Financial Terms Underlying asset

# Definition of Underlying asset

## Underlying asset

The asset that an option gives the option holder the right to buy or to sell.

# Related Terms:

## 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.

## Cash delivery

The provision of some futures contracts that requires not delivery of underlying assets but
settlement according to the cash value of the asset.

## Exercising the option

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

## 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.

## Path dependent option

An option whose value depends on the sequence of prices of the underlying asset
rather than just the final price of the asset.

## Perfect hedge

A financial result in which the profit and loss from the underlying asset and the hedge position
are equal.

Also called time value, the amount by which the option price exceeds its intrinsic value. The
value of an option beyond its current exercise value representing the optionholder's control until expiration,
the risk of the underlying asset, and the riskless return.

## Two-state 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 it can take on in the preceding time period.
Also called the binomial option pricing model.

## Volatility

A measure of risk based on the standard deviation of investment fund performance over 3 years.
Scale is 1-9; higher rating indicates higher risk. Also, the standard deviation of changes in the logarithm of an
asset price, expressed as a yearly rate. Also, volatility is a variable that appears in option pricing formulas. In
the option pricing formula, it denotes the volatility of the underlying asset return from now to the expiration
of the option.
Std Deviation = Rating
up to 7.99 = 1
8.00-10.99 = 2
11.00-13.99 = 3
14.00-16.99 = 4
17.00-19.99 = 5
20.00-22.99 = 6
23.00-25.99 = 7
26.00-28.99 = 8
29.00 and up = 9

## Volatility risk

The risk in the value of options portfolios due to the unpredictable changes in the volatility of
the underlying asset.

## Delta

The rate of change of the price of a derivative security relative to the
price of the underlying asset; i.e., the first derivative of the curve that relates
the price of the derivative to the price of the underlying security.

## Derivative

A financial instrument that is based on some underlying asset.
For example, an option is a derivative instrument based on the right to buy or
sell an underlying instrument.

## Gamma

The rate of change of delta for a derivative security relative to the
price of the underlying asset; i.e., the second derivative of the option price
relative to the security price.

## Acquisition of assets

A merger or consolidation in which an acquirer purchases the selling firm's assets.

## Asset

Any possession that has value in an exchange.

## Asset/equity ratio

The ratio of total assets to stockholder equity.

## Asset/liability management

Also called surplus management, the task of managing funds of a financial
institution to accomplish the two goals of a financial institution:
1) to earn an adequate return on funds invested, and
2) to maintain a comfortable surplus of assets beyond liabilities.

## Asset activity ratios

Ratios that measure how effectively the firm is managing its assets.

## Asset allocation decision

The decision regarding how an institution's funds should be distributed among the
major classes of assets in which it may invest.

## Asset-backed security

A security that is collateralized by loans, leases, receivables, or installment contracts
on personal property, not real estate.

## Asset-based financing

Methods of financing in which lenders and equity investors look principally to the
cash flow from a particular asset or set of assets for a return on, and the return of, their financing.

## Asset classes

Categories of assets, such as stocks, bonds, real estate and foreign securities.

## Asset-coverage test

A bond indenture restriction that permits additional borrowing on if the ratio of assets to
debt does not fall below a specified minimum.

## Asset for asset swap

Creditors exchange the debt of one defaulting borrower for the debt of another
defaulting borrower.

## Asset pricing model

A model for determining the required rate of return on an asset.

## Asset substitution

A firm's investing in assets that are riskier than those that the debtholders expected.

## Asset substitution problem

Arises when the stockholders substitute riskier assets for the firm's existing
assets and expropriate value from the debtholders.

## Asset swap

An interest rate swap used to alter the cash flow characteristics of an institution's assets so as to
provide a better match with its iabilities.

## Asset turnover

The ratio of net sales to total assets.

## Asset pricing model

A model, such as the Capital asset Pricing Model (CAPM), that determines the required
rate of return on a particular asset.

## Assets

A firm's productive resources.

## Assets requirements

A common element of a financial plan that describes projected capital spending and the
proposed uses of net working capital.

## Capital asset pricing model (CAPM)

An economic theory that describes the relationship between risk and
expected return, and serves as a model for the pricing of risky securities. The CAPM asserts that the only risk
that is priced by rational investors is systematic risk, because that risk cannot be eliminated by diversification.
The CAPM says that the expected return of a security or a portfolio is equal to the rate on a risk-free security

## Current assets

Value of cash, accounts receivable, inventories, marketable securities and other assets that
could be converted to cash in less than 1 year.

## Dynamic asset allocation

An asset allocation strategy in which the asset mix is mechanistically shifted in
response to -changing market conditions, as in a portfolio insurance strategy, for example.

## Exchange of assets

Acquisition of another company by purchase of its assets in exchange for cash or stock.

## Financial assets

Claims on real assets.

## Fixed asset

Long-lived property owned by a firm that is used by a firm in the production of its income.
Tangible fixed assets include real estate, plant, and equipment. Intangible fixed assets include patents,

## Fixed asset turnover ratio

The ratio of sales to fixed assets.

## Intangible asset

A legal claim to some future benefit, typically a claim to future cash. Goodwill, intellectual

## Liquid asset

asset that is easily and cheaply turned into cash - notably cash itself and short-term securities.

## Long-term assets

Value of property, equipment and other capital assets minus the depreciation. This is an
entry in the bookkeeping records of a company, usually on a "cost" basis and thus does not necessarily reflect
the market value of the assets.

## Limitation on asset dispositions

A bond covenant that restricts in some way a firm's ability to sell major assets.

## Net asset value (NAV)

The value of a fund's investments. For a mutual fund, the net asset value per share
usually represents the fund's market price, subject to a possible sales or redemption charge. For a closed end
fund, the market price may vary significantly from the net asset value.

## Net assets

The difference between total assets on the one hand and current liabilities and noncapitalized longterm
liabilities on the other hand.

## Non-reproducible assets

A tangible asset with unique physical properties, like a parcel of land, a mine, or a
work of art.

## Other current assets

Value of non-cash assets, including prepaid expenses and accounts receivable, due
within 1 year.

## Policy asset allocation

A long-term asset allocation method, in which the investor seeks to assess an
appropriate long-term "normal" asset mix that represents an ideal blend of controlled risk and enhanced
return.

assets that can be traded in a public market, such as the stock market.

## Quick assets

Current assets minus inventories.

## Real assets

Identifiable assets, such as buildings, equipment, patents, and trademarks, as distinguished from a
financial obligation.

## Reproducible assets

A tangible asset with physical properties that can be reproduced, such as a building or
machinery.

## Residual assets

assets that remain after sufficient assets are dedicated to meet all senior debtholder's claims in full.

## Return on assets (ROA)

Indicator of profitability. Determined by dividing net income for the past 12 months
by total average assets. Result is shown as a percentage. ROA can be decomposed into return on sales (net
income/sales) multiplied by asset utilization (sales/assets).

## Return on total assets

The ratio of earnings available to common stockholders to total assets.

## Riskless or risk-free asset

An asset whose future return is known today with certainty. The risk free asset is
commonly defined as short-term obligations of the U.S. government.

## Risky asset

An asset whose future return is uncertain.

## Risk-free asset

An asset whose future return is known today with certainty.

## Tactical Asset Allocation (TAA)

An asset allocation strategy that allows active departures from the normal
asset mix based upon rigorous objective measures of value. Often called active management. It involves
forecasting asset returns, volatilities and correlations. The forecasted variables may be functions of
fundamental variables, economic variables or even technical variables.

## Tangible asset

An asset whose value depends on particular physical properties. These i nclude reproducible
assets such as buildings or machinery and non-reproducible assets such as land, a mine, or a work of art. Also
called real assets. Related: Intangible asset

## Total asset turnover

The ratio of net sales to total assets.

## Underlying security

Options: the security subject to being purchased or sold upon exercise of an option
contract. For example, IBM stock is the underlying security to IBM options. Depository receipts: The class,
series and number of the foreign shares represented by the depository receipt.

## Wasting asset

An asset which has a limited life and thus, decreases in value (depreciates) over time. Also
applied to consumed assets, such as gas, and termed "depletion."

## ASSETS

Anything of value that a company owns.

## Current assets

Cash, things that will be converted into cash within a year (such as accounts receivable), and inventory.

## RATE OF RETURN ON TOTAL ASSETS

The percentage return or profit that management made on each dollar of assets. The formula is:
(Net income) / (Total assets)

## Current assets

Amounts receivable by the business within a period of 12 months, including bank, debtors, inventory and prepayments.

## Fixed assets

Things that the business owns and are part of the business infrastructure â€“ fixed assets may be
tangible or intangible.

## Intangible fixed assets

Non-physical assets, e.g. customer goodwill or intellectual property (patents and trademarks).

## Tangible fixed assets

Physical assets that can be seen and touched, e.g. buildings, machinery, vehicles, computers etc.

## Assets

Items owned by the company or expenses that have been paid for but have not been used up.

## Contra-asset account

An offset to an asset account that reduces the balance of the asset account.

## Intangible assets

assets owned by the company that do not possess physical substance; they usually take the form of rights and privileges such as patents, copyrights, and franchises.

## asset turnover ratio

A broad-gauge ratio computed by dividing annual
sales revenue by total assets. It is a rough measure of the sales-generating
power of assets. The idea is that assets are used to make sales, and the
sales should lead to profit. The ultimate test is not sales revenue on
assets, but the profit earned on assets as measured by the return on
assets (ROA) ratio.

## current assets

Current refers to cash and those assets that will be turned
into cash in the short run. Five types of assets are classified as current:
cash, short-term marketable investments, accounts receivable, inventories,
and prepaid expensesâ€”and they are generally listed in this order in
the balance sheet.

## fixed assets

An informal term that refers to the variety of long-term operating
resources used by a business in its operationsâ€”including real
estate, machinery, equipment, tools, vehicles, office furniture, computers,
and so on. In balance sheets, these assets are typically labeled property,
plant, and equipment. The term fixed assets captures the idea that the
assets are relatively fixed in place and are not held for sale in the normal
course of business. The cost of fixed assets, except land, is depreciated,
which means the cost is allocated over the estimated useful lives of the
assets.

## return on assets (ROA)

Although there is no single uniform practice for
calculating this ratio, generally it equals operating profit (before interest
and income tax) for a year divided by the total assets that are used to
generate the profit. ROA is the key ratio to test whether a business is
earning enough on its assets to cover its cost of capital. ROA is used for
determining financial leverage gain (or loss).

## Asset-specific Risk

The amount of total risk that can be eliminated by diversification by
creating a portfolio. Also known as company-specific risk or
unsystematic risk.

## Capital Asset Pricing Model (CAPM)

A model for estimating equilibrium rates of return and values of
assets in financial markets; uses beta as a measure of asset risk
relative to market risk

## Fixed Assets Turnover Ratio

A measure of the utilization of a company's fixed assets to
generate sales. It is calculated by dividing the sales for the period
by the book value of the net fixed assets.

## Return on Total Assets Ratio

A measure of the percentage return earned on the value of the
assets in the company. It is calculated by dividing the net income
available for distribution to shareholders by the book value of all
assets.

## Total Asset Turnover Ratio

A measure of the utilization of all of a company's assets to
generate sales. It is calculated by dividing the sales figure for the
period by the book value of the net fixed assets.

See debt ratio

## asset turnover

a ratio measuring asset productivity and showing the number of sales dollars generated by each dollar of assets

## capital asset

an asset used to generate revenues or cost savings
by providing production, distribution, or service capabilities
for more than one year

## Rho - The rate of change in a derivativeâ€™s price relative to the underlying

securityâ€™s risk-free interest rate.

## Asset

A resource, recorded through a transaction, that is expected to yield a benefit to a
company.

## Capital asset

A fixed asset, something that is expected to have long-term usage within
a company, and which exceeds a minimum dollar amount (known as the capitalization
limit, or cap limit).

## Current asset

Typically the cash, accounts receivable, and inventory accounts on the
balance sheet, or any other assets that are expected to be liquidated within a short
time interval.

## Fixed asset

An item with a longevity greater than one year, and which exceeds a companyâ€™s
minimum capitalization limit. It is not purchased with the intent of immediate
resale, but rather for productive use within a company.

## Intangible asset

A nonphysical asset with a life greater than one year. Examples are

## Other assets

A cluster of accounts that are listed after fixed assets on the balance sheet,
and which contain minor assets that cannot be reasonably fit into any of the other
main asset categories.

## Quick asset

Any asset that can be converted into cash on short notice. This is a subset
of a current asset, for it does not include inventory. Its most common components
are the cash, marketable securities, and accounts receivable accounts.

## capital asset pricing model (CAPM)

Theory of the relationship between risk and return which states that the expected risk
premium on any security equals its beta times the market risk premium.

## financial assets

Claims to the income generated by real assets. Also called securities.

## real assets

assets used to produce goods and services.

## Asset

Something that is owned; a financial claim or a piece of property that is a store of value.

## Asset

Probable future economic benefit that is obtained or controlled by an entity as a result of
a past transaction or event.