Underlier - Equity Derivatives Provision
|
2002 ISDA Equity Derivatives Definitions
A Jolly Contrarian owner’s manual™ Underlier in a Nutshell™
Original text
Resources and Navigation
|
Comparisons
A JC-curated sub-division of the General Definitions section. We sub-group the Section 1 definitions into the following subgroups:
- Transactions — Sections 1.1 - 1.12
- Underliers — Sections 1.13 - 1.16
- Trade Details — Sections 1.17 - 1.24
- Exchanges, Clearing Systems and Currencies — Sections 1.25 - 1.37
- Trade Features — Sections 1.38 - 1.41
- Calculation Agent and Determination Agent - Section 1.40 and 12.8(f)
- Knock-ins and Knock-outs — Sections 1.42 - 1.51
Basics
There are two basic concepts in the Equity Derivatives Definitions: Shares and Indices. A “Share” is a single common stock; an “Index” is a dynamically assembled collection of common stocks adjusted and valued according to pre-published index rules by an Index Sponsor. Shares are easy enough to hedge: just buy the stock — indices require quite a lot more wits about you, seeing as you need to buy all the shares, in the correct weighting, and the shares and their weighting are apt to change.
Both “Shares” and “Indices” can be gathered into static “Baskets” comprising multiple Shares, or Indices.
“Underlier”?
There isn’t a generic catch-all term for the “underlier” of an Equity Derivatives Transaction. This is a pity, since “Index, Share, Share Basket or Index Basket, as the case may from time to time and for the time being, be” isn’t the most elegant expression in the annals of legal literature.
Like nature, JC abhors a vacuum, though, so we will use “Underlier”, when our patience with ISDA’s crack drafting squad™ and its leaden drafting becomes as shiny, thin and translucent as the seat of an old pair of suit trousers.
“Baskets” versus “Indices”
You might wonder about the difference between Baskets and Indices, seeing as both are, loosely, baskets of Shares of one sort or another. It boils down to standardisation and independence of calculations and adjustments: an Index is an independently published return, calculated and adjusted by a third-party Index Sponsor according to pre-published rules, and neither dealer nor customer has much control over the composition or management of the Index during the life of a given swap.
A Basket is generally a portfolio of shares chosen by the counterparties, and management of disruptions, the substitution of Shares in the basket and so on is managed by the counterparties to the swap.
Index composition is controlled by the index sponsor according to predefined methodologies. Market participants have no direct control over constituent changes. Under a Basket the parties define and control the Basket composition and weighting.
Index modifications are handled through index adjustment rules set by the sponsor. Changes to Baskets require are agreed between the parties.
The Index sponsor calculates and publishes the level of the Index according to the methodology set out in the index rules. For a Share Basket the swap calculation agent needs to aggregate individual share prices according to the basket formula.
Under an Index Dividend treatment is standardised (price return indices exclude dividends, total return indices include them) whereas with a Basket the parties can choose, and if they really wish, customise the Dividend treatment for each component in the Basket.
Premium content
|
Here the free bit runs out. Subscribers click 👉 here. New readers sign up 👉 here and, for ½ a weekly 🍺 go full ninja about all these juicy topics👇
|
See also
- Manufacturing dividends