342 Frequently Asked Questions In Quantitative Finance

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American option An option which can be exercised at any time

of the holder’s choosing prior to expiration. See page 310.

Arbitrage Arbitrage is the making of a totally riskless profit in

excess of the risk-free rate of return. See page 25.

Asian option An option whose payoff depends on the average

value of the underlying asset over some time period prior to

expiration. See page 310.

Asset swap The exchange of two investments, or the cashflows

to those investments, between two parties.

Barrier option An option which either comes into being or

becomes worthless if a specified asset price is reached before

expiration. See page 311.

Base correlation A correlation used in a CDO model to repre-

sent the relationship between all underlyings from zero up to

a given detachment point. For example, the 0–3% and a 3–6%

tranches are separate instruments but between them one can

price a 0–6% tranche and so back out an implied correlation

from 0–6%, that is the base correlation. See page 315.

Basket A collection of financial instruments. In a basket

option the payoff depends on the behaviour of the many

underlyings. See page 312.

Bermudan swaption An option to enter into a swap that may

be exercised on any of a specified number of dates.

C++ An enhanced version of the C programming language

developed by Bjarne Stroustrup in 1983. The enhancements

include classes, virtual functions, multiple inheritance, tem-

plates, etc.