Business Glossary

pronounced as three letters, Wall Street shorthand for the Standard & Poor's 100 stock index, which comprises stocks for which options are traded on the Chicago Board Options Exchange (CBOE). OEX index options are traded on the Chicago Board Of Trade (CBOT), and futures are traded on the chicago mercantile exchange.

acronym for Bonds Enabling Annual Retirement Savings and the flip side of CUBS, acronym for Calls Underwritten By Swanbrook. Holders of BEARS receive the face value of bonds underlying call options but exercised by CUBS holders. If the calls are exercised, BEARS holders receive the aggregate of the exercise prices.

Bonds: brokerage-house practice of separating a bond into its corpus and coupons, which are then sold separately as zero-coupon securities. The 1986 Tax Act permitted municipal bond strips. Some, such as Salomon Brothers' tax-exempt M-CATS, represent prerefunding backed by U.S. Treasury securities held in escrow. Other strips include Treasuries stripped by brokers, such as TIGERS, and stripped mortgage- backed securities of government-sponsored issuers like Fannie Mae. A variation known by the acronym STRIPS (Separate Trading of Registered Interest and Principal of Securities) is a prestripped zerocoupon bond that is a direct obligation of the U.S. Treasury.
Options: option contract consisting of two put options and one call options on the same underlying stock or stock index with the same strike and expiration date. Compare with strap.
Stocks: to buy stocks with the intention of collecting their dividends. Also called dividend stripping. See also dividend rollover plan.

calls and puts on indexes of stocks. There are "broad" indexes applying to a wide range of firms and industries. There are also "narrow-based" indexes relating to one industry or economic sector. An advantage of investing in an index option is that an interest in many companies is possible with a limited investment. It should be noted, however, that options have a limited life, are used to speculate or to hedge, and are settled in cash. In other words, if an index option is exercised (not normally done), the investor would not receive (or pay) the underlying stock, but would, rather, settle in cash.

type of security, usually issued together with a bond or preferred stock, that entitles the holder to buy a proportionate amount of common stock at a specified price, usually higher than the market price at the time of issuance, for a period of years or to perpetuity; better known simply as a warrant. In contrast, rights, which also represent the right to buy common shares, normally have a subscription price lower than the current market value of the common stock and a life of two to four weeks. A warrant is usually issued as a sweetener, to enhance the marketability of the accompanying fixed income securities. Warrants are freely transferable and are traded on the major exchanges. They are also called stock-purchase warrants.

traditionally, an exchange of one security for another to change the maturities of a bond portfolio or the quality of the issues in a stock or bond portfolio, or because investment objectives have shifted. Investors with bond portfolio losses often swap for other higher-yielding bonds to be able to increase the return on their portfolio and realize tax losses. Recent years have seen explosive growth in more complex currency swaps, used to link increasingly global capital markets, and in interestrate swaps, used to reduce risk by synthetically matching the duration of assets and liabilities of financial institutions as interest rates got higher and more volatile. In a simple currency swap (swaps can be done with varying degrees of complexity), two parties sell each other a currency with a commitment to re-exchange the principal amount at the maturity of the deal. Originally done to get around the problems of exchange controls, currency swaps are widely used to tap new capital markets, in effect to borrow funds irrespective of whether the borrower requires funds within that market. The International Bank for Reconstruction and Development (World Bank) has been an active participant in currency swaps with U.S. corporations.

An interest-rate swap is an arrangement whereby two parties (called counterparties) enter into an agreement to exchange periodic interest payments. The dollar amount the counterparties pay each other is an agreed-upon periodic interest rate multiplied by some predetermined dollar principal, called the notational principal amount. No principal (no notational amount) is exchanged between parties to the transaction; only interest is exchanged. In its most common and simplest variation, one party agrees to pay the other a fixed rate of interest in exchange for a floating rate. The benefit of interest-rate swaps, which can be used to synthetically extend or shorten the duration characteristics of an asset or liability, is that direct changes in the contractual characteristics of the assets or the liabilities become matters affecting only administrative, legal, and investment banking costs.

U.S. Treasury issues, sold at a deep discount from face value. A zero-coupon security, they pay no interest during their lifetime, but return the full face value at maturity. They are appropriate for retirement or education planning. As treasury securities, CATS cannot be called away.

privilege granted to existing shareholders of a corporation to subscribe to shares of a new issue of common stock before it is offered to the public; better known simply as a right. Such a right, which normally has a life of two to four weeks, is freely transferable and entitles the holder to buy the new common stock below the public offering price While in most cases one existing share entitles the stockholder to one right, the number of rights needed to buy a share of a new issue (called the subscription ratio) varies and is determined by a company in advance of an offering. To subscribe, the holder sends or delivers to the company or its agent the required number of rights plus the dollar price of the new shares.

Rights are sometimes granted to comply with state laws that guarantee the shareholders' preemptive right-their right to maintain a proportionate share of ownership. It is common practice, however, for corporations to grant rights even when not required by law; protecting shareholders from the effects of dilution is seen simply as good business.

The actual certificate representing the subscription is technically called a subscription warrant, giving rise to some confusion. The term subscription warrant, or simply warrant, is commonly understood in a related but different sense-as a separate entity with a longer life than a right-maybe 5, 10, or 20 years or even perpetual- and with a subscription price higher at the time of issue than the market value of the common stock.

Subscription rights are offered to shareholders in what is called a rights offering, usually handled by underwriters under a standby commitment.

mortgage-backed bond that separates mortgage pools into different maturity classes, called tranches. This is accomplished by applying income (payments and prepayments of principal and interest) from mortgages in the pool in the order that the CMOs pay out. Tranches pay different rates of interest and can mature in a few months, or as long as 20 years. Issued by the Federal Home Loan Mortgage Corporation (Freddie Mac) and private issuers, CMOs are usually backed by government- guaranteed or other top-grade mortgages and have AAA ratings. In return for a lower yield, CMOs provide investors with increased security about the life of their investment compared to purchasing a whole mortgage-backed security. Even so, if mortgage rates drop sharply, causing a flood of refinancings, prepayment rates will soar and CMO tranches will be repaid before their expected maturity. CMOs are broken into different classes, called companion bonds or planned amortization class (PAC) bonds.

acronym for Treasury Investors Growth Receipt, a form of zero-coupon security first created by the brokerage firm of Merrill Lynch, Pierce, Fenner & Smith. TIGERS are U.S. government-backed bonds that have been stripped of their coupon. Both the corpus (principal) of the bonds and the individual coupons are sold separately at a deep discount from their face value. Investors receive face value for the TIGERS when the bonds mature but do not receive periodic interest payments. Under Internal Revenue Service rules, however, TIGER holders owe income taxes on the imputed interest they would have earned had the bond been a full coupon bond. To avoid having to pay taxes without having the benefit of the income to pay them from, most investors put TIGERS in Individual Retirement or Keogh accounts, or in other tax deferred plans. Also called TIGR.

investment grade bond backed by a pool of variously rated bonds, including junk bonds. CBOs are similar in concept to Collateralized Mortgage Obligations (CMOs), but differ in that CBOs represent different degrees of credit quality rather than different maturities. Underwriters of CBOs package a large and diversified pool of bonds, including high-risk, high-yield junk bonds, which is then separated into "tiers." Typically, a top tier represents the higher quality collateral and pays the lowest interest rate; a middle tier is backed by riskier bonds and pays a higher rate; the bottom tier represents the lowest credit quality and, instead of receiving a fixed interest rate, receives the residual interest payments-money that is left over after the higher tiers have been paid. CBOs, like CMOs, are substantially overcollateralized and this, plus the diversification of the pool backing them, earns them investment-grade bond ratings. Holders of third-tier CBOs stand to earn high yields or less money depending on the rate of defaults in the collateral pool. CBOs provide a way for big holders of junk bonds to reduce their portfolios and for securities firms to tap a new source of buyers in the disenchanted junk bond market of the early 1990s.

acronym for Standard & Poor's Depositary Receipt, traded on the American Stock Exchange under the ticker symbol "SPY." Called spiders, they are securities that represent ownership in a long-term Unit Investment Trust that holds a portfolio of common stocks designed to track the performance of the S&P 500 index. A SPDR entitles a holder to receive proportionate quarterly cash distributions corresponding to the dividends that accrue to the S&P 500 stocks in the underlying portfolio, less trust expenses. Like a stock, SPDRs can be traded continuously throughout the trading day, or can be held for the long-term. In contrast, S&P 500 index mutual funds are priced only once, at the end of each trading day. Amex also trades MidCap SPDRs, which track the S&P MidCap 400 index.

units of beneficial interest in the Diamonds Trust, a Unit Investment Trust that holds the 30 component stocks of the Dow Jones Industrial Average. First introduced in January, 1998, Diamonds trade under the ticker symbol "DIA" like any other stock on the American Stock Exchange. They are designed to offer investors a low-cost means of tracking the Dow Jones Industrial Average, the most widely recognized indicator of the American stock market. Diamonds pay monthly dividends (which can be reinvested into more shares of the trust) that correspond to the dividend yields of the component stocks of the Dow and pay capital gains distributions once a year. Diamonds are designed to trade at about 1/100 the level of the Dow Jones Industrial Average, so if the parent group comprises the Madrid, Barcelona, Bilbao, and Valencia stock exchanges, MF Mercados Financieros, Iberclear, and BME Consulting, low is at 10000, Diamonds will trade at about $100 per unit. Unlike open-end mutual funds, Diamonds trade like stocks, allowing investors to buy or sell at any time during the trading day, whereas index mutual funds are priced only once at the end of each trading day. Like open-end index funds, Diamonds charge low-management fees because there is little research or trading conducted by the trust's management. There are also no loads to buy Diamonds, though normal brokerage commissions do apply to trades. Whereas closed-end funds often trade at discounts to their Net Asset Values, investors can create an unlimited number of Diamonds trading units, which helps insure they will correlate closely with the performance of the Dow stocks in the portfolio. www.amex.com/dia.

mortgage-backed bond that separates mortgage pools into different maturity classes, called tranches. This is accomplished by applying income (payments and prepayments of principal and interest) from mortgages in the pool in the order that the CMOs pay out. Tranches pay different rates of interest and can mature in a few months, or as long as 20 years. Issued by the Federal Home Loan Mortgage Corporation (Freddie Mac) and private issuers, CMOs are usually backed by government- guaranteed or other top-grade mortgages and have AAA ratings. In return for a lower yield, CMOs provide investors with increased security about the life of their investment compared to purchasing a whole mortgage-backed security. Even so, if mortgage rates drop sharply, causing a flood of refinancings, prepayment rates will soar and CMO tranches will be repaid before their expected maturity. CMOs are broken into different classes, called companion bonds or planned amortization class (PAC) bonds.

contract in which two counter-parties agree to exchange interest payments of differing character based on an underlying notional principal amount that is never exchanged. There are three types of interest swaps: coupon swaps or exchange of fixed rate for floating rate instruments in the same currency; basis swaps or the exchange of floating rate for floating rate instruments in the same currency; and cross currency interest rate swaps involving the exchange of fixed rate instruments in one currency for floating rate in another.

Typically, a swap contract exchanges fixed rate obligations for a floating rate instrument in the same currency. In its simplest form, the two parties to an interest rate swap exchange their interest payment obligations (no principal changes hands) on two different kinds of debt instruments, one being a fixed interest rate, the other being a floating rate.

For example, the Student Loan Marketing Association (Sallie Mae) may want to swap rates with a mutual savings bank-a mutually beneficial transaction, as Sallie Mae, a highly rated institution because of its status as a federal agency, prefers floating rate to match short-term loans in its student loan portfolio. Sallie Mae can sell fixed rate debt at a relatively low cost, whereas the mutual savings bank prefers to match its long-term fixed rate mortgages with fixed rate funds.

bonds or notes backed by loan paper or accounts receivable originated by banks, credit card companies, or other providers of credit and often "enhanced" by a bank Letter of Credit or by insurance coverage provided by an institution other than the issuer. Typically, the originator of the loan or accounts receivable paper sells it to a specially created trust, which repackages it as securities with a minimum denomination of $1,000 and a term of five years or less. The securities are then underwritten by brokerage firms who reoffer them to the public. Examples are Certificate for Automobile Receivables (CARs) and so-called plastic bonds, backed by credit card receivables. Because the institution that originated the underlying loans or receivables is neither the obligor nor the guarantor, investors should evaluate the quality of the original paper, the worth of the guarantor or insurer, and the extent of the protection.

mortgagebacked securities formed by dividing the cash flows from a pool of mortgages into obligations with payment characteristics substantially different from the underlying mortgages. Innovation in the mortgage market has led to numerous derivative mortgage instruments: the Collateralized Mortgage Obligation (CMO) consisting of a series of bonds with different maturity classes; the interest-only (io) strip, receiving only interest payments; theprincipal-only (PO) strip, a security receiving only loan principal payments; and mortgageresidual which are the excess cash flow after debt service payments. Derivative securities often are used as hedging devices to immunize a loan portfolio against interest rate risk.

traditionally, an exchange of one security for another to change the maturities of a bond portfolio or the quality of the issues in a stock or bond portfolio, or because investment objectives have shifted. Investors with bond portfolio losses often swap for other higher-yielding bonds to be able to increase the return on their portfolio and realize tax losses. Recent years have seen explosive growth in more complex currency swaps, used to link increasingly global capital markets, and in interestrate swaps, used to reduce risk by synthetically matching the duration of assets and liabilities of financial institutions as interest rates got higher and more volatile. In a simple currency swap (swaps can be done with varying degrees of complexity), two parties sell each other a currency with a commitment to re-exchange the principal amount at the maturity of the deal. Originally done to get around the problems of exchange controls, currency swaps are widely used to tap new capital markets, in effect to borrow funds irrespective of whether the borrower requires funds within that market. The International Bank for Reconstruction and Development (World Bank) has been an active participant in currency swaps with U.S. corporations.

An interest-rate swap is an arrangement whereby two parties (called counterparties) enter into an agreement to exchange periodic interest payments. The dollar amount the counterparties pay each other is an agreed-upon periodic interest rate multiplied by some predetermined dollar principal, called the notational principal amount. No principal (no notational amount) is exchanged between parties to the transaction; only interest is exchanged. In its most common and simplest variation, one party agrees to pay the other a fixed rate of interest in exchange for a floating rate. The benefit of interest-rate swaps, which can be used to synthetically extend or shorten the duration characteristics of an asset or liability, is that direct changes in the contractual characteristics of the assets or the liabilities become matters affecting only administrative, legal, and investment banking costs.

investment grade securities backed by a pool of mortgages or trust deeds. Principal and interest payments on the underlying mortgages are used to pay semiannual interest and principal on the securities. Income from the principal and interest payments on the underlying mortgages are used to pay off the bonds.

Most mortgage-backed securities, such as Collateralized Mortgage Obligation and Real Estate Mortgage Income Conduit , consist of multiclass obligations that are divided into different classes of bonds to appeal to different investor needs. Because some mortgage pools will pay off faster than others, mortgaged-backed securities are typically issued as a series of several different bonds, each having a different maturity date.