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Appendix B. Glossary of Financial Risk Terms
This glossary gives concise definitions for consultation. The chapters explain the assumptions, calculations and limitations behind each term.
A–D
- Accrued premium
- CDS premium earned since the previous payment date but not yet paid. Settlement after a credit event can require accrued premium in addition to the protection payment.
- Adverse selection
- A situation in which information asymmetry makes the counterparties most willing to accept a contract systematically different from those a naive model assumes.
- Asset liquidity
- Ease and cost of turning an asset into cash through sale or secured financing.
- Asset-backed security (ABS)
- A security whose contractual cash flows depend on a pool of underlying receivables or other financial assets, often issued through an SPV and divided into tranches.
- Backtesting
- Comparison of model forecasts with realised outcomes using a consistent portfolio, horizon and loss definition. Exception frequency alone does not test every aspect of a risk model.
- Backwardation
- A term structure in which longer-dated forward or futures prices are below nearer-dated prices. A downward curve is not a guarantee that the future spot price will fall.
- Banking book
- Bank positions outside the regulatory trading book, commonly including lending and deposits. Accounting classification and regulatory book allocation are distinct decisions.
- Basis point
- One hundredth of a percentage point: 1 bp equals 0.01%, or 0.0001 as a decimal rate change.
- Basis risk
- Risk that movements in a hedge instrument do not closely match the hedged exposure.
- Beta
- Sensitivity of a portfolio return to the return of a reference market index.
- CAP curve
- Cumulative accuracy profile: cumulative share of defaults captured as borrowers are examined from highest to lowest predicted risk. It differs from the receiver operating characteristic curve.
- Capital at risk
- The amount of capital exposed to an adverse event, depending on the chosen risk framework.
- Cash Flow at Risk (CFaR)
- Adverse-tail quantile of projected actual cash flows relative to a forecast or benchmark.
- CDS
- Credit default swap: derivative transferring a specified credit-event exposure for a premium.
- Central counterparty (CCP)
- An entity that interposes itself between counterparties in eligible cleared transactions. Clearing changes counterparty risk and creates margin and liquidity requirements; it does not remove risk.
- Conditional default probability
- Probability of default during a specified interval conditional on survival to the beginning of that interval. It differs from cumulative default probability measured from origination.
- Contango
- A forward curve whose farther-dated contracts trade at higher prices than nearer-dated contracts.
- Convenience yield
- Economic advantage associated with physical possession of a commodity.
- Convexity
- Curvature of a bond price–yield relationship, improving on a duration-only approximation.
- Correlation
- Standardized measure of linear co-movement, bounded between −1 and +1.
- Covariance
- The expected product of deviations from two means, measuring linear co-movement in the original units of the variables. Portfolio variance combines every relevant covariance.
- Credit migration
- A change in assessed creditworthiness or rating grade short of outright default.
- Credit spread
- Yield increment over a specified benchmark, reflecting expected losses together with risk premia, liquidity and other pricing effects. It is not a direct physical default probability.
- Delta
- First derivative of option value with respect to underlying price.
- Detachment point
- Pool-loss threshold at which a tranche is completely exhausted. Its attachment point is the threshold at which the tranche first begins to absorb losses.
- Diversification
- Combining exposures whose losses are not perfectly aligned. Its benefit depends on dependence, concentration and the risk measure, and may weaken during stress.
- Duration
- Weighted bond cash-flow timing or price sensitivity, depending on specified definition.
- DV01 / PVBP
- Approximate monetary change in value for a one-basis-point parallel yield movement, with the quoted sign convention specified. For a positive-duration bond it is often reported as the magnitude of the loss from a yield rise.
E–H
- EAD
- Exposure at default, the amount owed or at risk when default occurs.
- Earnings at Risk (EaR)
- Adverse-tail sensitivity of reported accounting earnings.
- Economic capital
- Capital set to absorb unusually adverse losses above average expected loss.
- Economic FX exposure
- Sensitivity of future economic value or operating cash flows to exchange rates, including competitiveness, demand and input costs beyond existing contractual receivables.
- Economic value of equity (EVE)
- Present value of banking-book asset cash flows less liability cash flows under a stated valuation model. Its sensitivity need not have the same sign as near-term net interest income.
- EWMA
- Exponentially weighted moving average, a volatility updating rule that progressively reduces the weight assigned to older squared innovations.
- Expected Shortfall (ES)
- Average loss in the worst specified fraction of outcomes, using a quantile-integral definition that handles discrete probability masses consistently.
- Funding liquidity
- Capacity to raise cash or meet payment and margin obligations when due.
- Gamma
- Second derivative of option value with respect to underlying price.
- GARCH
- Generalised autoregressive conditional heteroskedasticity: a family of models in which conditional variance depends on past innovations and past variances.
- Geometric Brownian motion (GBM)
- A continuous-time price model with proportional drift and volatility. Its lognormal terminal distribution excludes price jumps and does not describe every asset or crisis regime.
- Haircut
- Discount to collateral market value used when determining secured funding.
- Hedge accounting
- An accounting framework that can align recognition of eligible hedging instruments and hedged items when designation and other requirements are satisfied. An economic hedge does not qualify automatically.
- Hedge ratio
- Amount of hedging instrument required to offset a chosen part of an exposure.
- Historical simulation
- Risk measurement by applying historical risk-factor shocks to the current portfolio and repricing. Historical portfolio returns and current-portfolio scenario losses need not be the same data.
- HQLA
- High-quality liquid assets, eligible assets in the LCR liquidity buffer.
I–P
- Initial margin
- Collateral collected to cover potential future exposure over a liquidation or close-out period. Its amount and eligibility can change as risk conditions change.
- IRRBB
- Interest rate risk in the banking book, including changes in economic value or net interest income.
- Leverage
- Exposure or assets relative to a specified capital base. Small asset-value changes can produce much larger percentage changes in equity when leverage is high.
- LGD
- Loss given default; default loss as a fraction of exposure after recovery.
- Liquidity Coverage Ratio
- Ratio of qualifying liquid assets to standardized stressed 30-day net outflows.
- Margin call
- A demand for additional cash or eligible collateral. An economically hedged portfolio may still face substantial interim funding needs.
- Mark-to-market
- Recognition or measurement by reference to current fair/market value.
- Merton model
- A structural credit model treating equity as a call option on firm assets and debt default as a consequence of asset value falling below the debt obligation at the model horizon.
- Model risk
- Risk of adverse decisions or losses caused by an incorrect, miscalibrated, misimplemented or misused model, including unreliable data and assumptions.
- Modified duration
- Approximate negative percentage bond price sensitivity per unit yield change.
- Monte Carlo simulation
- Numerical generation of scenarios under a specified stochastic model. More simulations reduce sampling error but do not repair a wrong model.
- Net interest income (NII)
- Interest income less interest expense over an accounting period. Repricing, customer behaviour, volumes and the term structure jointly determine its response to rate changes.
- NSFR
- Net Stable Funding Ratio, available stable funding divided by required stable funding.
- Operational hedging
- Changes in physical operations, financing, sourcing or production to reduce exposure.
- PD
- Probability that an obligor defaults within a specified horizon and definition.
Q–Z
- Repo
- Repurchase agreement, a form of collateralized short-term financing.
- Risk appetite
- The types and amounts of risk an institution is prepared to accept in pursuit of its objectives, translated into meaningful limits and governance responsibilities.
- Risk-neutral probability
- A pricing probability consistent with a specified no-arbitrage valuation model. It incorporates risk pricing and generally differs from an objective forecast of event frequency.
- Risk-weighted assets (RWA)
- Regulatory measure of exposures after capital-rule risk weight and model calculations.
- Rollover risk
- Risk that maturing funding cannot be renewed in the required amount or at an affordable price. Repeatedly replacing short hedges or funding can create rollover exposure.
- SPV
- Special-purpose vehicle holding transferred assets and issuing securities or other claims.
- Stress testing
- Evaluation of portfolio or business outcomes under specified adverse scenarios. A scenario can be informative without being assigned a precise probability.
- Systemic risk
- Risk of failure or destabilization propagating through the financial system.
- Theta
- Sensitivity of derivative value to elapsed calendar time or to remaining maturity. The chosen time convention determines the sign; it must be stated explicitly.
- Trading book
- Positions assigned to the regulatory trading book under applicable rules, generally involving trading intent or hedging of eligible trading positions. It is not synonymous with every fair-value accounting position.
- Transaction FX exposure
- Sensitivity of foreign-currency contractual/forecast transactions to exchange rates.
- Translation FX exposure
- Sensitivity of reporting-currency balance-sheet or consolidation numbers to exchange rates.
- Unexpected loss
- Severe credit-loss risk above expected loss; definitions vary across models.
- VaR
- Value at Risk: a loss-distribution quantile at a stated confidence level and horizon. Losses can exceed it, and it does not describe the severity of those exceedances.
- Variation margin
- Collateral transfers reflecting changes in the current market value of covered positions. Daily settlement can create immediate cash needs before gains elsewhere become available.
- Vega
- Sensitivity of an option’s value to a volatility input change.
- Wrong-way risk
- Dependence in which counterparty credit quality deteriorates when the exposure to that counterparty increases.
- Zero-coupon bond
- A debt instrument paying no interim coupon and a specified amount at maturity. Its price depends on the discount factor and the relevant credit and contractual assumptions.