A guide to the complex jargon of Wall Street

McClatchy NewspapersApril 16, 2010 

WASHINGTON — Here is a glossary of terms involved in the Goldman fraud case brought by the Securities and Exchange Commission:

Hedge fund — A fund that's open only to sophisticated investors who are able to meet steep minimal investment requirements. These funds offer prospects of both huge risk and huge reward, and invest in a wide array of products, from stocks and bonds to debt and commodities. They are mostly unregulated.

Securities — An instrument that represents a financial value, expressed either as debt securities reflecting bonds and government banknotes, or equities, which are common stocks.

Mortgage Bond — Often called mortgage-backed securities or asset-backed securities, these involve pools of mortgages that are packaged together and sold to investors as a security. The monthly payments or principal and interest made by U.S. homeowners serve as the monthly income stream for investors in these bonds.

Tranche — In an effort to spread and thus minimize investment risk, Wall Street firms that issue mortgage bonds layer the pools of mortgages into different levels of risk, or tranches. Investors who bought the safest tranche were guaranteed to lose the least amount of money in the event of a default, but also would enjoy the lowest return on their investment. Investors in higher-risk tranches reap greater rewards from a functioning mortgage bond, but stand to lose the most in a default.

Investment Grade — Many institutional investors such as endowments and pension funds are governed by internal rules that require them to buy only the safest investments, those carrying an investment grade. Credit-rating agencies give investment grades to the safest investments, ensuring investors there's little chance of default in a product carrying an investment-grade rating.

Collateralized Debt Obligation — CDOs are pools of debt securities whose underlying debt obligations are held as collateral. Investors are promised the payments derived from the underlying assets. These often include mortgage bonds and pools of other types of loans such as car loans, student loans or credit-card debt.

Special Purpose Vehicles — Created to package and issue CDOs.

Synthetic Collateralized Debt Obligation — In these complex products, the Special Purpose Vehicle doesn't actually own the portfolio of underlying mortgages but enters into private two-party deals, called credit-default swaps, which reference the performance of the underlying assets.

Credit-default swaps — A contract, negotiated privately between two parties, in which one party seeking protection from a credit default agrees to make regular payments similar to insurance premiums to a seller selling this protection. In exchange the seller who has agreed to "swap" the risk is liable for an agreed upon payout should there be a default on the bond on which the protection was purchased.

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