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Sovereign Asset and Liability Management: An E-Learning Training Course

Module 4

 

GLOSSARY

 

Accrual accounting: An accounting method that measures economic events when they occur, not when payment is actually received or disbursed. See cash accounting.

Asset: Something of value that is owned such as: a current asset which is of temporary nature and will be changed into cash within a short period; a fixed asset which is durable and can be used repeatedly; a floating asset which can be quickly converted into cash at or near its book value; an intangible asset which has no material substance like goodwill; a liquid asset which can very easily be converted into cash without appreciable loss in value as opposed to a frozen asset which may be difficult to sell quickly without loss in value. See book value.

Balance sheet: A financial statement that summarizes an entity’s assets, liabilities, and net worth.

Book value: The value of assets as they are stated in the books of the firm which usually is the value at which they were acquired. See asset, historical price, and mark-to-market.

Cash accounting: Accounting method in which receipts are recorded during the period they are received and the expenses in the period in which they are actually paid. See accrual accounting.

Contingent claims approach: An approach to measuring sovereign risk which models an issuer’s debt as a combination of risk free debt and a put option on the issuer’s assets.   Contingent claims approach is based on contingent claims analysis (CCA) which is the application of option-pricing theory to the valuation of assets, the future value of which depends on the future value of other assets.

Contingent liabilities: Arrangements under which one or more conditions must be fulfilled before a financial transaction takes place. In other words, they are obligations that arise from a particular, discrete event(s) that may or may not occur. They can be explicit or implicit,

Explicit contingent liabilities are contractual financial arrangements that give rise to conditional requirements that is, the requirements become effective if one or more stipulated conditions arise to make payments of economic value. For example, the contingent liability may arise from an existing debt, such as an institution guaranteeing payment to a third party.

Implicit contingent liabilities do not arise from a legal or contractual source but are recognized after a condition or event is realized. For example, covering the obligations of subnational (state and local) governments or the central bank in the event of default might be viewed as an implicit contingent liability of the central government.

Contingent liabilities are complex arrangements, and no single measurement approach can fit all situations; rather, comprehensive standards for measuring these liabilities are still evolving.

Credit risk: risk that a borrower will default on any payment it is obligated to make.

Currency risk: risk that arises from the change in price of one currency against another.

Debt overhang: This can refer either to the total outstanding debt or to the total debt that cannot be readily covered by expected economic growth.

Derivative instrument: Derivative financial instruments include a wide variety of financial assets and liabilities such as forwards, futures, and option contracts, swaps, swaptions, and hybrid securities including convertible bonds and other debt contracts with equity or income participation. In general, derivative instruments are financial assets whose value is derived from the value of another financial asset. A derivative instrument may be standardized and traded in secondary markets or it may be a custom-tailored contract between two parties. The majority of derivatives can be classified as either forward contracts or option contracts. See forwards, futures, option, swap, and swaption.

Direct explicit liabilities: Legal or contractual obligations of the government that will arise in any event. See direct implicit liabilities.

Direct implicit liabilities: Liabilities that will arise in any event but the government is not legally obliged to act on them. See direct explicit liabilities.

Dutch Disease: Negative consequences arising from large increases in a country's income. Dutch disease is primarily associated with a natural resource discovery, but it can result from any large increase in foreign currency, including foreign direct investment, foreign aid or a substantial increase in natural resource prices.  The term "Dutch disease" originates from a crisis in the Netherlands in the 1960s that resulted from discoveries of vast natural gas deposits in the North Sea. The newfound wealth caused the Dutch guilder to rise, making exports of all non-oil products less competitive on the world market.

Endogenous: Caused by factors or agents inside the system.

Exchange rates: The rate at which one currency can be exchanged for another.

Exogenous: Caused by factors or agents outside the system.

Financial assets: Financial claims, monetary gold, and Special Drawing Rights allocated by the IMF. See non-financial assets.

Fiscal risks: The possibility of deviations in fiscal variables from what was expected at the time of the budget or other forecast.  Fiscal risks include macroeconomic shocks and contingent liabilities.

Fixed rate: An interest rate on a loan which remains constant throughout the duration of the loan.  See variable rate.

Foreign reserves or foreign exchange reserves: Assets held by central banks and monetary authorities, usually in different reserve currencies and used to back liabilities and the various bank reserves deposited with the central bank, by the government or financial institutions.

Forward: Forward contracts are agreements to either buy, sell or exchange assets at a future date. Since the price or exchange ratio is fixed at the origination of the forward contract, its value depends upon the future value of the underlying asset.  See derivative.

If a sufficient volume of forward contracts is standardized with respect to amounts of the underlying asset, price, and maturity, and the performance of the two parties is guaranteed by another (e.g. a clearing house), then the forward contract can be traded in a secondary market. Such traded forward contracts are called futures contracts. Futures markets exist for major currencies, commodities, debt instruments (interest rates) and stock indices. See derivative.

Frontier market: a subset of emerging markets that are investable but have lower market capitalization and liquidity than more developed emerging markets.  The term was coined by the International Finance Corporation’s Farida Khambata in 1992.

Futures: See forwards.

Guarantee: An obligation will be satisfied by a third party if the primary obligor defaults. A guarantee involves a borrower, a lender, and the guarantor.  The guarantor ensures the obligation will be repaid if the borrower is unable to make payment.

Historical price: A measure of value used in accounting in which the price of an asset on the balance sheet is based on its nominal or original cost when acquired. See mark-to-market.

Indexation: Linking adjustments made to the value of a good, service or other metric, to a predetermined index.

Inflation: The general rate at which goods and services is rising, and subsequently, purchasing power is falling.

Interest rate: The amount contracted to be paid in a one unit interval of time for each unit of capital invested.

Liability: An amount payable by an entity for goods or services received, assets acquired, expenses incurred, construction carried out and amounts received that have, as yet, to be paid. See asset and contingent liability.

Liquidity: The degree to which an asset or security can be bought or sold in the market without affecting the asset or security’s price. 

Mark-to-market: the accounting act of recording the price or value of an asset or liability to reflect its current market value and not its book value. See historical price.

Market risk: Risk due to movements in market prices. Examples of market risk include: interest rate risk, currency risk, commodity risk, and equity risk.

Median: A value in an ordered set of values below and above which there is an equal number of values or which is the arithmetic mean of the two middle values if there is no one middle value.

Moral hazard: Increased risk taking due to the party taking the risks not bearing the costs that could be incurred.

Monetary gold: Gold owned by the authorities (or by others who are under the effective control of the authorities) and held as a reserve asset.  Transactions in monetary gold occur only between monetary authorities and their counterparts in other economies or between monetary authorities and international monetary organizations.

National liquidity: a measure of liquidity that includes foreign or foreign currency liabilities of banks and the corporate sector and not solely the assets and liabilities of the government and central bank.

Non-financial assets: All economic assets other than financial assets.  By implication, nonfinancial assets do not represent claims on other units. See financial assets.

Off-balance sheet: An asset, debt, or financing activity that is not included on the balance sheet.  Off balance sheet financings enable the government to pursue policy outcomes and allocate funding outside the normal budgetary process.  See balance sheet.

Options: Option contracts differ from forward contracts in that one party has the right but not the obligation to fulfil the contract. For example, the owner of a call (put) option has the right but not the obligation to buy (sell) an underlying asset at a specified price on a future date. The party who sells the option (the writer of the option) must perform at the discretion of the owner of the option and that's why the buyer of the option must pay a premium to the writer. This premium will reflect the likelihood that the future value of the underlying asset will make the option valuable to its owner. See derivative and swaption.

Original sin: A situation in which the domestic currency cannot be used to borrow abroad or domestically.

Portfolio: A grouping of financial assets such as stocks, bonds, and cash equivalents, as well as their mutual, exchange-traded and closed fund counterparts.

Portfolio approach: Strategy in which assets and liabilities are jointly managed to achieve an overall balance of risk and return rather than focus on the risk of each position.

Refinancing risk: risk that a borrower will not be able to borrow in order to pay existing debt.

Ricardian Equivalence: An economic theory that suggests that when a government tries to stimulate demand by increasing debt-financed government spending, demand remains unchanged.  This is because the public will save its excess money in order to pay for future tax increases that will be initiated to pay off the debt.  The theory was developed by David Ricardo in the nineteenth century.

Risk: The possibility of loss or injury.

Risk Tolerance: The willingness of an organization or participant to accept risk. See risk.

Security: A financial instrument that represents: an ownership position in a publicly-traded corporation (stock), a creditor relationship with governmental body or a corporation (bond), or rights to ownership as represented by an option. A security is a fungible, negotiable financial instrument that represents some type of financial value. The company or entity that issues the security is known as the issuer.

Special Drawing Rights (SDRs): An international type of monetary reserve currency, created by the International Monetary Fund (IMF) in 1969, which operates as a supplement to the existing reserves of member countries. Created in response to concerns about the limitations of gold and dollars as the sole means of settling international accounts, SDRs are designed to augment international liquidity by supplementing the standard reserve currencies.

Stochastic modeling: A method of economic modeling in which one or more variables within the model are random.  Stochastic modeling is for the purpose of estimating the probability of outcomes within a forecast to predict what conditions might be like under different situations.  The random variables are usually constrained by historical data.

Short term: Usually a period of less than one year.

Systemic risk: the risk that the failure of one institution (such as a bank) could cause other institutions to fail and harm the economy as a whole.

Swaps: Traditionally, the exchange of one security for another to change the maturity (bonds), quality of issues (stocks or bonds), or because investment objectives have changed. Recently, swaps have grown to include currency swaps and interest rate swaps.

Swaption: The right but not the obligation to enter into a future swap within a specified period of time. See option contract and derivative instrument.

Variable rate: A rate of interest that is computed by adding a spread to a predetermined base rate. For example, 1.25% over LIBOR. See base rate and spread. See fixed rate.

 

 

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