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Financial Glossary

Abandonment option

The option of terminating an investment earlier than originally planned.

Abnormal returns

Part of the return that is not due to systematic influences (market wide influences). In other words, abnormal returns are above those predicted by the market movement alone. Related: excess returns.

Absolute priority

Rule in bankruptcy proceedings whereby senior creditors are required to be paid in full before junior creditors receive any payment.

Accelerated cost recovery system (ACRS)

Schedule of depreciation rates allowed for tax purposes.

Accelerated depreciation

Any depreciation method that produces larger deductions for depreciation in the early years of a project's life. Accelerated cost recovery system (ACRS), which is a depreciation schedule allowed for tax purposes, is one such example.

Accounting earnings

Earnings of a firm as reported on itsincome statement.

Accounting exposure

The change in the value of a firm's foreign currency denominated accounts due to a change in exchange rates.

Accounting insolvency

Total liabilities exceed total assets. A firm with a negative net worth is insolvent on the books.

Accounting liquidity

The ease and quickness with which assets can be converted to cash.

Accounts payable

Money owed to suppliers.

Accounts receivable

Money owed by customers.

Accounts receivable turnover

The ratio of net credit sales to average accounts receivable, a measure of how quickly customers pay their bills.

Accretion (of a discount)

In portfolio accounting, a straight-line accumulation of capital gains on discount bond in anticipation of receipt of par at maturity.

Accrual bond

A bond on which interest accrues, but is not paid to the investor during the time of accrual. The amount of accrued interest is added to the remaining principal of the bond and is paid at maturity.

Accrued interest

The accumulated coupon interest earned but not yet paid to the seller of a bond by the buyer (unless the bond is in default).

Accumulated Benefit Obligation (ABO)

An approximate measure of the liability of a plan in the event of a termination at the date the calculation is performed. Related: projected benefit obligation.

Acid-test ratio

Also called the quick ratio, the ratio of current assets minus inventories, accruals, and prepaid items to current liabilities.

Acquiree

A firm that is being acquired.

Acquirer

A firm or individual that is acquiring something.

Acquisition

When a firm buys another firm.

Acquisition of assets

A merger or consolidation in which an acquirer purchases the selling firm's assets.

Acquisition of stock

A merger or consolidation in which an acquirer purchases the acquiree's stock.

Active

A market in which there is much trading.

Active portfolio strategy

A strategy that uses available information and forecasting techniques to seek a better performance than a portfolio that is simply diversified broadly. Related: passive portfolio strategy

Act of state doctrine

This doctrine says that a nation is sovereign within its own borders and its domestic actions may not be questioned in the courts of another nation.

Actuals

The physical commodity underlying a futures contract. Cash commodity, physical.

Additional hedge

A protection against borrower fallout risk in the mortgage pipeline.

Adjustable rate preferred stock (ARPS)

Publicly traded issues that may be collateralized by mortgagesand MBSs.

Adjusted present value (APV)

The net present value analysis of an asset if financed solely by equity (present value of un-levered cash flows), plus the present value of any financing decisions (levered cash flows). In other words, the various tax shields provided by the deductibility of interest and the benefits of other investment tax credits are calculated separately. This analysis is often used for highly leveraged transactions such as a leverage buy-out.

Administrative pricing rules

IRS rules used to allocate income on export sales to a foreign sales corporation.

Advance commitment

A promise to sell an asset before the seller has lined up purchase of the asset. This seller can offset risk by purchasing a futures contract to fix the sales price.

Adverse selection

A situation in which market participation is a negative signal.

Affirmative covenant

A bond covenant that specifies certain actions the firm must take.

After-tax profit margin

The ratio of net income to net sales.

After-tax real rate of return

Money after-tax rate of return minus theinflation rate.

Agencies

Federal agency securities.

Agency bank

A form of organization commonly used by foreign banks to enter the U.S. market. An agency bank cannot accept deposits or extend loans in its own name; it acts as agent for the parent bank.

Agency basis

A means of compensating the broker of a program trade solely on the basis of commission established through bids submitted by various brokerage firms. agency incentive arrangement. A means of compensating the broker of a program trade using benchmark prices for issues to be traded in determining commissions or fees.

Agency costs

The incremental costs of having an agent make decisions for a principal.

Agency cost view

The argument that specifies that the various agency costs create a complex environment in which total agency costs are at a minimum with some, but less than 100%, debt financing.

Agency pass-throughs

Mortgage pass-through securities whose principal and interest payments are guaranteed by government agencies, such as the Government National Mortgage Association (``Ginnie Mae ''), Federal Home Loan Mortgage Corporation (``Freddie Mac'') and Federal National Mortgage Association (``Fannie Mae'').

Agency problem

Conflicts of interest among stockholders, bondholders, and managers.

Agency theory

The analysis of principal-agent relationships, wherein one person, an agent, acts on behalf of anther person, a principal.

Agent

The decision-maker in a principal-agent relationship.

Aggregation

Process in corporate financial planning whereby the smaller investment proposals of each of the firm's operational units are added up and in effect treated as a big picture.

Aging schedule

A table of accounts receivable broken down into age categories (such as 0-30 days, 30-60 days, and 60-90 days), which is used to see whether customer payments are keeping close to schedule.

AIBD

Association of International Bond Dealers.

All equity rate

The discount rate that reflects only the business risks of a project and abstracts from the effects of financing.

All-in cost

Total costs, explicit and implicit.

All or none

Requirement that none of an order be executed unless all of it can be executed at the specified price.

All-or-none underwriting

An arrangement whereby a security issue is canceled if the underwriter is unable to re-sell the entire issue.

Alpha

A measure of selection risk (also known as residual risk) of a mutual fund in relation to the market. A positive alpha is the extra return awarded to the investor for taking a risk, instead of accepting the market return. For example, an alpha of 0.4 means the fund outperformed the market-based return estimate by 0.4%. An alpha of -0.6 means a fund's monthly return was 0.6% less than would have been predicted from the change in the market alone.
In a Jensen Index, it is factor to represent the portfolio's performance that diverges from its beta, representing a measure of the manager's performance.

Alpha equation

The alpha of a fund is determined as follows:

[ (sum of y) -((b)(sum of x)) ] / n
where: n =number of observations (36 months)
       b = beta of the fund
       x = rate of return for the S&P 500
       y = rate of return for the fund
     

Alternative mortgage instruments

Variations of mortgage instruments such as adjustable-rate and variable-rate mortgages, graduated-payment mortgages, reverse-annuity mortgages, and several seldom-used variations.

American Depositary Receipts (ADRs)

Certificates issued by a U.S. depositary bank, representing foreign shares held by the bank, usually by a branch or correspondent in the country of issue. One ADR may represent a portion of a foreign share, one share or a bundle of shares of a foreign corporation. If the ADR's are ``sponsored,'' the corporation provides financial information and other assistance to the bank and may subsidize the administration of the ADRs. ``Unsponsored'' ADRs do not receive such assistance. ADRs carry the same currency, political and economic risks as the underlying foreign share; the prices of the two, adjusted for the SDR/ordinary ratio, are kept essentially identical by arbitrage. American depositary shares(ADSs) are a similar form of certification.

American option

An option that may be exercised at any time up to and including the expiration date. Related: European option

American shares

Securities certificates issued in the U.S. by a transfer agent acting on behalf of the foreign issuer. The certificates represent claims to foreign equities.

American Stock Exchange (AMEX)

The second-largest stock exchange in the United States. It trades mostly in small-to medium-sized companies.

American-style option

An option contract that can be exercised at any time between the date of purchase and the expiration date. Most exchange-traded options are American style.

Amortization

The repayment of a loan by installments.

Amortization factor

The pool factor implied by the scheduled amortization assuming no prepayemts.

Amortizing interest rate swap

Swap in which the principal or national amount rises (falls) as interest rates rise (decline).

Analyst

Employee of a brokerage or fund management house who studies companies and makes buy-and-sell recommendations on their stocks. Most specialize in a specific industry.

Angels

Individuals providing venture capital.

Announcement date

Date on which particular news concerning a given company is announced to the public. Used in event studies, which researchers use to evaluate the economic impact of events of interest.

Annual effective yield

Same as percentage yield.

Annual fund operating expenses

For investment companies, the management fee and ``other expenses,'' including the expenses for maintaining shareholder records, providing shareholders with financial statements, and providing custodial and accounting services. For 12b-1 funds, selling and marketing costs are included.

Annualized gain

If stock X appreciates 1.5% in one month, the annualized gain for that sock over a twelve month period is 12*1.5% = 18%. Compounded over the twelve month period, the gain is (1.015)^12 = 19.6%.

Annualized holding period return

The annual rate of return that when compounded t times, would have given the same t-period holding return as actually occurred from period 1 to period t.

Annual percentage rate (APR)

The periodic rate times the number of periods in a year. For example, a 5% quarterly return has an APR of 20%.

Annual percentage yield (APY)

The effective, or true, annual rate of return. The APY is the rate actually earned or paid in one year, taking into account the affect of compounding. The APY is calculated by taking one plus the periodic rate and raising it to the number of periods in a year. For example, a 1% per month rate has an APY of 12.68% (1.01^12).

Annual rate of return

There are many ways of calculating the annual rate of return. If the rate of return is calculated on monthly basis, we somtimes multiply this by 12 to express an annual rate of return. This is often called the annual percentage rate. You can also compound and this called the annual percentage yield.

Annual report

Yearly record of a publicly held company's financial condition. It includes a description of the firm's operations, its balance sheet and income statement. SEC rules require that it be distributed to all shareholders. A more detailed version is called a 10-K.

Annuity

A regular periodic payment made by an insurance company to a policyholder for a specified period of time.

Annuity due

An annuity with n payments, wherein the first payment is made at time t = 0 and the last payment is made at time t = n - 1.

Annuity factor

Present value of $1 paid for each of t periods.

Annuity in arrears

An annuity with a first payment on full period hence, rather than immediately.

Anticipation

Arrangements whereby customers who pay before the final date may be entitled to deduct a normal rate of interest.

Antidilutive effect

Result of a transaction that increases earnings per common share (e.g. by decreasing the number of shares outstanding).

Appraisal ratio

The signal-to-noise ratio of an analyst's forecasts. The ratio of alpha to residual standard deviation.

Appraisal rights

A right of shareholders in a merger to demand the payment of a fair price for their shares, as determined independently.

Appropriation request

Formal request for funds for capital investment project.

Arbitrage

The simultaneous buying and selling of a security at two different prices in two different markets, resulting in profits without risk. Perfectly efficient markets present no arbitrage opportunities. Perfectly efficient markets seldom exist.

Arbitrage-free option-pricing models

Yield curve option-pricing models.

Arbitrage Pricing Theory (APT)

An alternative model to the capital asset pricing model developed by Stephen Ross and based purely on arbitrage arguments.

Arbitrageurs

People who search for and exploit arbitrage opportunities.

Arithmetic average (mean) rate of return

Arithmetic mean return.

Arithmetic mean return

An average of the subperiod returns, calculated by summing the subperiod returns and dividing by he number of subperiods.

ARMs

Adjustable rate mortgage. A mortgage that features predetermined adjustments of the loan interest rate at regular intervals based on an established index. The interest rate is adjusted at each interval to a rate equivalent to the index value plus a predetermined spread, or margin, over the index, usually subject to per-interval and to life-of-loan interest rate and/or payment rate caps.

Arms index

Also known as a trading index.

(TRIN) = (number of advancing issues)/(number of declining issues)

or

(Total up volume)/(total down volume).

An advance/decline market indicator. Less than 1.0 indicates bullish demand, while above 1.0 is bearish. The index often is smoothed with a simple moving average.

Arm's length price

The price at which a willing buyer and a willing unrelated seller would freely agree to transact.

Articles of incorporation

Legal document establishing a corporation and its structure and purpose.

Asian currency units (ACUs)

Dollar deposits held in Singapore or other Asian centers.

Asian option

Option based on the average price of the asset during the life of the option.

Ask

This is the quoted ask, or the lowest price an investor will accept to sell a stock. Practically speaking, this is the quoted offer at which an investor can buy shares of stock; also called the offer price.

Ask price

A dealer's price to sell a security; also called the offer price.

Asset

Any possession that has value in an exchange.

Asset activity ratios

Ratios that measure how effectively the firm is managing its assets.

Asset allocation decision

The decision regarding how an institution's funds should be distributed among the major classes of assets in which it may invest.

Asset-backed security

A security that is collateralized by loans, leases, receivables, or installment contracts on personal property, not real estate.

Asset-based financing

Methods of financing in which lenders and equity investors look principally to the cash flow from a particular asset or set of assets for a return on, and the return of, their financing.

Asset classes

Categories of assets, such as stocks, bonds, real estate and foreign securities.

Asset-coverage test

A bond indenture restriction that permits additional borrowing on if the ratio of assets to debt does not fall below a specified minimum.

Asset/equity ratio

The ratio of total assets to stockholder equity.

Asset for asset swap

Creditors exchange the debt of one defaulting borrower for the debt of another defaulting borrower.

Asset/liability management

Also called surplus management, the task of managing funds of a financial institution to accomplish the two goals of a financial institution: (1) to earn an adequate return on funds invested and (2) to maintain a comfortable surplus of assets beyond liabilities.

Asset pricing model

A model, such as the Capital Asset Pricing Model (CAPM), that determines the required rate of return on a particular asset.

Assets

A firm's productive resources.

Assets requirements

A common element of a financial plan that describes projected capital spending and the proposed uses of net working capital.

Asset substitution

A firm's investing in assets that are riskier than those that the debtholders expected.

Asset substitution problem

Arises when the stockholders substitute riskier assets for the firm's existing assets and expropriate value from the debtholders.

Asset swap

An interest rate swap used to alter the cash flow characteristics of an institution's assets so as to provide a better match with its liabilities.

Asset turnover

The ratio of net sales to total assets.

Assignment

The receipt of an exercise notice by an options writer that requires the writer to sell (in the case of a call) or purchase (in the case of a put) the underlying security at the specified strike price.

Asymmetric information

Information that is known to some people but not to other people.

Asymmetric taxes

A situation wherein participants in a transaction have different net tax rates.

Asymmetry

A lack of equivalence between two things, such as the unequal tax treatment of interest expense and dividend payments.

At-the-money

An option is at-the-money if the strike price of the option is equal to the market price of the underlying security. For example, if xyz stock is trading at 54, then the xyz 54 option is at-the-money.

Attribute bias

The tendency of stocks preferred by the dividend discount model to share certain equity attributes such as low price-earnings ratios, high dividend yield, high book-value ratio or membership in a particular industry sector.

Auction markets

Markets in which the prevailing price is determined through the free interaction of prospective buyers and sellers, as on the floor of the stock exchange.

Auction rate preferred stock (ARPS)

Floating rate preferred stock, the dividend on which is adjusted every seven weeks through a Dutch auction.

Auditor's report

A section of an annual report containing the auditor's opinion about the veracity of the financial statements.

Authorized shares

Number of shares authorized for issuance by a firm's corporate charter.

Autocorrelation

The correlation of a variable with itself over successive time intervals.

Automated Clearing House (ACH)

A collection of 32 regional electronic interbank networks used to process transactions electronically with a guaranteed one-day bank collection float.

Automatic stay

The restricting of liability holders from collection efforts of collateral seizure, which is automatically imposed when a firm files for bankruptcy under Chapter 11.

Autoregressive

Using past data to predict future data.

Availability float

Checks deposited by a company that have not yet been cleared.

Average

An arithmetic mean of selected stocks intended to represent the behavior of the market or some component of it. One good example is the widely quoted Dow Jones Industrial Average, which adds the current prices of the 30 DJIA's stocks, and divides the results by a predetermined number, the divisor.

Average accounting return

The average project earnings after taxes and depreciation divided by the average book value of the investment during its life.

Average (across-day) measures

An estimation of price that uses the average or representative price of a large number of trades.

Average age of accounts receivable

The weighted-average age of all of the firm's outstanding invoices.

Average collection period, or days' receivables

The ratio of accounts receivables to sales, or the total amount of credit extended per dollar of daily sales (average AR/sales * 365).

Average cost of capital

A firm's required payout to the bondholders and to the stockholders expressed as a percentage of capital contributed to the firm. Average cost of capital is computed by dividing the total required cost of capital by the total amount of contributed capital.

Average life

Also referred to as the weighted-average life (WAL). The average number of years that each dollar of unpaid principal due on the mortgage remains outstanding. Average life is computed as the weighted average time to the receipt of all future cash flows, using as the weights the dollar amounts of the principal paydowns.

Average maturity

The average time to maturity of securities held by a mutual fund. Changes in interest rates have greater impact on funds with longer average life.

Average rate of return (ARR)

The ratio of the average cash inflow to the amount invested.

Average tax rate

Taxes as a fraction of income; total taxes divided by total taxable income.

Away

A trade, quote, or market that does not originate with the dealer in question, e.g., ``the bid is 98-10 away from me.''