Risk Management Glossary

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sk Management Glossary - Finance, Energy, Technology & Statistics http://www.risk-glos

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The Risk Glossary

A: Accrual Bond - a bond on which interest accrues, but is not paid to the investor during the time ofaccrual. The amount of accrued interest is added to the principal of the bond and is paid atmaturity.

Actuals - the physical commodity underlying a futures contract. Also referred to as the cashcommodity or the physicals.

AICPA - an acronym for the American Institute of Certified Public Accountants, a professional

association representing CPA's in the U.S.

Algorithm - a defined, finite sets of steps, operations, or procedures that will produce a particularoutcome (e.g. computer programs, mathematical formulas, and recipes).

Alpha - a measure of the difference between a fund's actual returns and its expected returns given

its risk level as measured by its Beta. The Alpha is a measure of risk adjusted performance. AnAlpha is usually generated by regressing the security, portfolio or mutual fund's excess return onthe S&P 500 excess return. The Beta adjusts for the risk (the slope coefficient). The Alpha is the

intercept and is also know as the Jensen Index.

Altman Z Score - a credit scoring system developed in 1968 by Dr. Edward I. Altman, a financialeconomist and professor at New York University's Stern School of Business, to predict theprobability of a company entering bankruptcy within a twelve month period. The Altman Z-scoremodel is widely used as a guide to predict financial distress. The model indicates bankruptcy whenZ is less than 1.20, and survival when Z is greater than 2.90.

The Z-score is though not a substitute for an in-depth analysis and should not be used in isolationas a basis for making credit and investment decisions. The Z score has five ratios that are givendifferent weights. These five ratios are: working capital / total assets; retained earnings / totalassets; EBIT / total assets; market value of total equity / book value of total liabilities (for publiccompanies); and sales / total assets.

American Option - an option contract that may be exercised at any time prior to expiration. This

differs from a European Option, which may only be exercised on the expiration date.

Annualized Return - a return calculated over one period, but adjusted to be comparable to areturn calculated over a year.

Arbitrage - a trading and investment technique to cash-in on price differences between relatedmarkets, indices, or futures contracts based on those indices.


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ARCH - an acronym for autoregressive conditional heteroskedasticity.

Arithmetic Mean - the sum of a list of numbers, divided by the number of numbers. See alsoAverage below.

Asset Allocation - an investment strategy based on allocation of percentages of an investmentportfolio between stocks, bonds, or other asset classes.

Asian Option - an exotic option whose payoff depends on the price movements of the underlyingasset during some portion of the life of the option.

Autocorrelation - the correlation between a component of a stochastic process and itself lagged acertain period of time.

Average - usually denotes the arithmetic mean (see above), but it can also denote the median, themode, the geometric mean, and weighted means, among other things.

Average Price Option - an average rate option; see below. Also referred to as an APO.

Average Rate Option - a form of Asian option whose payoff is linked to the average underliervalue over a specified period. Although somewhat more complex to price relative to traditionalEuropean or American option structures, Average Rate Options are popular since they provide aprice hedge that better matches price exposures that are based on daily averages, such aspurchase/consumption of energy on a daily basis.

B: Backwardation - market situation in which futures prices are progressively lower in the distantdelivery months. See also Contango.

Barrier Option - a path-dependent option that terminates or is activated by the underlier reaching

some "barrier" price level.

Basis Point - 1/100th of 1%.

Basis Risk - the risk of financial loss due to a change in the price differential between the hedgeindex and the underlying cash price. Basis risk typically involves product, location or timedifferences.

Basle Accord (1988) - an international accord on bank capital requirements. Amended in 1996 toadd capital requirements for market risk.

Bayes Rule - a rule that expresses the conditional probability of the event A given the event B interms of the conditional probability of the event B given the event A.

Bell Curve - a common description of the characteristic shape of the most common of statistical

distributions: the Normal distribution.

Below Investment Grade Bond - a junk bond, whose credit rating is below BBB.

Bermuda Option - an option that allows exercise at discrete points in time after a certain date.Also known as a modified American option. See American, European and Asian options.


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Bernouilli Process - the simplest probability model - a single trial between two possibleoutcomes, such as a coin toss.

Beta - a measure of a stock's (or a portfolio's) volatility in relation to the overall market, which bydefinition has a beta of 1.0.

Bid-Ask Spread - the difference between prices at which dealers are willing to buy or sell. Alsoreferred to as the Bid-Offer Spread.

Binary Option - a type of option which features a discontinuous expiration value.

BIS - an acronym for the Bank for International Settlements. The BIS is an international body thatpromotes the cooperation of central banks, fulfils the function of a central banks' bank and acts asa clearing and settlement agent. The BIS also acts as a forum for discussion of internationalmonetary policy and conducts research into international banking developments.

Black-Derman-Toy Model (BDT) - an options pricing model using the Black/Derman/Toy

binomial interest rate model. This model is a set of simultaneous nonlinear equations. It is namedafter the late Fischer Black, Dr. Emanuel Derman of Goldman, Sachs & Co. and William Toy, whodeveloped the model in 1987.

Black-Scholes Model - an options pricing formula first developed in 1973 by Fisher Black andMyron Scholes for securities options and later applied to a range of other option structures.

Blue Sky Laws - laws various states have enacted to protect the public against securities frauds.The name is believed to have originated when a judge ruled that a particular stock had about thesame value as a patch of blue sky.

Brownian Motion - a stochastic process that has stationary independent increments whichfollows a normal distribution and also has continuous sample paths. It is a Markovian process,and is also known as a Wiener process.

BTU - an acronym for British Thermal Unit.

C: Call Option - option that gives the buyer the right, but not the obligation, to buy a futures contractfor a specified price within a specified period of time in exchange for a one-time premiumpayment. See also Put Option.

Call Spread - an option trading strategy involving buying a call option with a certain strike price

and selling a call option having the same expiration date as the first but at a different strike price.

Capacity [electric power] - the maximum power that a machine or system can produce or carrysafely. The maximum instantaneous output of a resource under specified conditions. For electricpower, the capacity of generating equipment is generally expressed in kilowatts or megawatts.

Capacity Factor - the amount of energy that a power generation plant actually generatescompared to its maximum rated output, expressed as a percentage.

Cash Flow Hedges - in U.S. accounting terminology, a hedge of a forecasted asset and liability


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acquisition, for which the gain or loss on the hedging instrument will remain in equity when theasset or liability is acquired. That gain or loss will subsequently be included in net profit or loss in

the same period as the asset or liability affects net profit or loss. See also FAS 133.

CBOT - an acronym for the Chicago Board of Trade.

CFTC - an acronym for the U.S. Commodities Futures Trading Commission.

Chi-Squared Distribution - the distribution for the square of a normal random variable. Thechi-squared distribution arises frequently in applications because of its close association with thenormal distribution.

CHP - an acronym for Combined Heat and Power. A term referring to cogeneration, morecommonly used in Europe and other non-U.S. countries.

CME - an acronym for the Chicago Mercantile Exchange.

CNG - an acronym for Compressed Natural Gas. CNG is natural gas that has been compressed

under high pressure (typically 2000 to 3600 psi).

Coefficient of Determination - a measure of the proportion of variance iny which can be

explained byx. See also r2.

Cogeneration - the production of electricity and useful thermal energy from a common fuelsource.

Combined Cycle - two or more generation processes in series or in parallel, configured tooptimize the energy output of the system. For electric power, the combination of a gas turbine anda steam turbine in an electric generation plant. The waste heat from the gas turbine provides the

heat energy for the steam turbine.

Confidence Interval - a confidence interval for a parameter is a random interval constructed fromdata in such a way that the probability that the interval contains the true value of the parameter canbe specified before the data are collected.

Contango - market situation in which prices in succeeding delivery months are progressivelyhigher than in the nearest delivery month; the opposite of backwardation. See also

Backwardation.

Continuous Variable - a quantitative variable is continuous if its set of possible values is

uncountable. Examples include temperature, exact height, exact age (including parts of a second).Since in practice one can never measure a continuous variable to infinite precision, continuousvariables are sometimes approximated by discrete variables.

Convexity - a measure of the sensitivity of duration to changes in yield levels. Convexity is ameasure of the stability or instability of the measured duration over a range of yields. If convexityis low, that is, if the price/yield relationship is close to a straight line, duration is stable. Ifconvexity is high, duration is unstable. The greater an instruments convexity, the less accurateduration will be. See also Duration.


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Cooling Degree Day - a typical index variable in weather derivative transactions. Also referredto as CDD.

Correlation - a measure of linear association between two (ordered) lists. Two variables can bestrongly correlated without having any causal relationship, and two variables can have a causalrelationship and yet be uncorrelated. In a two-dimensional plot, the degree of correlation betweenthe values on the two axes can be quantified by the so-called correlation coefficient (see below).

Correlation can be an important consideration in risk management for such areas as developingsurrogate hedges, structuring hybrid instruments, and demonstrating hedge effectiveness within

accounting & reporting rules ofFAS 133.

Correlation Coefficient - the correlation coefficient (also referred to as "r") provides an index ofthe degree to which variables co-vary in a linear fashion.

Counter Party Risk - the risk that a counter party to a transaction or contract will default (fail toperform) on its obligation under the contract. Counter party risk is not limited to credit risk (therisk that the counter party cannot fulfill its contractual obligations for payment) but may also result

from other problems associated with a counterparty unwilling to honor the contract.

Covariance - a measurement of the relationship between two variables. The arithmetic mean ofthe products of the deviations of corresponding values of two quantitative variables from theirrespective means.

Covariance Matrix - a square, symmetrical matrix in which the rows and columns are variables,and the entries are covariances. The diagonal elements (the covariance between a variable and

itself) will equal the variances.

Coverage Ratio - the ratio of earnings to some key expense, such as interest or dividend payout.

Cox-Ross-Rubinstein Option Pricing Model - an option pricing model developed by John Cox,Stephen Ross, and Mark Rubinstein that can be adapted to include effects not included in the

Black-Scholes Model (e.g., early exercise).

Crack Spread - a commodity-product spread involving the purchase of crude oil futures and thesale of gasoline and heating oil futures.

Credit Default Swap - a bilateral over-the-counter (OTC) contract in which the seller agrees tomake a payment to the buyer in the event of a specified credit event in exchange for a fixedpayment or series of fixed payments; the most common type of credit derivative; also called Credit

Swap.

Credit Derivative - derivative product with a payoff that depends on risk factors related to creditquality, such as yield spread over Treasuries, price discount from par, or a "credit event" such as adrop in credit rating or some sort of failure, such as occurrence of default, insolvency orbankruptcy.

Credit Risk - the risk that a counter party to a transaction or contract does not perform, includingrepayment on debt obligations but also payments on commercial transactions such as hedges andderivatives.


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Credit Scoring - a system used by lenders to calculate the statistical probability of repayment onpossible loans or extensions of credit.

Critical Day Option - an option structure used for weather derivative transactions where theoption payoff is based on defined critical conditions being met for a specified number of days.

Cumulative Probability Distribution Function - the cumulative distribution function of arandom variable is the chance that the random variable is less than or equal tox, as a function ofx.

Currency Risk - the financial risk posed by fluctuating worldwide exchange rates.

Current Ratio - refers to the ratio computed as the current assets divided by current liabilitiesfrom the most recent quarter. The current ratio is a measure of a firm's immediate financial healthand its ability to meet current obligations.

Curvilinear Function - a function whose value, when plotted, will follow a continuous but notnecessarily straight line, such as a polynomial, logistic, exponential, or sinusoidal curve.

D: DAX - a benchmark index tracking 30 blue chip stocks traded on the Frankfurt Stock Exchange.

Dashboard - in risk management, trading and financial applications, a consolidated report and/orgraphical display highlighting key financial results and control metrics, such as current and

trending level ofVaR, current trading positions against established limits, and daily

Mark-to-Market gains and losses.

Default Probability - the likelihood that a transaction counter party will default on an obligation.

Degree Day - a typical index variable in weather derivative transactions. Degree Days are a

practical method for determining cumulative temperatures over the course of a season. Originallydesigned to evaluate energy demand and consumption, degree days are based on how far theaverage temperature departs from a human comfort level of 65 degrees Fahrenheit. See alsoCooling Degree Day and Heating Degree Day.

Delta - sensitivity of an option's value to a change in the price of the underlying futures contract,also referred to as an option's futures-equivalent position. Deltas are positive for calls, andnegative for puts. Deltas of deep in-the-money options are approximately equal to one; deltas ofat-the-money options are 0.5; and deltas of deep out-of-the-money options approach zero.

Delta Hedging - a hedging strategy that uses futures contracts to hedge options and involves

re-balancing an option portfolio periodically to maintain a specific delta (e.g. a delta of zero).

Delta Neutral - refers to a position or portfolio involving options that is designed to have anoverall delta of zero.

Denatured - ethanol that has had a substance added to make it unfit for human consumption.

Derivative Instrument - an instrument which derives value from the value of some commodity orother financial instrument. Often referred to simply as Derivatives. Various authorities definederivative instruments in broad, inclusive terms or narrow, exclusive terms. For U.S. accounting


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rules in FAS 133, the FASB defines derivatives narrowly.

Designated Hedges - in U.S. accounting terminology under FAS 133, a derivative transaction thathas been specified and contemporaneously documented as intended to hedge the financial risks ofan asset or liability position, a firm commitment, or a foreign currency position or forecastedtransaction.

Differential Swap - a Quanto swap.

DIG - an acronym for the FASB's Derivatives Implementation Group, which is a task force thatwas created by the FASB in 1998 concurrent with their issuance of FASB Statement No. 133,Accounting for Derivative Instruments and Hedging Activities, to assist the FASB in providingguidance on questions that companies would face when they began implementing FAS 133.

Digital Option - a Binary Option.

Dispersion - the distribution pattern of measurements. The Standard Deviation is the mostcommon measure of dispersion.

Distillate Oil - any distilled product of crude oil. A light petroleum product used for home heatingand most machinery.

Dividend Yield - a stock's dividend expressed as a percentage of the share price.

Drexel Burnham Lambert - the now defunct investment bank that dominated thejunk bondmarket of the 1980's.

Duration - a sophisticated measure of the average timing of cash flows from an asset or a liabilityor from an asset portfolio or a liability portfolio. Essentially, duration is a more accurate measure

of maturity because it reflects the timing of cash flows from periodic interest and/or principalpayments in addition to the cash flows represented by the funds transferred at maturity.

Duration is computed by summing the present values of all of the future cash flows aftermultiplying each by the time until receipt, and then dividing that product by the sum of the present

value of the future cash flows without weighting them for the time of receipt. See also Convexity.

Duration-Convexity Matching - a technique of asset-liability matching.

E: Efficient Frontier - a theoretical set of portfolios offering optimal risk-reward tradeoffs.

EDGAR - is a federally registered trademark of the U.S. Securities and Exchange Commission(SEC) and is the acronym for Electronic Data Gathering, Analysis, and Retrieval. EDGAR is theSEC's system used by all public companies to transmit required filings, such as quarterly reportsand annual reports and ongoing disclosure obligations. EDGAR filings can be accessed onlinedirectly from the SEC or through various online service companies.

EFP - an acronym for Exchange for Physicals; an alternative to physical settlement offered bymany futures exchanges. See below.

EITF - an acronym for the Emerging Issues Task Force, a unit of the Financial Accounting


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Foundation that addresses accounting issues not yet addressed by a published FASB Statement ofFinancial Accounting Standards.

Embedded Derivatives - within a U.S. accounting context of FAS 133, portions of contracts thatmeet the definition of a derivative when the entire nonderivative contract cannot be considered a

financial instruments derivative. See also FAS 133.

Emissions Credits - the instruments created by regulations in the U.S. market to encouragemarket-driven reductions of pollution.

Ethanol - ethyl alcohol produced by fermentation and distillation. An alcohol compound with thechemical formula CH3CH20H formed during sugar fermentation by yeast. Also referred to as grain

alcohol. Used as a gasoline additive for octane enhancement.

European Option - an option that can only be exercised on its expiration date. See also

American Option.

Exchange for Physicals (EFP) - a transaction in which the buyer of a cash commodity transfers to

the seller a corresponding amount of long futures contracts, or receives from the seller acorresponding amount of short futures, at a price difference mutually agreed upon. In this way, theopposite hedges in futures of both parties are closed out simultaneously.

Exchange Traded - traded on a regulated exchange such as the New York Stock Exchange,

Chicago Board of Trade, or New York Mercantile Exchange.

Exercise Price (Strike Price) - the price, specified in the option contract, at which the underlyingfutures contract, security, or commodity will move from seller to buyer.

Extendable Option - an option whose expiration may be extended.

Extrapolation - estimation of the value of a variable for future times at which the value has notyet been observed. This estimate may be reasonably reliable for short times into the future, but forlonger time periods the estimate may become less accurate.

Extrinsic Value - the time value of an option, which reflects the probability that the option maymove into the money before expiration.

F: Fair Value - in the pricing of financial instruments, the value determined by mathematicalmodeling of the instruments value.

Also used as a defined term in U.S. accounting standards as fair value accounting and 'fair valuehedges' as in FASB Statement FAS 133. A Fair Value Hedge is a hedge of the exposure tochanges in the fair value of a recognized asset or liability, or of an unrecognized firm commitment,which are attributable to a particular risk.

Fallen Angel - a bond that was investment grade when issued, but has since degraded to junkquality.

FAS 133 - Financial Accounting Standard 133,Accounting for Derivative Instruments andHedging Activities, Statement issued by the Financial Accounting Standards Board in June 1998


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[the full text of FAS 133 is available here in PDF format]. FAS 133 establishes accounting andreporting standards for derivative instruments, including certain derivative instruments embeddedin other contracts, and for hedging activities.

Since 1998 when FAS 133 was first issued, there has been an on-going evolution of the accountingrules for derivatives and physical energy supply contracts. This has included the issuance of FAS138, FAS 149, and the various Derivatives Implementation Group (DIG) and Emerging Issues

Task Force (EITF) rules subsequently adopted by the Financial Accounting Standards Board. See

also Hedge Accounting.

FAS 138 - Financial Accounting Standard 138,Accounting for Certain Derivative Instruments andCertain Hedging Activities, Statement issued by the Financial Accounting Standards Board in June

2000 to amend FAS 133. The full text of FAS 138 is available here in PDF format.

FAS 149 - Financial Accounting Standard 149,Amendment of Statement 133 on DerivativeInstruments and Hedging Activities, Statement issued by the Financial Accounting Standards

Board in April 2003 to further amend FAS 133. The full text of FAS 149 is available here in PDFformat.

FASB - the Financial Accounting Standards Board, which is the designated organization in theU.S. private sector for establishing standards of financial accounting and reporting. The standardsare officially recognized as authoritative by the U.S. Securities and Exchange Commission and theAmerican Institute of Certified Public Accountants.

Fence - a long (short) underlying position together with a long (short) out-of-the-money put and ashort (long) out-of-the-money call, with the options all having the same expiration date.

FCM - Futures Commission Merchant; an individual or organization accepting orders to buy orsell futures or futures options. A person or organization in this role needs to be certified by the

Commodities Futures Trading Commission.

Firm Liquidated Damages - a contract that requires firm [certain] delivery of the specifiedcommodity, or the payment of its equivalent financial value as damages for failure to perform.

Firm Power - electric power which is guaranteed by the supplier to be available at all timesduring a period covered by a commitment. That portion of a customer's energy load for whichservice is assured by the utility provider.

Floor - a type of derivative instrument that offers protection against declining prices, exchangerates or interest rates.

Financial Engineering - the field of applied finance devoted to the design and pricing ofderivative instruments and structured products.

Foreign Currency Hedges - transactions entered into in order to eliminate or mitigate thefinancial risks of exposures to fluctuations in foreign exchange rates. In U.S. accountingterminology, derivative transactions meeting the criteria specified in Financial AccountingStandard 133. See also FAS 133 above.

Functional Currency - as terminology in U.S. accounting standards, the primary currency in


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which an entity conducts its operation and generates and expends cash.

Futures Contract - a transaction on a regulated futures exchange, such at the NYMEX or CBOT.

G: G - the Commodity Futures Symbol which represents the February Delivery Month.

Gamma - the sensitivity of an option's delta to changes in the price of the underlying futures

contract.

Gas Turbine - a turbine that converts the energy of hot compressed gases (produced by burningfuel in compressed air) into mechanical power.

Gasification - a chemical or heat process to convert a solid fuel to a gaseous form.

Gasohol - a motor vehicle fuel that is a blend of unleaded gasoline and ethanol.

Generalized ARCH - a generalization of the autoregressive conditional heteroskedasticitymodel. Also referred to as GARCH.

Geometric Return - log return.

Glass-Steagal Act - the United States 1933 Banking Act that separated commercial andinvestment banking and formed the FDIC.

Greeks - a set of factor sensitivities used for measuring risk exposures related to options or other

derivatives. The key Greek measures are: delta, gamma, rho, theta, and vega.

Green Book - a compendium of information on FAS 133, or other statements and materials

related to FAS 133, prepared by the Financial Accounting Standards Board (FASB), which

encompasses about 800 pages.

Group of 30 Report - an influential 1993 industry report on OTC derivatives. Also referred to asthe G-30 Report.

H: Hammersmith and Fulham decision - a 1992 legal decision that invalidated existing derivativescontracts with numerous U.K. local councils.

Heat Rate - the amount of fuel energy required by a power generation unit to produce onekilowatt-hour of electrical output.

Heating Degree Day - a typical index variable in weather derivative transactions. Also referredto as HDD.

Heavy-tailed Distribution (fat-tailed) - a distribution in which the extreme portion of thedistribution (the part farthest away from the median) spreads out further relative to the width of thecenter (middle 50%) of the distribution than is the case for the normal distribution. For asymmetric heavy-tailed distribution, the probability of observing a value far from the median ineither direction is greater than it would be for the normal distribution. Heavy-tailed describes a

distribution with excess kurtosis.


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Hedge - a transaction or position taken in order to eliminate or mitigate the risk of adverse pricemovements in an exposure position such as an existing asset or liability position.

Hedge Accounting - accounting methodology established by provisions of FAS 133 for reportingof gains and losses on transactions intended to hedge exposed positions. Various criteria must bemet as specified in FAS 133 in order to use hedge accounting for U.S. financial reporting. See also

FAS 133.

Hedge Effectiveness - in U.S. accounting terminology, a criteria that must be met in order to useHedge Accounting for U.S. financial reporting. This provision has proven problematic in the

energy industry where partial hedges for such exposure components as basis risk are widely used.Under the rules of FAS 133 when testing for hedge effectiveness, only interest rate exposures canbe broken down into their component parts. See also FAS 133.

Henry Hub - a natural gas pipeline hub in Louisiana that serves as the delivery point for New

York Mercantile Exchange natural gas futures contracts and often serves as a benchmark forwholesale natural gas prices across the U.S.

Herstatt Risk - settlement risk; named after the German bank, Herstatt, whose 1974 failurehighlighted the dangers of settlement risk.

Heteroskedasticity - a condition where a stochastic process has non-constant second moments[variance].

High Grade - a phrase used to describe investments with the highest quality ratings usuallyAAA or AA.

Historical Volatility - the annualized Standard Deviation of percent changes in prices over a

specific period. It is an indication of past volatility in market prices. See also Implied Volatility.

Holding Period - a time period over which the variability in the value of a portfolio of assets orpotential earnings from some economic activity is assessed. See also VaR.

I: IAS 39 - an accounting standard titled, Financial Instruments: Recognition and Measurement,issued by the International Accounting Standards Committee (IASC). IAS 39 is similar, but much

less complex, than the U.S. FASB's FAS 133.

Implied Volatility - a volatility level inferred from an option price. See also Historical Volatility.

In-The-Money - a term used to describe an option contract that has a positive value if exercised.

Interest Rate Parity - an arbitrage condition that must hold between the spot interest rates ofdifferent currencies.

International Accounting Standards Committee (IASC) - an organization headquartered inLondon that has been charged with developing international accounting standards.

Interpolation - for a given a set of bivariate data (x,y), imputing a value of y corresponding tosome value of x at which there is no measurement of y, where the value of x is within the range of


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the measured values of x. See also, Extrapolation.

Intrinsic Value - the amount by which an option is in-the-money. An option which is notin-the-money has no intrinsic value. For calls, intrinsic value equals the difference between theunderlying futures price and the option's strike price. For puts, intrinsic value equals the option'sstrike price minus the underlying futures price. Intrinsic value is never less than zero.

Inverse Floater - a floater whose coupon varies inversely to its reference rate.

ISDA - the International Swaps and Derivatives Association.

It's Lemma - a continuous time version of the Taylor expansion, which relates the change in astochastic function to the change in the stochastic variable. In mathematics, It's lemma is used instochastic calculus to find the differential of a function of a particular type of stochastic process.The lemma is widely employed in mathematical finance. Named after the Japanese mathematicianand professor at Kyoto University. See also It's Theorem.

J: J - the Commodity Futures Symbol which represents the April Delivery Month.

January Effect - the tendency for small capitalization stocks to exhibit an upward bias in theirprice behavior during the month of January. Some observers believe this may be partiallyattributable to the influence of index funds buying stocks for various retirement plans when newcontributions would be qualified to commence in January.

Jensen Index - an index that uses the capital asset pricing model to determine whether a moneymanager outperformed a market index.

Joint Normal Distribution - a multivariate distribution with normal marginal distributions.

Joule - a measurement unit for energy.

Jump-Diffusion Model - a stochastic process that combines random jumps with a geometric

Brownian motion.

Junk Bond - a bond whose credit rating is below BBB.

K: K - the Commodity Futures Symbol which represents the May Delivery Month.

Kappa - a value representing the expected change in the price of an option. Also known as

Lambda.

Kilowatt - a standard unit of measure for electricity; the rate at which energy is supplied. Named

for James Watt, inventor of the modern steam engine. See also Watt.

Kilowatt Hour - a unit of measure for electric energy equal to a thousandth of a megawatt hour.For example, a 100 watt lightbulb used for 10 hours equals one kilowatt hour (kWh). See alsoMegaWatt Hour.

Kholodnyi Model - a valuation model developed by the mathematician Valery A. Kholodnyi for


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use in valuing and hedging electric power price risks in environments of extreme price spikes.

KMV Model - a commercial implementation of the asset value model of credit risk. [KMV was aboutique software firm that is now owned by Moodys.]

Knock-in Option - an option feature which triggers the activation of an option contract. Alsoreferred to as Down-and-In and Up-and-In, depending on the structure.

Knockout Option - an option that becomes worthless in the event that the underlying commodityor currency crosses a certain price level.

Kurtosis - a parameter describing the peakedness and tails of a probability distribution relative to

the benchmarklog normal distribution.

L: Law of Averages - the statistical concept that the average of independent observations of randomvariables that have the same probability distribution is increasingly likely to be close to theexpected value of the random variables as the number of observations grows.

Law of Large Numbers - the statistical concept that in repeated, independent trials with the sameprobability of success in each trial, the percentage of successes is increasingly likely to be close tothe chance of success as the number of trials increases.

Least Squares Remapping - a global remapping implemented using the method of least squares(see below).

Leptokurtosis - the property of a statistical distribution to have more occurrences far away from

the mean than would be predicted by a Normal distribution. Also referred to as 'Fat Tails'.

LIBOR - the London Interbank Offered Rate. The rate of interest at which banks borrow funds

from other banks, in marketable size, in the London interbank market.

Linear Instruments - financial instruments whose value varies in a linear fashion with underlying

market price changes. This includes financial instruments such as futures and plain vanilla swaps.

Linear Least Squares - the principle or method by which the fit of a function to data is such thatthe sum of the squared residuals is minimized. In linear regression, the function is a line.

The sum of the squares of the residuals is used instead of the absolute values because this allowsthe residuals to be treated as a continuous differentiable quantity. However, because squares of theresiduals are used, outlying points can have a disproportionate effect on the fit, a property which

may or may not be desirable depending on the particular problem being considered.

Liquidity - a market condition in which assets or products can be traded with ease withoutdramatically altering their current quoted prices. A market is said to be "liquid" when it has a highlevel of trading activity and open interest.

LME - an acroynm for the London Metal Exchange.

LNG - an acronym for Liquified Natural Gas; natural gas that has been condensed to a liquid bycooling the gas.


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Load [electrical] - the amount of electrical power required on electrical equipment or on anelectric system.

Load Factor [electrical] - the ratio of average demand to maximum demand or total capacity.

Log Normal Distribution - a probability distribution such that the natural logarithm of thevariable is normally distributed.

Long Position - the state of actually owning a security, contract, or commodity; in trading and riskmanagement jargon also referred to as a 'long'. Opposite of a short.

Lookback Option - an exotic option whose payoff depends on the minimum or maximum price ofthe underlying asset during some portion of the life of the option.

M: M - the Commodity Futures Symbol which represents the June Delivery Month.

Mark-to-Market (MTM) - the act of assigning a current market value to an asset.

Market Cap or Market Capitalization - a value placed on a shareholder-owned company. It iscomputed by multiplying the number of outstanding shares by the current share price.

Market Risk - the potential to experience financial losses due to fluctuations in the prices atwhich equities, foreign currencies, interest rate linked securities, and commodities can be boughtor sold.

Markov Process - a stochastic process where the future expected value of a value (such as anasset price) is dependent only on the current value. Named after the Russian mathematicianAndrey Andreyevich Markov (1856-1922).

Material Adverse Change (MAC) - generally any negative event that would be consideredmaterial by creditors. MAC clauses are often used as contract provisions that trigger definedchanges, rights or actions.

Mean - is often considered as the simple arithmetic average of the sum of the observed valuesdivided by the number of observations. It is customary to represent the Mean by .

Mean Reversion - a tendency for a stochastic process to remain near, or return over time to along-run average.

MMBtu - one million British thermal units.

Model Risk - the risk of financial loss due to weakness or inaccuracy of a financial model used forvaluing assets or portfolios of assets and/or managing risk.

Moments [of a statistical distribution] - the shape of any distribution can be described by itsvarious 'moments'. The first four moments are: The first moment is the Mean [see above] whichindicates the central tendency of a distribution. The second moment is the Variance which

indicates the width or deviation. The third moment is the Skewness which indicates any

asymmetric "leaning" to either left or right. The fourth moment is the Kurtosis which indicates the


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degree of central "peakedness" or, equivalently, the "fatness of the outer tails.

Monte Carlo - an analytical technique in which a large number of simulations are run usingrandom quantities for uncertain variables and using the distribution of results to infer which valuesare most likely. The name comes from the Monte Carlo section of the city-state of Monaco, whichis known for its casinos and gambling.

N: N - the Commodity Futures Symbol which represents the July Delivery Month.

Naked Calls - an option strategy for which the investor sells a call against securities, commoditiesor other positions that the investor does not own.

NASDAQ - the acronym for the National Association of Securities Dealers Automated Quotationsor Quote system that links brokers and dealers in an unified price quotation system.

Net Settlement - a contract provision that allows for netting out payables and receivables in termsof cash or items that can be readily converted to cash in an established market.

NGL - natural gas liquids; a general term for all liquid products separated from natural gas in a gasprocessing plant. NGL's include propane, butane, ethane, and natural gasoline.

Negative Carry - the condition whereby a portfolio after financing considerations generates anegative income stream or loss.

Non-attainment Area - a U.S. geographic area in which air quality is worse than that allowed bythe U.S. federal air pollution standards.

Normal Distribution - a continuous probability distribution whose probability density function

has a "bell" shape. A normal distribution is symmetric, and has zero skewness. A normal

distribution is fully described with two parameters, its mean and standard deviation.

Notional - the face amount of a transaction; typically used as the basis for interest paymentcalculations or determination of other payment amounts. This face or prinicipal amount is referredto as 'notional' since it is not typically an amount that is paid or received.

O: Odds (betting) - as typically used in wagering outcomes, the odds of success/winning areexpressed in the form "r:s" ("r to s") and correspond to the probability of succeeding/winning[P=s/(r+s)]. Therefore, given a probability P, the odds of succeeding/winning are"(1/P)-1 : 1".

Octane - an octane number or octane rating is a value used to indicate the resistance of a motorfuel to knock (ping). Octane numbers are based on a scale on which isooctane is 100 (minimalknock) and heptane is 0 (bad knock). For example, a gasoline with an octane number of 92 has thesame knock as a mixture of 92% isooctane and 8% heptane.

Option - a contract that gives the right, but not the obligation, to purchase or sale an underlyingasset at a specified price during a defined time period.

Option Premium - the amount that an option buyer pays to the seller.


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Open Interest - the total number offutures contracts or option contracts that have not yet beenexercised, expired, or fulfilled by delivery.

Operational Risk - the risk to financial or other institutions from inadequate or failed internalprocesses, people and systems or from external events.

Out of the Money - for call options, the condition where the price of the underlying asset is lessthan the exercise or strike price of the option. Conversely, for put options, the condition where theprice of the underlying asset is higher than the strike price of the option.

Outliers - probabilistically remote events that are often viewed as statistically independent as well.Various techniques can test if actual data differ in a statistically significant manner from the

benchmark or normal distribution.

Over The Counter (OTC) - traded in some context other than a formal exchange.

Oxygenate - a gasoline fuel additive containing hydrogen, carbon and oxygen. The oxygen

content promotes more complete combustion of gasoline, which reduces tailpipe emissions ofcarbon monoxide.

P: Par - the stated face amount assigned to a security by the issuer.

Parametric - a term used to classify curves for which the path is described by a mathematicalfunction rather than a set of coordinates.

Parametric VaR - linear Value at Risk.

Path Dependent Option - an option whose valuation and payoff depends on the realized price

path of the underlying asset, such as an Asian option or a Lookback option.

Payoff Diagram - a graph of a transaction's payoff as a function of underlier value at expiration.

P/E Ratio - the latest closing price of a stock divided by the latest 12 months' earnings per share.Also known as the P/E Multiple.

Precipitation Swaps (or Options) - instruments linked to the extent of rainfall or snowfall. Theparty taking out a precipitation swap would receive payment for precipitation above a certainlevel. Parties interested in this might include holiday resorts who rely on good weather to bring inrevenue. The parties on the other side might include ski resorts which rely on a certain level of

snow.

Public Company Accounting Oversight Board - U.S. entity established as a non-profit

corporation by the Sarbanes-Oxley Act of 2002 to oversee the audit of public companies that aresubject to the securities laws.

Public Utility Districts - a U.S. publicly-owned energy producer or distributor. Also referred to asPUD's. PUD's operate as special government districts under the authority of elected commissions.Public Utility Districts are typically not regulated by state public utility commissions.


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PUHCA - an acronym for the Public Utility Holding Company Act of 1935, a U.S. federal lawthat governs electric utility organization and ownership structures, and regulates the functions,activities, expansion, and operations of utility holding companies.

The U.S. Federal Trade Commission investigation of electric and gas utilities in the late 1920's,and the FTC's subsequent report in 1935, which alleged that holding company abuses had causedthe bankruptcy of some of the largest holding companies as well as the loss of investor savings ledto passage of the Public Utility Act of 1935. Title I of the act was the Public Utility HoldingCompany Act.

PUHCA requires interstate holding companies that are engaged through their subsidiaries in theelectric utility business or in the retail distribution of natural or manufactured gas to register withthe U.S. Securities and Exchange Commission (SEC) and to file reports containing detailedinformation about their organization, financial structure, and operations. PUHCA requires thesecompanies to operate as coordinated, integrated systems, confined to a single area or region.

PURPA - an acronym for the Public Utility Regulatory Policies Act, a U.S. federal law requiring autility to buy the power produced by a qualifying facility at a price equal to that which the utility

would otherwise pay if it were to build its own power plant or buy power from another source.

Put-Call Parity - a relationship between the prices of European put and call options on the sameunderlier.

Put Option - an option which gives the option buyer the right, but not the obligation, to sell afutures contract at a specific price within a specific period of time in exchange for a one-time

premium payment. See also Call Option.

Q: Quadratic Portfolio - in the context of Value-at-Risk, a portfolio whose portfolio mappingfunction is a quadratic polynomial.

Quadratic Programming - a variant of linear programming whereby the objective function isquadratic rather than linear. For example, in portfolio selection, the variance of the portfolio(which is a quadratic function) may be minimized subject to constraints on the mean return of theportfolio.

Qualifying Facility - a power production facility that qualifies for special treatment under the U.S.Public Utility Regulatory Policies Act (PURPA). A qualifying facility must generate its powerusing cogeneration, biomass, waste, geothermal energy or renewable resources, such as solar andwind. PURPA prohibits utilities from owning majority interest in qualifying facilities.

Quality Spread - the spread between Treasury securities and non-Treasury securities that areidentical in all respects except for quality rating. For example, the difference between yields onTreasuries and the yields on single A-rated industrial bonds. Also referred to as the credit spread.

Quantile - a notion from probability. Generally, the specific value of a variable that divides thedistribution into two parts, those values greater than the quantile value and those values that areless. For instance, p percent of the values are less than the pth quantile.

Quantitative Research - the use of advanced mathematical valuation and econometric models toassess potential returns and risks.


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Quanto Option - an option in one currency, but which pays out in another. These currencyoptions have a guaranteed exchange rate that enable buyers who like the underlying asset, Germanbonds for example, but not the assets pricing currency, to arrange to be paid in a different currencyfor a fee.

Quanto Swap - an interest rate swap in one currency, but which pays out in another based on afixed exchange rate.

Quartile - of the three quartiles, the first or lower quartile (LQ) of a list is a number (notnecessarily a number in the list) such that at least 1/4 of the numbers in the list are no larger thanit, and at least 3/4 of the numbers in the list are no smaller than it. The second quartile is themedian. The third or upper quartile (UQ) is a number such that at least 3/4 of the entries in the listare no larger than it, and at least 1/4 of the numbers in the list are no smaller than it.

Quick Asset Ratio - refers to the ratio of cash, cash equivalents and accounts receivable relativeto the total current liabilities. Also known as the Acid Test Ratio. This measure of liquidity is

more rigorous than the Current Ratio.

R: r - the correlation coefficient, which provides an index of the degree to which paired measuresco-vary in a linear fashion. It is the square root of the coefficient of determination, describedbelow. The correlataion coefficient can range in value between -1 and 1.

r2 - the coefficient of determination, which varies between 0 and 1. It is loosely interpreted as 'theproportion of variance iny which can be explained byx'.

It is the percentage of the total sum of squares of the dependent variable that the independentvariable explains, after one optimizes the intercept and the slope coefficient of the independent

variable. In other words, r2 is the percentage by which volatility of a linear combination of the

dependent and independent variables and a constant declines after choosing the optimal interceptand slope coefficient.

Random Error - measurement error which is in general different each time a measurement ismade, and behaves like a number drawn with replacement from a box of numbered tickets whoseaverage is zero. All measurements are subject to error, which can often be broken down into twocomponents: the random error as previously noted, and the systematic error (bias) that affects allmeasurements the same way.

Random Sample - a sample whose members are chosen at random from a given population insuch a way that the chance of obtaining any particular sample can be computed. Random samplescan be drawn with or without replacing objects between draws.

Range Forward - a type of derivative instrument. A forward exchange rate contract that placesupper and lower bounds on the cost of foreign exchange.

Rank Tests - nonparametric tests that are calculated by replacing the data by their rank values.

Ratio Spread - an options strategy using either puts or calls, in which one buys options and thensells a different amount of options.


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Red Herring - a preliminary prospectus issued by stock-underwriting firms to measure investorinterest in a prospective stock offering. This prospectus must contain a warning, printed in red, that

the document does not contain all the information normally required by the Securities andExchange Commission, and that some parts may be changed before the final prospectus is issuedto the public. It excludes the offering price and the coupon of the new issue.

Reference Temperature - a typical index variable in weather derivative transactions.

Regression Analysis - an analysis to relate one or more dependent variables to one or moreindependent variables.

Repo - an agreement in which one party sells a security to another party and agrees to repurchaseit on a specified date for a specified price. Also referred to as a repurchase agreement.

Reserve Margin - the amount by which a utility's total electric power capacity exceeds maximumelectric demand.

Reverse Crack - the sale of crude oil against the purchase of the refined products. In futures

trading, it is the simultaneous sale of crude oil futures versus the purchase of heating oil andgasoline futures.

Rho - the interest rate sensitivity of an option relative to a change in the interest rate option pricingvariable. It measures an option's change in value for a given change in the interest rate.

Risk Adjusted Return - a measure of abnormal rate of return that shows how an asset performedrelative to a benchmark asset with the same risk. Determined by subtracting from the rate of return

on an asset a rate of return from another asset that has similar risk. The Beta against the

benchmark can be used to calculate an Alpha which is also risk adjusted preformance.

Risk Capital - venture capital invested in small companies and start-up ventures in return forequity ownership. Generally, venture capitalists (VC's) supply capital to companies that have ahigher risk profile, and which likely could not currently obtain funding in traditional equity or debtmarkets by listing on a stock exchange or borrowing from banks or other financial institutions.

In return for sustaining extra risk, VC's typically seek substantial equity, a seat on the board, andpossibly control or the ratcheting up of their equity stake if performance targets are not met. Inaddition to funding, the VC's may also provide management expertise and technical support totheir investee companies. Most VC's will look for an exit strategy within two to five years, througha private sale of the firm or their ownership stake, or through an IPO.

Risk Policies & Procedures - the fundamental control documents in most corporate riskmanagement programs.

Risk Register - a basic document of risk management control systems, on which all significantrisk factors for an entity are identified, ranked and assigned.

Risk Audit - an audit that provide an independent assessment of the risk management practices ofa company, and verifies that the company has appropriate risk management controls, and that itadheres to these to controls and mitigates risk in compliance with approved policies andprocedures.


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Risk Management - the process of identifying and evaluating risks and selecting and managingtechniques to adapt to risk exposures.

Risk/Reward Ratio - the relationship between the probability of loss and profit. This ratio isoften used as a basis for trade selection or comparison.

Rollover - transfer of a position to a different delivery month.

S: Sarbanes-Oxley Act of 2002 - U.S. legislation enacted in response to the accounting scandals of2001-2002. The Act was named after Senator Paul Sarbanes and Representative Michael Oxleyand is arranged in eleven titles. Compliance with provisions of the Act is mandatory.

The Sarbanes-Oxley Act of 2002 is generally considered the single most important piece oflegislation affecting corporate governance, financial disclosure, and public accounting since theU.S. securities laws enacted in the 1930's. The Act is often referred to variously as SOX, S-O, orSOA. The full text of the legislation is shown here in a PDF format. A summary of the Act isprovided by the American Institute of Certified Public Accountants.

Scenario Planning - a methodology that attempts to build plausible views of a small number ofdifferent possible futures for an organisation operating in conditions of high uncertainty.

SEC - an acronym for the United States Securities and Exchange Commission.

SEC Form 8-K - United States Securities and Exchange Commission (SEC) required currentreport filing. This form is required by the SEC when a publicly held company incurs any event thatmight affect its financial situation or the share value of its stock.

SEC Form 10-K - United States Securities and Exchange Commission (SEC) required annual

report filing. An audited document required by the SEC and sent to a public company's or mutualfund's shareholders at the end of each fiscal year, reporting the financial results for the year(including the balance sheet, income statement, cash flow statement and description of companyoperations) and commenting on the outlook for the future.

SEC Form 10-Q - United States Securities and Exchange Commission (SEC) required quarterlyreport filing. This is an unaudited document required by the SEC for all U.S. public companies,reporting the financial results for the quarter and noting any significant changes or events in thequarter. Quarterly reports contain financial statements, a discussion from the management, and alist of "material events" that have occurred with the company (such as a stock split or acquisition).

Settlement Price - the closing range of prices after a trading session, used to calculate gains andlosses, margin calls, and invoice prices for deliveries in futures market accounts.

SFAS 133 - Statement of Financial Accounting Standard 133. See FAS 133.

SFE - an acronym for the Sydney Futures Exchange.

SIMEX - an acronym for the Singapore International Monetary Exchange.

Six Sigma - terminology used to designate a quality measure or characteristics such as


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defects-per-unit, parts-per million defective, and the probability of a failure/error. The term"sigma" is used to designate the distribution or spread about the mean (average) of any process orprocedure. Six Sigma denotes a failure rate of 3.4 parts per million or 99.99966% good. Sigma is aletter in the Greek alphabet.

Skewness - indicates any asymmetric "leaning" to either left or right of a probability distribution.

Skewness is the third 'moment' of a distribution.

Spark Spread - the relationship between the price of electricity and the price of natural gas orother fuel used to generate electricity. The spark spread reflects the costs, or anticipated costs, ofproducing power.

It can be used as a method of converting millions of British thermal units (Btu's) to megawatthours, and vice versa. The spread is simply the heat rate (a proxy for efficiency) of a specificgenerating plant or power system (the number of Btu's needed to make one kilowatt hour ofelectricity), multiplied by the cost of energy expressed as dollars per Btu's.

Standard Deviation - the square root of the variance of a probability distribution. The Standard

Deviation is one of several indices of variability that characterize the dispersion among themeasures in a given population.

Stochastic - a process that is random.

Straddle - an option trading strategy using a combination of a put and a call with the sameepiration date and same strike price. This strategy is based on an expectation that the pricevolatility level of the underlying asset will increase and generate a potential trading profit on theoptions position.

Stress Test - a test of a model for pricing or risk management, using an extreme scenario or range

of scenarios.

Structured Note - a derivative instrument whose value is based on that of an underlying index.

Sunshine Option - a derivative instrument that is triggered by the number of hours of sunshine

during some defined period for the life of the option. Such options (weather derivatives) can beof use as hedges of revenues, for example, by summer holiday resorts that could be compensated ifthe number of hours of sunshine fell below a certain specified level.

Swap - a contract between two counter parties to exchange future cash flows in accordance with aspecified formula for exchange.

Swaption - an option to enter into a swapi.e., the right, but not the obligation, to enter into aspecified type of swap at a specified future date.

Swing Options - an option contract that provides a volume range, rather than a fixed quantity, forthe specified underlying. Swing options have wide application in commodity markets since theseoptions can provide an effective match to underlying exposures where there is uncertainty as to

quantity (volumetric risk), however, valuing and trading such options is highly complexquantitatively.


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SWOT Analysis - an analysis of Strengths, Weaknesses, Opportunities and Threats. Thismethodology is widely used in strategic assessments and planning.

Systemic Risk - the risk that the entire financial system collapses due to some catastrophic marketevent triggering the failure.

T: Ted Spread - the difference between Treasury bill and eurodollar futures prices. A widening TED

Spread is seen as an indication of credit quality concerns in the banking sector.

Tenor - the time remaining to maturity for a financial instrument, transaction, asset or liability, ora portfolio of these items.

Theta - sensitivity of an option's value to a change in the amount of time remaining untilexpiration.

Time Decay - the tendency of an option to decline in value as the expiration date approaches,

especially if the price of the underlying instrument is exhibiting low volatility.

Total Return Swap - a type ofcredit derivative.

Tolling - an agreement between an electric power generator and a power buyer in which the buyersupplys the fuel (such as natural gas) and receives an amount of electric power based upon anagreed heat rate (conversion efficiency).

Total Return Swap - a type of credit derivative.

Triple Witching Hour - the final hour of the stock market trading session on the third Friday ofMarch, June, September, and December, when option contracts and futures contracts expire onmarket indexes used by program traders.

Transformation - the process of coverting lists into other lists, or variables into other variables(e.g. to transform a list of Celsius temperatures into the corresponding list of Fahrenheittemperatures, one would multiply each element by 9/5, and add 32 to each product).

Tranche - the piece, portion or slice of a deal or structured financing.

U: U - the Commodity Futures Symbol which represents the September Delivery Month.

Underlying - in an option contract, the security or commodity that is delivered when the contract

is exercised.

Unit Investment Trust - an investment vehicle which is funded at the beginning and onceinvestments are acquired acts like a liquidating investment. For example, commodity rights,corporate bonds, or mortgage backed securities would be acquired.

Universal Volatility Model - any of a class of option pricing models that model volatility skew by

combining elements of local volatility,jump-diffusion and stochastic volatility models.

Up-and-Out - an options structure by which option contract dies or ceases to be active when an


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indicator, such as price, goes through an upside trigger point or threshold.

V: V - the Commodity Futures Symbol which represents the October Delivery Month.

Value at Risk (VaR) - a quantitative methodology for estimating market risk. A more detaileddescription of VaR can be displayed from the Risk Limited Factoids page here.

Variance - a measure of volatility, risk, or statistical dispersion. It is the square of the standarddeviation.

Variance-Covariance VaR - linear VaR.

Vega - the measure of change in an option value given a change in the volatility.

Venn Diagram - a pictorial depiction of the relations among sets or events, where set are shownas regions with the overlap of the regions corresponds to the intersection of the sets. If the regionsdo not overlap, the sets are disjoint.

Volatility - a measurement of the rate of price change of a futures contract, security, or otherinstrument underlying an option. See also Historical Volatility, Implied Volatility.

Volatility Smile - a condition where implied volatilities for in-the-money and out-of-the-moneystrikes exceed those for at-the-money strikes. Graphically depiction of this condition is a curve inthe form of a 'smile', hence the name.

Volumetric Risk - risk resulting from uncertainty and changes in exposure level for usage,

productions or other factors. Hedge instruments structured to manage such risks include Swing

Options.

W: Wasting Asset - a derivative instrument that may expire worthless after a stated time or event.Options, Rights, and Warrants are examples.

Watt - the common base unit of power in the metric system. One watt equals one joule per second.It is the power developed in a circuit by a current of one ampere flowing through a potential

difference of one volt. One Watt = 3.413 Btu/hr.

Weather Derivative - a derivative instrument whose payoff is based on a specified weather eventand is used to hedge the financial impact of weather fluctuations.

Weather can adversely impact company revenues or increase costs. Use of weather derivatives canhelp mitigate the impact that adverse weather may have on profitability and reduce earningsvolatility. In 2001 it was estimated that the weather derivatives market had grown to a $4.2 billionnotional market value with approximately 4,000 contracts traded.

Key participants in the weather derivatives market include: energy marketers/utilities, insuranceand reinsurance companies, financial institutions, over-the-counter (OTC) derivatives brokers,insurance brokers, and most recently hedge funds.

Weather derivatives are not the same as insurance, which is generally for low-probability events


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like hurricanes and tornados. In contrast, derivatives cover high-probability events likedryer-than-expected summers.

Wheeling [electric power] - the process of transferring electrical energy between buyer and sellerin different geographical areas by way of an intermediate utility or utilities.

Wiener Process - a type ofMarkov Stochastic process. It refers to changes in value over small

time periods. Sometimes, this process is also called Brownian motion.

Wrangle - an options spread that is long (short) both a ratio call spread and a ratio put spread.

Writer Extendible Option - an option whose expiration is extended if some pre-defined conditionis met.

X: X - the Commodity Futures Symbol which represents the November Delivery Month.

Y: Yankee Bonds - bonds issued in the United States by foreign banks and corporations, butdenominated in U.S. dollars. Such bonds must usually be registered with the U.S. Securities andExchange Commission (SEC).

Yankee CD's - CD's issued in the domestic U.S. market, typically New York, by a branch of aforeign bank.

Yard - industry jargon for one billion units of a currency. Especially used in currency trading toreduce the risk of error in voice communications due to confusion on pronunciation of 'billion'rather than 'million' units traded.

Yield - the annual return on an investment, typically expressed as a percentage.

Yield Curve Option-Pricing Models - models that can incorporate different volatility

assumptions along the yield curve, such as the Black-Derman-Toy model. Also calledarbitrage-free option-pricing models.

Yield Curve - a graphic representation of market yield for a fixed income security plotted againstthe maturity of the security.

Yield Curve Strategies - positioning a portfolio to capitalize on expected changes in the shape ofthe yield curve.

Yield to Maturity - the percentage rate of return paid on a bond, note or other fixed incomesecurity which is bought and held to its maturity date. The calculation for the yield to maturity isbased on the coupon rate, length of time to maturity, and market price. The calculation assumesthat coupon interest paid over the life of the bond will be reinvested at the same rate, which is asimplifying assumption that may at times differ significantly from actual conditions.

Z: Z - the Commodity Futures Symbol which represents the December Delivery Month.

Z Bond - an Accrual Bond.


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Z Score - a statistical measure that quantifies the distance (measured in standard deviations) a datapoint is from the mean of a data set. The terminology is also used to refer to the output from a

credit-strength test that gauges the likelihood of bankruptcy, more precisely known as the Altman

Z Score.

Zero-Beta Portfolio - a portfolio designed to have zero systematic risk, similar to the risk-free

asset, that is, having a Beta of zero.

Zero Cost Collar - a transaction which has little or zero cash outlay for the initiating party, andprovides price protection in a range between a floor and ceiling.

Zero Coupon - refers to a debt instrument that does not make coupon payments, but, rather, is

issued at a deep discount to par and redeemed at par at maturity.

Zero-One Integer Programming - an analytical methodology that can be used to determine thesolution to a capital rationing problem.

Zero-Sum Game - a condition or type of game wherein one participant can gain only at the

expense of another player.

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Risk Management Glossary