Glossary of Key Terms: Options, Futures, and Derivatives

21. Glossary of Key Terms

Welcome to the glossary section of the “Financial Instruments for Beginners: Comprehensive Guide to Options, Futures, and Derivatives.” This glossary compiles an alphabetical list of key terms defined throughout the guide. Each term is accompanied by a clear, concise definition and cross-references to the chapters where it is discussed in detail. This section serves as a quick reference to enhance your understanding of financial instruments and prepare you for the US Securities Exams.

A

Arbitrage
The simultaneous purchase and sale of an asset to profit from a difference in the price. It exploits price discrepancies in different markets. See Chapter 5.3.3.

Asset-Backed Securities (ABS)
Financial securities backed by a pool of assets such as loans, leases, credit card debt, or receivables. See Chapter 11.3.

B

Bonds
Debt securities issued by entities such as governments or corporations to raise capital, promising to pay back with interest. Key features include par value, coupon rate, and maturity. See Chapter 3.2.

Broker
An individual or firm that acts as an intermediary between an investor and a securities exchange. See Chapter 14.3.

C

Call Option
A financial contract that gives the holder the right, but not the obligation, to buy an asset at a specified price within a specific time period. See Chapter 6.2.

Clearinghouse
An intermediary between buyers and sellers in financial markets, ensuring the transaction is completed smoothly. See Chapter 14.2.

Commodity Markets
Markets where raw or primary products are exchanged. These commodities are traded on regulated exchanges. See Chapter 10.1.

Credit Derivatives
Financial instruments used to manage exposure to credit risk, often involving the transfer of risk without transferring the underlying asset. See Chapter 9.2.

D

Debt Instruments
Financial obligations that require the issuer to pay back the borrowed amount with interest. Includes bonds and other fixed-income securities. See Chapter 3.1.

Derivatives
Financial contracts whose value is derived from an underlying asset, index, or rate. Common derivatives include options, futures, and swaps. See Chapter 5.1.

Diversification
A risk management strategy that mixes a wide variety of investments within a portfolio to reduce exposure to any single asset or risk. See Chapter 2.3.

Dividend
A portion of a company’s earnings distributed to shareholders, usually in the form of cash or additional stock. See Chapter 4.3.

E

Equity Instruments
Securities that represent ownership in a company, such as stocks. They entitle the holder to a share of the company’s profits and assets. See Chapter 4.1.

Exchange-Traded Funds (ETFs)
Investment funds traded on stock exchanges, much like stocks. They hold assets such as stocks, commodities, or bonds. See Chapter 12.3.

F

Futures Contracts
Standardized legal agreements to buy or sell something at a predetermined price at a specified time in the future. See Chapter 7.1.

Foreign Exchange (Forex)
The global marketplace for trading national currencies against one another. See Chapter 10.3.

Forward Contracts
Customized contracts between two parties to buy or sell an asset at a specified future date for a price agreed upon today. See Chapter 8.1.

H

Hedging
A risk management strategy used to offset potential losses in an investment by taking an opposite position in a related asset. See Chapter 5.3.1.

Hedge Funds
Investment funds that employ various strategies to earn active returns for their investors. They may use leverage, derivatives, and other sophisticated strategies. See Chapter 12.2.

I

Intrinsic Value
The actual value of an option if it were exercised immediately, calculated as the difference between the underlying asset’s price and the option’s strike price. See Chapter 6.5.

Interest Rate Swaps
A financial derivative contract in which two parties exchange interest rate cash flows, based on a specified notional amount. See Chapter 8.2.1.

L

Liquidity
The ease with which an asset can be converted into cash without affecting its market price. See Chapter 2.4.

M

Market Risk
The risk of losses in investments due to movements in market prices. See Chapter 13.1.

Mutual Funds
Investment programs funded by shareholders that trade in diversified holdings and are professionally managed. See Chapter 12.1.

O

Options
Contracts that give the buyer the right, but not the obligation, to buy or sell an underlying asset at a set price on or before a certain date. See Chapter 6.1.

Operational Risk
The risk of loss resulting from inadequate or failed internal processes, people, and systems, or from external events. See Chapter 13.4.

P

Par Value
The face value of a bond, or the amount that will be paid back to the bondholder at maturity. See Chapter 3.2.1.

Preferred Stock
A type of equity security that has a higher claim on assets and earnings than common stock, typically with fixed dividends. See Chapter 4.2.

Premium
The price paid for an option contract, representing the cost of acquiring the option. See Chapter 6.3.

R

Real Estate Investment Trusts (REITs)
Companies that own, operate, or finance income-producing real estate across a range of property sectors. See Chapter 12.4.

Regulatory Bodies
Organizations that oversee the financial markets and ensure compliance with laws and regulations. Key bodies include the SEC, CFTC, and FINRA. See Chapter 19.1.

Risk Management
The process of identification, analysis, and acceptance or mitigation of uncertainty in investment decisions. See Chapter 13.5.

S

Securities
Tradable financial assets such as stocks, bonds, and options. They represent an ownership position, a creditor relationship, or rights to ownership. See Chapter 1.1.

Speculation
The act of trading in an asset, or conducting a financial transaction, that has a significant risk of losing value but also holds the expectation of a significant gain. See Chapter 5.3.2.

Stock Exchanges
Marketplaces where stocks, bonds, and other securities are bought and sold. They facilitate the exchange of securities between buyers and sellers. See Chapter 14.1.

Strike Price
The set price at which an option holder can buy (call) or sell (put) the underlying security. See Chapter 6.3.

Swaps
Derivative contracts through which two parties exchange financial instruments, typically involving cash flows based on a notional principal amount. See Chapter 8.2.

T

Time Value
The portion of an option’s premium that exceeds its intrinsic value, representing the potential for additional profit due to time remaining until expiration. See Chapter 6.5.

U

Underlying Asset
The financial asset upon which a derivative’s price is based. Examples include stocks, bonds, commodities, and currencies. See Chapter 5.2.

V

Volatility
A statistical measure of the dispersion of returns for a given security or market index, often used as a measure of risk. See Chapter 13.1.

Voting Rights
The rights of shareholders to vote on matters of corporate policy, including decisions on the board of directors and other significant corporate actions. See Chapter 4.3.

W

Warrants
Derivatives that give the holder the right to purchase securities from the issuer at a specific price within a certain time frame. See Chapter 9.1.

This glossary is designed to serve as a quick reference for key terms related to financial instruments, options, futures, and derivatives. For a deeper understanding of each term, refer to the respective chapters indicated in the cross-references.

Quiz Time!