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Financial Instruments:  Recent Innovation

Source: Encyclopedia of Banking & Finance (9h Edition) by Charles J Woelfel
(We recommend this as work of authority.)
      

Wall Street has developed numerous innovative financial instruments in recent years.  These new financial instruments are difficult to classify according to traditional categories:  debt, equity, and hedging instruments.  Frequently they are hybrid instruments.  The following "Glossary of Selected Financial Instruments" has been published in the Journal of Accountancy, November 1989, using the following categories:  Debt instruments; Asset-backed securities; equity instruments; hedging instruments.

Debt instruments:

Commercial paper:  Unsecured short-term (up to 270 days) obligations issued through brokers or directly.  The interest is usually discounted.  Universal commercial paper:  Foreign currency denominated commercial paper that trades and settles in the United States.

Convertible bonds:  Debt securities that are convertible into the stock of the issuer at a specified price at the option of the holder.

Carrot and stick bonds:  Carrots have a low conversion premium to encourage early conversion, and sticks allow the issuer to call the bond at a specified premium if the common stock is trading at a specified percentage above the strike price.

Convertible bonds with a premium put:  Convertible bonds issued at face value with a put entitling the bondholder to redeem the bonds for more than their face value.

Debt with equity warrants:  Bonds issued with warrants for the purchase of shares.  The warrants are separately tradeable.

Dual-currency bonds:  Bonds that are denominated and pay interest in one currency and are redeemable in another currency thus allowing interest rate arbitrage between two markets.

COPS (covered option securities):  Short-term debt that gives the issuer an option to repay the principal and interest in U.S. dollars or a mutually acceptable foreign currency.

ECU bonds (European currency unit bonds):  A Eurobond denominated in a basket of currencies of the 10 countries that constitute the European Community.  The bonds pay interest and principal in ECUs or in any of the 10 currencies at the option of the holder.

ICONs (indexed currency option notes):  A bond denominated and paying interest and principal in dollars but with principal payments linked to the exchange rate of another currency.

PERLS (principal exchange-rate-linked securities):  Securities paying interest and principal in dollars but with principal payments linked to the exchange rate between the dollar and a second currency.

Flip-flop notes:  An instrument that allows investors to switch between two types of securities for example, to switch from a long-term bond to a short-term fixed-rate note.

FRNs (floating rate notes):  Debt instruments that feature periodic interest rate adjustments.

Capped floater:  An FRN with an interest rate ceiling.

Convertible FRNs:  The issuer can convert the FRNs into long-term fixed rate bonds.

Drop-lock FRNs:  The FRNs automatically convert to fixed-rate bonds when short-term interest rates fall below a specified level.

Minimax FRNs:  FRNs with upper and lower interest limits that is, a ceiling and a floor.

Indexed debt instruments:  Instruments with guaranteed and contingent payments, the latter being linked to an index or prices of certain commodities (oil or gold, for example).

Bull and bear bonds:  Bonds linked to upward and downward movements in a designated index.  Bulls yield more in a rising market; bears yield more in a falling market.

SPINs (Standard and Poor's indexed notes):  A debt instrument feaEagle Tradersg interest payments linked to the performance of the Standard and Poor's stock indexes.

Put bonds:  Bonds that the investor can put (or tender) back to issuer after a specified period.

Stripped government securities:  A type of zero coupon bond, these securities represent long-term Treasury bonds "stripped" of semiannual interest coupons by an investment banker who resells these coupons and an interest in the principal payments.  Investment banks market these stripped securities under such registered acronyms as

CATs:  certificates of accrual on Treasury certificates.

COUGRs:  certificates of government receipts.

STAGs:  sterling transferrable accruing government securities.

STRIPs:  separate trading of registered interest and principal of securities.

TIGRs:  Treasury investment growth certificates

ZEBRAs:  zero coupon eurosterling bearer or registered accruing certificates.

Zero-coupon bonds:  A bond that's sold at a deep discount from its face value.  It carries no interest coupon, but investors receive the gradual appreciate to face value.

LYONs:  (liquid yield option notes):  Zero-coupon bonds that are convertible into the issuer's common stock.

Asset-Backed Securities:

CMOs:  (collateralized mortgage obligations):  Debt obligations that are backed by a pool of whole mortgages or mortgage-backed securities such as Ginnie Maes.

Mortgage backed Securities:  A participation in an organized pool of residential mortgages, including Ginnie Maes (Government National Mortgage Association), Fannie Maes (Federal National Mortgage Association) and Freddie Macs (Federal Home Loan Mortgage Corporation).

Securitized receivables:  Debt securities collateralized by a pool of receivables.

CARDs:  (certificates of amortizing revolving debts) backed by credit card debt.

CARs:  (Certificates of automobile receivables) backed by automobile loans.

CLEOs:  (collateralized lease equipment obligations) backed by leasing receivables.

FRENDS:  (floating rate enhanced debt securities) backed by LBO loan participations.

Equity Instruments:

MMP:  (MONEY MARKET PREFERRED STOCK OR DUTCH AUCTION PREFERRED STOCK):  Preferred stock feaEagle Tradersg dividends that are reset at a dutch auction that is, an action in which the securities are sold at the lowest yield necessary to sell the entire issue.  Several investment banks have issued these instruments under such registered names as CAMPS:  cumulative auction market preferred stock.

CMPS:  Capital market preferred stock.  Convertible MMP stock:  MMPs that can be converted into common stock.

DARTS:  dutch-auction rate transferable securities.

FRAPS:  fixed rate auction preferred stock.

MAPS:  market auction preferred stock.

STARS:  SHORT-TERM AUCTION RATE CUMULATIVE PREFERRED STOCK.

straps:  STATED RATE AUCTION PREFERRED STOCK.

PIK (pay in kind) preferred stock:  Dividends are paid in additional shares of preferred stock

Eschangeable PIK preferred stock:  The issuer can convert the PIK stock into debt.

Hedging Instruments:

Butterfly spread:  Options strategy involving two calls and two puts in the same or different markets, with several maturity dates.

Calendar spread:  Options strategy that involves buying and selling options on the same security with different maturities.

Cancelable forward exchange contracts:  The holder has the unilateral right to cancel the contract at maturity.

CIRCUS:  Combined currency and interest rate swap.

convertible option contracts:  A foreign currency option that converts to a forward contract if the forward exchange rate falls below a trigger price.

Cross-hedging:  Hedging one exposure with an instrument pegged to another market or index.

Cylinder options:  A combined call option and put option on currency.

Range Forwards:  A forward exchange contract specifying a range of exchange rates within which currencies will be exchanged at maturity.

ZCRO (zero cost ratio option):  A cylinder option with a put written in an amount offsetting the call premiums.

OPOSSMS:  Options to purchase or sell specified mortgage-backed securities.

Perpendicular spread:  Options strategy using options with the same maturities but different strike prices.

Swaption:  An option to enter or be forced to enter a swap.

Synthetic instruments:  Two or more transactions that have the effect of a financial instrument.  For example, a fixed-rate bond combined with an interest rate swap can result in a synthetic floating rate instrument.

Zero-coupon swap:  A swap of zero-coupon debt into floating rate debt.

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