Definition of Convertibles

Convertibles

Securities (generally bonds or preferred shares) that are exchangeable at the option of the holder for common shares of the issuing firm.

Abandonment option

The option of terminating an investment earlier than originally planned.

Adjustable rate preferred stock (ARPS)

Publicly traded issues that may be collateralized by mortgages and MBSs.

Affirmative covenant

A bond covenant that specifies certain actions the firm must take.

American option

An option that may be exercised at any time up to and including the expiration date.
Related: European option

American shares

Securities certificates issued in the U.S. by a transfer agent acting on behalf of the foreign
issuer. The certificates represent claims to foreign equities.

American-style option

An option contract that can be exercised at any time between the date of purchase and
the expiration date. Most exchange-traded options are American style.

Arbitrage-free option-pricing models

Yield curve option-pricing models.

Asian option

option based on the average price of the asset during the life of the option.

Auction rate preferred stock (ARPS)

Floating rate preferred stock, the dividend on which is adjusted every
seven weeks through a Dutch auction.

Authorized shares

Number of shares authorized for issuance by a firm's corporate charter.

Bargain-purchase-price option

Gives the lessee the option to purchase the asset at a price below fair market
value when the lease expires.

Barrier options

Contracts with trigger points that, when crossed, automatically generate buying or selling of
other options. These are very exotic options.

Basket options

Packages that involve the exchange of more than two currencies against a base currency at
expiration. The basket option buyer purchases the right, but not the obligation, to receive designated
currencies in exchange for a base currency, either at the prevailing spot market rate or at a prearranged rate of
exchange. A basket option is generally used by multinational corporations with multicurrency cash flows
since it is generally cheaper to buy an option on a basket of currencies than to buy individual options on each
of the currencies that make up the basket.

Binomial option pricing model

An option pricing model in which the underlying asset can take on only two
possible, discrete values in the next time period for each value that it can take on in the preceding time period.

Black-Scholes option-pricing model

A model for pricing call options based on arbitrage arguments that uses
the stock price, the exercise price, the risk-free interest rate, the time to expiration, and the standard deviation
of the stock return.

Book-entry securities

The Treasury and federal agencies are moving to a book-entry system in which Securities are not represented by engraved pieces of paper but are maintained in computerized records at the
Fed in the names of member banks, which in turn keep records of the Securities they own as well as those they
are holding for customers. In the case of other Securities where a book-entry has developed, engraved
Securities do exist somewhere in quite a few cases. These Securities do not move from holder to holder but are
usually kept in a central clearinghouse or by another agent.

Brady bonds

bonds issued by emerging countries under a debt reduction plan.

Call an option

To exercise a call option.

Call option

An option contract that gives its holder the right (but not the obligation) to purchase a specified
number of shares of the underlying stock at the given strike price, on or before the expiration date of the
contract.
Call premium
Premium in price above the par value of a bond or share of preferred stock that must be paid to
holders to redeem the bond or share of preferred stock before its scheduled maturity date.

Cash flow per common share

Cash flow from operations minus preferred stock dividends, divided by the
number of common shares outstanding.

Collateral trust bonds

A bond in which the issuer (often a holding company) grants investors a lien on
stocks, notes, bonds, or other financial asset as security. Compare mortgage bond.

Common market

An agreement between two or more countries that permits the free movement of capital
and labor as well as goods and services.

Common stock

These are Securities that represent equity ownership in a company. common shares let an
investor vote on such matters as the election of directors. They also give the holder a share in a company's
profits via dividend payments or the capital appreciation of the security.

Common stock/other equity

Value of outstanding common shares at par, plus accumulated retained
earnings. Also called shareholders' equity.

Common stock equivalent

A convertible security that is traded like an equity issue because the optioned
common stock is trading high.

Common stock market

The market for trading equities, not including preferred stock.

Common stock ratios

Ratios that are designed to measure the relative claims of stockholders to earnings
(cash flow per share), and equity (book value per share) of a firm.

Common-base-year analysis

The representing of accounting information over multiple years as percentages
of amounts in an initial year.
common-size analysis The representing of balance sheet items as percentages of assets and of income
statement items as percentages of sales.

Compound option

option on an option.

Confirmation

he written statement that follows any "trade" in the Securities markets. Confirmation is issued
immediately after a trade is executed. It spells out settlement date, terms, commission, etc.

Conflict between bondholders and stockholders

These two groups may have interests in a corporation that
conflict. Sources of conflict include dividends, distortion of investment, and underinvestment. Protective
covenants work to resolve these conflicts.

Convertible bonds

bonds that can be converted into common stock at the option of the holder.

Convertible exchangeable preferred stock

Convertible preferred stock that may be exchanged, at the
issuer's option, into convertible bonds that have the same conversion features as the convertible preferred
stock.

Convertible preferred stock

preferred stock that can be converted into common stock at the option of the holder.

Corporate bonds

Debt obligations issued by corporations.

Covered or hedge option strategies

Strategies that involve a position in an option as well as a position in the
underlying stock, designed so that one position will help offset any unfavorable price movement in the other,
including covered call writing and protective put buying. Related: naked strategies

Cumulative preferred stock

preferred stock whose dividends accrue, should the issuer not make timely
dividend payments. Related: non-cumulative preferred stock.

Currency option

An option to buy or sell a foreign currency.

Cushion bonds

High-coupon bonds that sell at only at a moderate premium because they are callable at a
price below that at which a comparable non-callable bond would sell. Cushion bonds offer considerable
downside protection in a falling market.

Dealer options

Over-the-counter options, such as those offered by government and mortgage-backed
Securities dealers.

Debt securities

IOUs created through loan-type transactions - commercial paper, bank CDs, bills, bonds, and
other instruments.

Delivery options

The options available to the seller of an interest rate futures contract, including the quality
option, the timing option, and the wild card option. Delivery options make the buyer uncertain of which
Treasury Bond will be delivered or when it will be delivered.

Discount securities

Non-interest-bearing money market instruments that are issued at a discount and
redeemed at maturity for full face value, e.g. U.S. Treasury bills.

Dollar bonds

Municipal revenue bonds for which quotes are given in dollar prices. Not to be confused with
"U.S. Dollar" bonds, a common term of reference in the Eurobond market.

Doubling option

A sinking fund provision that may allow repurchase of twice the required number of bonds
at the sinking fund call price.

Down-and-in option

Barrier option that comes into existence if asset price hits a barrier.

Down-and-out option

Barrier option that expires if asset price hits a barrier.

Elasticity of an option

Percentage change in the value of an option given a 1% change in the value of the
option's underlying stock.

Embedded option

An option that is part of the structure of a bond that provides either the bondholder or
issuer the right to take some action against the other party, as opposed to a bare option, which trades
separately from any underlying security.

Equity options

Securities that give the holder the right to buy or sell a specified number of shares of stock, at
a specified price for a certain (limited) time period. Typically one option equals 100 shares of stock.

Equityholders

Those holding shares of the firm's equity.

Eurodollar bonds

Eurobonds denominated in U.S.dollars.

European option

option that may be exercised only at the expiration date. Related: american option.

European-style option

An option contract that can only be exercised on the expiration date.

Euroyen bonds

Eurobonds denominated in Japanese yen.

Exchangeable Security

Security that grants the security holder the right to exchange the security for the
common stock of a firm other than the issuer of the security.

Exempt securities

Instruments exempt from the registration requirements of the Securities Act of 1933 or the
margin requirements of the SEC Act of 1934. Such Securities include government bonds, agencies, munis,
commercial paper, and private placements.

Exercising the option

The act buying or selling the underlying asset via the option contract.

Federal agency securities

Securities issued by corporations and agencies created by the U.S. government,
such as the Federal Home Loan Bank Board and Ginnie Mae.

Firm

Refers to an order to buy or sell that can be executed without confirmation for some fixed period. Also,
a synonym for company.

Firm commitment underwriting

An undewriting in which an investment banking firm commits to buy the
entire issue and assumes all financial responsibility for any unsold shares.

Firm's net value of debt

Total firm value minus total firm debt.

Firm-specific risk

See:diversifiable risk or unsystematic risk.

Floating-rate preferred

preferred stock paying dividends that vary with short-term interest rates.

Foreign currency option

An option that conveys the right to buy or sell a specified amount of foreign
currency at a specified price within a specified time period.

Fully diluted earnings per shares

Earnings per share expressed as if all outstanding convertible Securities
and warrants have been exercised.

Futures option

An option on a futures contract. Related: options on physicals.

Garmen-Kohlhagen option pricing model

A widely used model for pricing foreign currency options.

General obligation bonds

Municipal Securities secured by the issuer's pledge of its full faith, credit, and
taxing power.

Generally Accepted Accounting Principals (GAAP)

A technical accounting term that encompasses the
conventions, rules, and procedures necessary to define accepted accounting practice at a particular time.

Global bonds

bonds that are designed so as to qualify for immediate trading in any domestic capital market
and in the Euromarket.

Government securities

Negotiable U.S. Treasury Securities.

Greenshoe option

option that allows the underwriter for a new issue to buy and resell additional shares.

Holder-of-record date

The date on which holders of record in a firm's stock ledger are designated as the
recipients of either dividends or stock rights. Also called date of record.

Index and Option Market (IOM)

A division of the CME established in 1982 for trading stock index
products and options. Related: Chicago Mercantile Exchange (CME).

Index option

A call or put option based on a stock market index.

International bonds

A collective term that refers to global bonds, Eurobonds, and foreign bonds.

Intrinsic value of an option

The amount by which an option is in-the-money. An option which is not in-themoney
has no intrinsic value. Related: in-the-money.

Intrinsic value of a firm

The present value of a firm's expected future net cash flows discounted by the
required rate of return.

Investment grade bonds

A bond that is assigned a rating in the top four categories by commercial credit
rating companies. For example, S&P classifies investment grade bonds as BBB or higher, and Moodys'
classifies investment grade bonds as Ba or higher. Related: High-yield bond.

Irrational call option

The implied call imbedded in the MBS. Identified as irrational because the call is
sometimes not exercised when it is in the money (interest rates are below the threshold to refinance).
Sometimes exercised when not in the money (home sold without regard to the relative level of interest rates).

Liquid yield option note (LYON)

Zero-coupon, callable, putable, convertible bond invented by Merrill

Long bonds

bonds with a long current maturity. The "long bond" is the 30-year U.S. government bond.

Lookback option

An option that allows the buyer to choose as the option strike price any price of the
underlying asset that has occurred during the life of the option. If a call, the buyer will choose the minimal
price, whereas if a put, the buyer will choose the maximum price. This option will always be in the money.

Liquid yield option note (LYON)

Zero-coupon, callable, putable, convertible bond invented by Merrill Lynch & Co.

Long bonds

bonds with a long current maturity. The "long bond" is the 30-year U.S. government bond.

Management/closely held shares

Percentage of shares held by persons closely related to a company, as
defined by the Securities and exchange commission. Part of these percentages often is included in
Institutional Holdings -- making the combined total of these percentages over 100. There is overlap as
institutions sometimes acquire enough stock to be considered by the SEC to be closely allied to the company.

Manufactured housing securities (MHSs)

Loans on manufactured homes - that is, factory-built or
prefabricated housing, including mobile homes.

Margin requirement (Options)

The amount of cash an uncovered (naked) option writer is required to
deposit and maintain to cover his daily position valuation and reasonably foreseeable intra-day price changes.

Market segmentation theory or preferred habitat theory

A biased expectations theory that asserts that the
shape of the yield curve is determined by the supply of and demand for Securities within each maturity sector.

Monthly income preferred security (MIP)

preferred stock issued by a subsidiary located in a tax haven.
The subsidiary relends the money to the parent.

Mortgage-Backed Securities Clearing Corporation

A wholly owned subsidiary of the Midwest Stock
Exchange that operates a clearing service for the comparison, netting, and margining of agency-guaranteed
MBSs transacted for forward delivery.

Mortgage-backed securities

Securities backed by a pool of mortgage loans.

Multi-option financing facility

A syndicated confirmed credit line with attached options.

Naked option strategies

An unhedged strategy making exclusive use of one of the following: Long call
strategy (buying call options ), short call strategy (selling or writing call options), Long put strategy (buying
put options ), and short put strategy (selling or writing put options). By themselves, these positions are called
naked strategies because they do not involve an offsetting or risk-reducing position in another option or the
underlying security.
Related: covered option strategies.

Neglected firm effect

The tendency of firms that are neglected by security analysts to outperform firms that
are the subject of considerable attention.

Non-cumulative preferred stock

preferred stock whose holders must forgo dividend payments when the
company misses a dividend payment.
Related: Cumulative preferred stock

Option

Gives the buyer the right, but not the obligation, to buy or sell an asset at a set price on or before a
given date. Investors, not companies, issue options. Investors who purchase call options bet the stock will be
worth more than the price set by the option (the strike price), plus the price they paid for the option itself.
Buyers of put options bet the stock's price will go down below the price set by the option. An option is part of
a class of Securities called derivatives, so named because these Securities derive their value from the worth of
an underlying investment.

Option elasticity

The percentage increase in an option's value given a 1% change in the value of the
underlying security.

Option not to deliver

In the mortgage pipeline, an additional hedge placed in tandem with the forward or
substitute sale.

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