Financial glossary

Derivative

A derivative is a financial instrument whose value depends on (or is derived from) the value of an underlying. The underlying can either be stocks, bonds, interest rates, commodities or foreign exchange. Derivatives’ main categories are options, swaps, forwards and futures. Derivatives enable a wide range of underlying exposure, such as leveraged exposure, short exposure or even customised exposure (with the use of options). In contrast to their flexibility, derivatives may involve counterparty risk.

Duration

The duration of a bond is a measure of time (in years) expressing either:

• the weighted average maturity of all discounted bond cash flows (Macaulay duration)
• or, the bond price sensitivity to yield movements (modified duration) For a bond with a fixed coupon, modified and Macaulay durations are close and linked by the following relationship:
  Modified duration = Macaulay duration/(1+yield) Duration is widely used to measure risks of fixed income portfolios, either the risk of variation in credit spread or in risk-free rates.
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