Finance Glossary

FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) Working Capital Management A managerial accounting strategy focusing on maintaining efficient levels
of both components of working capital, current assets and current liabilities, in respect to each other. Working capital management ensures a company has sufficient cash flow in order to meet its short-term debt obligations and operating expenses. Implementing an effective working capital management system is an excellent way for many companies to improve their earnings. The two main aspects of working capital management are ratio analysis and management of individual components of working capital. A few key performance ratios of a working capital management system are the working capital ratio, inventory turnover and the collection ratio. Ratio analysis will lead management to identify areas of focus such as inventory management, cash management, accounts receivable and payable management. Ratio Analysis A tool used by individuals to conduct a quantitative analysis of information in a company's financial statements. Ratios are calculated from current year numbers and are then compared to previous years, other companies, the industry, or even the economy to judge the performance of the company. Ratio analysis is predominately used by proponents of fundamental analysis. There are many ratios that can be calculated from the financial statements pertaining to a company's performance, activity, financing and liquidity. Some common ratios include the price-earnings ratio, debt-equity ratio, earnings per share, asset turnover and working capital Inventory Turnover A ratio showing how many times a company's inventory is sold and replaced over a period.
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FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) Although the first calculation is more frequently used, COGS (cost of goods sold) may be substituted because sales are recorded at market value, while inventories are usually recorded at cost. Also, average inventory may be used instead of the ending inventory level to minimize seasonal factors This ratio should be compared against industry averages. A low turnover implies poor sales and, therefore, excess inventory. A high ratio implies either strong sales or ineffective buying.High inventory levels are unhealthy because they represent an investment with a rate of return of zero. It also opens the company up to trouble should prices begin to fall. Capital Budgeting The process of determining whether or not projects such as building a new plant or investing in a long-term venture are worthwhile. Also known as "investment appraisal". Popular methods of capital budgeting include net present value (NPV), internal rate of return (IRR), discounted cash flow (DCF) and payback period. Internal Rate Of Return (IRR) The discount rate often used in capital budgeting that makes the net present value of all cash flows from a particular project equal to zero. Generally speaking, the higher a project's internal rate of return, the more desirable it is to undertake the project. As such, IRR can be used to rank several prospective projects a firm is considering. Assuming all other factors are equal among the various projects, the project with the highest IRR would probably be considered the best and undertaken first. IRR is sometimes referred to as "economic rate of return (ERR)". You can think of IRR as the rate of growth a project is expected to generate. While the actual rate of return that a given project ends up generating will often differ from its estimated IRR rate, a project with a substantially higher IRR value than other available options would still provide a much better chance of strong growth. IRRs can also be compared against prevailing rates of return in the securities market. If a firm can't find any projects with IRRs greater than the returns that can be generated in the financial markets, it may simply choose to invest its retained earnings into the market. Supply Chain Management (SCM) The management and coordination of a product's supply chain for the purpose of increasing efficiency and profitability. Typically, SCM will attempt to centrally control or link the production, shipment and distribution of a product. By managing the supply chain, COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 2
FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) companies are able to cut excess fat and provide products faster. This is done by keeping tighter control of internal inventories, internal production, distribution, sales and the inventories of the company's product purchasers. Cash Flow 1. A revenue or expense stream that changes a cash account over a given period. Cash in-flows usually arise from one of three activities financing, operations or investing - though they also occur as a result of donations or gifts in the case of personal finance. Cash out-flows result from expenses or investments. This holds true for both business and personal finance. 2. An accounting statement - the statement of cash flows - that shows the amount of cash generated and used by a company in a given period, calculated by adding non-cash charges (such as depreciation) to net income after taxes. Cash flow can be attributed to a specific project, or to a business as a whole. Cash flow can be used as an indication of a company's financial strength. 1. In business as in personal finance, cash flows are essential to solvency. They can be presented as a record of something that has happened in the past, such as the sale of a particular product, or forecasted into the future, representing what a business or a person expects to take in and to spend. Cash flow is crucial to an entity's survival. Having ample cash on hand will ensure that creditors, employees and others can be paid on time. If a business or person does not have enough cash to support its operations, it is said to be insolvent, and a likely candidate for bankruptcy should the insolvency continue. 2. The statement of a business's cash flows is often used by analysts to gauge financial performance. Companies with ample cash on hand are able to invest the cash back into the business in order to generate more cash and profit Inventory The raw materials, work-in-process goods and completely finished goods that are considered to be the portion of a business's assets that are ready or will be ready for selling. Inventory represents one of the most important assets that most businesses possess, because the turnover of inventory represents one of the primary sources of revenue generation and subsequent earnings for the companies' shareholders/owners Possessing a high amount of inventory for long periods of time is not usually good for a business, because there are inventory storage, obsolescence and spoilage costs. However, possessing not enough COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 3
FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) inventory isn't good either, because the business runs the risk of losing out on potential sales and potential market share as well. Inventory management forecasts and strategies, such as a just-in-time inventory system, can help minimize inventory costs because goods are created or received as inventory only when needed. Free Cash Flow (FCF) A measure of financial performance calculated as operating cash flow minus capital expenditures. In other words, free cash flow (FCF) represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value. Without cash, it's tough to develop new products, make acquisitions, pay dividends and reduce debt.
It can also be calculated by taking operating cash flow and subtracting capital expenditures. Economic Order Quantity (EOQ) An inventory-related equation that determines the optimum order quantity that a company should hold in its inventory given a set cost of production, demand rate and other variables. This is done to minimize variable inventory costs. The full equation is as follows:
where : S = Setup costs D = Demand rate P = Production cost I = Interest rate (considered an opportunity cost, so the risk-free rate can be used) COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 4
FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) The EOQ formula can be modified to determine production levels or order interval lengths, and is used by large corporations around the world, especially those with large supply chains and high variable costs per unit of production. Despite the equation's relative simplicity by today's standards, it is still a core algorithm in the software packages that are sold to the largest companies in the world Capital Expenditure (CAPEX) Funds used by a company to acquire or upgrade physical assets such as property, industrial buildings or equipment. This type of outlay is made by companies to maintain or increase the scope of their operations. These expenditures can include everything from repairing a roof to building a brand new factory The amount of capital expenditures a company is likely to have depends on the industry it occupies. Some of the most capital intensive industries include oil, telecom and utilities. In terms of accounting, an expense is considered to be a capital expenditure when the asset is a newly purchased capital asset or an investment that improves the useful life of an existing capital asset. If an expense is a capital expenditure, it needs to be capitalized; this requires the company to spread the cost of the expenditure over the useful life of the asset. If, however, the expense is one that maintains the asset at its current condition, the cost is deducted fully in the year of the expense Variable Cost A cost that changes in proportion to a change in a company's activity or business A good example of variable cost is the fuel for an airline. This cost changes with the number of flights and how long the trips are. Fixed Cost A cost that remains constant, regardless of any change in a company's activity A good example is a lease payment. If you are leasing a building at $2,000 per month, then you will pay that amount each month, no matter how well or how poorly the business is doing Capital Reserve A type of account on a municipality's or company's balance sheet that is reserved for long-term capital investment projects or any other large and anticipated expense(s) that will be incurred in the future. This type of COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 5
FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) reserve fund is set aside to ensure that the company or municipality has adequate funding to at least partially finance the project Contributions to the capital reserve account can be made from government subsidies, donated funds, or can be set aside from the firm's or municipality's regular revenue-generating operations. Once recorded on the reporting entity's balance sheet, these funds are only to be spent on the capital expenditure projects for which they were initially intended, excluding any unforeseen circumstances Cost-Benefit Analysis A process by which business decisions are analyzed. The benefits of a given situation or business-related action are summed and then the costs associated with taking that action are subtracted. Some consultants or analysts also build the model to put a dollar value on intangible items, such as the benefits and costs associated with living in a certain town. Most analysts will also factor opportunity cost into such equations. Prior to erecting a new plant or taking on a new project, prudent managers will conduct a cost-benefit analysis as a means of evaluating all of the potential costs and revenues that may be generated if the project is completed. The outcome of the analysis will determine whether the project is financially feasible, or if another project should be pursued Balance Sheet A financial statement that summarizes a company's assets, liabilities and shareholders' equity at a specific point in time. These three balance sheet segments give investors an idea as to what the company owns and owes, as well as the amount invested by the shareholders. The balance sheet must follow the following formula: Assets = Liabilities + Shareholders' Equity Each of the three segments of the balance sheet will have many accounts within it that document the value of each. Accounts such as cash, inventory and property are on the asset side of the balance sheet, while on the liability side there are accounts such as accounts payable or long-term debt. The exact accounts on a balance sheet will differ by company and by industry, as there is no one set template that accurately accommodates for the differences between different types of businesses. It's called a balance sheet because the two sides balance out. This makes sense: a company has to pay for all the things it has (assets) by either borrowing money (liabilities) or getting it from shareholders (shareholders' equity). COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 6
FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE)
The balance sheet is one of the most important pieces of financial information issued by a company. It is a snapshot of what a company owns and owes at that point in time. The income statement, on the other hand, shows how much revenue and profit a company has generated over a certain period. Neither statement is better than the other - rather, the financial statements are built to be used together to present a complete picture of a company's finances. Financial Asset An asset that derives value because of a contractual claim. Stocks, bonds, bank deposits, and the like are all examples of financial assets. Unlike land and property--which are tangible, physical assets--financial assets do not necessarily have physical worth. Asset 1. A resource having economic value that an individual, corporation or country owns or controls with the expectation that it will provide future benefit. 2. A balance sheet item representing what a firm owns. 1. Assets are bought to increase the value of a firm or benefit the firm's operations. You can think of an asset as something that can generate cash flow, regardless of whether it's a company's manufacturing equipment or an individual's rental apartment. 2. In the context of accounting, assets are either current or fixed (noncurrent). Current means that the asset will be consumed within one year. Generally this includes things like cash, accounts receivable and inventory. Fixed assets are those that are expected to keep on providing benefit for more than one year, such as equipment, buildings, real estate, etc Contingent Asset An asset in which the possibility of an economic benefit depends solely upon future events that can't be controlled by the company. Due to the uncertainty of the future events, these assets are not placed on the balance sheet. However, they can be found in the company's financial statement notes These assets, which are often simply rights to a future potential claim, are based on past events. An example might be a potential settlement from a lawsuit. The company does not have enough certainty to place the settlement value on the balance sheet, so it can only talk about the COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com
FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) potential in the notes. This improves the accuracy of financial statements and removes potential abuses Liability A company's legal debts or obligations that arise during the course of business operations. These are settled over time through the transfer of economic benefits including money, goods or services. Recorded on the balance sheet (right side), liabilities include loans, accounts payable, mortgages, deferred revenues and accrued expenses. Liabilities are a vital aspect of a company's operations because they are used to finance operations and pay for large expansions. They can also make transactions between businesses more efficient. For example, the outstanding money that a company owes to its suppliers would be considered a liability. Outside of accounting and finance this term simply refers to any money or service that is currently owed to another party. One form of liability, for example, would be the property taxes that a homeowner owes to the municipal government. Current liabilities are debts payable within one year, while long-term liabilities are debts payable over a longer period. Income Statement A financial statement that measures a company's financial performance over a specific accounting period. Financial performance is assessed by giving a summary of how the business incurred its revenues and expenses - due to both operating and non-operating activities. It also shows the net profit or loss incurred over a specific accounting period, typically over a fiscal quarter or year. Also known as the "profit and loss statement" or "statement of revenue and expense". The income statement is the one of the three major financial statements, the other two being the balance sheet and the statement of cash flows. The income statement is divided into two parts: the operating and nonoperating sections. The portion of the income statement that deals with operating items is interesting to investors and analysts alike because this section discloses information about revenues and expenses that are a direct result of the regular business operations. For example, if a business creates sports equipment, then the operating items section would talk about the revenues and expenses involved with the production of sports equipment. COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com
FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) The non-operating items section discloses revenue and expense information about activities that are not tied directly to a company's regular operations. For example, if the sport equipment company sold a factory and some old plant equipment, then this information would be in the non-operating items section Tangible Asset An asset that has a physical form such as machinery, buildings and land This is the opposite of an intangible asset such as a patent or trademark. Whether an asset is tangible or intangible isn't inherently good or bad. For example, a well-known brand name can be very valuable to a company. On the other hand, if you produce a product solely for a trademark, at some point you need to have "real" physical assets to produce it. Profit The same as net income: total earnings less expenses In other words, profit is the money a business makes after accounting for all the expenses. Profit is the goal of every company. Loan When a lender gives money or property to a borrower, and the borrower agrees to return the property or repay the borrowed money, along with interest, at a predetermined date in the future Borrowing money to buy a new car is a loan, as is borrowing money for home improvements Profitability Ratios A class of financial metrics that are used to assess a business's ability to generate earnings as compared to its expenses and other relevant costs incurred during a specific period of time. For most of these ratios, having a higher value relative to a competitor's ratio or the same ratio from a previous period is indicative that the company is doing well Some examples of profitability ratios are profit margin, return on assets and return on equity. It is important to note that a little bit of background knowledge is necessary in order to make relevant comparisons when analyzing these ratios. For instances, some industries experience seasonality in their operations. The retail industry, for example, typically experiences higher revenues and earnings for the Christmas season. Therefore, it would not be too useful to compare a retailer's 4th quarter profit margin with its 1st quarter profit margin. On the other hand, comparing a retailer's 4th quarter profit margin with the profit margin from the same period a year before would be far more informative COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 9
Mortgage A debt instrument that is secured by the collateral of specified real estate property and that the borrower is obliged to pay back with a predetermined set of payments. Mortgages are used by individuals and businesses to make large purchases of real estate without paying the entire value of the purchase up front. Mortgages are also known as "liens against property", or "claims on property". In a residential mortgage, a homebuyer pledges his or her house to the bank. The bank has a claim on the house should the homebuyer default on paying the mortgage. In the case of a foreclosure, the bank may evict the home's tenants and sell the house, using the income from the sale to clear the mortgage debt Opportunity Cost 1. The cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the benefits you could have received by taking an alternative action. 2. The difference in return between a chosen investment and one that is necessarily passed up. Say you invest in a stock and it returns a paltry 2% over the year. In placing your money in the stock, you gave up the opportunity of another investment - say, a risk-free government bond yielding 6%. In this situation, your opportunity costs are 4% (6%-2%) 1. The opportunity cost of going to college is the money you would have earned if you worked instead. On the one hand, you lose four years of salary while getting your degree; on the other hand, you hope to earn more during your career, thanks to your education, to offset the lost wages. Here's another example: if a gardener decides to grow carrots, his or her opportunity cost is the alternative crop that might have been grown instead (potatoes, tomatoes, pumpkins, etc.). In both cases, a choice between two options must be made. It would be an easy decision if you knew the end outcome; however, the risk that you could achieve greater "benefits" (be they monetary or Profit and Loss Statement (P&L) A financial statement that summarizes the revenues, costs and expenses incurred during a specific period of time - usually a fiscal quarter or year. These records provide information that shows the ability of a company to generate profit by increasing revenue and reducing costs. The P&L COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 10
FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) statement is also known as a "statement of profit and loss", an "income statement" or an "income and expense statement". The statement of profit and loss follows a general format that begins with an entry for revenue and subtracts from revenue the costs of running the business, including cost of goods sold, operating expenses, tax expense and interest expense. The bottom line (literally and figuratively) is net income (profit). The balance sheet, income statement and statement of cash flows are the most important financial statements produced by a company. While each is important in its own right, they are meant to be analyzed together. Economics A social science that studies how individuals, governments, firms and nations make choices on allocating scarce resources to satisfy their unlimited wants. Economics can generally be broken down into macroeconomics, which concentrates on the behavior of the aggregate economy, and microeconomics, which focuses on individual consumers. Economics is often referred to as "the dismal science". Two of the major approaches in economics are named the classical and Keynesian approaches. Classical economists believe that markets function very well, will quickly react to any changes in equilibrium and that a "laissez faire" government policy works best. On the other hand, Keynesian economists believe that markets react very slowly to changes in equilibrium (especial to changes in prices) and that active government intervention is sometimes the best method to get the economy back into equilibrium Annual Report 1. An annual publication that public corporations must provide to shareholders to describe their operations and financial conditions. The front part of the report often contains an impressive combination of graphics, photos and an accompanying narrative, all of which chronicle the company's activities over the past year. The back part of the report contains detailed financial and operational information. 2. In the case of mutual funds, an annual report is a required document that is made available to fund shareholders on a fiscal year basis. It discloses certain aspects of a fund's operations and financial condition. In contrast to corporate annual reports, mutual fund annual reports are best described as "plain vanilla" COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 11
FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) in terms of their presentation. 1. It was not until legislation was enacted after the stock market crash in 1929 that the annual report became a regular component of corporate financial reporting. Typically, an annual report will contain the following sections: -Financial Highlights -Letter to the Shareholders -Narrative Text, Graphics and Photos -Management's Discussion and Analysis -Financial Statements -Notes to Financial Statements -Auditor's Report -Summary Financial Data -Corporate Information 2. A mutual fund annual report, along with a fund's prospectus and statement of additional information, is a source of multi-year fund data and performance, which is made available to fund shareholders as well as to prospective fund investors. Unfortunately, most of the information is quantitative rather than qualitative, which addresses the mandatory accounting disclosures required of mutual funds.
Premium 1. The total cost of an option. 2. The difference between the higher price paid for a fixed-income security and the security's face amount at issue. 3. The specified amount of payment required periodically by an insurer to provide coverage under a given insurance plan for a defined period of time. The premium is paid by the insured party to the insurer, and primarily compensates the insurer for bearing the risk of a payout should the insurance agreement's coverage be required. 1. The premium of an option is basically the sum of the option's COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 12
FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) intrinsic and time value. It is important to note that volatility also affects the premium. 2. If a fixed-income security (bond) is purchased at a premium, existing interest rates are lower than the coupon rate. Investors pay a premium for an investment that will return an amount greater than existing interest rates. 3. A common example of an insurance premium comes from auto insurance. A vehicle owner can insure the value of his or her vehicle against loss resulting from accident, theft and other potential problems. The owner usually pays a fixed premium amount in exchange for the insurance company's guarantee to cover any economic losses incurred under the scope of the agreement. Fundamental Analysis A method of evaluating a security by attempting to measure its intrinsic value by examining related economic, financial and other qualitative and quantitative factors. Fundamental analysts attempt to study everything that can affect the security's value, including macroeconomic factors (like the overall economy and industry conditions) and individually specific factors (like the financial condition and management of companies). The end goal of performing fundamental analysis is to produce a value that an investor can compare with the security's current price in hopes of figuring out what sort of position to take with that security (underpriced = buy, overpriced = sell or short). This method of security analysis is considered to be the opposite of technical analysis. Fundamental analysis is about using real data to evaluate a security's value. Although most analysts use fundamental analysis to value stocks, this method of valuation can be used for just about any type of security. For example, an investor can perform fundamental analysis on a bond's value by looking at economic factors, such as interest rates and the overall state of the economy, and information about the bond issuer, such as potential changes in credit ratings. For COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 13
FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) assessing stocks, this method uses revenues, earnings, future growth, return on equity, profit margins and other data to determine a company's underlying value and potential for future growth. In terms of stocks, fundamental analysis focuses on the financial statements of a the company being evaluated. One of the most famous and successful users of fundamental analysis is the Oracle of Omaha, Warren Buffett, who has been well known for successfully employing fundamental analysis to pick securities. His abilities have turned him into a billionaire. Intrinsic Value 1. The actual value of a company or an asset based on an underlying perception of its true value including all aspects of the business, in terms of both tangible and intangible factors. This value may or may not be the same as the current market value. Value investors use a variety of analytical techniques in order to estimate the intrinsic value of securities in hopes of finding investments where the true value of the investment exceeds its current market value. 2. For call options, this is the difference between the underlying stock's price and the strike price. For put options, it is the difference between the strike price and the underlying stock's price. In the case of both puts and calls, if the respective difference value is negative, the instrinsic value is given as zero. 1. For example, value investors that follow fundamental analysis look at both qualitative (business model, governance, target market factors etc.) and quantitative (ratios, financial statement analysis, etc.) aspects of a business to see if the business is currently out of favor with the market and is really worth much more than its current valuation. 2. Intrinsic value in options is the in-the-money portion of the option's premium. For example, If a call options strike price is $15 and the underlying stock's market price is at $25, then the intrinsic value of the call option is $10. An option is usually never worth less than what an option holder can receive if the option is exercised. Book Value COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com
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1. The value at which an asset is carried on a balance sheet. In other words, the cost of an asset minus accumulated depreciation. 2. The net asset value of a company, calculated by total assets minus intangible assets (patents, goodwill) and liabilities. 3. The initial outlay for an investment. This number may be net or gross of expenses such as trading costs, sales taxes, service charges and so on. In the U.K., book value is known as "net asset value". Book value is the accounting value of a firm. It has two main uses: 1. It is the total value of the company's assets that shareholders would theoretically receive if a company were liquidated. 2. By being compared to the company's market value, the book value can indicate whether a stock is under- or overpriced. 3. In personal finance, the book value of an investment is the price paid for a security or debt investment. When a stock is sold, the selling price less the book value is the capital gain (or loss) from the investment. Depreciation 1. In accounting, an expense recorded to allocate a tangible asset's cost over its useful life. Because depreciation is a noncash expense, it increases free cash flow while decreasing reported earnings. 2. A decrease in the value of a particular currency relative to other currencies. 1. Depreciation is used in accounting to try to match the expense of an asset to the income that the asset helps the company earn. For example, if a company buys a piece of equipment for $1 million and expects it to have a useful life of 10 years, it will be depreciated over 10 years. Every accounting year, the company COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 15
FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) will expense $100,000 (assuming straight-line depreciation), which will be matched with the money that the equipment helps to make each year. 2. Examples of currency depreciation are the infamous Russian ruble crisis in 1998, which saw the ruble lose 25% of its value in one day. Share Capital Funds raised by issuing shares in return for cash or other considerations. The amount of share capital a company has can change over time because each time a business sells new shares to the public in exchange for cash, the amount of share capital will increase. Share capital can be composed of both common and preferred shares. Also known as "equity financing". The amount of share capital a company reports on its balance sheet only accounts for the initial amount for which the original shareholders purchased the shares from the issuing company. Any price differences arising from price appreciation/depreciation as a result of transactions in the secondary market are not included. For example, suppose ABC Inc. raised $2 billion from its initial public offering. Over the next year, the total value of its shares increases to $5 billion. In this case, the value of the share capital is still only $2 billion because ABC Inc. had received only $2 billion from the sale of its securities to the investing public. Shares A unit of ownership interest in a corporation or financial asset. While owning shares in a business does not mean that the shareholder has direct control over the business''''''''''''''''s day-to-day operations, being a shareholder does entitle the possessor to an equal distribution in any profits, if any are declared in the form of dividends. The two main types of shares are common shares and preferred shares. COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com
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FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) In the past, shareholders received a physical paper stock certificate that indicated that they owned "x" shares in a company. Today, brokerages have electronic records that show ownership details. Owning a "paperless" share makes conducting trades a simpler and more streamlined process, which is a far cry from the days were stock certificates needed to be taken to a brokerage before a trade could be conducted. While shares are often used to refer to the stock of a corporation, shares can also represent ownership of other classes of financial assets, such as mutual funds. Stock A type of security that signifies ownership in a corporation and represents a claim on part of the corporation's assets and earnings. There are two main types of stock: common and preferred. Common stock usually entitles the owner to vote at shareholders' meetings and to receive dividends. Preferred stock generally does not have voting rights, but has a higher claim on assets and earnings than the common shares. For example, owners of preferred stock receive dividends before common shareholders and have priority in the event that a company goes bankrupt and is liquidated. Also known as "shares" or "equity". A holder of stock (a shareholder) has a claim to a part of the corporation's assets and earnings. In other words, a shareholder is an owner of a company. Ownership is determined by the number of shares a person owns relative to the number of outstanding shares. For example, if a company has 1,000 shares of stock outstanding and one person owns 100 shares, that person would own and have claim to 10% of the company's assets. Stocks are the foundation of nearly every portfolio. Historically, they have outperformed most other investments over the long run. Sensex COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com
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An abbreviation of the Bombay Exchange Sensitive Index (Sensex) - the benchmark index of the Bombay Stock Exchange (BSE). It is composed of 30 of the largest and most activelytraded stocks on the BSE. Initially compiled in 1986, the Sensex is the oldest stock index in India. The index is calculated based on a free-float capitalization method when weighting the effect of a company on the index. This is a variation of the market cap method, but instead of using a company's outstanding shares it uses its float, or shares that are readily available for trading. The free-float method, therefore, does not include restricted stocks, such as those held by company insiders that can't be readily sold. To find the free-float capitalization of a company, first find its market cap (number of outstanding shares x share price) then multiply its free-float factor. The free-float factor is determined by the percentage of floated shares to outstanding. For example, if a company has a float of 10 million shares and outstanding shares of 12 million, the percent of float to outstanding is 83%. A company with an 83% free float falls in the 80-85% free-float factor, or 0.85, which is then multiplied by its market cap (e.g., $120 million (12 million shares x .$10/share) x 0.85 = $102 million free-float capitalization). Shareholder Any person, company, or other institution that owns at least 1 share in a company. A shareholder may also be referred to as a stockholder. Shareholders are the owners of a company. They have the potential to profit if the company does well, but that comes with the potential to lose if the company does poorly. Market Capitalization The total dollar market value of all of a company's outstanding shares. Market capitalization is calculated by multiplying a company's shares outstanding by the current market price of one share. The investment community uses this figure to determining COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 18
FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) a company's size, as opposed to sales or total asset figures. Frequently referred to as "market cap". If a company has 35 million shares outstanding, each with a market value of $100, the company's market capitalization is $3.5 billion (35,000,000 x $100 per share). Company size is a basic determinant of asset allocation and riskreturn parameters for stocks and stock mutual funds. The term should not be confused with a company's "capitalization," which is a financial statement term that refers to the sum of a company's shareholders' equity plus long-term debt. The stocks of large, medium and small companies are referred to as large-cap, mid-cap, and small-cap, respectively. Investment professionals differ on their exact definitions, but the current approximate categories of market capitalization are: Large Cap: $10 billion plus Mid Cap: $2 billion to $10 billion Small Cap: Less than $2 billion
Nifty 50 The 50 stocks that were most favored by institutional investors in the 1960s and 1970s. Companies in this group were usually characterized by consistent earnings growth and high P/E ratios. The nifty-50 stocks got their notoriety in the bull markets of the 1960s and early 1970s. They became known as "one-decision" stocks because investors were told they could buy and hold forever. Examples of nifty-50 stocks included General Electric, Coca-Cola, and IBM. However, part of this list included companies that have been troubled in the last decade, such as Xerox and Polaroid. General Ledger COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 19
A company's accounting records. This formal ledger contains all the financial accounts and statements of a business. The ledger uses two columns: one records debits, the other has offsetting credits Bond A debt investment in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate. Bonds are used by companies, municipalities, states and U.S. and foreign governments to finance a variety of projects and activities. Bonds are commonly referred to as fixed-income securities and are one of the three main asset classes, along with stocks and cash equivalents.. The indebted entity (issuer) issues a bond that states the interest rate (coupon) that will be paid and when the loaned funds (bond principal) are to be returned (maturity date). Interest on bonds is usually paid every six months (semi-annually). The main categories of bonds are corporate bonds, municipal bonds, and U.S. Treasury bonds, notes and bills, which are collectively referred to as simply "Treasuries." Two features of a bond - credit quality and duration - are the principal determinants of a bond's interest rate. Bond maturities range from a 90-day Treasury bill to a 30-year government bond. Corporate and municipals are typically in the 3-10-year range.
Trial Balance A bookkeeping worksheet in which the balances of all ledgers are compiled into debit and credit columns. A company prepares a trial balance periodically, usually at the end of every reporting period. The general purpose of producing a trial balance is to ensure the entries in a company's bookkeeping system are mathematically correct. COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 20
Preparing a trial balance for a company serves to detect any mathematical errors that have occurred in the double-entry accounting system. Provided the total debts equal the total credits, the trial balance is considered to be balanced, and there should be no mathematical errors in the ledgers. However, this does not mean there are no errors in a company's accounting system. For example, transactions classified improperly or those simply missing from the system could still be material accounting errors that would not be detected by the trial balance procedure Stagflation A condition of slow economic growth and relatively high unemployment - a time of stagnation - accompanied by a rise in prices, or inflation. Stagflation occurs when the economy isn't growing but prices are, which is not a good situation for a country to be in. This happened to a great extent during the 1970s, when world oil prices rose dramatically, fueling sharp inflation in developed countries. For these countries, including the U.S., stagnation increased the inflationary effects. Zero-Coupon Bond A debt security that doesn't pay interest (a coupon) but is traded at a deep discount, rendering profit at maturity when the bond is redeemed for its full face value. Also known as an "accrual bond". Some zero-coupon bonds are issued as such, while others are bonds that have been stripped of their coupons by a financial institution and then repackaged as zero-coupon bonds. Because they offer the entire payment at maturity, zero-coupon bonds tend to fluctuate in price much more than coupon bonds. Consumer Price Index (CPI) COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 21
A measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. The CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them; the goods are weighted according to their importance. Changes in CPI are used to assess price changes associated with the cost of living. Sometimes referred to as "headline inflation".
The U.S. Bureau of Labor Statistics measures two kinds of CPI statistics: CPI for urban wage earners and clerical workers (CPIW), and the chained CPI for all urban consumers (C-CPI-U). Of the two types of CPI, the C-CPI-U is a better representation of the general public, because it accounts for about 87% of the population. CPI is one of the most frequently used statistics for identifying periods of inflation or deflation. This is because large rises in CPI during a short period of time typically denote periods of inflation and large drops in CPI during a short period of time usually mark periods of deflation. Discount The condition of the price of a bond that is lower than par. The discount equals the difference between the price paid for a security and the security's par value. For example, if a bond with a par value of $1,000 is currently selling for $990 dollars, it is selling at a discount. Business 1. An organization or enterprising entity engaged in commercial, industrial or professional activities. A business can be a for-profit entity, such as a publicly-traded corporation, or a nonprofit organization engaged in business activities, such as an agricultural cooperative. COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 22
FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) 2. Any commercial, industrial or professional activity undertaken by an individual or a group. 3. A reference to a specific area or type of economic activity. 1. Businesses include everything from a small owner-operated company such as a family restaurant, to a multinational conglomerate such as General Electric. 2. To "do business" with another company, a business must engage in some kind of transaction or exchange of value with that company. 3. In this sense, the word "business" can be used to refer to a specific industry or activity, such as the "real estate business" or the "advertising business Entrepreneur An individual who, rather than working as an employee, runs a small business and assumes all the risk and reward of a given business venture, idea, or good or service offered for sale. The entrepreneur is commonly seen as a business leader and innovator of new ideas and business processes. Entrepreneurs play a key role in any economy. These are the people who have the skills and initiative necessary to take good new ideas to market and make the right decisions to make the idea profitable. The reward for the risks taken is the potential economic profits the entrepreneur could earn Retail Banking Retail banking is typical mass-market banking where individual customers use local branches of larger commercial banks. Services offered include: savings and checking accounts, mortgages, personal loans, debit cards, credit cards, and so forth. This is very different from wholesale banking Small And Midsize Enterprises (SME) COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 23
A business that maintains revenues or a number of employees below a certain standard. Every country has its own definition of what is considered a small and medium-sized enterprise. In the United States, there is no distinct way to identify SME; it typically it depends on the industry in which the company competes. In the European Union, a small-sized enterprise is a company with fewer than 50 employees, while a medium-sized enterprise is one with fewer than 250 employees. SME firms tend to spend a lot of money on IT and, as a result, these businesses are strongest in the area of innovation. The need to attract capital to fund projects is therefore essential for small and medium-sized enterprises. To be competitive SME firms require "out of the box" solutions, even if they involve surrendering some functionality. Bank A commercial institution licensed as a receiver of deposits. Banks are mainly concerned with making and receiving payments as well as supplying short-term loans to individuals. In most countries banks are supervised by the national government or central bank. Capital 1. Financial assets or the financial value of assets such as cash. 2. The factories, machinery and equipment owned by a business. Capital is an extremely vague term whose specific definition depends on the context in which it is used. In general, it refers to financial resources available for use. Security An instrument representing ownership (stocks), a debt agreement (bonds), or the rights to ownership (derivatives). COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 24
A security is essentially a contract that can be assigned a value and traded. Examples of a security include a note, stock, preferred share, bond, debenture, option, future, swap, right, warrant, or virtually any other financial asset. Derivative In finance, a security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterized by high leverage. Futures contracts, forward contracts, options and swaps are the most common types of derivatives. Because derivatives are just contracts, just about anything can be used as an underlying asset. There are even derivatives based on weather data, such as the amount of rain or the number of sunny days in a particular region. Derivatives are generally used to hedge risk, but can also be used for speculative purposes. For example, a European investor purchasing shares of an American company off of an American exchange (using American dollars to do so) would be exposed to exchange-rate risk while holding that stock. To hedge this risk, the investor could purchase currency futures to lock in a specified exchange rate for the future stock sale and currency conversion back into euros. Portfolio Management The art and science of making decisions about investment mix and policy, matching investments to objectives, asset allocation for individuals and institutions, and balancing risk against. performance. Portfolio management is all about strengths, weaknesses, COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 25
FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) opportunities, and threats in the choice of debt vs. equity, domestic vs. international, growth vs. safety, and many other tradeoffs encountered in the attempt to maximize return at a given appetite for risk.
In the case of mutual and exchange-traded funds, there are two forms of portfolio management: passive and active. Passive management simply tracks a market index, commonly referred to as indexing or index investing. Active management involves a single manager, co-managers, or a team of managers who attempt to beat the market return by actively managing a fund's portfolio through investment decisions based on research and decisions on individual holdings. Closed-end funds are generally actively managed. Equity 1. A stock or any other security representing an ownership interest. 2. On a company's balance sheet, the amount of the funds contributed by the owners (the stockholders) plus the retained earnings (or losses). Also referred to as "shareholders' equity". 3. In the context of margin trading, the value of securities in a margin account minus what has been borrowed from the brokerage. 4. In the context of real estate, the difference between the current market value of the property and the amount the owner still owes on the mortgage. It is the amount that the owner would receive after selling a property and paying off the mortgage. 5. In terms of investment strategies, equity (stocks) is one of the principal asset classes. The other two are fixed-income (bonds) and cash/cash-equivalents. These are used in asset allocation planning to structure a desired risk and return profile for an investor's portfolio. The term's meaning depends very much on the context. In general, you can think of equity as ownership in any asset after all debts associated with that asset are paid off. For example, a COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 26
FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) car or house with no outstanding debt is considered the owner's equity because he or she can readily sell the item for cash. Stocks are equity because they represent ownership in a company.
Assets Under Management (AUM) In general, the market value of assets an investment company manages on behalf of investors. There are widely differing views on what the term means. Some financial institutions include bank deposits, mutual funds and institutional money in their calculations. Others limit it to funds under discretionary management where the client delegates responsibility to the company Repurchase Agreement (Repo) A form of short-term borrowing for dealers in government securities. The dealer sells the government securities to investors, usually on an overnight basis, and buys them back the following day. For the party selling the security (and agreeing to repurchase it in the future) it is a repo; for the party on the other end of the transaction, (buying the security and agreeing to sell in the future) it is a reverse repurchase agreement. Repos are classified as a money-market instrument. They are usually used to raise short-term capital. Participatory Notes Financial instruments used by investors or hedge funds that are not registered with the Securities and Exchange Board of India to invest in Indian securities. Indian-based brokerages buy India-based securities and then issue participatory notes to foreign investors. Any dividends or capital gains collected from the underlying securities go back to the investors.
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FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) In many ways, this is similar to an informal ADR process, where brokerages hold on to stocks for foreign investors. However, Indian regulators are not very happy about participatory notes because they have no way to know who owns the underlying securities. Regulators fear that hedge funds acting through participatory notes will cause economic volatility in India's exchanges. Broker 1. An individual or firm that charges a fee or commission for executing buy and sell orders submitted by an investor. 2. The role of a firm when it acts as an agent for a customer and charges the customer a commission for its services. 3. A licensed real estate professional who typically represents the seller of a property. A broker's duties may include: determining market values, advertising properties for sale, showing properties to prospective buyers, and advising clients with regard to offers and related matters. Traditionally, only the wealthy could afford a broker and access the stock market. The Internet triggered an explosion of discount brokers; brokers that let you trade at a smaller fee, but don't provide personalized advice. Because of discount brokers, almost anybody can afford to invest in the market Dividend 1. A distribution of a portion of a company's earnings, decided by the board of directors, to a class of its shareholders. The dividend is most often quoted in terms of the dollar amount each share receives (dividends per share). It can also be quoted in terms of a percent of the current market price, referred to as dividend yield. 2. Mandatory distributions of income and realized capital gains made to mutual fund investors. 1. Dividends may be in the form of cash, stock or property. Most secure and stable companies offer dividends to their stockholders. Their share prices might not move much, but the COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 28
FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) dividend attempts to make up for this. High-growth companies rarely offer dividends because all of their profits are reinvested to help sustain higher-than-average growth. 2. Mutual funds pay out interest and dividend income received from their portfolio holdings as dividends to fund shareholders. In addition, realized capital gains from the portfolio's trading activities are generally paid out (capital gains distribution) as a year-end dividend. Foreign Direct Investment (FDI) An investment abroad, usually where the company being invested in is controlled by the foreign corporation. An example of FDI is an American company taking a majority stake in a company in China Foreign Institutional Investor (FII) An investor or investment fund that is from or registered in a country outside of the one in which it is currently investing. Institutional investors include hedge funds, insurance companies, pension funds and mutual funds. The term is used most commonly in India to refer to outside companies investing in the financial markets of India. International institutional investors must register with the Securities and Exchange Board of India to participate in the market. One of the major market regulations pertaining to FIIs involves placing limits on FII ownership in Indian companies. Special Economic Zone (SEZ) Designated areas in countries that possess special economic regulations that are different from other areas in the same country. Moreover, these regulations tend to contain measures that are conducive to foreign direct investment. Conducting business in a SEZ usually means that a company will receive tax incentives and the opportunity to pay lower tariffs. COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 29
While many countries have set up special economic zones, China has been the most successful in using SEZ to attract foreign capital. In fact, China has even declared an entire province (Hainan) to be an SEZ, which is quite distinct, as most SEZs are cities. Securities And Exchange Board Of India (SEBI) The regulatory body for the investment market in India. The purpose of this board is to maintain stable and efficient markets by creating and enforcing regulations in the marketplace. The Securities and Exchange Board of India is similar to the U.S. SEC. The SEBI is relatively new (1992) but is a vital component in improving the quality of the financial markets in India, both by attracting foreign investors and protecting Indian investors. Dalal Street A term that refers to the Bombay Stock Exchange, the major stock exchange in India. The street is home not only the Bombay Stock Exchange but also a large number of other financial institutions. The term "Dalal Street" is used in the same way as "Wall Street" in the U.S., referring to the country's major stock exchanges and overall financial system. These terms are often seen in the financial media. International Monetary Fund (IMF) An international organization created for the purpose of: 1. Promoting global monetary and exchange stability. 2. Facilitating the expansion and balanced growth of international trade. 3. Assisting in the establishment of a multilateral system of payments for current transactions. COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 30
The IMF plays three major roles in the global monetary system. The Fund surveys and monitors economic and financial developments, lends funds to countries with balance-of-payment difficulties, and provides technical assistance and training for countries requesting it Balance Of Payments (BOP) A record of all transactions made between one particular country and all other countries during a specified period of time. BOP compares the dollar difference of the amount of exports and imports, including all financial exports and imports. A negative balance of payments means that more money is flowing out of the country than coming in, and vice versa. Balance of payments may be used as an indicator of economic and political stability. For example, if a country has a consistently positive BOP, this could mean that there is significant foreign investment within that country. It may also mean that the country does not export much of its currency. This is just another economic indicator of a country's relative value and, along with all other indicators, should be used with caution. The BOP includes the trade balance, foreign investments and investments by foreigners. Balance Of Trade - BOT The largest component of a country's balance of payments. It is the difference between exports and imports. Debit items include imports, foreign aid, domestic spending abroad and domestic investments abroad. Credit items include exports, foreign spending in the domestic economy and foreign investments in the domestic economy. A country has a trade deficit if it imports more than it exports; the opposite scenario is a trade surplus. The balance of trade is one of the most misunderstood indicators of the U.S. economy. For example, many people believe that a trade deficit is a bad thing. However, whether a trade deficit is bad thing or not is relative to the business cycle and economy. In a recession, countries like to export more, creating jobs and demand. In a strong expansion, countries like to import more, COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 31
FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) providing price competition, which limits inflation and, without increasing prices, provides goods beyond the economy's ability to meet supply. Thus, a trade deficit is not a good thing during a recession but may help during an expansion. Special Drawing Rights (SDR) An international type of monetary reserve currency, created by the International Monetary Fund (IMF) in 1969, which operates as a supplement to the existing reserves of member countries. Created in response to concerns about the limitations of gold and dollars as the sole means of settling international accounts, SDRs are designed to augment international liquidity by supplementing the standard reserve currencies. You can think of SDRs as an artificial currency used by the IMF and defined as a "basket of national currencies". The IMF uses SDRs for internal accounting purposes. SDRs are allocated by the IMF to its member countries and are backed by the full faith and credit of the member countries' governments.
Dumping 1. In international trade, this occurs when one country exports a significant amount of goods to another country at prices much lower than in the domestic market. 2. A slang term for selling a stock with little regard for price. 1. Dumping is fought through the use of tariffs and quotas Quota In the context of international trade, this is a limit put on the amount of a specific good that can be imported. Quotas are used to prevent other countries from "dumping." Tariff COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 32
FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) A taxation imposed on goods and services imported into a country. Also known as a duty tax. Governments generally impose tariffs to raise revenue and protect domestic industries from foreign competition caused by factors like government subsidies, or lower priced goods and services Reserve Bank Of India (RBI) The central bank of India, which was established on April 1, 1935, under the Reserve Bank of India Act. The RBI uses monetary policy to create financial stability in India and is charged with regulating the country's currency and credit systems. Located in Mumbai, the Reserve Bank of India serves the financial market in many ways. One of its most important functions is establishing an overnight interbank lending rate. The Mumbai Interbank Offer Rate, or MIBOR, serves as a benchmark for interest rate related financial instruments in India Interbank Rate The rate of interest charged on short-term loans made between banks. Banks borrow and lend money in the interbank market in order to manage liquidity and meet the requirements placed on them. The interest rate charged depends on the availability of money in the market, on prevailing rates and on the specific terms of the contract, such as term length. \ Banks are required to hold an adequate amount of liquid assets, such as cash, to manage any potential withdrawals from clients. If a bank can't meet these liquidity requirements, it will need to borrow money in the interbank market to cover the shortfall. Some banks, on the other hand, have excess liquid assets above and beyond the liquidity requirements. These banks will lend money in the interbank market, receiving interest on the assets. There is a wide range of published interbank rates, including the LIBOR, which is set daily based on the average rates on loans made within the London interbank market COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com
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Money Market The securities market dealing in short-term debt and monetary instruments. Money market instruments are forms of debt that mature in less than one year and are very liquid. Treasury bills make up the bulk of the money market instruments. Securities in the money market are relatively riskfree Certificate Of Deposit (CD) A savings certificate entitling the bearer to receive interest. A CD bears a maturity date, a specified fixed interest rate and can be issued in any denomination. CDs are generally issued by commercial banks and are insured by the FDIC. The term of a CD generally ranges from one month to five years. A certificate of deposit is a promissory note issued by a bank. It is a time deposit that restricts holders from withdrawing funds on demand. Although it is still possible to withdraw the money, this action will often incur a penalty. For example, let's say that you purchase a $10,000 CD with an interest rate of 5% compounded annually and a term of one year. At year's end, the CD will have grown to $10,500 ($10,000 * 1.05). CDs of less than $100,000 are called "small CDs"; CDs for more than $100,000 are called "large CDs" or "jumbo CDs". Almost all large CDs, as well as some small CDs, are negotiable. Commercial Paper An unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories and meeting short-term liabilities. Maturities on commercial paper rarely range any longer than 270 days. The debt is usually issued at a discount, reflecting prevailing market interest rates.
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FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) Commercial paper is not usually backed by any form of collateral, so only firms with high-quality debt ratings will easily find buyers without having to offer a substantial discount (higher cost) for the debt issue. A major benefit of commercial paper is that it does not need to be registered with the Securities and Exchange Commission (SEC) as long as it matures before nine months (270 days), making it a very cost-effective means of financing. The proceeds from this type of financing can only be used on current assets (inventories) and are not allowed to be used on fixed assets, such as a new plant, without SEC involvement. Hypothecation When a person pledges a mortgage as collateral for a loan, it refers to the right that a banker has to liquidate goods if you fail to service a loan. The term also applies to securities in a margin account used as collateral for money loaned from a brokerage. \ You are said to "hypothecate" the mortgage when you pledge it as collateral for a loan
Pledged Asset An asset that is transferred to a lender for the purpose of securing debt. The lender of the debt maintains possession of the pledged asset, but does not have ownership unless default occurs. \ A pledged asset is returned to the borrower when all conditions of the debt have be satisfied. Home buyers can sometimes pledge assets, such as securities, to lending institutions in order to reduce the necessary down payment. Thus, these securities would not have to be sold in order to meet the down-payment requirements, allowing for any capital appreciation while maintaining the associate mortgage benefits Capital Appreciation COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 35
FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) A rise in the market price of an asset. Capital appreciation is one of two major ways for investors to profit from an investment in a company. The other is through dividend income Capital Gain 1. An increase in the value of a capital asset (investment or real estate) that gives it a higher worth than the purchase price. The gain is not realized until the asset is sold. A capital gain may be short term (one year or less) or long term (more than one year) and must be claimed on income taxes. A capital loss is incurred when there is a decrease in the capital asset value compared to its purchase price. 2. Profit that results when the price of a security held by a mutual fund rises above its purchase price and the security is sold (realized gain). If the security continues to be held, the gain is unrealized. A capital loss would occur when the opposite takes place \ 1. Long-term capital gains are usually taxed at a lower rate than regular income. This is done to encourage entrepreneurship and investment in the economy. 2. Tax conscious mutual fund investors should determine a mutual fund's unrealized accumulated capital gains, which are expressed as a percentage of its net assets, before investing in a fund with a significant unrealized capital gain component. This circumstance is referred to as a fund's capital gains exposure. When distributed by a fund, capital gains are a taxable obligation for the fund's investors Gross Domestic Product (GDP) The monetary value of all the finished goods and services produced within a country's borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory. COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 36
GDP = C + G + I + NX where: "C" is equal to all private consumption, or consumer spending, in a nation's economy "G" is the sum of government spending "I" is the sum of all the country's businesses spending on capital "NX" is the nation's total net exports, calculated as total exports minus total imports. (NX = Exports - Imports) GDP is commonly used as an indicator of the economic health of a country, as well as to gauge a country's standard of living. Critics of using GDP as an economic measure say the statistic does not take into account the underground economy transactions that, for whatever reason, are not reported to the government. Others say that GDP is not intended to gauge material well-being, but serves as a measure of a nation's productivity, which is unrelated.
Inflation The rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling. As inflation rises, every dollar will buy a smaller percentage of a good. For example, if the inflation rate is 2%, then a $1 pack of gum will cost $1.02 in a year. Most countries' central banks will try to sustain an inflation rate of 2-3%.
What is the relationship between oil prices and inflation?
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FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) The price of oil and inflation are often seen as being connected in a cause and effect relationship. As oil prices move up or down, inflation follows in the same direction. The reason why this happens is that oil is a major input in the economy - it is used in critical activities such as fueling transportation and heating homes - and if input costs rise, so should the cost of end products. For example, if the price of oil rises, then it will cost more to make plastic, and a plastics company will then pass on some or all of this cost to the consumer, which raises prices and thus inflation. The direct relationship between oil and inflation was evident in the 1970s, when the cost of oil rose from a nominal price of $3 before the 1973 oil crisis to around $40 during the 1979 oil crisis. This helped cause the consumer price index (CPI), a key measure of inflation, to more than double from 41.20 in early 1972 to 86.30 by the end of 1980. Let's put this into perspective: while it had previously taken 24 years (1947-1971) for the CPI to double, during the 1970s it took about eight years. However, this relationship between oil and inflation started to deteriorate after the 1980s. During the 1990's Gulf War oil crisis, crude prices doubled in six months from around $20 to around $40, but CPI remained relatively stable, growing from 134.6 in January 1991 to 137.9 in December 1991. This detachment in the relationship was even more apparent during the oil price run-up from 1999 to 2005, in which the annual average nominal price of oil rose from $16.56 to $50.04. During this same period, the CPI rose from 164.30 in January 1999 to 196.80 in December 2005. Judging by this data, it appears that the strong correlation between oil prices and inflation that was seen in the 1970s has weakened significantly. For more information, see our Inflation tutorial and The Consumer Price Index: A Friend To Investors. Get A FREE Options Investing Kit COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 38
Portfolio A grouping of financial assets such as stocks, bonds and cash equivalents, as well as their mutual, exchange-traded and closedfund counterparts. Portfolios are held directly by investors and/or managed by financial professionals. Prudence suggests that investors should construct an investment portfolio in accordance with risk tolerance and investing objectives. Think of an investment portfolio as a pie that is divided into into pieces of varying sizes representing a variety of asset classes and/or types of investments to accomplish an appropriate risk-return portfolio allocation. For example, a conservative investor might favor a portfolio with large cap value stocks, broad-based market index funds, investment-grade bonds and a position in liquid, high-grade cash equivalents. In contrast, a risk loving investor might add some small cap growth stocks to an aggressive, large cap growth stock position, assume some high-yield bond exposure, and look to real estate, international, and alternative investment opportunities for his or her portfolio.
Diversification A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique contends that a portfolio of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio. Diversification strives to smooth out unsystematic risk events in a portfolio so that the positive performance of some investments will neutralize the negative performance of others. Therefore, the benefits of diversification will hold only if the securities in the portfolio are not perfectly correlated. Studies and mathematical models have shown that maintaining a well-diversified portfolio of 25 to 30 stocks will COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 39
FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) yield the most cost-effective level of risk reduction. Investing in more securities will still yield further diversification benefits, albeit at a drastically smaller rate. Further diversification benefits can be gained by investing in foreign securities because they tend be less closely correlated with domestic investments. For example, an economic downturn in the U.S. economy may not affect Japan's economy in the same way; therefore, having Japanese investments would allow an investor to have a small cushion of protection against losses due to an American economic downturn. Most non-institutional investors have a limited investment budget, and may find it difficult to create an adequately diversified portfolio. This fact alone can explain why mutual funds have been increasing in popularity. Buying shares in a mutual fund can provide investors with an inexpensive source of diversification.
Mutual Fund An investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. Mutual funds are operated by money mangers, who invest the fund's capital and attempt to produce capital gains and income for the fund's investors. A mutual fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus. One of the main advantages of mutual funds is that they give small investors access to professionally managed, diversified portfolios of equities, bonds and other securities, which would be quite difficult (if not impossible) to create with a small amount of capital. Each shareholder participates proportionally in the gain or loss of the fund. Mutual fund units, or shares, are issued and can typically be purchased or redeemed as needed at the fund's current net asset value (NAV) per share, which is sometimes expressed as NAVPS
Prospectus COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com
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A formal legal document, which is required by and filed with the Securities and Exchange Commission, that provides details about an investment offering for sale to the public. A prospectus should contain the facts that an investor needs to make an informed investment decision. Also known as an "offer document". There are two types of prospectuses for stocks and bonds: preliminary and final. The preliminary prospectus is the first offering document provided by a securities issuer and includes most of the details of the business and transaction in question. Some lettering on the front cover is printed in red, which results in the use of the nickname "red herring" for this document. The final prospectus is printed after the deal has been made effective and can be offered for sale, and supersedes the preliminary prospectus. It contains finalized background information including such details as the exact number of shares/certificates issued and the precise offering price. In the case of mutual funds, which, apart from their initial share offering, continuously offer shares for sale to the public, the prospectus used is a final prospectus. A fund prospectus contains details on its objectives, investment strategies, risks, performance, distribution policy, fees and expenses, and fund management.
Beta A measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. Also known as "beta coefficient". Beta is calculated using regression analysis, and you can think of beta as the tendency of a security's returns to respond to swings in the market. A beta of 1 indicates that the security's price will move with the market. A beta of less than 1 means that the security will be less volatile than the market. A beta of greater than 1 indicates that the security's price will be more volatile than the market. For example, if a stock's beta is 1.2, it's COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 41
FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) theoretically 20% more volatile than the market. Many utilities stocks have a beta of less than 1. Conversely, most high-tech Nasdaq-based stocks have a beta of greater than 1, offering the possibility of a higher rate of return, but also posing more risk.
Alpha 1. A measure of performance on a risk-adjusted basis. Alpha takes the volatility (price risk) of a mutual fund and compares its risk-adjusted performance to a benchmark index. The excess return of the fund relative to the return of the benchmark index is a fund's alpha. 2. The abnormal rate of return on a security or portfolio in excess of what would be predicted by an equilibrium model like the capital asset pricing model (CAPM). 1. Alpha is one of five technical risk ratios; the others are beta, standard deviation, R-squared, and the Sharpe ratio. These are all statistical measurements used in modern portfolio theory (MPT). All of these indicators are intended to help investors determine the risk-reward profile of a mutual fund. Simply stated, alpha is often considered to represent the value that a portfolio manager adds to or subtracts from a fund's return. A positive alpha of 1.0 means the fund has outperformed its benchmark index by 1%. Correspondingly, a similar negative alpha would indicate an underperformance of 1%. 2. If a CAPM analysis estimates that a portfolio should earn 10% based on the risk of the portfolio but the portfolio actually earns 15%, the portfolio's alpha would be 5%. This 5% is the excess return over what was predicted in the CAPM model.
Standard Deviation 1. A measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher the deviation. Standard deviation is calculated as the square root of variance. 42 COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com
2. In finance, standard deviation is applied to the annual rate of return of an investment to measure the investment's volatility. Standard deviation is also known as historical volatility and is used by investors as a gauge for the amount of expected volatility. Standard deviation is a statistical measurement that sheds light on historical volatility. For example, a volatile stock will have a high standard deviation while the deviation of a stable blue chip stock will be lower. A large dispersion tells us how much the return on the fund is deviating from the expected normal returns.
Volatility 1. A statistical measure of the dispersion of returns for a given security or market index. Volatility can either be measured by using the standard deviation or variance between returns from that same security or market index. Commonly, the higher the volatility, the riskier the security. 2. A variable in option pricing formulas showing the extent to which the return of the underlying asset will fluctuate between now and the option's expiration. Volatility, as expressed as a percentage coefficient within option-pricing formulas, arises from daily trading activities. How volatility is measured will affect the value of the coefficient used. In other words, volatility refers to the amount of uncertainty or risk about the size of changes in a security's value. A higher volatility means that a security's value can potentially be spread out over a larger range of values. This means that the price of the security can change dramatically over a short time period in either direction. A lower volatility means that a security's value does not fluctuate dramatically, but changes in value at a steady pace over a period of time. One measure of the relative volatility of a particular stock to the market is its beta. A beta approximates the overall volatility of a security's returns against the returns of a relevant benchmark (usually the S&P 500 is used). For example, a stock with a beta COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 43
FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) value of 1.1 has historically moved 110% for every 100% move in the benchmark, based on price level. Conversely, a stock with a beta of .9 has historically moved 90% for every 100% move in the underlying index.
Hedge Making an investment to reduce the risk of adverse price movements in an asset. Normally, a hedge consists of taking an offsetting position in a related security, such as a futures contract. An example of a hedge would be if you owned a stock, then sold a futures contract stating that you will sell your stock at a set price, therefore avoiding market fluctuations. Investors use this strategy when they are unsure of what the market will do. A perfect hedge reduces your risk to nothing (except for the cost of the hedge).
Index A statistical measure of change in an economy or a securities market. In the case of financial markets, an index is an imaginary portfolio of securities representing a particular market or a portion of it. Each index has its own calculation methodology and is usually expressed in terms of a change from a base value. Thus, the percentage change is more important than the actual numeric value. Stock and bond market indexes are used to construct index mutual funds and exchange-traded funds (ETFs) whose portfolios mirror the components of the index. The Standard & Poor's 500 is one of the world's best known indexes, and is the most commonly used benchmark for the stock market. Other prominent indexes include the DJ Wilshire 5000 (total stock market), the MSCI EAFE (foreign stocks in Europe, Australasia, Far East) and the Lehman Brothers Aggregate Bond Index (total bond market). COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 44
Because, technically, you can't actually invest in an index, index mutual funds and exchange-traded funds (based on indexes) allow investors to invest in securities representing broad market segments and/or the total market.
Capital Asset Pricing Model (CAPM) A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities.
The general idea behind CAPM is that investors need to be compensated in two ways: time value of money and risk. The time value of money is represented by the risk-free (rf) rate in the formula and compensates the investors for placing money in any investment over a period of time. The other half of the formula represents risk and calculates the amount of compensation the investor needs for taking on additional risk. This is calculated by taking a risk measure (beta) that compares the returns of the asset to the market over a period of time and to the market premium (Rm-rf).
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FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) The CAPM says that the expected return of a security or a portfolio equals the rate on a risk-free security plus a risk premium. If this expected return does not meet or beat the required return, then the investment should not be undertaken. The security market line plots the results of the CAPM for all different risks (betas). Using the CAPM model and the following assumptions, we can compute the expected return of a stock: if the risk-free rate is 3%, the beta (risk measure) of the stock is 2 and the expected market return over the period is 10%, the stock is expected to return 17% (3%+2(10%-3%)). Savings Account A deposit account held at a bank or other financial institution that provides principal security and a modest interest rate. Depending on the specific type of savings account, the account holder may not be able to write checks from the account (without incurring extra fees or expenses) and the account is likely to have a limited number of free transfers/transactions. Savings account funds are considered one of the most liquid investments outside of demand accounts and cash. Because savings accounts almost always pay lower interest rates than Treasury bills and certificates of deposit, they should not be used for long-term holding periods. Their main advantages are liquidity and superior rates compared to checking accounts. Most modern savings accounts offer access to funds through visits to a local branch, over the internet and through automated teller machines. Bank A commercial institution licensed as a receiver of deposits. Banks are mainly concerned with making and receiving payments as well as supplying short-term loans to individuals. In most countries banks are supervised by the national government or central bank. Investment Bank (IB) COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com
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A financial intermediary that performs a variety of services. This includes underwriting, acting as an intermediary between an issuer of securities and the investing public, facilitating mergers and other corporate reorganizations, and also acting as a broker for institutional clients. The role of the investment bank begins with pre-underwriting counseling and continues after the distribution of securities in the form of advice. Exchange-Traded Fund (ETF) A security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange, thus experiencing price changes throughout the day as it is bought and sold. Because it trades like a stock whose price fluctuates daily, an ETF does not have its net asset value (NAV) calculated every day like a mutual fund does. By owning an ETF, you get the diversification of an index fund as well as the ability to sell short, buy on margin and purchase as little as one share. Another advantage is that the expense ratios for most ETFs are lower than those of the average mutual fund. When buying and selling ETFs, you have to pay the same commission to your broker that you'd pay on any regular order. One of the most widely known ETFs is called the SPDR (Spider), which tracks the S&P 500 index and trades under the symbol SPY.
Earnings Per Share (EPS) A company's earnings, also known as net income or net profit, divided by the number of shares outstanding. Equities Shares of stock in a company. Because they represent a proportional share in the business, they are "equitable claims" on the business itself. COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 47
Gilt Funds Funds that invest in government securities, which may be short or long-term in nature. Higher the maturity of the portfolio, greater will be the volatility when interest rates change. Index Fund A passively managed mutual fund that seeks to match the performance of a particular market index. Partially due to lower expenses, index funds outperform the majority of actively managed mutual funds. Liquidity A measure of how quickly a stock can be sold at a fair price and converted to cash. Illiquid stocks are stocks that don't trade in high volume. Thus, having too many shares of a stock that doesn't trade frequently would make for a position that cannot necessarily be sold. MIBOR (Mumbai Interbank Offer Rate) This is the rate of interest at which banks borrow funds from other banks, in marketable size, in the Mumbai interbank market. Money Market Fund Mutual fund that invests typically in short-term government instruments (treasury bills) and commercial paper (CPs) and Certificates of Deposit (CDs). These funds tend to be lower-yielding, but less risky than most other types of funds. Option A call option is a contract in which a seller gives a buyer the right, but not the obligation, to buy the optioned shares of a company at a set price (the strike price) for a certain period of time. If the stock fails to exceed the strike price before the expiration date, the option expires worthless. A put option is a contract that gives the buyer the right, but not the obligation, to sell the stock underlying the contract at a predetermined price (the strike price). The seller (or writer) of the put option is obligated to buy the stock at the strike price. COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 48
Preferred Stock Preferred stock pays a dividend on a regular schedule and is given preference over common stock in regard to the payment of dividends or -- heaven forbid - any liquidation of the company. Their share prices tend to remain stable, and will generally not carry the voting rights that common stock does. Risk Tolerance The measurement of an investor's willingness to suffer a decline (or repeated declines) in the value of investments while waiting and hoping for them to increase in value. Generally investors are risk averse. Rupee Cost Averaging Strategy of making regular investments into a mutual fund and having earnings automatically reinvested. This way, when the share price drops, more shares are bought at lower prices. Time Value Of Money (TVM) The basic principle that money can earn interest, and so something that is worth Rs. 1 today will be worth more in the future if invested. This is also referred to as future value Total Return The rate of return on an investment, including reinvestment of distributions. Tracking Error A divergence between the price behavior of a position or portfolio and the price behavior of a benchmark. Trustee An individual who holds or manages assets for the benefit of another. Cyclical Stock Stock of a company whose performance is generally related (or thought to be COPYRIGHT@RESERVED 2007-08 PH:9890939673, EMAIL ME 4 FOR MORE FINANCIAL TERMS AT:neeraj2885@gmail.com 49
related) to the performance of the economy as a whole. Paper, steel, and the automotive stocks are thought to be cyclical because their earnings tend to be hurt when the economy slows and are strong when the economy turns up. Food and drug stocks, on the other hand, are not considered "cyclicals," as consumers pretty much need to eat and care for their health regardless of the performance of the economy.
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Finance Glossary

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FINANCE GLOSSARY BY NEERAJ AGRAWAL, MBA(FINANCE) Working Capital Management A managerial accounting strategy focusing on maintaining efficient levels

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