stock Exchange; New York Stock Exchange Stock inde,x futures, appeal of, and arbitrage in cash markets, hedging in, 15&-7 'Striking' price, Swap market, 49, 50 Tap stock (UK), 121 Telser, L. G., 99n time curves, time-stamping, 34 'Treasuries', 104 yield, 111, 117 Treasury bills UK, ,121 us. 15,21,22,69, 70,83,91-2, 97-8, 138n, 167 Treasury bonds (US), and long bonds, 112 market, 104-8, and options, 162 Uncovered option writing, 159 Variable rate stock (UK), 121 Volatility, 115 of interest rates, 69-70, 127 of long bonds, I 02 of real exchange rate, 61 ofreal interest rate, 61, 4 of price, 21 War Loan (UK), 119 Yield current, 128 of GNMA, 110, Ill of long bonds, 102, 107, to maturity, 128 and speculation, 96 spreads, of'treasuries', Ill, 117 Yield curve, 12-13,25-6,27, 136 'butterfly' of, 26, 28n and convertible issue, 121 and forward-futures prices, 135 and futures time, and investor speculations, 125 UK, Yield maintenance contract, 114 Yield spreads, z account, 17