SYLLABUS Previous: 10 APPENDIX
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Next: 10.2 Notation and symbols
10.1 Glossary of keywords
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GLOSSARY:
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DATA
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Accrual period
- Time interval between the payment of bond coupons or swap settlements.
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American exercise style
- Contract that can be exercised at any time during its life.
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Arbitrage
- Trading strategy taking advantage of the price difference of two or
more securities to make an immediate (risk free) profit.
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Arbitrageur
- Person who uses arbitrage as a trading strategy to make immediate
(risk free) profits.
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Asset
- Something of value, a property owned by a person or a company.
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Bear
- Animal used as a symbol when the market prices are falling in an economic
downturn.
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Bid price
- The price a potential buyer is willing to pay for a security.
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Boundary conditions (natural / essential)
- Conditions (usually justified by no-arbitrage arguments) that are imposed
on the boundary of the domain where the solution of a differential equation
is sought. Natural conditions are usually imposed through a surface term
after partial integration; essential conditions are imposed explicitly in
the linear system by replacing an equation by the condition.
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Broker
- Individual who buys and sells goods for other persons.
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Bull
- Animal used as a symbol when the market prices are rising in an economic
upturn.
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Call option
- Security giving its holder the right and no obligation to buy an underlying
asset.
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Cap
- Collection of caplets maturing at different
times.
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Caplet
- Interest rate option providing for an upper limit on the interest rate;
a caplet entitles the holder to the difference between the spot rate and
the strike if this is positive, or zero otherwise.
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Capital
- Amount of money that is invested or used to start a business.
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Capital gain
- Amount of cash raised by the original owners who sell shares in the
initial public offering (IPO) of a company.
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Capital asset pricing model (CAPM)
- Linear fit measuring the relative performance of a portfolio in
comparison with a market index average.
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Capitalism
- Economic system in which a country's business and industry is controlled
and run for profit by private owners.
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Clearing margin
- A margin deposit by a member of a clearing house (e.g. a broker) that
guarantees the performance of all the parties in a financial transaction.
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Collar
- Interest rate option combining a cap and a
floor used as an insurance to guarantee
that the interest rates remain within a certain interval.
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Commission
- Part of a cost that is proportional to the total value of a trade.
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Contingent claims
- A demand that can be made only if one or more specified outcomes occur.
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Coupon
- Predetermined amount of cash payed as an interest during the life of a bond.
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Covered
- A written option is covered if the writer also has an opposing market
position on a share-for-share basis in the underlying security.
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Delivery date
- The date when a
forward or
futures
contract ends with an amount of cash payed in exchange for the
underlying asset.
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Delivery price
- Amount of cash in a forward contract
that will be payed on the
maturity date
in exchange of the
underlying asset.
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Derivative
- Financial instrument whose value is derived from another asset.
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Deterministic
- Which can be predicted with certainty from the past.
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Discount
- Amount below the par value; difference between a bond principal and the
present value.
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Discount bond
- Zero coupon bond.
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Discount factor
- Present value of EUR 1 received some time in the future.
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Discount function
- Function measuring the present value of one unit due at a later time.
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Distribution (log-normal)
- Function measuring the probability density of an event using a log-normal
law; incremental changes of stock prices are almost log-normally
distributed.
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Distribution (normal)
- Function measuring the probability density of an event using the famous
bell-shaped curve; incremental changes of bond prices are sometimes normally
distributed.
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Diversification
- Dividing the investment into a variety of securities.
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Dividend
- Portion of a company's profits payed out in cash to the shareholders.
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Drift
- Slow systematic movement in the same direction.
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Efficient market
- Economy in which prices immediately and fully reflect all relevant
information.
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Efficient frontier
- In the modern portfolio theory, it is the locus of all the portfolios
where the highest possible return is achieved after reducing the
specific risk through diversification.
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Entrepreneur
- Person who tries to make money by starting or running a business, especially
when this involves taking a financial risk.
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Equilibrium swap rate
- Fixed coupon making the swap worthless when it is initially issued.
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European exercise style
- Contract that can be exercised only at the expiry date.
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Exercise an option
- Use the right to exchange the underlying for a fixed amount of cash.
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Exercise (or strike) price
- The price at which the underlying may be bought or sold.
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Exotic option
- Option that is not plain vanilla and is generally not traded on an exchange.
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Expected value
- Average value obtained by weighting
possible realizations by their
probabilities.
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Expiry time
- Date when an option contract ends.
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Face (or principal) value
- Amount of cash an issuer (borrower) agrees to pay at the maturity.
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Fannie Mae
- US government-sponsored federal national mortgage association.
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Fee
- Part of a cost that does not depend on the total value of a trade.
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Fixed income instruments
- Bonds and preferred stock that pay a predetermined amount of cash.
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Fixed interest rate
- Predetermined return on investment of a bond, which remains independent of
the market spot rate.
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Fixed leg (of a swap)
- Part of the contract involving payments that are predetermined (risk-free)
and remain independent of the spot rate.
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Floating leg (of a swap)
- Part of the contract involving payments that depend on the spot rate and
therefore carry a financial risk.
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Floor
- Collection of floorlets maturing at different
times.
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Floorlet
- Interest rate option providing for a lower limit on the interest rate;
it entitles the holder to the difference between the strike and the spot
rate if this is positive, or zero otherwise.
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Forward rate
- Interest
payed today at time
for a loan with a specified
maturity
and starting at some point in the future
, where
.
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Forward rate agreement (FRA)
- Agreement to borrow or lend an amount of cash some time in the future
at an interest rate that is fixed today.
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Forward contracts
- Agreement between a buyer and a seller to exchange certain goods for
a fixed price some time in the future.
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Forward price
- The delivery price in a forward contract chosen so as to make it worthless.
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Freddie Mac
- US government-sponsored federal home mortgage loan corporation.
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Futures contract
- Special type of standardized forward contract
enabling anonymous trades on an exchange with a protection against defaults
through a clearing margin.
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Gearing
- Strategy increasing the return of portfolio by increasing the investment risk.
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Gross domestic product (GDP)
- Total value of goods and services produced by a country.
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Go long
- Purchase an asset in exchange of cash.
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Go (or sell) short
- Sell an asset that has been borrowed from another investor.
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Hedger
- Person who buys securities to reduce the investment risk in a portfolio.
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Hedging
- Strategy reducing the investment risk of a portfolio at the expense of
smaller returns.
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Holder
- The purchaser of an option.
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Implied volatility
- Volatility of an underlying asset, as
measured from the price of derivatives assuming a standard pricing model.
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In-the-money
- Subset of an option series that has a finite
intrinsic value
that is payed out to the holder at the expiry.
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Initial / Terminal conditions
- Value of a function of time that is known at the beginning of a calculation.
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Initial public offering (IPO)
- First sale of a company's shares to the public.
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Intrinsic value
- The value of an option if it would expire with the underlying at its current
price.
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Investor
- Person or organization that buys property in the hope of making a profit.
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Investment
- Money used to realize a project in the hope of making a profit.
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Itô's lemma
- Mathematical formula relating the differential of a stochastic function
to differential of its stochastic arguments.
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London inter bank offered rate (LIBOR)
- The rate of interest that major international banks in London charge
each other for borrowings.
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Market
- Occasion when people buy and sell goods.
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Market maker
- Person who's job it is to determine a fair price of a certain asset
and to help buyers and sellers exchange that over-the-counter outside
the market.
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Market price of risk
- Parameter measuring how much the investors are risk seeking or risk averse.
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Market value
- Spot price obtained via offer and demand
from sellers and buyers on the market.
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Markov process
- Stochastic process where consecutive increments are independent from the past.
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Martingales
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Maturity date
- The end of the life of a contract.
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Maximum likelyhood estimation
- Statistical method built so as to maximize the chance that a model fits
a given dataset.
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Mean reversion
- Tendency of a quantity to evolve towards a long term average.
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Modern Portfolio Theory (MPT)
- Description of rational investment choices based on risk-return trade-offs
and efficient diversification.
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Monte-Carlo simulation
- Computer calculation performed with a crowd of random walkers to
statistically sample the evolution of market prices by adding small
increments.
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Net asset Value (NAV)
- Total value of the fund's investment.
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Notional principal
- The amount of cash used to calculate the payments in an interest rate swap;
the principal is ``notional'' because it is never really exchanged.
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Numeraire asset
- Arbitrary asset chosen to measure the relative performance of an investment
in dimensionless units.
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Offer price
- The price a seller is asking in exchange for a security.
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Open-end fund
- Mutual fund where the holdings are continually reinvested and new shares
are created on demand.
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Option
- Security giving its holder a right, but not the obligation, to buy or
sell an asset at a set price on or before a given date.
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Option class
- Options having the same underlying and the same type of contract (put, call, etc).
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Option series
- Option from the same class having the
same exercise price and expiry date.
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Out-of-the-money
- Subset of an option series that has no
intrinsic value
and expires worthless.
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Over-the-counter (OTC)
- Non-standard exchange of goods carried out between two parties outside
the market, generally without disclosing the price to the public.
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Par
- Equal to the principalkeywd:principal or face value of a security.
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Parameters: financial / numerical
- Financial parameters entirely specify the problem; numerical parameters
only serve to control the calculation and should never affect the result.
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Path dependent option
- Option with a payoff depending on the price history of the underlying.
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Portfolio
- Set of shares and financial instruments held by a person or an organization.
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Possible realizations
- Outcomes of a random variable that have a finite probability to occur.
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Premium
- Amount that is in excess of the par value, i.e. the positive difference
between the present value and the nominal principal value.
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Principal (or face) value
- Amount of cash an issuer (borrower) agrees to pay at the maturity.
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Principal components
- Partly uncorrelated random varialbles that can explain most of the
statistical observations from the markets.
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Probability
- Measure of the likelihood that something will occur.
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Put-call parity
- Relation between the price of vanilla options with the same strike price
and expiry.
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Put option
- Security giving its holder the right and no obligation to sell an underlying
asset.
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Random
- Which cannot be predicted with certainty from the past.
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Redemption date
- Date when a debt security is has to be payed back, marking the end of the
lifetime of a bond.
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Random walk
- Unpredictable motion resulting from increments that are generally assumed
to be independent of the past (Markov property).
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Reset and payment times
- Beginning and end of the time interval
(accrual period)
between the payment of coupons in a bond or the exchange of interest
payments in a swap.
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Risk
- The possibility of something bad happening sometime in the future.
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Risk premium
- Reward the investors ask for taking a larger investment risk.
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Security
- Document proving that somebody is the owner of certain goods or has a
right to acquire them in the future.
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Smile
- Graph with a minimum implied volatility
for an underlying at-the-money.
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Specific risk
- The uncertain outcome of an investment can be divided in specific and
non-specific risks. Specific risk can entirely be eliminated through
combination of anti-correlated assets and diversification; non-specific
risk affects the entire market.
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Speculator
- Person who buys and sells goods in the hope of making a profit from
his view on the evolution of the market.
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Split
- When a growing company emits new shares to reduce the price quoted in
the market. In a 2-for-1 split, 2 new shares are exchanged for every
share that was previously owned.
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Spot
- The value for immediate delivery.
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Stochastic
- Something that includes an unpredictable random component.
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Strike (or exercise) price
- The price at which the underlying may be bought or sold.
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Suzerain
- In the Middle Ages, the suzerain was a person who owned the right over
another (called the vassal) who promised to fight and be loyal in
return for being given land to live on.
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Swap (of interest rates, currency exchange rates, etc)
- Contract whereby two parties agree to exchange, at known dates in the future,
a fixed for a floating set of rates without ever exchanging the principal.
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Tenor of a bond
- Time interval between the payment of consecutive coupons.
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Term structure of interest rates
- Interest rates calculated for bonds of different maturities.
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Time value
- Difference between the intrinsic value
and the value of an option before it expires.
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Transaction costs
- The cost of carrying out a trade (fees, commissions, plus the difference
between the price obtained and the middle of the bid-offer prices quoted
on the market).
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Treasury rate
- Interest rate payed by the central bank responsible for a given currency.
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Tree
- Method to approximate a dynamical system by recursively adding / subtracting
a fixed number of increments to all the possible outcomes.
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Underlying
- Security that parties agree to exchange under conditions in a derivative
contract.
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Vanilla
- Simplest form of a contract.
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Venture capital
- High risk investment given in return for a participation in the control
and the future earnings of a start-up company that develops a new product.
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Volatility
- A measure of the uncertainty of the price of an asset.
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Wiener process
- Markov process where the increments are normally distributed with zero
mean and a variance proportional to the time step.
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Writer
- The seller of an option, usually a large financial institution.
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Zero-coupon bond
- A bond without coupon, where the principal and the interest are paid
at the maturity date.
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Zero-sum game
- Game where the earning from one player exactly equals the loss from another.
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Next: 10.2 Notation and symbols
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