Financial market

I just had one of my actuarial exam hours ago and it was related to financial mathematics. I thought it would be useful for you to know some of the terms commonly used in the financial market since most of us will be dealing with the market in the future, even if you are not doing a finance or business-related major. So there you go:

There are many types of rates being used in the market.

1. Annual effective interest rate

It's a rate which is commonly used by banks or other financial institutions. An annual rate is, as it's named, the interest rate in yearly basis. The annual rate can be divided into a few rates too. The most commonly used ones are:

a) annual continuously compounded rate - an annual rate which credits interest to your account in a continuously rate, literally, like in every second.

b) nominal annual rate - an annual rate which credits interest to your account in a specific period of time within a year. The most common ones are nominal quarterly compounded annual rate (in which the account will be credited interest every 3 months) and semiannually compounded annual rate (in which the account will be credited interest every 6 months).

2. Spot rate

Bond is commonly used in the financial market, too. There are treasuries bonds, zero coupon bond and etc. These are the tools which are used as a way of lending or borrowing money. Spot rate is normally used to quote the price of zero coupon bond when it's settled on the spot or immediately (this suggests why it's called spot rate). You might be wondering what zero coupon bond is. It is a bond which does not give any payment in between the date of purchase and the expiration date.

3. Forward rate

It's the future yield rate of a commodity. For example, it can be used to determine the forward price of a forward contract. A forward contract is an agreement between two parties that one is obliged to sell/buy an underlying asset from the other party at the expiration/delivery date. The forward price is the amount that is paid at the expiration date. There is no cost on entering a forward contract but there is an obligation for both parties to exercise the contract.

4. Swap rate

As the name suggests, it is the rate at which financial institutions use when they are borrowing money from each other (ie. swap their funds). However, this might be more difficult to understand than you might have thought.