Chapter

APPENDIX 4

Author(s):
International Monetary Fund
Published Date:
April 2005
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Glossary

Asset-backed securities.

Bonds or notes backed by loan paper or accounts receivable originated by banks, credit card companies, or other providers of credit and often enhanced by a bank letter of credit or by insurance coverage provided by an institution other than the issuer.

Asset liability management.

The management of business and financial risks by matching the financial characteristics (on and off balance sheet) of an entity’s assets to those of its liabilities.

Back office.

The area of reserve management operations responsible for confirmation, settlement, and, in many cases, reconciliation of reserve management transactions.

Benchmark.

The mix of currencies, investment instruments, and duration that reflect the reserve manager’s tolerance for exposure to liquidity, credit, and market risks.

Confidence intervals.

An estimate of the probability (confidence) that an observation will fall within or outside a specified range. If the underlying data are normally distributed, a 68% confidence interval is estimated as the mean plus and minus one standard deviation and a 95% confidence interval is estimated as the mean plus and minus two standard deviations.

Credit risk.

The risk of nonperformance or default by borrowers on loans or other financial assets, or by a counterparty on financial contracts. Credit risk includes replacement cost risk, principal risk, and cash deposit risk.

Currency risk.

The risk of adverse movements in foreign currency across exchange rates that reduce the domestic currency value of international reserves. Currency risk on reserve assets also arises with an appreciation of the domestic currency.

Custodial risk.

The risk of loss of securities held in custody occasioned by the insolvency, negligence, or fraudulent action of the custodian or of a sub-custodian.

Custodian.

An entity, often a bank, that safekeeps and administers securities for its customers and that may provide various other services, including clearing and settlement, cash management, foreign exchange, and securities lending.

Custody.

The safekeeping and administration of securities and other financial instruments on behalf of others.

Dealing risk.

Dealers exceed their authority in dealing with counterparties or instruments, or incorrectly process a transaction.

Delivery versus payment.

A link between a securities transfer and a funds transfer system that ensures that delivery occurs if, and only if, payment occurs.

Delta.

Delta measures the relationship between an option price and the underlying futures contract or stock price.

Derivative product.

A contract or convertible security that changes in value in concert with and/or obtains much of its value from price movements in a related or underlying security, future, or other instrument or index.

Duration.

A measure of the sensitivity of a portfolio to movements in market yields by determining the time-weighted average of the present values of all future cash flows of a security or a portfolio, discounted at current interest rates.

Financial error or misstatement risk.

The failure of the accounting system and related controls to properly record all transactions and accounting adjustments.

Front office.

The area responsible for initiating investment transactions in accordance with approved delegations, limits, and benchmarks and the prompt and accurate entry of transactions into the investment management system.

Information ratio.

Information ratio measures excess return over the benchmark per unit of observed risk.

Information technology risk.

The failure of critical electronic data processing, communication, and information systems causing severe disruption to reserve management functions.

Interest rate risk.

Sometimes also referred to as an element of market risk, interest rate risk involves the adverse effects of increases in market yields that reduce the present value of fixed interest investments in the reserve portfolio. Interest rate risk increases, ceteris paribus, with the duration of a portfolio.

Internal audit.

An independent source of assurance about the management of risks and the operation of the control system that assists management of an organization in the effective discharge of its responsibilities.

Legal risk.

The possibility of losses from contracts that are not legally enforceable or not properly documented.

Liquidity risk.

Liquidity risk refers to the possible difficulties in selling (liquidating) large amounts of assets quickly, possibly in a situation where market conditions are also unfavorable, resulting in adverse price movements.

Market risk.

Risks associated with changes in market prices, such as interest rates and exchange rates. Changes in interest rates affect market prices of fixed interest securities. Hence, shorter duration securities are less at risk than long-term, fixed rate securities.

Mean variance analysis.

The process of identifying and evaluating portfolios that offer the highest expected return for given levels of variance.

Middle office.

Located between the front and back offices, the middle office’s role is to monitor that all transactions have been performed properly, that risks are being monitored and limits observed, and that relevant information is available for management.

Mortgage-backed securities.

Debt instruments collateralized by residential, commercial, or industrial real estate mortgages.

Official foreign exchange reserves.

Those external assets that are readily available to and controlled by monetary authorities for direct financing of payments imbalances, for indirectly regulating the magnitude of such imbalances through intervention in exchange markets to affect the currency exchange rate, and/or for other purposes. To meet this definition, reserve assets need to be liquid or marketable foreign currency assets that are under the effective control of, or “usable” by, the reserve manager and held in the form of convertible foreign currency claims of the authorities on nonresidents. To be recognized as part of official foreign exchange reserves, gold must be held by the monetary authorities, as monetary gold.

Operational risk.

A range of different types of risks, arising from inadequacies, failures, or nonobservance of internal controls and procedures that threaten the integrity and operation of business systems.

Performance attribution system.

An analytical framework that isolates the effects and measures the return contributions of market allocation, currency management, and security selection decisions. Performance attribution is used to evaluate the quality of the separate asset allocation and selection decisions that create a portfolio.

Pfandbriefe.

Pfandbriefe are covered bonds issued to fund loans that are secured, as a rule, by first ranking mortgages or land charges (Mortgage Pfandbriefe) or lending to the public sector (Public Pfandbriefe). They are issued by German private mortgage banks, private ship mortgage banks, and public sector credit institutions.

Portfolio optimization.

Use of a linear or quadratic model to structure a portfolio to maximize or minimize yield, long-term rate sensitivity, etc., or to increase or reduce exposure to certain industries, market sectors, or macroeconomic factors, subject to prespecified constraints.

Public debt management.

The process of establishing a strategy for managing the government’s debt in order to raise the required amount of funding, achieve its risk and cost objectives, and to meet any other sovereign debt management goals the government may have set.

Repurchase agreement (repo).

A contract to sell and subsequently repurchase securities at a specified date and price.

Reputation risk.

A reserve manager’s reputation and credibility may be called into question as a result of inappropriate reserve management actions, or unauthorized release of information.

Reserve assets.

See official foreign exchange reserves.

Reserve management.

The process by which public sector assets are managed in a manner that provides for the ready availability of funds, the prudent management of risks, and the generation of a reasonable return on the funds invested.

Risk.

The possibility of financial or other losses arising from an entity’s financial exposures and/or the failure of its internal control systems.

Securities lending.

A carefully collateralized process of loaning portfolio positions to custodians, dealers, and short-sellers who must make physical delivery of fungible positions.

Settlement risk.

The potential loss as a result of failure to settle, for whatever reason other than default, by the counterparty.

Sovereign risk.

The risk that a foreign sovereign government will restrict the ability of a holder to gain access to its assets or the proceeds from the sale of such assets. Sovereign risk is an inevitable feature of reserve management since assets are necessarily held in foreign countries, often in sovereign government securities of major investment currencies, and for which there are no better investment alternatives available.

Tracking error.

Tracking error is the differential in performance between a portfolio and its benchmark, indicating the standard deviation of relative returns.

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