Mortgage-backed security: These are bundles of mortgages sold as securities among financiers across the country and around the world. They were initially offered by the Federal National Mortgage Association (Fannie Mae), which was chartered by the federal government to buy FHA and VA mortgages on the secondary market, pool them, and sell them as "mortgage-backed securities" to investors on the open market. In 1970, Congress created a new secondary mortgage market participant, the Federal Home Loan Mortgage Corp. (Freddie Mac), to provide secondary mortgage support for conventional mortgages. Fannie Mae was also allowed to bundle conventional mortgages. Bundling mortgages reduces a lender's risk from default on any one loan, but it also makes it hard to identify the value of the security because it can include good loans with bad ones.

Derivatives: Lenders and borrowers can further reduce their risk from failing mortgages and other investments (including commodities such as grains and oil) by trading derivatives. Derivatives known as futures, forwards, options and swaps attempt to protect a buyer from changes such as the early payoff of a loan, a local economic downturn that increases mortgage failures, inflation, stock market indexes or even a change in the weather. Trading in these instruments has exploded in the last decade with larger computers, more elaborate software programs, mathematical models and creative traders.

Credit default swaps: These are derivative contracts similar to insurance policies to protect buyers in the event of a default on a mortgage security or other financial instrument. But because there is no requirement to actually hold any asset or suffer a loss, a credit default swap can also be used for speculative purposes and is not generally considered insurance for regulatory purposes. The Securities and Exchange Commission says the market in these swaps, with a notional value of $58 trillion, is completely unregulated and has doubled in the last two years.

Over-the-counter derivatives: These are privately negotiated and traded directly between two parties, without going through an exchange or other intermediary. The OTC derivative market is the largest market for derivatives and is unregulated. As of December, the Bank for International Settlements estimated the total amount of OTC derivatives was $596 trillion.

Exchange-traded derivatives: These are traded on specialized exchanges like the CME Group (the Chicago Mercantile Exchange, the Chicago Board of Trade and the New York Mercantile Exchange). These exchanges act as intermediaries and take a fee from both sides of the trade to act as a guarantee.

Mark-to-market accounting: This is an accounting approach that assigns value to a financial instrument like a security or derivative based on the current market price. Bonds and other debt instruments have values based on maturity dates, but their worth in the meantime is based on prices similar instruments fetch in market trades. In a poor market, this accounting approach would reduce a firm's asset values and require, for example, greater collateral for additional debt.

Deleveraging: This is the reduction of financial instruments or borrowed capital previously used to increase the potential return of an investment. It is the opposite of leveraging. Increasing leverage increases a firm's risk; deleveraging attempts to lower risk. When a firm deleverages its balance sheet, it is a sign of slowing growth.

SOURCE: Dallas Morning News research