Glossary

A

ABS (Asset-backed securities): A security whose value and income are derived from and backed by underlying assets. The collateral is often some form of loan.


B

Basel II: Standards regulating how much capital a bank must retain in relation to the risk it faces. The regulations also require adequate risk management and disclosure of public information.

Basel III: Refers to a new update to the Basel Accords (Basel I and Basel II).

Basis point: One-hundredth of a percentage point (0.01 per cent). Thus, 100 basis points are equal to one per cent and 25 basis points to one-quarter of one per cent.

Bond: A fixed-interest promissory note or debt instrument issued by a government, municipality, credit market company, mortgage institution or large company. Bonds generally have a long maturity, at least one year. Periodic payments are made prior to maturity, at which time the principal amount is repaid.


C

Capital adequacy regulations: Rules governing capital adequacy of banks. See also Basel II and Basel III.

Capital market: Umbrella term for the stock, credit and derivative markets.

CDO (Collateralised debt obligation): A structured credit instrument made up of bonds, from many different securitised loan portfolios and other assets. This composite portfolio is then structured into segments with different credit risks.

CDS (Credit default swap): A contract between two parties in which one of the parties buys protection against the credit risk in a bond by paying a premium. The seller receives the premium in return for accepting the credit risk. The instrument is used as a form of insurance as well as for speculative purposes.

Central counterparty: An institution that acts as a seller to all the buyers and a buyer to all the sellers of financial instruments on an exchange.

Certificate: A security for trading in the money market. A certificate is a debt instrument issued by e.g. a bank or a company with the purpose of borrowing money. Maturity is a maximum of one year.

Core Tier 1 capital: Tier 1 capital after deductions for Tier 1 capital supplements.

Core Tier 1 capital ratio: Core Tier 1 capital in relation to risk-weighted assets.

Covered bond: A bond whose holder has a special benefit right in a bankruptcy. Covered bonds are intended to be more creditworthy than non-covered bonds, which reduces the cost of funding.

Credit rating agency: A company that assigns ratings, i.e. makes an assessment of the credit risk associated with a company.

Credit risk: The risk of a borrower failing to meet commitments.

Currency swap: An agreement to buy/sell a currency at the daily rate and then sell/buy back the same currency on a later date at a pre-determined rate.


D

Deposit guarantee: An insurance on funds deposited with affiliated credit institutions. If a credit institution defaults, savers recover their deposits, usually up to a fixed amount.

Derivative: A financial instrument that entails agreements on commitments at a given future point in time. The value of a derivative is linked to an underlying asset. The most common derivative instruments are options, futures and swaps.


E

Euribor: Interbank rate within the EMU (European Monetary Union) zone


F

FX-swap: See Currency swap.


G


H

Hybrid capital: A cross between equity and debt. In the event of a default, hybrid capital has higher priority than equity but lower priority than borrowed capital (bonds).


I

Implied volatility: Market participants’ expectations of future variations in share prices, derived from option pricing. Volatility is usually measured as the standard deviation of the share’s rate of return.

Interbank market: The market where banks trade interest and currencies with each other.

Interbank rate: A daily reference rate based on the interest rates for unsecured loans that banks offer to one another (such as EURIBOR, LIBOR etc.).


J


K

Key policy rate: The interest rates which a central bank sets for the purpose of monetary policy.


L

Liquidity risk: The risk of not being able to meet payment obligations without the cost of obtaining the funds increasing materially. Liquidity risk in a financial instrument entails that an investment cannot be immediately liquidated at all or without falling sharply in value.

Loan-to-value ratio: Borrowers’ debt in relation to the collateral’s market value. For example, a household’s loan-to-value ratio for its home corresponds to the household’s debt collateralised by the home divided by the market value of the home.


M

Market risk: The risk that unfavourable fluctuations on the financial markets, mainly for interest rates, shares and currencies, will result in losses.

MBS (Mortgage-backed securities): A specific variation of a securitisation in which the return on the security is received via interest payments from a collection of mortgages.

Monetary policy: Aims of Central Banks to influence inflation, the exchange rate and/or economic activity by altering the amount of money in circulation and adjusting key policy rates.


N

Net interest income (NII): Consists primarily of interest income from lending less interest expenditure for funding and deposits.


O


P

P/E ratio (Price/Earnings): The price of a share in relation to earnings.


Q        


R

Repo: A financial instrument resembling a loan. The participant receiving the money (the seller) transfers the security to the purchaser. At the same time, the seller undertakes to repurchase the security from the purchaser, at a predetermined date, for a slightly greater sum of money. The difference between the sale and the repurchase is equivalent to the interest rate on a loan.

Risk premium: The additional return an investor requires as compensation for an additional risk.

Risk-weighted assets: Total assets and off-balance sheet commitments totalled, valued and risk-weighted in accordance with the prevailing capital adequacy regulations.


S

Securitisation: A financing process whereby a number of loans (e.g. mortgages or credit card loans) are bundled together and sold on to a company created specifically for the purpose and financed by issuing securities in the market.

SIV (Structured Investment Vehicle): A company that has been kept off the bank’s balance sheet. A SIV’s assets consist of different types of loans and structured products. SIVs are financed with certificates with short runs as well as with corporate bonds that have longer maturities. SIV debts are divided into different segments (tranches) that have different ratings. If a SIV makes a loss it first affects the owners of the lower rating segment, then the owners of the higher rating segment.

Spread: Usually the difference between two interest rates. In the bond market, spread is measured in basis points (see Basis point).

Stress test: Analysis of different scenarios to test the resilience of banks and households to unexpected and negative events.

Structured products: Pools of securitised loans. The most common products are collateralised debt obligation (CDO) and mortgage-backed securities (MBS).

Swap: A bilateral agreement to exchange a specific currency / interest rate in return for another currency / interest rate for a predetermined period according to specific conditions.

Syndicated loan: A loan where a bank sells parts of the loan to other banks, often internationally.


T         

TED spread: The difference between a 3-month interbank rate and a 3-month treasury bill rate.

Tier 1 capital: Equity less proposed dividends, deferred tax assets and intangible assets such as goodwill. Tier 1 capital may also include certain types of subordinated debt, so-called Tier 1 capital supplements or hybrid capital.

Tier 1 capital ratio: Tier 1 capital in relation to risk-weighted assets.

Tier 1 capital supplements: Certain types of perpetual subordinated notes may be included in the Tier 1 capital if permission is granted by the financial supervisory authorities.


U


V

Volatility: Usually measured as the standard deviation of an asset’s rate of return.


W        


X


Y


Z