Glossary of Alternative Investments Terms

Abandon
The act of an option holder in electing not to exercise or offset an option.

A.B.S.
Asset backed security. A term describing certain finance structures where the underlying obligation and the source of interest and capital repayment is generated from the cash flow from a particular financial asset or pool of assets or from the predetermined proceeds from the disposal of the asset.

Active Premium
The return on an investment's annualized return minus the benchmark's annualized return.

Actuals
The physical or cash commodity, as distinguished from a commodity futures contract. Also see Cash and Spot Commodity.

Add-on Method
A method of paying interest where the interest is added onto the principal at maturity or interest payment dates.

Adjusted Futures Price
The cash-price equivalent reflected in the current futures price. This is calculated by taking the futures price times the conversion factor for the particular financial instrument (e.g. bond or note) being delivered.

Advisory Board
A group whose functions include approval of valuations of investments and dealing with conflicts of interest. They may also approve distributions, review audits and consider requested exemptions from partnership covenants.

Against Actuals
See Exchange For Physicals.

Aggregation
Also called netting. Refers to a portfolio perspective when calculating the carried interest between general partners and limited partners.

Aggregation in Futures
The principle under which all futures positions owned or controlled by one trader (or group of traders acting in concert) are combined to determine reporting status and compliance with speculative limits.

Aggressive
Aggressive growth invests in equities expected to enjoy higher than normal growth in EPS. Typically have high P/E ratios, low or no dividends, often smaller capitalization. Often concentrates in sectors like technology, banking or biotechnology. Hedges by shorting equities where an earnings disappointment is expected or by shorting stock indexes. Normally has a long bias.

Alpha
Alpha measures the non-systematic return, that which cannot be attributed to the market. It shows the difference between a fund's actual return and its expected return, given its level of systematic (or market) risk (as measured by beta). A positive alpha indicates that the fund has performed better than its beta would predict. Alpha is widely viewed as a measure of the value added or lost by a fund manager.

Altman-Salomon Center Index
This is a benchmark which measures the performance of issues which have defaulted. The index includes " all public, non-convertible corporate debt issues that have either filed for bankruptcy or defaulted on a scheduled interest or principal payment". A weighted average of market value is used to calculate the yields and returns. The weighted average is calculated by each issue being weighted according to the product of its face amount outstanding and its price (as a percentage of par) as of the beginning of the measurement period.

Approved Delivery Facility
Any bank, stockyard, mill, storehouse, plant, elevator or other depository that is authorized by an exchange for the delivery of commodities tendered on futures contracts.

Arbitrage
The simultaneous purchase and sale of a security, currency or market at different prices to capture the price spread. See Merger Arbitrage, Convertible Arbitrage, Fixed Income Arbitrage, Risk Arbitrage, Index Arbitrage, Volatility Arbitrage, MBS Arbitrage, International Credit Arbitrage.

Asset Protection Trust
A trust established offshore to protect the settlor's assets against those who may make claims against them, including creditors, former spouses and dependents on death. Some offshore jurisdictions provide protection from creditor claims against persons who have guaranteed bank loans.

Asset swap
The term used for interest rate swap or cross-currency swap transactions for hedging interest rate and foreign exchange risk in fixed income securities. Convertible arbitrage managers often 'swap out' of the debt portion of the convertible leaving only the equity derivative. This effectively removes the interest-rate risk and credit risk.

Assign
To make an option seller perform his obligation to assume a short futures position (as a seller of a call option) or a long futures position (as a seller of a put option).

Assignable Contract
One which allows the holder to convey his rights to a third party. Exchange-traded contracts are not assignable.

At-the-Money
When an option's exercise price is the same as the current trading price of the underlying commodity, the option is at-the-money.

Average Gain (Gain Mean)
This is the arithmetic mean of the periods with a gain. It is calculated by summing the returns for the gain periods (where return > 0) and dividing by the number of gain periods.

Average Loss (Loss Mean)
The arithmetic mean of the periods with a loss.

Back Months
Those futures delivery months with expiration or delivery dates furthest into the future; futures delivery months other than the spot or nearby delivery month.

Backwardation
Under the theory of normal backwardation, futures prices will tend to rise over the life of a contract because hedgers tend to be short the futures market. Hedgers tend to be short the futures contract as insurance against their cash position. The hedgers will pay the speculators a return to hold long positions in order to offset their risk. This is known as normal backwardation. A market is considered to be in backwardation when the cash price exceeds the future price or a nearby futures price is greater than a more distant futures price. If the reverse is true and hedgers are long futures contracts, the futures contract price would decline over its life. This situation is known as contango. For there to be normal backwardation, speculators must be long futures contracts. Only in this manner will the futures price continue to rise as more speculators need to be compensated for their risk exposure. Conversely, for there to be contango, speculators must be net short futures contracts. Only in this manner will the futures price continue to decline over its life for the speculator to be rewarded for his exposed risk.

Bare Trust
Also known as dry, formal, naked, passive or simple trusts. The trustees have no duties other than to convey the trust properly to the beneficiaries when called upon to do so.

Basis
The difference between the spot or cash price of a commodity and the price of the nearest futures contract for the same or a related commodity. Basis is usually computed in relation to the futures contract next to expire and may reflect different time periods, product forms, qualities, or locations.

Basis Grade
The grade of a commodity used as the standard or par grade of a futures contract.

Basis Risk
The risk associated with an unexpected widening or narrowing of basis between the time a hedge position is established and the time that it is lifted.

Bear Spread
The simultaneous purchase and sale of two futures contracts in the same or related commodities with the intention of profiting from a decline in prices but at the same time limiting the potential loss if this expectation does not materialize. In agricultural products, this is accomplished by selling a nearby delivery and buying a deferred delivery.

Bear Vertical Spread
A strategy employed when an investor expects a decline in a commodity price but at the same time seeks to limit the potential loss if this expectation is not realized. This spread requires the simultaneous purchase and sale of options of the same class and expiration date but different strike prices. For example, if call options are spread, the purchased option must have a higher exercise price than option that is sold.

Beta
A measure of the relationship of a fund's movement relative to a benchmark, such as a market index. Beta is the correlation (a measure of the statistical relationship between fund and benchmark) multiplied by the magnitude of relative volatility of the fund to the benchmark. A fund with a beta of 1.2 relative to a benchmark, for example, is expected to move 12% when the benchmark moves 10%. When the fund is comprised of the same instruments as the benchmark, beta can be thought of as a measure of relative volatility. A low beta does not necessarily indicate that the fund has low volatility, rather, it may indicate that the fund's returns are not related to the movement of the market benchmark.

Blocked Funds
Term for reserving funds by one bank for the benefit of another bank. Blocking of funds is a commonly used banking procedure to ensure that the same funds are not used twice. Often more beneficial to an investor than a bank guarantee.

Booking the Basis
A forward pricing sales arrangement in which the cash price is determined either by the buyer or seller within a specified time. At that time, the previously-agreed basis is applied to the then-current futures quotation.

Box Transaction
An option position in which the holder establishes a long call and a short put at one strike price and a short call and a long put at another strike price, all of which are in the same contract month in the same commodity.

Bucketing
Directly or indirectly taking the opposite side of a customer's order into a broker's own account or into an account in which a broker has an interest, without open and competitive execution of the order on an exchange.

Bull Vertical Spread
A strategy used when an investor expects that the price of a commodity will go up but at the same seeks to limit the potential loss should this judgment be in error. This strategy involves the simultaneous purchase and the sale of options of the same class and expiration date but different strike prices. For example, if call options are spread, the purchased option must have a lower exercise or strike price than the sold option.

Butterfly Spread
A three-legged spread in futures or options. In the option spread, the options have the same expiration date but differ in strike prices. For example, a butterfly spread in soybean call options might consist of two short calls at a $6.00 strike price, one long call at $6.50 strike price, and one long call at a $5.50 strike price.

Calendar Spread
The simultaneous sale and purchase of either calls or puts with the same strike price but different expiration months. See Interdelivery Spread and Horizontal Spread.

Call Option
An option contract that give the 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.

Calmar Ratio
Used to measure return relative to downside risk. Defined as the Compound Annualized Return over the last 3 years divided by the Maximum Drawdown (absolute value) over the last 3 years.

Cap
An option-like contract for which the buyer pays a fee or premium, to obtain protection against a rise in a particular interest rate above a certain level. For example, an interest rate cap may cover a specified principal amount of a loan over a designated time period such as a calendar quarter. If the covered interest rate rises above the rate ceiling, the seller of the rate cap pays the purchaser an amount of money equal to the average rate differential times the principal amount times one quarter.

Capping
Effecting commodity or security transactions shortly prior to an option's expiration date depressing or preventing a rise in the price of the commodity or security so that previously written call options will expire worthless and the premium the writer received will be protected.

Capital Structure Arbitrage
Many issuers have more than one class of share. The prices of each of these shares trade in ranges relative to each other but often move out of line. Other shares may have an equivalent vehicle that trades in a different market (e.g. European equities and their American Depository Receipt counterparts). The strategy profits from the disparity in prices between these shares in the different markets.

Carried Interest
The general partner's share of the profits generated from a partnership. Typically general partners receive 20% of the profits and the limited partners receive 80%.

Carrying Charge
The cost of storing a physical commodity, such a grain or metal, over a period of time. The carrying charge includes insurance, storage and interest on the invested funds as well as other incidental costs. In interest rate futures markets, it refers to the differential between the yield on a cash instrument and the cost of funds necessary to buy the instrument. Also referred to as Cost of Carry.

Carrying Charges
Cost of storing a physical commodity or holding a financial instrument over a period of time. Includes insurance, storage and interest on the invested funds as well as other incidental costs. It is a carrying charge market when there are higher futures prices for each successive contract maturity. If the carrying charge is adequate to reimburse the holder, it is called a "full charge". Also see Negative Carry, Positive Carry and Contango.

Carryover
Grain and oilseed commodities not consumed during the marketing year and remaining in storage at year's end. These stocks are "carried over" into the next marketing year and added to the stocks produced during that crop year.

Cash Commodity
The physical or actual commodity as distinguished from the futures contract. Sometimes called Spot Commodity or Actuals..

Cash Settlement
Transactions generally involving index-based futures contracts that are settled in cash based on the actual value of the index on the last trading day, in contrast to those that specify the delivery of a commodity or financial instrument.

Changer
A clearing member of both the Mid-America Commodity Exchange (MCE) and another futures exchange who, for a fee, will assume the opposite side of a transaction on the MCE by taking a spread position between the MCE and another futures exchange which trades an identical, but larger, contract. Through this service, the changer provides liquidity for the MCE and an economical mechanism for arbitrage between the two markets.

Cheapest to Deliver
A method to determine which particular cash debt instrument is most profitable to deliver against a futures contract.

Clawback
A partnership provision that allows for a review of the total profit distribution from the partnership at the end of the term. The clawback is a mechanism to recapture overpayments to the general partners if they received more than their stated carried interest. The clawback provision requires return of any excess to the limited partners.

Clearinghouse
An agency or separate corporation of a futures exchange that is responsible for settling trading accounts, collecting and maintaining margin monies, regulating delivery and reporting trade data. The clearinghouse becomes the buyer to each seller (and the seller to each buyer) and assumes responsibility for protecting buyers and sellers from financial loss by assuring performance on each contract.

Closed-End Fund
A type of fund that issues a set number of shares and typically trades on a stock exchange. Unlike more traditional open-end funds, transactions in shares of closed-end funds are based on their market price as determined by the forces of supply and demand in the marketplace. The market price of a closed-end fund may be above (at a premium) or below (at a discount) the value of its underlying portfolio (or NAV).

Closing Transaction
A transaction in which at some point prior to expiration, the option holder makes an offsetting sale of an identical option, or the option writer makes an offsetting purchase of an identical option. A closing transaction in an option reduces or cancels out an investor's previous position as the holder or the writer of that option.

Co-investment
Direct investment by a limited partner in a company in which the fund is invested.

Collar
The simultaneous purchase of a cap and the sale of a floor with the aim of maintaining interest rates within a defined range. The premium income from the sale of the floor reduces or offsets the cost of buying the cap.

Collateralized Loans
The strategy is to invest in securitized bank loans to earn a positive carry over the funding rate. Fees are earned for arranging loans and deal syndication as well.

Commitment
The obligation of a limited partner to contribute an agreed amount of capital to a fund.

Commodity Pool Operator (CPO)
An individual or organization that operates or solicits funds for a commodity pool.

Commodity Trading Adviser (CTA)
A person who, for compensation or profit, directly or indirectly advises others as to the value of the advisability of buying or selling futures contracts or commodity options. Advising indirectly includes exercising trading authority over a customer's account as well as providing recommendations through written publications or other media.

Congestion
A market situation in which shorts attempting to cover their positions are unable to find an adequate supply of contracts provided by longs willing to liquidate or by new sellers willing to enter the market, except at sharply higher prices.

Contango
Market situation in which prices in succeeding delivery months are progressively higher than in the nearest delivery month; the opposite of "backwardation".

Contract Exit for Non-performance
A condition in a financial agreement that enables the investor to take back his funds if the result represented is not achieved.

Contract Grades
Those grades of a commodity which have been officially approved by an exchange as deliverable in settlement of a futures contract.

Convergence
The tendency for prices of physicals and futures to approach one another, usually during the delivery month. Also called a "narrowing of the basis".

Conversion
When trading options on futures contracts, a position created by selling a call option, buying a put option, and buying the underlying futures contract, where the options have the same strike price and the same expiration.

Convertible Arbitrage
Convertible arbitrage looks for mispricing between a convertible security and the underlying common stock. Convertible securities have a theoretical value that is based on a number of factors, including the value of the underlying stock. When the trading price of a convertible moves away from its theoretical value, an arbitrage opportunity exists.

This strategy typically involves purchasing undervalued convertible securities (bonds, preferred shares and warrants) and hedging the underlying equity risk by selling short an appropriate amount of common shares of the issuer. Properly executed, this strategy creates a net position which is substantially neutral to the movements in the underlying equity and has an attractive yield. Interest income on the convertible bond plus the rebate on the short stock typically provide a positive carry or static return. There are further opportunities for gains independent of market direction as the relative value relationship between the long bond and short stock changes.

Convexity
A bond is said to have positive convexity if its price rises more rapidly than an index in a bull market, when interest rates decline, and falls more slowly in a bear market, when interest rates rise. Convexity explains the difference between price change estimated by a bond's duration (see Duration) and its actual price change when market yields change. Thus it is a measure of the shape of the price/yield curve relationship. Negative convexity simply means behaviour is worse than expected by a simple duration calculation.

Correlation
A statistical measure of the degree to which the movements of two variables are related. For example, a hedge fund's returns may have positive or negative correlation with the market.

Correlation Coefficient
A measure of how closely the returns on two asset classes move together. The greatest possible correlation coefficient is 1.0, meaning the returns of two asset classes move in unison. The minimum correlation coefficient is -1.0, meaning the returns move in unison, but in opposite directions. Positive coefficients mean the movement is, on average, in the same direction, negative coefficients mean the movements are in opposite directions. A correlation coefficient of 0 means that knowing the direction of one asset class's returns will not help predict the direction of the other asset class's movement.

Covariance
A measure of the degree to which returns on two risky assets move in tandem. A positive covariance means that asset returns move together. A negative covariance means they vary inversely.

Crack
In energy futures, the simultaneous purchase of crude oil futures and the sale of petroleum product futures to establish a refining margin.

Credit Equivalent
Value amount representing the credit risk exposure in off-balance sheet transactions. In the case of derivatives, credit equivalent value represents the potential cost at current market prices of replacing the contract's cash flow in the case of default by the counter-party.

Credit Risk
The risk that a counter party to a transaction will fail to perform according to the terms and conditions of the contract, thus causing the holder of the claim to suffer a loss.

Crop (Marketing) Year
The time span from harvest to harvest for agricultural commodities. The crop marketing year varies slightly with each ag commodity, but it tends to begin at harvest and end before the next year's harvest, e.g. the marketing year for soybeans begins September 1 and end August 31. The futures contract month of November represents the first major new-crop marketing month, and the contract month of July represents the last major old-crop marketing month for soybeans.

Cross-Hedging
Hedging a cash commodity using a different but related futures contract when there is no futures contract for the cash commodity being hedged and the cash and futures markets follow similar price trends (e.g. using soybean meal futures to hedge fish meal).

Crush Spread
In the soybean futures market, the simultaneous purchase of soybean futures and the sale of soybean meal and soybean oil futures to establish a processing margin.

Currency Swaps
A transaction involving the exchange of cash flows and principal in one currency for those in another with an agreement to reverse the principal swap at a future date.

Dedicated Short Bias
The short biased managers invest mostly in short positions in equities and equity derivative products. To be classified as a short biased manager, the short bias of the manager's portfolio must be constantly greater than zero. To affect the short sale, the manager borrows the stock from a counter party (often its prime broker) and sells it in the market. The proceeds from the sale are kept by the broker as collateral. An additional margin of typically 5% to 50% must be deposited in the form of liquid securities. The margin is adjusted daily. Leverage is created because margin is below 100%. Short selling can be time consuming and expensive. The manager needs very efficient stock borrowing and lending facilities. Because of this, short positions are sometimes implemented by selling forward; selling stock index futures or buying put options and put warrants on single stocks or stock indices.

Deliverable Grades
The standard grades of commodities or instruments listed in the rules of the exchanges that must be met when delivering cash commodities against futures contracts. Grades are often accompanied by a schedule of discounts and premiums allowable for delivery of commodities of lesser or greater quality than the standard called for by the exchange. Also referred to as contract grades.

Deliverable Stocks
Stocks of commodities located in exchange approved storage, for which receipts may be used in making delivery on futures contracts. In the cotton trade, the term refers to cotton certified for delivery.

Delivery Day
The third day in the delivery process at the Chicago Board of Trade , when the buyer's clearing firm presents the delivery notice with a certified check for the amount due at the office of the seller's clearing firm.

Delivery Month
A specific month in which delivery may take place under the terms of a futures contract. Also referred to as contract month.

Delivery, Nearby
The nearest traded month. In plural form, one of the nearer trading months.

Delivery
The transfer of the cash commodity from the seller of a futures contract. Each futures exchange has specific procedures for delivery of a cash commodity. Some futures contracts, such as stock index contracts, are cash settled.

Delta Margining
An option margining system used by some exchange members and/or floor traders which equates the changes in option premiums with the changes in the price of the underlying futures contract to determine risk factors on which to base the margin requirements.

Delta
A measure of how much an option premium charges, given a unit change in the underlying futures price. Delta of ten is interpreted as the probability that the option will be in-the-money by expiration.

Derivative
An instrument whose value, usefulness, and marketability is dependent upon or derives from an underlying asset. Classes of derivatives include futures contracts, options, currency forward contracts, swaps, and options on futures.

Derivative Based Strategies
These are funds that invest in markets typically dominated by derivative instruments. For example, commodity funds typically invest in futures contracts and currency funds typically invest in forward contracts and swap agreements.

Diagonal Spread
A spread between two call options or two put options with different strike prices and different expiration dates.

Differentials
Price differences between classes, grades and delivery locations of various stocks of the same commodity.

Distressed Securities
Buys equity, debt, or trade claims at deep discounts of companies in or facing bankruptcy or reorganization. Profits from the market's lack of understanding of the true value of the deeply discounted securities and because the majority of investors cannot own below investment grade securities.

The strategy involves investing in the illiquid debt or equity of firms in or near bankruptcy to profit from potential recovery. Portfolios are generally unlevered. Equity risk may be hedged by shorting the stock or using index derivatives.

Distribution Policy
The term "distribution" related to how both the general and limited partners receive profits as the investments are liquidated.

Double Hedging
As used by the CFTC, it implies a situation where a trader holds a long position in the futures market in excess of the speculative limit as an offset to a fixed price sale even though the trader has an ample supply of the commodity on hand to fill all sales commitments.

Downside Deviation
Similar to the loss standard deviation except the downside deviation considers only the returns that fall below a defined Minimum Acceptable Return (MAR) rather than the arithmetic mean. For example, if the MAR is assumed to be 10 %, the downside deviation would measure the variation of each period that falls below 10 %.

Downside Risk
The measurement of the variability of returns below a minimum acceptable return specified by the investor. Downside risk is an alternative measurement that challenges standard deviation - the most widely accepted calculation of risk. Unlike standard deviation, downside risk calculations do not include returns above the minimum acceptable return target, because they pose no threat to the investor's ability to meet their investment objectives.

Drawdown
A drawdown is any losing period during an investment time frame. It is calculated by taking the peak to valley loss relative to the peak for a stated time period. The figure is expressed as a percentage. For example, fund ABC had a return of 10% in March and a return of - 5% in July. The drawdown for this period (March to July) would be 15%.

Dual Trading
Dual trading occurs when (1) a floor broker executes customer orders and, on the same day, trades for his own account or an account in which he has an interest; or (2) a Futures Commission Merchant carries customer accounts and also trades, or permits its employees to trade, in accounts in which it has a proprietary interest, also on the same day.

Emerging Equity Long/Short
The strategy attempts to exploit informational inefficiencies in emerging markets. Portfolios will generally take long positions in the securities of firms operating in emerging markets. Shorts may not be available in many emerging markets so the manager may have to short ADR's or related securities.

Emerging Markets
Invests in equity or debt of emerging (less mature) markets which tend to have higher inflation and volatile growth. Short selling is not permitted in many emerging markets, and, therefore, effective hedging is often not available, although Brady bonds can be partially hedged via U.S. Treasury futures and currency markets.

Equilibrium Price
The market price at which the quantity supplied of a commodity equals the quantity demanded.

Equity Arbitrage
Strategies that exploit mispricings of equity and equity derivative securities.

Equity Market Neutral
A strategy under which the manager attempts to remove all directional market risk by being equally long and short. Such equality would cover at least dollar neutrality and extend in varying degrees to style, industry, and capitalization. The goal of the equity market neutral manager is to focus on bottom-up security selection and eliminate the impact of market movements on portfolio return. Besides security selection the manager controls the amount of cash and total investment exposure.

Event-Driven
An investment strategy seeking to identify and exploit pricing inefficiencies that have been caused by some sort of corporate event, such as a merger, spin-off, distressed situation, or recapitalization. Event-Driven strategies involve attempting to predict the outcome of a particular transaction as well as the optimal time at which to commit capital to it. The uncertainty about the outcome of these events creates investment opportunities for managers who can correctly anticipate their outcomes.

Exchange for Physicals (EFP)
A transaction generally used by two hedgers who want to exchange futures for cash positions. Also referred to as against actuals or versus cash.

Exchange of Futures for Cash
A transaction in which the buyer of a cash commodity transfers to the seller a corresponding amount of long futures contracts, or receives from the seller a corresponding amount of short futures, at a price difference mutually agreed upon. In this way the opposite hedges in futures of both parties are closed out simultaneously. Also called EFP (Exchange for Physical), AA (Against Actuals) or Ex-Pit transactions.

Exit Strategy
This is the means by which a private equity investor realizes upon the original investment. Typical mechanisms include an IPO, company buyback, acquisition by a third party, merger with another company, secondary sales in which the original investor sells to other investors or a write-off of an unsuccessful investment.

Exotic Options
Any of a wide variety of options with non-standard payout structures, including Asian options and Lookback options. Exotic options are mostly traded in the over-the-counter market.

Expiration Cycle
An expiration cycle relates to the dates on which options on a particular underlying security expire. A given option, other than LEAPS®, will be assigned to one of three cycles, the January cycle, the February cycle or the March cycle.

Expiration Date
Options on futures generally expire on a specific date during the month preceding the futures contract delivery month. For example, an option on a March futures contract expires in February but is referred to as a March option because its exercise would result in a March futures contract position.

FAB Spread
Five Against Bond. A futures spread trade involving the buying (selling) of a five-year Treasury bond futures contract and the selling (buying) of a long-term (15-30 year) Treasury bond futures contract.

FAN Spread
Five Against Note. A futures spread trade involving the buying (selling) of a five-year Treasury note futures contract and the selling (buying) of a ten-year Treasury bond futures contract.

Feed Ratio
The relationship of the cost of feed, expressed as a ration to the sale price of animals, such as the corn-hog ratio. These serve as indicators of the profit margin or lack of profit in feeding animals to market weight.

First Notice Day
According to Chicago Board of Trade rules, the first day on which a notice of intent to deliver a commodity in fulfillment of a given month's futures contract can be made by the clearinghouse to a buyer. The clearinghouse also informs the sellers who they have been matched up with.

Fixed Income Arbitrage
The fixed income arbitrageur attempts to profit from price anomalies between related interest rate instruments. The majority of managers trade globally, although a few just focus on the US market. In order to generate returns sufficient to exceed the transaction costs, leverage may range from 10 times up to 150 times NAV employed. Genuine fixed income arbitrageurs typically aim to deliver steady returns with low volatility, due to the fact that the directional risk is mitigated by hedging against interest rate movements, or by the use of spread trades. Fixed income arbitrage can include interest rate swap arbitrage, US and non-US government bond arbitrage, forward yield curve arbitrage, and Mortgage Backed Securities Arbitrage.

Floor
A contract whereby the seller agrees to pay to the purchaser in return for the payment of a premium, the difference between current interest rates and an agreed (strike) rate times the notional amount, should interest rates fall below the agreed rate. A floor contract is effectively a string of interest rate guarantees.

Forfaiting
The process of purchasing at a discount letters of credit or similar documents held as payment for goods sold to foreign buyers. This has the effect of giving exporters earlier payment by paying a premium to the forfaiter.

Forwardation
See Contango.

Forward (Cash) Contract
A cash contract in which a seller agrees to deliver a specific cash commodity to a buyer sometime in the near future. Forward contracts, in contrast to futures contracts, are privately negotiated and are not standardized.

Forward foreign exchange contract
An agreement between two parties to set exchange rates in advance

Forward rate agreement ( FRA )
An agreement between two parties to set future borrowing / lending rates

Full Carrying Charge Market
A futures market where the price difference between delivery months reflects the total costs of interest, insurance and storage.

Funds of Funds
The hedge fund industry's closest equivalent to a mutual fund, the majority of funds of funds invest in multiple hedge funds (5 to 100) with different investment styles. The objective is to smooth out the potential inconsistency of the returns from having all of the assets invested in a single hedge fund. Funds of funds can offer an effective way for an investor to gain exposure to a range of hedge funds and strategies without having to commit substantial assets or resources to the specific asset allocation, portfolio construction and individual hedge fund selection. A growing number of style or category specific funds of funds have been launched during the past few years. For example, funds of funds which invest only in Event Driven managers; or funds of funds which invest only in Equity Market Neutral style managers.

More About Fund of Funds

Fungibility
The characteristic of interchangeability. Futures contracts for the same commodity and delivery month are fungible due to their standardized specifications for quality, quantity, delivery date and delivery locations.

Futures Commission Merchant (FCM)
An individual or organization that solicits or accepts orders to buy or sell futures contracts or options on futures and accepts money or other assets from customers to support such orders. Also referred to as commission house or wire house.

Futures Contract
A legally binding agreement, made on the trading floor of a futures exchange, to buy or sell a commodity or financial instrument sometime in the future. Futures contracts are standardized according to the quality, quantity and delivery time and location for each commodity. The only variable is price, which is discovered on an exchange trading floor.

Futures-equivalent
A term frequently used with reference to speculative position limits for options on futures contracts. The futures-equivalent of an option position is the number of options multiplied by the previous day's risk factor or delta for the option series. For example, 10 deep out-of-money options with a risk factor of 0.20 would be considered 2 futures-equivalent contracts. The delta or risk factor used for this purpose is the same as that used on delta-based margining and risk analysis systems.

Gain Standard Deviation
Similar to standard deviation, except this statistic calculates a mean return for only the periods with a gain and then measures the variation of only the gain periods around this gain mean. This is a measure of the volatility of upside performance.

Gamma
A measure of how fast delta changes, given a unit change in the underlying futures price.

General Partner
The manager of a limited partnership. The general partner has full responsibility for investing the capital. The general partner also bears personal liability for any lawsuits that arise from the investment's activities, but is often indemnified by the fund.

Ginzy Trading
A trade practice in which a floor broker, in executing an order - - particularly a large order - - will fill a portion of the order at one price and the remainder of the order at another price to avoid an exchange's rule against trading at fractional increments or "split ticks".

Give Up
A contract executed by one broker for the client of another broker that the client orders to be turned over to the second broker. The broker accepting the order from the customer collects a wire toll from the carrying broker for the use of the facilities. Often used to consolidate many small orders or to disperse large ones.

Global Macro
Aims to profit from changes in global economies, typically brought about by shifts in government policy which impact interest rates, in turn affecting currency, stock, markets. Participates in all major markets - equities, bonds, currencies and commodities though not always at the same time. Uses leverage and derivatives to accentuate the impact of market moves. Utilizes hedging, but leveraged directional bets tend to be the largest impact on performance.

Globex
An international electronic trading system for futures and options that allows participating exchanges to list their products for trading after the close of the exchanges' open outcry trading hours. Developed by Reuters Limited for use by the Chicago Mercantile Exchange (CME), Globex was launched on June 25, 1992, for certain CME contracts. Various MATIF (Marche a Terme International de France) contracts began trading on the system on March 15, 1993.

Gross Exposure
The total of a fund's long and short positions in relation to the assets of the fund. For example, if the fund is 80% long and 50% short, then the fund is 130% gross invested.

Hedge Fund
There is no formal definition in securities law for hedge fund. In broad terms, a hedge fund is an investment fund that endeavors to deliver absolute returns in all market conditions, with lower volatility and low correlation to bond and equity markets. Hedge funds encompass a wide range of strategies, all intended to reduce risk while focusing on absolute rather than relative returns. Hedge funds employ an extensive suite of sophisticated techniques not available to conventional funds, including short selling, derivatives and leverage.

More About Hedge Funds

Hedger
An individual or company owning or planning to own a cash commodity corn, soybeans, wheat, U.S. Treasury bonds, notes, bills, etc. and concerned that the cost of the commodity may change before either buying or selling it in the cash market. A hedger achieves protection against changing cash prices by purchasing (selling) futures contracts of the same or similar commodity and later offsetting that position by selling (purchasing) futures contracts of the same quantity and type as the initial transaction.

Hedging
The practice of offsetting the price risk inherent in any cash market position by taking an equal but opposite position in the futures market. Hedgers use the futures market to protect their businesses from adverse price changes. See Selling (Short) Hedge and Purchasing (Long) Hedge.

High Water Mark
The high point of value that an investment fund has reached. This term is often used in the context of fund manager's performance fee. Because the income of an investment manager is performance based, a high water mark means if the manager loses money over one time period they have to get back to the high water mark before getting a performance fee on new gains. For example, you invest $100,000 in a fund and your investment falls to $90,000 after 1 year. The manager would not be entitled to a performance fee until after surpassing the high water mark or highest point of value of the investment - which in this case is $100,000.

High Yield
High yield investing involves applying a buy/hold, or a trading strategy to high yield securities. Managers may buy the high yield debt of a company that they think will get a credit upgrade or that might be in a position to redeem the outstanding high coupon issue. Other areas of opportunity include buying the discounted bonds of companies that are potential take over targets. Some managers combine these strategies with levered pools of bank debt. Portfolio securities are generally sold when they reach upside or downside price targets, or if the issuer of the securities, or industry fundamentals change materially.

Until recently high yield was primarily a US focused strategy. However, today it can be global. Some managers include emerging market bonds, others limit themselves to investment grade countries only.

Hog/Corn Ratio
The relationship of feeding costs to the dollar value of hogs. It is measured by dividing the price of hogs ($/hundredweight) by the price of corn ($/bushel). When corn prices are high relative to pork prices, fewer units of corn equal the dollar value of 100 pounds of pork. Conversely, when corn prices are low in relation to pork prices, more units of corn are required to equal the value of 100 pounds of pork. See Feed Ratio.

Horizontal Spread
The purchase of either a call or put option and the simultaneous sale of the same type of option with typically the same strike price but with a different expiration month. Also referred to as a calendar spread.

Hurdle Rate
A minimum return requirement before incentive fees apply. It is often the current interest rate on Treasury bills. In private equity, the minimum return paid to the Limited Partner before the General Partner receives any share of the profits.

IFC Global Index
The IFC Global Index is a market capitalization weighted index that measures the market movements of 32 emerging markets. The Global Index is intended to represent the performance of the most active stocks in their respective stock markets and to be the broadest possible indicator of market movements. The markets include China, Korea, Philippines, Taiwan, India, Indonesia, Malaysia, Pakistan, Sri Lanka, Thailand, Argentina, Brazil, Chile, Columbia, Mexico, Peru, Venezuela, Czech republic, Egypt, Greece, Israel, Hungary, Jordan, Morocco, Nigeria, Poland, Russia, Saudi Arabia, Slovakia, South Africa, Turkey and Zimbabwe.

IFC Investable Index
The IFC Investable Index is a subset of the IFC Global Index; it includes only those securities, which are "Investable", i.e. those stocks which are freely available to foreign institutional investors. This index is also capitalization weighted. The regional weights are notably different from the Global Index.

Incentive Fee
See Performance Fee.

Index Arbitage
This strategy involves the purchase or sale of a basket of equities that replicates or closely tracks the listed index futures contract for those particular equities. The simultaneous purchase or sale of the futures contract offsets the directional risk of the position. Profits are generated by capturing any discount or premium in the price of the futures contract relative to its underlying basket of equities. The basket is dynamically adjusted for changes in the weightings of the constituent stocks. Within this strategy there can be additional opportunities. Add/deletes involve trading the stocks that are periodically deleted from the index against new stocks that are added to the index.

Information Ratio
The Active Premium divided by the Tracking Error. This relates the degree by which an investment has beaten the benchmark to the consistency by which the investment has beaten the benchmark.

In Sight
The amount of a particular commodity that arrives at terminal or central locations is or near producing areas. When a commodity is "in sight", it is inferred that reasonably prompt delivery can be made; the quantity and quality also become known factors rather than estimates.

Intercommodity Spread
A spread in which the long and short legs are in two different but generally related commodity markets. Also called an Intermarket spread. See Spread.

Interdelivery Spread
A spread involving two different months of the same commodity. Also called an Intracommodity spread. See Spread.

Interest Rate Swap
A transaction in which two counterparties exchange interest payment streams of differing character based on an underlying notional principal amount. The three main types are coupon swaps (fixed rate to floating rate in the same currency), basis swaps (one floating rate index to another floating rate index in the same currency) and cross-currency interest rate swaps (fixed rate in one currency to floating rate in another).

Intermarket Spread
The sale of a given delivery month of a futures contract on one exchange and the simultaneous purchase of the same delivery month and futures contract on another exchange.

Internal Rate of Return
IRR is the generally accepted methodology for measuring the performance of private equity investments. The IRR is the annualized implied discount rate calculated from a series of cash flows. It is the return that equates the present value of all invested capital in an investment to the present value of all returns.
IRR is preferred for private equity for several reasons. First, cash flow is controlled by the General Partner, negating the need to make time-weighted cash flow adjustments for the purpose of equitable comparisons. Secondly, the cash flow pattern inherent in the lifecycle of a private equity investment may create distortions on a time-weighted rate of return that are not indicative of the true investment performance. For example, the initial funding in partnerships may be used for expenses that result in a very large percentage loss on a very small invested base in the first few periods. Because only cash flows and the closing market value are used in IRR calculations, the return is not affected by interim pricing inaccuracies, as would be the case for a time-weighted rate of return.

International Business Company (IBC)
A term used to define a variety of offshore corporate structures. Common to all IBC's are the dedication to business use outside the incorporating jurisdiction, rapid formation, secrecy, broad powers, low cost, low to zero taxation and minimal filing and reporting requirements. An increasing number of offshore jurisdictions are permitting the use of nominee shareholders, directors and officers.

In-the-Money Option
An option having intrinsic value. A call option is in-the-money if its strike price is below the current price of the underlying futures contract. A put option is in-the-money if its strike price is above the current price of the underlying futures contract.

Intrinsic Value
A measure of the value of an option or a warrant if immediately exercised. The amount by which the current price for the underlying commodity or futures contract is above the strike price of a call option or below the strike price of a put option for the commodity or futures contract.

Introducing Broker (or IB)
Any person (other than a person registered as an "associated person" of a futures commission merchant) who is engaged in soliciting or in accepting orders for the purchase or sale of any commodity for future delivery on an exchange who does not accept any money, securities, or property to margin, guarantee, or secure any trades or contracts that result there from.

Inverted Market
A futures market in which the nearer months are selling at prices higher than the more distant months; a market displaying "inverse carrying charges," characteristic of markets with supply shortages. See Backwardation.

Jensen's Alpha
Quantifies the extent to which an investment has added value relative to a benchmark. Jensen Alpha is equal to the investment's average return in excess of the risk-free rate minus the beta times the benchmark's average return in excess of the risk-free rate.

Jones Model
Developed and launched by sociologist and journalist Alfred Winslow Jones in 1949. While traditional mutual fund models took only long positions in stocks, Jones's Model, a limited partnership, combined long positions (in favored stocks) with short positions (in stocks expected to decline) in the same sector, thus insulating or "hedging" the model against market movement. The return earned by the model would depend on the manager's skill in stock selection rather than on the movement of the market. The model thus targeted an absolute return rather than a relative return to the market's performance. For his services Jones charged a performance fee of 20% of realized profits and was required to invest his own capital in the fund. The Jones Model is committed to capital preservation. See Long/Short Equity.

Kurtosis
The kurtosis is the fourth moment about the mean divided by the square of the variance. It is a nondimensional quantity which measures the relative "peakedness" or flatness of a distribution, relative to a normal distribution. A distribution with positive kurtosis is called leptokurtic; a distribution with negative kurtosis is called platykurtic. An in-between distribution is called mesokurtic.

Kurtosis is a measure of how outlier-prone a distribution is. The kurtosis of the normal distribution is 3. Distributions that are more outlier-prone than the normal distribution have kurtosis greater than 3; distributions that are less outlier-prone have kurtosis less than 3.

Lambda
The ratio of a change in the option price to a small change in the option volatility. It is the partial derivative of the option price with respect to the option volatility.
Large Order Execution (LOX) Procedures
Rules in place at the Chicago Mercantile Exchange that authorize a member firm which receives a large order from an initiating party to solicit counterparty interest off the exchange floor prior to open execution of the order in the pit and that provide for special surveillance procedures. The parties determine a maximum quantity and an "intended execution price". Subsequently, the initiating party's order quantity is exposed to the pit; any bids (or offers) up to and including those at the intended execution price are hit (acceptable). The unexecuted balance is then crossed with the contraside trader found using the LOX procedures.

Last Notice Day
The final day on which notices of intent to deliver on futures contracts may be issued.

Last Trading Day
According to the Chicago Board of Trade rules, the final day when trading may occur in a given futures or options contract month. Futures contracts outstanding at the end of the last trading day must be settled by delivery of the underlying commodity or securities or by agreement for monetary settlement (in some cases by EFPs).

Leaps
Long-dated, exchange-traded options.

Leverage
When investors borrow funds to increase the amount that they have invested in a particular position, they use leverage. Investors use leverage when they believe that the return from the position will exceed the cost of the borrowed funds. Sometimes, managers use leverage to enable them to take on new positions without having to liquidate other positions prematurely. Leverage can effectively increase the potential for higher capital gain returns on investment capital, but can also increase the risk of greater capital loss.

Limited Liability Company (LLC)
An alternative structure to a limited partnership. It is often described as a hybrid between a corporation and a partnership because it offers limited liability like a corporation and single taxation on income like a partnership.

Limited Partner
An investor in a limited partnership. Limited partners provide the capital, but have not direct involvement in the management of the fund. Limited partners have limited liability but also have limited control over the management of the fund.

Limited Partnership
The most common format used in structuring private equity investments. Limited partners provide the capital, but have no direct involvement in the management of the fund. Limited Partners have limited liability but also have limited control over the management of the fund.

Linkage
The ability to buy (sell) contracts on one exchange (such as the Chicago Mercantile Exchange) and later sell (buy) them on another exchange (such as the Singapore International Monetary Exchange)

Liquidity
The ability to dissolve positions on demand. Many hedge funds may not want to or may not be able to dissolve positions on demand. Redemptions are normally limited to once a week, once a month, or even longer periods.

Locked-In
A hedged position that cannot be lifted without offsetting both sides of the hedge. Also refers to being caught in a limit price move.

Long/Short Equity
Sometimes referred to as equity hedged. The manager uses a combination of long and short positions in stocks to reduce market risk and focus on identifying individual stocks to buy or sell. Managers will generally be proactive in varying their "net" long position based on the market outlook. They may also raise cash to protect capital. Manager skill impacts the level of market risk (longs less shorts) total exposure (longs plus shorts) and selection of individual securities. Managers usually use fundamental analysis and may have a style bias. They will usually focus on one geographical area. Managers often invest significantly in the mid and small cap areas, which tend to be more inefficient than the large capitalization equity area.

Longest Losing Streak
The number of consecutive months a fund has had negative performance.

Long the Basis
A person or firm that has bought the spot commodity and hedged with a sale of futures is said to be long the basis.

Lookback Option
An option whose payoff depends on the minimum or maximum price of the underlying asset during some portion of the life of the option.

Look-Back Provisions
Partnership provisions that allow for a review of the total profit distribution from the partnership at the end of the term. The look-back is a mechanism to recapture overpayments to the general partners if they received more than their stated carried interest. The look-back provision requires return of any excess to the limited partners.

Loss Standard Deviation
A measure of the volatility of downside performance, this statistic calculates a mean return for only the periods with a loss and then measures the variation of only the losing periods around this loss mean.

Maintenance
A set minimum margin (per outstanding futures contract) that customer must maintain in his margin account.

Managed Futures
Represents an industry comprised of professional money managers known as commodity trading advisors who manage client assets on a discretionary basis, using global futures markets as an investment medium.

More About Managed Futures

Management Buyout (MBO)
Acquisition of a company by its existing management. The financing structure may involve a significant amount of borrowed capital, (thus resembles an LBO), or may have a more balanced debt/equity mix if equity financing is available to management.

Market-if-Touched (MIT) Order
An order that becomes a market order when a particular price is reached. A sell MIT is placed above the market; a buy MIT is placed below the market. Also referred to as a board order.

Market Neutral - Arbitrage
Attempts to hedge out most market risk by taking offsetting positions, often in different securities of the same issuer. For example, can be long convertible bonds and short the underlying issuers equity. May also use futures to hedge out interest rate risk. Focuses on obtaining returns with low or no correlation to both the equity and bond markets. These relative value strategies include fixed income arbitrage mortgage backed securities, capital structure arbitrage, and closed-end fund arbitrage.

Market Neutral - Securities Hedging
Invests equally in long and short equity portfolios generally in the same sectors of the market. Market risk is generally reduced, but effective stock analysis and stock picking is essential to obtaining meaningful results. Leverage can be used to enhance returns. Usually low or no correlation to the market. Sometimes uses market index futures to hedge out systematic (market) risk. Relative benchmark index usually T-bills.

Master-Feeder Fund
The term used for interest rate swap or cross-currency swap transactions for hedging interest rate and foreign exchange risk in fixed income securities. Convertible arbitrage managers often 'swap out' of the debt portion of the convertible leaving only the equity derivative. This effectively removes the interest-rate risk and credit risk.

Maximum Drawdown
A typical structure for a hedge fund that has both US investors and non-US investors. An offshore 'master' fund is owned by two 'feeder' funds: one is a US limited partnership (LP) and the other is an offshore fund. As the investors will have different tax treatments, US investors invest into the US feeder fund and non-US investors invest into the offshore feeder fund. All the investment funds are then pooled at the master level and managed by the fund manager.

Merger Arbitrage
An investment strategy that involves investing in securities of companies that are the subject of some form of corporate transaction, including acquisition or merger proposals, cash offers and leveraged buy-outs. These transactions will generally involve the exchange of securities for cash, other securities or a combination of cash and other securities. Typically, a manager goes long the stock of a company being acquired or merging with another company, and sells short the stock of the acquiring company.

Mezzanine Debt
Privately negotiated subordinated debt investments, usually with a parallel investment in equity securities at relatively low cost or at nominal cost. Subordinated convertible debt is often combined with preferred shares, structured with warrants or options.

Minimum Acceptable Return (MAR)
An investment return "floor" chosen by the individual investor, that serves as the dividing line between a good and bad performance outcome. For example, if an investor is only worried about losing money, the investor's MAR would be zero and any negative returns would be viewed as risky or bad, if an investor needs to earn 7% annual return (i.e. their personal MAR) in order to meet their goals, any return under 7% would be considered risky or bad.

Mortgage Backed Securities Arbitrage
The mortgage backed securities strategy specializes in arbitraging mortgage backed securities and their derivatives. This strategy takes place primarily in the United States. The market is over the counter and extremely complex. The two greatest risks are prepayment and valuation; all securities are marked to market, but the pricing and valuation models used by the different participants may vary, and overall market liquidity has a huge impact.

Most Favored Nation Clause
A clause that states that any side agreements negotiated by other investors will be also extended to the investor who has the most favored nation clause.

Nearbys
The nearest delivery months of a commodity futures market.

Net Asset Value (NAV)
The total value of the fund's portfolio less liabilities. Equal to the closing market value of all securities within a portfolio plus all other assets, subtracting all liabilities, and then dividing the result by the total number of shares outstanding.

Net Exposure
The percentage of a fund is currently net invested in the market. It is calculated as the difference between the long and the short positions. For example, if a fund is 100% long and 25% short, then the fund is 75% net invested.

Net Long
A portfolio position whereby the long positions in a portfolio represent a greater portion than the short positions.

Net Short
A portfolio position whereby the short positions in a portfolio represent a greater portion than the long positions.

NOB Spread
Note Against Bond. A futures spread trade involving the buying (selling) of a Treasury note futures contract and the selling (buying) of a Treasury bond futures contract.

No-Fault Divorce
A clause that stipulates the conditions under which limited partners may stop contributing capital to the partnership or even terminate the partnership.

Non-systematic risk
Non-market or company specific risk factors that cannot be eliminated by diversification, in contrast to systematic risk which refers to risk factors common to an entire economy.

Notice of Delivery
A notice that must be presented by the seller of a futures contract to the clearinghouse. The clearinghouse then assigns the notice and subsequent delivery instrument to a buyer. Also Notice of Intention to Deliver.

Offset
Liquidating a purchase of futures contracts through the sale of an equal number of contracts of the same delivery month, or liquidating a short sale of futures through the purchase of an equal number of contracts of the same delivery month.

Offshore Banking Unit (OBU)
A bank in an offshore financial center, not allowed to conduct business in the domestic market but only with other OBU's or with foreign persons.

Offshore Booking Centers
An offshore financial center used by international banks as a location for "shell branches" to book certain deposits and loans. Such offshore bookings are often utilized to avoid regulatory restrictions and taxes.

Offshore Limited Partnership
A partnership, the general partner of which is an offshore company. The limited partners may be onshore entities.

Offshore Trust
The quality that differentiates an offshore trust from an onshore trust is portability. The offshore trust can be transferred to additional jurisdictions to maintain confidentiality and to advantage desirable facets of the new jurisdictions laws.

On Track (or Track Country Station)
(1) A type of deferred delivery in which the price is set f.o.b. seller's location, and the buyer agrees to pay freight costs to his destination; (2) commodities loaded in railroad cars on track.

Open Interest
The total number of futures or options contracts of a given commodity that have not yet been offset by an opposite futures or option transaction nor fulfilled by delivery of the commodity or option exercise. Each open transaction has a buyer and a seller, but for calculation of open interest, only one side of the contract is counted.

Opportunistic
This strategy refers to managers with the broad mandate to invest in any opportunity they identify in debt, equities, foreign currencies, physical commodities and derivatives in both developed and emerging markets globally. They invest in directional as well as hedged positions and typically use leverage in order to increase their invested position.

Option
The right, but not the obligation, to buy (for a call option) or sell (for a put option) a specific amount of a given stock, commodity, currency, index, or debt, at a specified price (the strike price) during a specified period of time.

Pairs Trading
An investment strategy that seeks to identify two companies with similar characteristics whose equity securities are currently trading at a price relationship that is out of their historical trading range. Investment strategy will entail buying the undervalued security, while short selling the overvalued security.

Partnership Agreement
Legal document that sets forth the terms and conditions of a private equity or hybrid investment vehicle. The partnership agreement also establishes the roles of general and limited partners.

Path Dependent Option
An option whose valuation and payoff depends on the realized price path of the underlying asset, such as an Asian option or a Lookback option.

Pegging
Effecting commodity transactions to prevent a decline in the price of the commodity so that previously written put options will expire worthless, thus protecting premiums previously received.

Performance Bond Margin
The amount of money deposited by both a buyer and seller of a futures contract or an options seller to ensure performance of the term of the contract. Margin in commodities is not a payment of equity or down payment on the commodity itself, but rather it is a security deposit.

Percent Long
The amount of a fund, expressed as a percentage, that is invested in long positions.

Percent Short
The amount of a fund, expressed as a percentage, that is invested in short positions.

Performance Fee
Compensation paid to a manager who achieves returns above a high water mark or a hurdle rate. Sometimes referred to as an incentive fee.

Position Limit
The maximum number of speculative contracts one can hold as determined by the Commodity Futures Trading Commission and/or the exchange upon which the contract is traded. Also referred to as trading limit.

Price Basing
A situation where producers, processors, merchants or consumers of a commodity establish commercial transaction prices based on the futures prices for that or a related commodity (e.g., an offer to sell corn at 5 cents over the December futures price). This phenomenon is commonly observed in grain and metal markets.

Prime Broker
A broker who provides services to hedge funds in addition to trade execution, including some or all of back office, trade reconciliation, financing, recordkeeping and custody.

Principals' Market
A market where the ring dealing members act as principals for the transactions they conclude across the ring and with their clients.

Prompt Date
The date on which the buyer of an option will buy or sell the underlying commodity (or futures contract) if the option is exercised.

Proof of Funds (POF)
A document by which the principal's bank states that the principal owns the funds required for the transaction. Usually, proof of funds can also be delivered in the form of a recent bank, security or custody statement.

Protector
A person appointed by the settlor/grantor of a trust, who has limited powers to control the trustee. The protector usually has the right to change trustees.

R-Squared
R-Squared reflects the percentage of a fund's movements that is explained by movements in the fund's benchmark index. An R-Squared of 100 means that all movements of a fund are completely explained by movements in the benchmark index. A low R-Squared means that few of a fund's movements are explained by the movements of the index. For example, an R-Squared of 35 means that 35 % of a fund's movements can be explained by movements in the fund's index. R-Squared is used to assess the significance of a particular alpha or beta. As a rule, a higher R-Squared indicates a more reliable beta figure. Conversely, if the R-Squared is lower, then the beat is less relevant to the performance of the fund.

Ratio Hedge
The number of options compared to the number of futures contracts bought or sold in order to establish a hedge that is risk neutral.

Ratio Spread
This strategy, which applies to both puts and calls, involves buying or selling options at one strike price in greater number than those bought or sold at another strike price.
Redemption
The return of an investor's principal in a security, such as a stock, bond, or mutual fund at it's current market value less fees.

Redemption Fee
A fee charged upon a voluntary redemption from an investment fund.

Redemption Notice Period
The required notification period of an intended redemption request. Notification is usually required in writing.

Regulation D
This strategy, usually called Reg D, involves investing in micro and small capitalization public companies which are raising money in the private capital markets. The manager can invest via the stock, via convertibles or other derivatives. Investments usually take the form of receiving a convertible bond or convertible preferred issue in return for an injection of capital. What is unique about these securities is that, unlike, standard convertible bonds or preferreds, the exercise price either floats or is subject to a look back provision. This has the effect of insulating the investor from a decline in the price of the underlying stock. Typically the investor will be long the convertible, short a percentage of common stock and also hold warrants. On the effective dates of the transaction the manager can exercise, if he chooses to, and convert into common stock at a better market price.

Reset or Floating Conversion Rate Securities
This strategy involves investing either directly and/or indirectly in either the common shares, convertible securities or warrants of a public company. A common form of this strategy involves providing private financing.

Retender
In specific circumstances, some contract markets permit holders of futures contracts who have received a delivery notice through the clearing house to sell a futures contract and return the notice to the clearinghouse to be reissued to another long; others permit transfer of notices to another buyer. In either case, the trader is said to have retendered the notice.

Reverse Conversion
With regard to options, a position created by buying a call option, selling a put option, and selling the underlying futures contract.

Reverse Crush Spread
The sale of soybean futures and the simultaneous purchase of soybean oil and meal futures. The purchase of soybean futures and the simultaneous sale of soybean oil and meal futures.

Risk
The extent to which investment returns fluctuate from period to period. The primary types of risks associated with alternative investments include financial risk, operating and business risk, liquidity risk, structural risk, valuation risk, and country risk when undertaking international investments (Also see Standard Deviation).

Risk Arbitrage
See Merger Arbitrage.

Roll-Over
A trading procedure involving the shift of one month of a straddle into another future month while holding the other contract month. The shift can take place in either the long or short straddle month. The term also applies to lifting a near futures position and re-establishing it in a more deferred delivery month.

Round Turn
A completed transaction involving both a purchase and a liquidating sale, or a sale followed by a covering purchase.

Scalper
A speculator on the trading floor of an exchange who buys and sells rapidly, with small profits or losses, holding his positions for only a short time during a trading session. Typically, a scalper will stand ready to buy at a fraction below the last transaction price and to sell at a fraction above, thus creating market liquidity.

Secondary Funds
Partnership-style funds formed for the purpose of acquiring limited partnership interests, as a secondary purchase, from an original investor who no longer wants to own the limited partnership interest. These funds are typically purchased at a discount from their estimated value in recognition that the purchaser is acquiring a relatively illiquid investment. Secondary Funds are often considered to be in the Special Situations category.

Sector Funds
Sector funds invest in specific industries or segments of the economy. They tend to be equity long/short managers that develop a view of the industry and use fundamental analysis to identify opportunities within that industry.

Selling Hedge (or Short Hedge)
Selling futures contracts to protect against possible declining prices of commodities that will be sold in the future. At the time the cash commodities are sold, the open futures position is closed by purchasing an equal number and type of futures contracts as those that were initially sold. See Hedging.

Series
All option contracts of the same class that also have the same expiration date and strike price.

Settlement Price
The last price paid for a commodity on any trading day. The exchange clearinghouse determines a firm's net gains or losses, margin requirements, and the next day's price limits, based on each futures and options contract settlement price. If there is a closing range of prices, the settlement price is determined by averaging those prices. Also referred to as settle or closing price.

Sharpe Ratio
Used to measure how much profit an investor received per unit of risk. The higher the ratio, the safer (less risky) the strategy.

Sharpe Ratio = (Net Return - Risk Free Rate of Return)/Risk
Where Risk = Standard Deviation of the Return
A ratio greater than or equal to one indicates that the return is greater than or proportional to the risk the investor incurred to earn that return. A Sharpe Ratio greater than 1.0 is generally considered very good, while a ratio greater than 2.0 is considered excellent.

Shipping Certificate
A negotiable instrument used by several futures exchanges as the futures delivery instrument for several commodities (e.g. soybean meal, plywood and white wheat). The shipping certificate is issued by exchange-approved facilities and represents a commitment by the facility to deliver the commodity to the holder of the certificate under the terms specified herein. Unlike an issuer of a warehouse receipt who has physical product in store, the issuer of a shipping certificate may honour its obligation from current production or through-put as well as from inventories.

Shock Absorber
A temporary restriction in the trading of stock index futures which becomes effective following a significant intraday decrease in stock index futures prices. Designed to provide an adjustment period to digest new market information, the restriction bars trading below a specified price level. Shock Absorbers are generally market specific and at tighter levels than circuit breakers.

Short Exposure
The percentage of a fund's assets that are invested in short positions. For example, a manager may be 60% long and 100% short, giving him a market exposure of 40% net short.

Short Investing
An investment strategy where the manager sells securities short in anticipation of being able to rebuy them at a future date at a lower price due to the manager's assessment of the market.

Short Position
A short position occurs when an individual investor sells a security they do not own.

Short Selling
Is the selling of a security that the seller does not own.

Skewness
The skewness is the third moment about the mean divided by the cube of the standard deviation. It characterizes the degree of asymmetry of a distribution around its mean. The skewness is nondimensional. It is a pure number that characterizes only the shape of the distribution. A positive value of skewness signifies a distribution with an asymmetric tail extending out towards more positive x; a negative value signifies a distribution whose tail extends out towards more negative x.

Soft Commodities
Commodities such as coffee, cocoa, sugar and may include oilseeds, cotton, grains and orange juice. Metals, livestock and financial futures are generally not included in this category.

Sortino Ratio
The Sortino Ratio was developed to distinguish between good volatility and bad volatility. It is similar to the Sharpe Ratio, except it uses downside deviation for the denominator, whereas Sharpe uses standard deviation. Downside deviation only considers returns that fall below a determined threshold, rather than the mean. It would be expected that a fund managed within tight risk limits would have a smaller downside deviation than the typical upward standard deviation. This smaller divisor means a relatively higher Sortino when compared to the Sharpe. If the Sortino is lower than the Sharpe, then the fund might be riskier than the Sharpe Ratio alone implies.

Sold-Out-Market
When liquidation of a weakly-held position has been completed, and offerings become scarce, the market is said to be sold-out.

Special Situations
Invests in event-driven situations such as mergers, hostile takeovers, reorganizations, or leveraged buyouts. May involve simultaneous purchase of stock in companies being acquired, and the sale of stock in its acquirer, hoping to profit from the spread between the current market price and the ultimate purchase price of the company. May also utilize derivatives to leverage returns and to hedge out interest rate and/or risk. Results generally not dependent on direction of market.

Spread (or Straddle)
The purchase of one futures delivery month against the sale of another futures delivery month of the same commodity; the purchase of one delivery month of one commodity against the sale of that same delivery month of a different commodity; or the purchase of one commodity in one market against the sale of the commodity in an another market, to take advantage of a profit from a change in price relationships. The term spread is also used to refer to the difference between the price of a futures month and the price of another month of the same commodity. A spread can also apply to options.

Spreadlock
An option to enter into a currency or interest rate swap. One party may agree to provide a swap over a defined period ( usually less than 6 months ) at an agreed-upon spread over a reference rate comparable to the maturity of the anticipated swap.

Stages
First Stage
Financing provided to companies that have expended their initial capital and require funds, often to initiate commercial manufacturing and sales.

Second Stage
Working capital for the initial expansion of a company that is producing and shipping and has growing accounts receivable and inventories. Although the company has clearly made progress, it may not yet be showing a profit.

Third Stage
Funds provided for the major growth of a company whose sales volume is increasing and that is beginning to break even or turn profitable. These funds are typically for plant expansion, marketing and working capital development of an improved product.

Follow-on/Later Stage
A subsequent investment made by an investor who has made a previous investment in the company - generally a later stage investment in comparison to the initial investment.

Standard Deviation
The most widely accepted measurement of volatility (risk). Specifically, it measures the degree to which returns have been spread out around their historical mean or average. It is the square root of the variance ( average squared difference between the actual return and the average return ). Standard deviation does not distinguish between positive and negative volatility. In other words, it interprets any movement above or below the historical mean - as undesirable. Upside volatility is "good risk".

Statistical Arbitrage
A strategy that attempts to profit from deviations in the price of securities from historical relationships or patterns that are quantified by statistical methods. This strategy is based on the premise that historical price relationships or patterns among correlated assets are likely to hold in the future.

Steer/Corn Ratio
The relationship of cattle prices to feeding costs. It is measured by dividing the price of cattle ($/hundredweight) by the price of corn ($/bushel). When corn prices are high relative to cattle prices, fewer units of corn equal the dollar value of 100 pounds of cattle. Conversely, when corn prices are low in relation to cattle prices, more units of corn are required to equal the value of 100 pounds of beef. See Feed Ratio.

Sterling Ratio
A return / risk ratio in which return is defined as the Compound Annualized Rate of Return over the last 3 years, and risk is defined as the Average Yearly Maximum Drawdown over the last 3 years less an arbitrary 10 %. To calculate the average yearly drawdown, the latest 3 years is divided into 3 separate 12-month periods and the maximum drawdown is calculated for each. These 3 drawdowns are averaged to produce Average Yearly Maximum Drawdown for the 3 year period.

Stop-Close-Only Order
A stop order which can only be executed, if possible, during the closing period of the market.

Strangle
An option position consisting of the purchase or sale of put and call options having the same expiration but different strike prices.

Strangle
The simultaneous sale or purchase of both a call and a put with the same expiration month and different strike prices.

Strike Price
The stated price per share for which underlying stock may be purchased (in the case of a call option) or sold (in the case of a put option) by an option holder.

Strong Hands
When used in connection with delivery of commodities on futures contracts, the term usually means that the party receiving the delivery notice probably will take delivery and retain ownership of the commodity; when used in connection with futures positions, the term usually means positions held by trade interests or well-financed speculators.

Swap
In general, the exchange of one asset or liability for a similar asset or liability for the purpose of lengthening or shortening maturities, or raising or lowering coupon rates, to maximize revenue or minimize financing costs. In securities, this may entail selling one issue and buying another in foreign currency, it may entail buying a currency on the spot market and simultaneously selling it forward. Swaps may also involve exchanging income flows; for example, exchanging the fixed rate coupon stream of a bond for a variable rate payment stream, or vice versa, while not swapping the principal component of the bond.

Swaption
An option to enter into a swap - - i.e., the right, but not the obligation, to enter into a specified type of swap at a specified future date.

Switch
Offsetting a position in one delivery month of a commodity and simultaneous initiation of a similar position in another delivery month of the same commodity, a tactic referred to as "rolling forward".

Systematic Risk
Also called market risk, systematic risk is an unanticipated event that effects almost all assets in some part, because the effect is economy -wide.

Statistical Arbitrage
Statistical arbitrage strategies are long/short stock portfolios that are determined based on quantitative models for selecting specific stocks and measuring market exposure. Based on these models, high ranking securities are purchased and low ranking securities are sold short in relative quantities designed to result in an aggregate portfolio that is neutral to broad equity market movements. Often, these models rely upon fundamental balance sheet and income statement data such as: earnings yield; dividend yield; revisions in earnings forecasts; relationship between market capitalization, revenues and net asset values; earnings forecasts; and price histories. Other approaches utilize factor analysis to measure risk factors and relative attractiveness.

Subordinated Debt
High yield junior debt financing, which may be secured or unsecured. Normally the investor purchases a debenture; if secured the debenture will be subordinated to all senior debt within the issuer. If unsecured, the debenture will be subordinated not only to the senior debt but potentially all trade liabilities as well. The lender typically receives a commitment fee for arranging the transaction, a relatively high coupon and an equity kicker. The term of subordinated debt ranges from 5 to 10 years, but always longer than the senior debt to ensure that the subordinated lender cannot be repaid before the senior lender.

Systematic Trading
These strategies take a directional view in markets based on computer models. The strategies reflect an emphasis on market trends and behavioral psychology.

Ted Spread
The difference between the price of the three-month U.S. Treasury bill futures contract and the price of the three-month Eurodollar time deposit futures contract with the same expiration month.

Theta
A derivative of the option price equation with respect to the remaining time to expiration of the option. A measure of the sensitivity of the value of the option to the passage of time.

Tick
The smallest allowable increment of price movement for a futures contract. Also referred to as Minimum Price Fluctuation.

Time Value
The amount of money option buyers are willing to pay for an option in the anticipation that, over time, a change in the underlying futures price will cause the option to increase in value. In general, an option premium is the sum of time value and intrinsic value. Any amount by which an option premium exceeds the option's intrinsic value can be considered time value. Also referred to as extrinsic value.

Tracking Error (Annualized)
A measure of the unexplained portion of performance relative to a benchmark. It is calculated