The language of the market is buzzing with special terms -
often with quite similar meanings.
HARTMUT SCHWAEZBACH /
Hedging: If a business holds stocks of a commodity, it runs the risk of making losses if the price falls. This loss can be avoided by hedging, which involves selling a good forward, for delivery at an agreed price at a future date, or by selling in the futures market.
Derivatives: These are tradable securities whose value is derived from the actual or expected price of some asset – a commodity, security or currency. They can be used as a hedge, to reduce risks, or for speculation. Futures contracts, futures on stock market indices, options and swaps are all derivatives.
Futures, options and swaps: A futures contract is an agreement to buy or sell a good, share, or currency at a future date, at a price decided when the contract is entered into. An option is like a futures contract except that in this case there is a right, but no obligation, to trade at an agreed price at a future date. An interest-rate swap is a transaction by which financial institutions change the form of their assets or debts. Swaps can be between fixed and floating rate debt, or between debt in different currencies.
Stock market indices: The most famous are the Dow Jones Industrial Average, an index of share prices on the US stock market based on 30 leading US companies, the FTSE 100, an index of Britain’s 100 top companies, and the Japanese equivalent, the NIKKEI 225.
Foreign exchange market: This is where currencies are traded. There is no one location for this market, however, as it operates via computer and telephone connections. The total turnover of world foreign exchange markets is enormous – many times the total international trade in goods and services.
Mutual fund: A financial institution which holds shares on behalf of investors. The investors buy shares or ‘units’ in the fund, which uses their money to buy shares in a range of companies. An investor selling back the units gets the proceeds of selling a fraction of the fund’s total portfolio rather than just shares in one or two companies.
Equities: The ordinary shares or common stock of companies. The owners of these shares are entitled to the residual profits of companies after all claims of creditors, debenture holders and preference shareholders have been satisfied. The value of their expected yield fluctuates more than other shares.
Junk bonds: Bonds issued on a very doubtful security, by firms where there is serious doubt as to whether interest and redemption payments will actually be made. Because they are risky, lenders are only prepared to hold them if promised returns are high enough.
Source: Oxford Dictionary of Economics by John Black (OUP, 1997).