the correlation co-efficient, which provides an index of the degree to which paired measures co-vary in a linear fashion. It is the square root of the co-efficient of determination, described below. The correlation co-efficient can range in value between -1 and 1.

   the co-efficient of determination, which varies between 0 and 1. It is loosely interpreted as ‘the proportion of variance in y which can be explained by x’It is the percentage of the total sum of squares of the dependent variable that the independent variable explains, after one optimises the intercept and the slope co-efficient of the independent variable. In other words, r2 is the percentage by which volatility of a linear combination of the dependent and independent variables and a constant declines after choosing the optimal intercept and slope co-efficient.

   an option in which the underlying factors are referred to as colours. Hence, a two-factor option, such as a spread option, would be a two-colour rainbow option.

   a range binary pays out if a specified spot rate trades within a given range over a specified period of time, in exchange for payment of a premium. The lower the volatility of the spot rate, the more likely the buyer is to benefit. see corridor option, trigger condition

    see cylinder

    see risk-adjusted returns on capital

   any number of contractual clauses that call for some change in the counterparty relationship, given a change in the debt rating.

   the point at which a company may be spiralling towards further rating downgrades once a rating trigger has been initiated.

   a ratio spread involves buying differentamounts of similar options with differing strike prices. The purchase of an in-the-money option is financed by the selling of out-of-the-money options. Conversely, the out-of-the-money options are financed by selling in-the-money options.

   a non-traded asset or liability whose profit-and-loss sensitivity to a commodity price or other market variable mimics that of an option contract. Extracting oil from an oilfield is a classic example of a real option. If oil prices remain low, the field can be left dormant at no additional cost. If oil prices rise sufficiently, the profits earned on the sale of the oil will more than outweigh the costs of extraction.

   up-to-date prices for commodities, moving with every purchase or sale.

   a rebate is paid to the holder of a derivative, such as a barrier option, if the instrument is knocked out or is never activated.

   exchange notation for contracts trading beyond the next 12 months. For example, in November 2005, ‘red December’ refers to December 2006.

   in an energy derivatives contract, the market price reference based on a particular location or specified grade or blend of the commodity, which is used for settlement of the contract.

   a typical index variable in weather derivative transactions.

   the products derived from crude oil that has been processed in a refinery.

   a plant where crude oil is separated into various components, such as usable products or feedstocks.

   the uplift obtained – usually expressed in cents per barrel – from reforming naphtha into gasoline.

   a cleaner form of gasoline, providing significant reductions in emissions of ozone-forming and toxic air pollutants.

   the vaporisation of liquefied natural gas (LNG) after transport to its destination, in order to directly deliver natural gas to downstream markets. Regasification traditionally has been done by the LNG ships offloading their cargo as liquid into tanks at on-shore terminals, which then convert it to natural gas, however, the technology now exists for regasification on board specially designed vessels such as Energy Bridge LNG ships so that natural gas can be delivered directly into the natural gas pipelines. Similarly, dockside regasification can be done at specially equipped seaports such at the GasPort now operational in the UK.

   organisations to administer the electricity transmission grid on a regional basis throughout North America (including Canada). Creation of RTOs was encouraged by the Federal Energy Regulatory Commission (Ferc) under the terms of Ferc order 2000.

   an analysis to relate one or more dependent variables to one or more independent variables.

   the risk that an asset manager will be unable to match the yield from an interest rate instrument (such as a swap or bond) when reinvesting its coupon payments and principal repayments.

   an option giving the buyer the right to the return from a single asset from a basket of two or more, either as a cash settlement or by physical delivery. The asset selected may be the best- or worst-performing of the assets in the basket, as measured against a common or independent benchmark.

   any form of energy that is replaced by nature, with or without human assistance. Common forms of renewable energy include wind, solar, geothermal and tidal energy.

   the replacement cost of a financial instrument is its current market value. In credit risk terms, it is the cost of replacing a given contract if the counterparty defaults.

   to replicate the payout of an option by buying or selling other instruments. In the case of dynamic replication, this involves dynamically buying or selling the underlying (or futures, where transaction costs are cheaper) in proportion to an option’s delta. In the case of static replication, the option is hedged with a basket of standard options whose composition does not change with time.

   to buy (or sell) a security while at the same time agreeing to sell (or buy) the same security at a predetermined future date. The price of the second transaction determines the repo rate, the interest rate earned on the security between the two transactions. In a reverse repo, the buyer sells cash in exchange for a security.

   the amount of reserve capacity set by the North American Electric Reliability Corporation that needs to be on the accounting books of an electricity utility. It has to have a certain specified amount of capacity above the utility’s peak requirements, which are calculated using probabilistic models.

   back-up power that must be made available at all times to meet fluctuations in system demand within a given range, to ensure smooth, continuous delivery of energy at proper voltage and current levels.

   heavy fuel oil produced from the residue in the fractional distillation process rather than from the distilled fractions.

   the use of gas or electricity transmission facilities to “wheel in” energy from various suppliers to local customers.

   Thompson Reuters is a leading source of news and information for businesses and professionals www.reuters.com

   to take advantage of mispriced options by creating a synthetic long futures position and hedging it by selling futures contracts against it. A trader may buy an undervalued call, at the same time selling a fairly valued put and buying a futures contract. The same strategy could be applied if the put was undervalued. The ability to undertake this riskless arbitrage relies on put-call parity. see also box, conversion

   the sale of crude oil against the purchase of the refined products. In futures trading, it is the simultaneous sale of crude oil futures versus the purchase of heating oil and gasoline futures.

   a measure of an option’s sensitivity to a change in interest rates; this will affect the future price of the option and the time value of the premium. Its impact increases with the maturity of the option.

   funds at risk in a company or trading business.

   control and limitation of the risks faced by an organisation due to its exposure to changes in financial market variables, such as foreign exchange and interest rates, equity and commodity prices or counterparty creditworthiness. It may be necessary because of the financial impact of an adverse move in the market variable (market risk); because the organisation is ill-prepared to respond to such a move (operational risk); because a counterparty defaults (credit risk); or because a specific contract is not enforceable (legal risk). Market risks are usually managed by hedging with financial instruments, although a firm may also reduce risk by adjusting its business practices (see natural hedge). While financial derivatives lend themselves to this purpose, risk can also be reduced through judicious use of the underlying assets – for example, by diversifying portfolios.

   assessment of a firm’s exposure to risk.

   the fundamental control documents in most corporate risk management programmes.

   a payment that factors in the inherent risk of a trade.

   a technique of risk analysis that assumes a higher return for a riskier project than a less risky one.

   a swap that enables futures traders to lock-in their roll-over costs by paying the average difference between near and far contracts.

   a clause in a contract that allows the contract to be extended beyond the initially agreed termination date.

   the risk that a derivative hedge position will be at a loss at expiration, necessitating a cash payment when the expiring hedge is replaced with a new one.

   a term sometimes used to describe the oil market in northwest Europe. There is no Rotterdam trading floor, as oil business is transacted electronically, by telephone or on the futures markets in New York, London or Singapore.

   an outlawed trade in which two counterparties trade the same asset at the same price to effectively boost their trading volume figures and artificially inflate revenues. Also known as wash trade.

    see regional transmission organisations