30-360: Accrued interest convention in which the denominator of the day count fraction is 180 or 360 for annual and semiannual coupon bonds, respectively, while the numerator is determined by 30 times the number of whole months since the last coupon plus the number of days between today and the day in the month the coupon is paid.

Accrued Interest: Interest due on a security from issue date or last coupon payment date to the present.

Actual-Actual: Accrued interest convention in which the day count fraction consists of actual days since the last coupon divided by actual days in the coupon period.

Annuity: A stream of regularly-scheduled payments, usually of the same size. 

Arbitrage: The simultaneous purchase and sale of a product in order to realize a riskless profit.

Average Life: The weighted average time for the return of principal, where the weights are the principal payments for each period. 

Bond Equivalent Yield (BEY):   Interest rates that are comparable to that earned on a Treasury note or bond, computed on a semiannual basis over a calendar year.

Bond Pricing Equations: The mathematical relationship between the bond's cash flows, the rate of interest, maturity and price.

Bond: An interest-bearing or discounted corporate or government security that obliges the issuer to pay a fixed dollar amount, the principal, on a fixed date in the future, the maturity date.

Bullet Bond: A bond in which all principal is paid at maturity.

Business Cycle: A measure of the level of activity of a nation's economy, measured by the pattern of movement in real gross domestic product (GDP). The business cycle has three stages, namely recession, characterized by falling real GDP, recovery, the stage immediately following a recession in which real GDP is growing, but still below the previous peak, and expansion, where real GDP levels are above that of the previous peak.

Calendar Year: A calendar year contains 365 days, except in leap years when it has 366 days.

Capital Market: The market for long-term funds. Instruments are equity and credit market securities with original maturity greater than 1 year. Credit market securities consist of bonds and bank loans.

Cash Flow Yield: The yield-to-maturity of a portfolio or a security with uneven cash flows.

Certificate of Deposit (CD): A fixed-rate time deposit for which there may be a secondary market.

Clean Price: Price of a bond excluding accrued interest.

Commercial Paper: Short-term unsecured debt issues of large corporations, usually issued in discount form.

Conditional Prepayment Rate (CPR): A benchmark for projecting prepayments of a residential mortgage pool that assumes that a given fraction of the remaining principal balance in the pool is prepaid each month until maturity. Also referred to as Constant Prepayment Rate.

Contraction Risk: The risk to the investor in mortgage-backed securities due to decreases in the prepayment rate. When the prepayment rate increases, typically when interest rates have fallen, the effective maturity of the security shortens.

Conventional Bond: A bond that has constant coupons with all principal repaid at maturity. A bond with level coupons and bullet amortization.

Convexity: The rate of change of duration of a bond or bond portfolio with respect to changes in the yield-to-maturity of the bond or portfolio.

Coupon Rate: The annual coupon of a bond divided by the bond's principal.

Coupon: The periodic (annual, semiannual) payment, as a proportion of principal.

Credit markets: The market for all debt instruments, short-term and long-term, which links surplus savings units with deficit spending units.

Current Yield: The annual coupon of a bond divided by the bond's market price.

Day Count Fraction: The ratio of the number of days since the bond was issued or the last coupon was paid to the number of days in the current coupon period. The day count fraction is used to compute accrued interest for coupon bonds and other interest-bearing securities.

Deficit Spending Unit (DSU): An economic unit - household, business or government agency - whose expenditures exceed its income or revenues.

Dirty Price: Price of a bond including accrued interest. Also called all-in price or invoice price.

Discount Rate: The ratio of the earnings on an investment to the principal to be received at maturity, divided by the fraction of the year your investment is outstanding. Also called Bank Discount Rate.

Discount Securities: Securities issued at a price below the principal to be received at maturity.

Duration or Macaulay's Duration: The weighted average term to maturity of all the cash flows of a bond or bond portfolio where the weights are the present values of the cash flows.

Euro: The common currency adopted by 11 of the 15 members of the European Union. As in the US, there is a single set of interest rates and a single central bank within the "euro zone."

Eurocurrency Market: The market for credit transactions which are denominated in any currency except that of the host and are subject to few rules and regulations of the host Also known as the External Market.

Eurodollars: Dollar-denominated deposits held out of the U.S. in foreign banks and in foreign branches of U.S. banks. Eurocurrencies are currencies held out of the country (or region) of origin.

Extension Risk: The risk to the investor in mortgage-backed securities due to increases in the prepayment rate. When the prepayment rate decreases, typically when interest rates have risen, the effective maturity of the security lengthens.

Federal Funds: Excess reserves loaned among banks. Funds are transferred by wire for same day settlement and typical maturity is one day.

Financial Year: A hypothetical year, containing 360 days, in which every month is assumed to have exactly 30 days.

Foreign Bond: A bond issued in the national market by a nonresident borrower. Examples of foreign bonds are "Yankee" bonds in the U.S., "Bulldogs" in the U.K. "Samurai bonds" in Japan, etc.

Forward Market: The market for delivery of a currency on a chosen future date at a rate set now, the forward rate, with payment on delivery.

Forward Rate: A rate of interest for a specific interval of time starting on a specific date in the future. 

Future Value: The value at a future date of principal invested now at either a simple or compound rate.

Government Bonds: Securities issued by a country's central government, e.g., U.S. Treasury. Gilts" refer to British Treasuries, "JGBs" are Japanese Government Bonds, "Bunds" refer to German Treasuries and "OATs," "BTFs" and "BTANs" are issued by the French government.

Holding Period Yield: The return realized from a security sold before maturity.

Implied Forward Rate: A forward rate of interest that causes the investment return of two short-term instruments to equal the return of a single long-term investment.

Interest Payment Convention: The convention according to which a bond accrues and pays coupon interest.

Interest Rate: The ratio of the earnings on an investment to the principal invested. The annual rate of interest is the rate of interest divided by the fraction of the year the investment is outstanding. 

Interest Rate Parity: An alignment of a sequence of short-term interest rates such that the return realized by rolling over the short-term investments equals the return of the equivalent long-term investment. 

Interest-Bearing Securities: Securities which are usually issued and redeemed at the same value, the principal. The interest is based on a proportion of the principal. Interest-bearing money market securities, such as TDs and NCS are sometimes called "add-on interest" securities.

Interest-on-Interest (IOI): That part of bond earnings derived from reinvesting the coupons at the prevailing interest rate until maturity.

Intermediation: The process of converting surplus savings units' deposits into loans for deficit spending units. The intermediation typically involves size intermediation, maturity transformation and risk absorption.

LIBID: The rate paid on a corporate deposit in the Eurocurrency market. Typically, LIBID = LIBOR - 1/8%, although the spread can vary among different currencies, as well as in different time periods.

LIBOR (London InterBank Offer Rate): The rate required by one bank to place a $10,000,000 time deposit with another highly-regarded bank, originally in the Eurodollar market. LIBOR values are typically for 1, 3, 6 and 12 months. LIBOR rates are quoted today for a large number of Eurocurrencies.

Liquid: A security is liquid if it can be converted into cash at any time at a low cost. Usually applies to short-term marketable securities and very short-term nonmarketable instruments.

Macaulay's Duration: The weighted average term to maturity of all the cash flows of a bond or bond portfolio where the weights are the present values of the cash flows.

Marketable: Indicating the existence of buyers and sellers. A security is marketable if it can be bought or sold at any time.

Modified Duration: Macaulay's duration divided by 1 plus the periodic rate of interest.

Money Market: The market for short-term funds. Instruments are debt securities usually with maturity between 1 day and 1 year. Instruments consist of short-term securities and bank loans. Securities are usually only of the highest credit quality. A place to safely invest temporarily-excess funds.

Mortgage Passthroughs: Mortgage-backed bonds created from a pool of residential mortgage loans in which all payments, less a servicing fee, are passed through, pro rata, to the bond investors.

National Market:  The market for credit transactions which are denominated in the currency of the host and are subject to all rules and regulations of the host. Also known as the Internal Market.

Negotiable Certificate of Deposit (NCD): A bank CD that can be traded in a secondary market.

On-the-Run: The most-recently auctioned Treasury security for a given maturity class. Securities issued previously will be called off-the-run issues.

Par Bond Yield Curve: A graph, in 6-month increments, of Treasury coupon rates such that each bond is priced at par and yields the spot rate.

Prepayment Risk: The risk to the investor in mortgage-backed securities due to changes in the prepayment rate.

Prepayment: Unscheduled early repayment of principal.

Present Value: The value today of a future payment discounted at an appropriate rate of interest.

Principal:  The face amount or par value of a debt security.

PSA Model: A prepayment model for pools of residential mortgages based on an assumed constant rate of prepayment each month after a period of seasoning. See Speed.

Repurchase Agreement (Repo or RP): A (U.S. Treasury or federal agency) security that is sold with a simultaneous agreement to repurchase one or more days in the future. Banks are restricted to dealing in Treasury and agency issues. Other firms can repo virtually any asset.

Residential Mortgage: Fixed or variable-rate loan secured by real estate, used to finance the purchase of residential property. Typical residential mortgages have level payments, fixed interest rates, and are self-amortizing.

Risk: The possibility of an economic loss. Foreign Exchange Risk is the possibility of an economic loss due to adverse movements in exchange rates. Interest Rate Risk is the profit impairment due to unexpected movements in interest rates.

Secondary Market: The market for buying and selling previously-issued securities.

Securitization: The process of converting loans, leases or other financial commitments into bonds, or other debt market instruments. A simple example would be a portfolio of residential mortgages used to create mortgage pass-through securities.

Single Monthly Mortality Rate (SMM): The percentage of outstanding principal balance of a pool of residential mortgages prepaid each month.

Speed: A term that refers to the rate of prepayments on a pool of residential mortgage loans in reference to a given prepayment convention, e.g., "PSA 100." See PSA Model.

Spot Market: The market for "immediate" delivery of a currency at a rate set now, the spot rate. "Immediate" usually refers to two business days between order and delivery and settlement.

Spot Yield: The yield of a single cash flow to be received in the future which discounts the future value back to the present value.

Term Premium: The difference between long-term and short-term interest rates when the market expects no change in interest rates in the foreseeable future.

Term Structure of Interest Rates: A chart plotting the spot yields of a family of zero-coupon bonds having similar properties (e.g., credit risk, marketability, etc.) against the maturity of the bonds.

Time Deposit (TD): A bank deposit, usually interest-bearing, with a fixed maturity.

Total Return: The realized return of a bond that is held to maturity. Total return includes coupons, return of principal and interest earned on reinvested coupons (interest-on-interest).

Treasuries: Securities issued by the U.S. Treasury. Treasury Bills are issued in discount form with maturity up to 1 year. Treasury notes and bonds are Interest-bearing securities, with notes having a maturity between 1 and 10 years, while Treasury bonds have  maturities between 10 and 30 years. "Gilts" refer to British Treasuries, "JGBs" are Japanese Government Bonds, "Bunds" refer to German Treasuries and "OATs," "BTFs" and "BTANs" are issued by the French government.

Year: A standardized unit of time used for financial calculations. A Financial Year is a hypothetical year, containing 360 days, in which every month is assumed to have exactly 30 days. A Calendar Year contains 365 days, except in leap years when it has 366 days.

Yield Curve: A chart plotting the yield-to-maturity of a family of bonds having similar properties (e.g., credit risk, marketability, etc.) against the maturity of the bonds.

Yield by Iteration: The process of determining the interest rate that discounts all future cash flows back to the present value by entering successive "guesses" for the interest rate and computing the present value. Often used for securities or portfolios with irregular cash flows. (C1S2: Sc25-28-2)

Yield-to-Maturity (YTM): The single rate of interest that discounts all future bond cash flows, both coupons and principal, back to the present value. The YTM is the same as the internal rate of return.