A finance and risk management technique based on a put-call parity strategy that consists of selling a put and buying call (a synthetic long position), while shorting the underlying stock. As long as the put and call have the same underlying, strike price and expiration date, a synthetic long position will have the same risk/return profile as ownership of an equivalent amount of the underlying stock. In a typical reverse-conversion transaction, a brokerage firm short sells stock and hedges this position by buying its call and selling its put. Whether the brokerage firm makes money depends on the borrowing cost of the shorted stock and the put and call premiums, all of which may render a return better than the money market with very low risk. In the context of futures markets, a trader would be synthetically long and short the underlying futures while looking for arbitrage opportunities.
A non-parallel yield curve shift in which long- and short-term yields decrease by a greater degree than intermediate rates. This yield curve shift effectively humps the curve, adding to the curvature of the yield curve. |||For example, a negative butterfly shift can happen when short- and long term-rates decrease by 75 basis points (0.75%), while intermediate rates only decrease by 50 basis points (0.50%). This is the reverse of a positive butterfly, in which short- and long-term rates increase more than intermediate rates.
A substitute for a swap arrangement that is terminated before it matures. A swap may be ended early if there is a termination event or a default. If a swap is terminated early, both parties will cease to make the agreed-upon payments and the counterparty who caused the early termination may be required to pay damages to the other counterparty. A replacement swap is likely to have different terms, or interest rates, than the original swap since market conditions usually will have changed. As such, the damages (called “termination payments”) will factor in the difference in interest rates between the original swap and the replacement swap.Possible termination events include legal or regulatory changes that prevent one or both parties from fulfilling the contract terms (“illegality”), the placement of a withholding tax on the transaction (“tax event” or “tax event upon merger”), or a reduction in one counterparty’s creditworthiness (“credit event”). Failure to pay or a declaration of bankruptcy by either party are examples of default events. To give a real-life example, when Lehman Brothers declared bankruptcy in 2008, entities that were involved in swaps with Lehman had to seek replacement swaps.
The opportunity lost when municipal bond issuers assume proceeds from debt offerings and then invest that money for a period of time (ideally in a safe investment vehicle) until the money is used to fund a project, or to repay investors. The lost opportunity occurs when the money is reinvested and the debt issuer earns a rate or return that is lower than what must actually be paid back to the debt holders. |||As an example, XYZ issuer distributes $50 million in municipal bonds paying 6%. The issuer takes in this money, and then invests it at 4.2% for a period of one year, because the prevailing market will not pay a higher rate. The issuer has lost the equivalent of 1.8% interest that it could have earned or retained.
A clause in a lease that outlines the terms for renewing or extending an original lease agreement. The renewal option appears as a covenant in the original lease and provides specifications under which the leaseholder can renew or extend the original lease term for an additional, specified time and rate (rent). A renewal option provides the leaseholder the option, but not the obligation, to renew or extend a lease agreement beyond its initial terms. A start-up business may, for example, rent an office space for five years. A renewal option would allow the business to renew or extend the lease to remain in the office space beyond the five-year lease term. This can be beneficial to the business: if it is doing well in the location, it can remain for an additional term; if it is doing poorly, it can close shop at the end of the initial term without defaulting on the lease and without pressure to renew or extend it.
A warrant that is issued without a host bond. A naked warrant allows the holder to buy or sell a particular financial instrument, such as a bond or shares, but unlike a normal warrant, it is not sold with an accompanying bond. Naked warrants are typically issued by banks or other financial institutions that are not also issuing a bond, and can be traded in the stock market. |||Normal warrants are issued with an accompanying bond (a warrant-linked bond), giving the investor holding the warrant the right to exercise it and acquire shares of the company that issued the underlying bond. The company writing the bond is typically the same company issuing the underlying bond. Naked warrants, on the other hand, can be backed by a variety of underlying investments, including stocks, and are considered more flexible.
An employee stock option that grants additional options upon exercise of the original. The employee satisfies the exercise price of their current option with shares rather than cash. The reload option will have the same expiry date as the original option, however, the strike price will be equal to the share price at the time the original option is exercised. Also known as restoration option.
A certificate issued by a local or municipal authority for the purpose of funding a public works project. This type of obligation is financed by an tax assessment made upon the residents that will benefit from the facility. Mutual investment certificate income is always tax-free to the recipient. |||These certificates essentially function as a type of general obligation bond, although they are technically in a different category. They are not backed directly by revenue from the project, but by the local taxpayers. The revenue from the projects behind the certificates also may be collected directly by the contractor building or renovating the facility, instead of the locality.
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