Glossary

Annual percentage return The return for a year, determined as the product of the interest rate per compounding period and the number of compounding periods in a year.

Annuity due An even series of cash flows occurring at even intervals of time, with cash flows occurring at the beginning of each period.

APR See Annual Percentage Rate.

Arithmetic rate of return The arithmetic average of subperiod rates of return.

ART See Alternative risk transfer.

Articles of incorporation A legal document that specifies the name of the corporation, its place of business, and the nature of its business.

Asset allocation The mix of investments from different asset classes in a portfolio.

Asset management See Investment management.

Asset management companies See Investment company.

Asset manager See Portfolio manager.

Asset pricing model A theoretical model of how investors price assets in the market.

Asset retirement liability Contractual or statutory obligation to retire or decommission an asset.

Asset turnover See Total asset turnover.

Asset-backed securities Debt obligations that are backed by assets other than residential mortgages.

Assets Resources of a business enterprise, which may consist of cash, inventory, property, and equipment.

Asymmetric information Uneven possession or access to information necessary to value assets.

Atlantic option See Bermuda option.

At-the-money option The situation in which a call option’s exercise price is equal to the underlying’s value or a put option’s exercise price is equal to the underlying’s value.

Average credit sales per day The credit sales for a period, divided by the number of days in the period.

Average day’s cost of goods sold The cost of goods sold over a period, divided by the number of days in the period.

Average purchases per day The purchases over a period, divided by the number of days in the period.

Balance sheet A report of assets, liabilities, and equity of a company at a point in time.

Balanced scorecard A set of measures of performance that address different aspects of a company’s strategic plan.

Bankers’ acceptance Short-term loan that is backed by a bank’s promise to pay. Generally used in import and export transactions.

Bankruptcy A legal process of settling the claims of creditors and owners for a company in financial distress.

Bankruptcy costs The direct and indirect costs associated with a company in Chapter 11 bankruptcy.

Base interest rate The interest rate for an investment without any default risk, which is the sum of the real interest rate and the expected rate of inflation.

Basic earnings per share Net earnings to common shareholders over a fiscal period, divided by the weighted average shares outstanding during the fiscal period.

Bermuda option An option that can be exercised before the expiration date, but only on specified dates.

Best-efforts underwriting An underwriting arrangement whereby the investment bank does not buy the issue from the issuer, but rather sells the security to the public, earning a profit on those shares it sells.

Beta A measure of the sensitivity of the returns on an asset to changes in the returns in the market.

Biased expectations theory The theory that purports that forward rates represent both expected future rates, as well as other factors.

Black-Scholes option pricing model An option pricing model of a European option, that values an option based on the price of the underlying, the exercise price, the risk free rate of interest, the time remaining to expiration, and the volatility of the underlying asset’s value.

Bond Indebtedness that has an indenture agreement. In general use, a debt with an original maturity greater than 10 years.

Bond Indebtedness in the form of a security.

Bonding costs Costs incurred by the agent in an agency relationship to insure that the agent acts in the principal’s best interest.

Bonus A cash reward based on some performance measure.

Book value The value of an asset at a point in time according to financial reporting standards.

Budget A company’s investment and financing plans, expressed in monetary terms.

Budgeting The mapping out of the sources and uses of funds for future periods.

Business finance See Financial management.

Business risk The uncertainty associated with the sales and operating profit of a business, determined in large part by the business enterprise’s line of business.

Business risk The risk associated with the uncertainty of operating earnings; the combination of sales and operating risk.

Busted convertible See Fixed income equivalent.

Bylaws Rules of governance of a corporation.

Call provision A provision of a security that allows the issuer of the security to buy the security from investors at a specified price, the call price.

Call schedule A schedule of call prices corresponding to different dates on which a callable security can be bought back by the issuer.

546 GLOSSARY

Callable bond A debt obligation that may be bought back by the issuer at a specified price.

Capital Long-term sources of financing, which include interest-bearing debt and equity.

Capital asset pricing model An asset pricing model that allows for only one risk factor (market risk) to affect the prices of assets.

Capital budgeting The decision process of allocating a company’s funds to long-term investments.

Capital budgeting The process of identifying and selecting investments in longlived assets; that is, selecting assets expected to produce benefits over more than one year.

Capital lease Rental obligations that are long-term, fixed obligations. Capital market The market for long-term financial instruments.

Capital market line The line depicting the relation between the return on a portfolio and risk, where risk is measured in terms of the variance of the returns of the portfolio.

Capital structure A company’s mixture of debt and equity that is used to support the operating and investing activities of a company.

Capital structure The mix of debt and equity used to finance a company. Capital yield The return on a share of stock from the change in the value of

the share of stock.

CAPM See Capital asset pricing model.

Carrying value See Book value.

Cash-and-carry trade A futures position in which the investor sell futures and borrows to buy the underlying asset, and then delivers this asset and pays off the loan at the end of the contract.

Cash conversion cycle The length of time a business enterprise ties up cash, on average, in net working capital.

Cash flow The flow of funds of a company within a period of time.

Cash flow from financing activities The cash flow associated with borrowing, debt repayment, issuance of stock, the payment of dividends, and repurchasing stock.

Cash flow from investing activities The cash flow associated with capital expenditures, asset retirement, or other changes in long-term investments.

Cash flow from operating activities The sum of net income, noncash expenses, less any decrease in working capital accounts.

Cash flow from operations See Cash flow from operating activities.

Cash flow interest coverage ratio The number of times that a period’s interest expenses could be paid by the company’s cash flow before interest and taxes for that period; a measure of a company to satisfy its debt obligations.

Cash flow to capital expenditures coverage ratio The ratio of cash flow of a company over a period to the company’s capital expenditures for the period.

Cash flow to debt ratio The ratio of cash flow to the sum of a company’s debt obligations.

Cash market The exchange of an asset for cash.

Cash settlement contracts Futures contracts that are settled in cash, instead of taking an offsetting position.

Cat bond See Insurance-linked note.

Catastrophe-linked bond See Insurance-linked note.

Catastrophic risk management The planning intended to minimize the impact of potential catastrophic events.

CD See Certificate of deposit. CDS See Credit default swap.

Certificate of deposit A promissory note of a bank to pay a depositor. Characteristic line The empirical model such that the excess returns on a stock

are a linear function of the excess return on the market portfolio. Classical safety-first rules Decision rules that focus on the minimization of the

probability of loss.

Close corporation See Closely held corporation.

Closed-end fund A regulated investment company invests in a portfolio of investments, but which does not issue additional shares or redeem shares.

Closely held corporation A corporation that has a few owners who exert complete control over the decisions of the corporation.

CML See Capital market line.

Cognitive biases Systematic bias in decision making.

Commercial bank Depository institution, which accepts deposits from savers and lends or invests these deposits.

Commercial paper A promissory note issued by a large, creditworthy company or municipality.

Commodity swap An agreement in which two parties agree to exchange payments based on the value of a specified commodity.

Common stock The security that represents the residual ownership in a corporation.

Common-size analysis An analysis of the financial accounts of a company that requires comparing an account to a benchmark.

Comparative advantage The advantage a company has over other companies in terms of the cost of producing or distributing goods and services.

Competitive advantage The advantage a company has over other companies as a result of the market’s structure.

Complementary projects Projects in which the investment in one enhances the cash flows of one or more other projects.

Compound interest An arrangement in which interest is paid on both the principal amount and the accumulated interest.

Compounding The process of interest being paid on both the principal and the interest already earned on this principal.

Conditional value at risk A safety-first rule that focuses on expected value of a portfolio’s returns, given that the value at risk has been exceeded.

Contingent projects Projects that are dependent on the acceptance of another project.

Continuous compounding Interest that is compounded instantaneously. Contracting costs The costs associated with creating and enforcing contractual

agreements, such as a loan.

Conversion parity price See Market conversion price.

Conversion provision A provision of a security that allows the investor to exchange the security for another security.

Conversion ratio The number of shares of common stock that the investor in a convertible security receives if the investor chooses to convert the security into stock.

Conversion value The value of the stock that an investor in a convertible receives in exchange for the convertible security; the product of the conversion ratio and the market price of the stock.

Convertible bond An indebtedness that may be converted into ownership units of the issuer at the option of the investor at a specified rate.

Convertible bond A debt obligation that permits the investor to exchange the bond for another security, such as the common stock of the bond issuer.

Convertible note See Convertible bond.

Core risk Risks that a business enterprise is in the business to bear.

Corporate finance See Financial management.

Corporation An entity granted its existence by a state, operated to the benefit of the owners (the shareholders), who have limited liability.

Correlation A standardized measure of how the outcomes of two assets covary, which ranges from –1 to +1; the result of the covariance of two assets’ possible outcomes divided by the product of the two assets’ standard deviations.

Cost of capital The return that providers of capital (creditors and owners) expect for the use of their funds; the marginal cost of raising an additional dollar of capital.

Counterparty The other party to an exchange.

Counterparty The party on the opposite side of the transaction. Counterparty risk The uncertainty regarding the ability of the counterparty to

perform in a transaction.

Covariance of a random variable A measure of how two assets’ returns vary together for a given probability distribution.

Credit default swap An agreement for credit protection against specified events that affect the credit quality of a bond.

Credit protection buyer The party to a credit default swap that pays for protection from specific events that affect the credit quality of a security.

Credit protection seller The party to a credit default swap that agrees to insure against the impairment of the credit quality of a security.

Credit spread The risk premium between the yields on Treasury securities and non–Treasury securities.

Creditor The lender of funds.

Crossover rate The discount rate at which the net present values of two projects are equal.

Currency swap An agreement in which two parties agree to swap cash flows in different currencies.

Current assets Assets that can reasonably be converted into cash within one operating cycle or one year, whichever is longer.

Current liability An obligation that is due within one year or one operating cycle, whichever is longer.

Current ratio A liquidity ratio that measures the company’s ability to meets its current obligations, calculated as is the ratio of current assets divided by current liabilities.

Current yield The ratio of the annual coupon on a bond to its market value.

CVaR See Conditional value at risk.

Date of record The date that determines which investors receive a particular distribution.

Days purchases outstanding On average, the number of days of purchases outstanding at the end of the period.

Days sales in inventory The number days of inventory on hand at a point in time, considering the average days’ sales.

Days sales outstanding The number of days of credit sales that are represented by the account balance in accounts receivable.

DDM See Dividend discount models

Debt A promise to repay the amount borrowed, plus interest, at a specified point of time in the future.

Debt instrument See Debt.

Debt ratio The ratio of debt to equity.

Debt-equity ratio See Debt-to-equity ratio.

Debt-to-assets ratio The proportion of the assets of a company that are fi- nanced by debt obligations; the ratio of debt to total assets.

Debt-to-capital ratio The ratio of interest-bearing debt to total capital. Debt-to-equity ratio The ratio of debt to equity of a company. Declaration date The date the board of directors declares a distribution.

Declining balance method Depreciation method in which a constant rate is applied against a declining carrying value of an asset.

Default risk The risk that the issuer of a security will be unable to make timely payment of interest or principal when due.

Deferred annuity An even series of cash flows occurring at even intervals of time, with the first cash flow occurring beyond one period from today.

Deferred tax liability An account that represents the expected tax obligation.

550 GLOSSARY

Defined benefit plan A pension plan in which the plan sponsor promised to make specified payments to qualifying employees at retirement.

Defined contribution plan A pension plan in which the plan sponsor commits to a specified contribution, but the amount upon retirement is not guaranteed.

Degree of financial leverage A measure of the sensitivity of earnings to owners to changes in operating earnings, attributed to the use of debt financing.

Delivery date See Settlement date

Demand deposit Funds deposited with a bank that can be withdrawn upon demand of the depositor.

Depository institutions An entity that accepts deposits and loans funds. Depreciation tax shield The amount of the reduction in taxes resulting from

the depreciation deduction.

Derivative A security whose value depends on the value of an underlying asset, such as a stock.

Derivative instrument See Derivative.

DFL See Degree of financial leverage.

Diluted earnings per share Adjusted net earnings to common shareholders over a fiscal period, divided by the weighted average shares potentially outstanding during the fiscal period, where potential shares reflect convertible securities and executive stock options.

Discount rate The rate of interest that Federal Reserve Bank charges banks who borrow using the Fed discount window.

Discount rate Rate of interest used to translate future cash flows into a value today.

Discounted payback period The time it takes for a project’s discounted cash inflows to add up to the initial cash outflow.

Discounting The process of determining a present value of some future value or set of cash flows.

Diversifiable risk factors See Unsystematic risk factors.

Diversification The reduction of risk from investing in assets whose returns are not perfectly correlated with one another.

Diversification The reduction of risk, without sacrificing return, by investing in assets whose returns are not perfectly, positively correlated.

Diversify The application of diversification principles to reduce the risk of a portfolio.

Dividend A distribution to share owners.

Dividend A distribution to the owners of a corporation.

Dividend discount models Models for valuing stock that uses an estimate of current dividends, expected growth in dividends, and a required rate of return.

Dividend payout ratio The proportion of earnings paid in the form of cash dividends during a period.

Dividend payout ratio The proportion of earnings paid out in the form of cash dividends to shareholders.

Dividend per share The monetary amount of dividend paid per share of stock.

Dividend reinvestment plan A program that allows shareholders to reinvest cash dividends in shares of the company.

Dividend yield The return on a share of stock in the form of dividends; the ratio of dividend per share to the share price.

Dividend yield The ratio of dividends on a share of stock to the market value of the stock.

Dividend–price ratio See Dividend yield.

Dividends per share A monetary amount of dividends that are paid per share of stock.

Dividends received deduction A deduction available to corporations of a portion of the dividends received from another corporation.

Dollar return The sum of the change in the market value of a portfolio and any capital or income distributions from the portfolio.

Dollar-weighted rate of return The internal rate of return of an investment. Domestic market Market in which issuers domiciled in a country issue securi-

ties and in which these securities are traded.

Downside risk See Lower partial moment risk measure. DPO See Days payables outstanding.

DRP See Dividend reinvestment plan. DSI See Days sales in inventory. DSO See Days sales outstanding.

DuPont system A method of decomposing a return ratio into its components, such as profit margins and turnovers, to facilitate understanding of change in the return ratio.

Dutch auction An offer to buy that specifies a range of prices, with those willing to sell specifying a price within the range. Once offers are made, the buyer pays that price (based on bids) necessary to purchase the desired quantity.

Dynamic asset allocation An process of altering the mix of assets in a portfolio from the portfolio’s long-term mix in response to changing market conditions.

EAR See Effective annual rate.

Earnings before interest, depreciation, and amortization Operating income of a company before the deduction for depreciation expense and amortization.

EBITDA See Earnings before interest, depreciation, and amortization.

Economic agents Entities that make investment decisions in financial markets. Economic life The length of time that the investment provides economic

profits.

Economic value added A measure of a company’s economic profit.

552 GLOSSARY

Effective annual rate The rate of interest for an annual period that takes into account the compounding of interest within the year.

Effective rate of interest See Effective annual rate.

Efficient frontier The set of efficient portfolios for a set of assets.

Efficient portfolio A portfolio that provides the highest expected return for a given level of risk.

Employee stock ownership plan A defined contribution pension plan that is designed to invest in the employer stock on the behalf of the employee.

Enterprise risk management The management of the risk of a business enterprise that is inclusive of the different operations, segments, and subsidiaries of a business entity, which views risk of the entire enterprise.

Equity The ownership interest in a business enterprise.

Equity instrument A security or unit of ownership in a company.

Equity investment style A process of classifying equity securities based on a dimension or characteristic, such as size or a multiple, with expectation of taking advantage of superior returns that are attributed to the dimension or characteristic.

Equivalent taxable yield The yield on a taxable security that is equivalent, after tax, to the return on a similar maturity, features, and risk to a municipal, nontaxable security.

ERM See Enterprise risk management. ESOP See Employee stock ownership plan. ETF See Exchange-traded fund. Euromarket See External market.

European option An option that can only be exercised at the end of the expiration period.

EVA See Economic value added.

Excess reserve The amount by which actual reserves exceed required reserves of a bank.

Exchange A market with a physical location for the trading of assets. Exchange-traded fund A fund, similar to an open-end fund or a closed-end

fund, with units representing shares of this fund traded much like stocks.

Ex-date See ex-dividend date.

Ex-dividend date The date determined by the exchanges to identify which investors are owners as of the declared date of record.

Exercise price See Strike price.

Expansion project A project that enlarges the company’s established market or product line.

Expectations theory A theory that states that the observed structure of interest rates reflects investors’ expectations regarding future interest rates.

Expected shortfall See Conditional value at risk. Expected tail loss See Conditional value at risk.

Expense ratio An annual operating expense associated with a regulated investment company.

External market A market in which securities are offered at issuance simultaneously to investors in a number of countries and issued outside the jurisdiction of any single country.

Face value See Maturity value.

Feasible portfolio Any portfolio that can be constructed with available assets. Fed discount window The lending of funds to banks by the Federal Reserve to

meet banks liquidity needs.

Federal funds market The market that banks use to manage any shortage in the required reserve.

Federal funds rate The rate of interest charged to banks on borrowed funds. Fiduciary duty The legal responsibility to make decisions or to see that deci-

sions are made that are in the best interest of a party.

FIFO See First-in, First-out.

Finance The application of economic principles to decision making that involves the allocation of money under conditions of uncertainty.

Financial analysis The analysis of the financial performance and financial condition of a company.

Financial asset Intangible asset that represents a claim on future cash flows. Financial distress Situation in which a company makes decisions under pres-

sure to satisfy its legal obligations to creditors.

Financial economics Another term used to identify finance, which emphasizes the role of economics in financial decision making.

Financial instrument Evidence of ownership to a claim on future cash flows, such as a stock or a bond.

Financial intermediary An entity that facilitates the flow of funds from those with excess funds to those in need of funds for investment purposes.

Financial leverage The use of debt to finance a business enterprise.

Financial management The financial decision making of a business entity. Also referred to as business finance and corporate finance.

Financial planning The allocation of a company’s financial resources to achieve a company’s investment objectives.

Financial restructuring A significant alteration of a company’s capital structure.

Financial risk Uncertainty associated with a party’s reliance on debt financing, relative to equity financing.

Financial risk The uncertainty associated with the earnings to the owners of a business due to the use of debt, which generally has a fixed cost and commits the business to a legal obligation to repay the debt.

Financial risk The uncertainty regarding the outcome in terms of a financial measure, such as earnings.

554 GLOSSARY

Finite life general DDM A specific dividend discount model that uses a terminal or expected future price of the stock at some future period in place of a set of dividends beyond that point in time.

Firm commitment offering An underwriting arrangement whereby the investment bank buys the securities from the issuer and then sells these securities to investors.

First-in, first-out Inventory method in which the oldest costs of inventory are used in calculating costs of goods sold.

Fixed asset A long-term asset that has a physical existence, such as equipment or a building.

Fixed income equivalent The value of a convertible security as a straight bond, which results from the value in conversion being significantly below the security’s straight value.

Fixed income instrument Financial assets whose cash flows are specified contractually, such as a bond or a note.

Flat yield curve A yield curve in which the rates of higherand shorter-maturity securities are similar.

Foreign market Market in which issuers not domiciled in a country issue securities and the securities are traded.

Foreign market The market for securities that are issued by issuers who are not domiciled in the country.

Forward rate The interest rate that is expected to exist in the future.

Forward stock split See Stock split.

Framing Decision making that is influenced by the situation or the manner in which the situation is presented.

Free cash flow The cash flow of a company in excess of the expenditures for profitable investments.

Free cash flow to equity Cash flow from operations, less capital expenditures, plus net borrowings.

Free cash flow to the firm Cash flow from operations, adjusted for the after-tax interest expense, less capital expenditures.

Funded retained risk An assumed risk in which funds are set aside to absorb potential losses.

Futures contract A legal agreement between a buyer and seller such that the seller agrees to make a delivery and the buyer agrees to take delivery of something at a specified price at the end of a specified period of time.

Futures price The price agreed to in a futures contract for a specific transaction.

GAAP See Generally accepted accounting principles.

General partnership A partnership in which the partners share in the management of the business, share in its profits and losses, and are responsible for the liabilities of the business.

Generally accepted accounting principles In the United States, accounting methods that are codified by the Financial Accounting Standards Board.

Government-owned corporation Corporate entities funded by the federal government for specific projects.

Government-sponsored enterprise A corporations created by the federal government.

Gross plant and equipment The total cost of physical assets. Gross profit margin The ratio of gross profit to revenues.

Gross property, plant, and equipment See Gross plant and equipment.

Growth rate The rate at which a value appreciates or depreciates.

GSE See Government-sponsored enterprise.

Hedge fund A pool of investment funds that are not regulated and are available for investment only to accredited investors.

Hedgeable rate See Forward rate.

Heuristic A rule of thumb or guide that reduces decision time.

Holding period return The yield on an asset over a specified period, considering the change in the value of the asset and any cash flows, such as interest or dividends.

Horizontal common-size analysis The restatement and comparison of accounts relative to a benchmark, where that benchmark is that accounts value in a selected base year.

Humped yield curve A yield curve in which the rates of longer-maturity securities are similar to those of shorter-maturity securities, but less than the rates on intermediate-maturity securities.

Illegal insider trading The trading of the stock of a company based on nonpublic, material information by an insider of the company.

Income statement A summary of operating performance of a business entity over a period of time.

Incremental cash flows The change in a company’s cash flows related to a specific project.

Independent directors See Outside directors.

Independent projects Projects whose cash flow are not related to those of another project.

Indexed funds A regulated investment company that invests funds in a portfolio that is intended to replicate an index.

Individually managed account See Separately managed account.

Individually sponsored plan A pension plan that is for a specific individual. Information asymmetry The situation in which a party or parties to a transac-

tion have more information than the other party or parties to the transaction.

Initial margin The minimum amount deposited per contract at the inception of a position.

Inside directors Members of the board of directors who are employees of the corporation.

Insurance premium The payment made for insurance protection.

556 GLOSSARY

Insurance-linked note Synthetically insurance in the form of a capital market debt obligation, often used for insurance large losses, such as catastrophe losses.

Intangible asset An asset that has no physical existence.

Intangible asset A nonfinancial asset that does not have a physical existence, but creates future cash flows for a company.

Interbank yield curve See Swap rate yield curve.

Interest coverage ratio The number of times that a period’s interest expenses could be paid by the company’s earnings before interest and taxes for that period; a measure of a company to satisfy its debt obligations.

Interest rate swap An agreement in which two parties agree to swap cash flows based on interest rates.

Interest tax shield The amount of tax savings due to the deductibility of interest to arrive at taxable income, computed as the product of the marginal tax rate and the interest expense.

Internal market The domestic and foreign markets for securities issued in the domestic market.

Internal rate of return The yield on an investment, assuming that all intermediate cash flows are reinvested at this yield; the discount rate at which the present value of all cash flows of an investment is equal to zero.

In-the-money option The situation in which a call option’s exercise price is less than the underlying’s value or a put option’s exercise price is greater than the underlying’s value.

Intrinsic value The value of an option if exercised immediately.

Inventories Investments in raw material, work in process, and finished goods, which are expected to be sold to customers.

Inventory turnover The number of times, on average, that inventory flows into and out of a company.

Inverted yield curve A yield curve in which the rates of longer-maturity securities are lower than those of shorter-maturity securities.

Investment company An entity that manage the funds of individuals, businesses, and state and local governments.

Investment management The decision making regarding individual and institutional funds. Also referred to as asset management, portfolio management, money management, and wealth management.

Investment manager See Portfolio manager.

Investment profile An graph of a capital project’s net present value as a function of its cost of capital.

Investment value See Straight value.

Investor A party that buys an asset, such as a security, with the anticipation of a return in the form of future cash flows.

Investor’s equity The value of an investment position reduced by any borrowed amount.

IRR See Internal rate of return.

Issuer An entity that provides a security, such as a stock or a bond, in exchange for funds.

Joint venture A business entity formed as either a corporation or a partnership, generally for a specific business purpose and life.

Key performance indicators Measures used in a balanced scorecard.

Last-in, first-out Inventory method in which the most recent costs of inventory are used in calculating costs of goods sold.

Leveraged portfolio A portfolio in which the investor borrows funds to purchase some of the assets in the portfolio.

Liabilities Obligations to repay the amount owed, in some cases with interest.

LIBOR See London Interbank Offered Rate. LIFO See Last-in, First-out.

Limited liability The presence of a limit on owners’ liability for obligations of the business enterprise.

Limited liability company A form of business in which the owners have limited liability, but the business may elect to be taxed as a partnership.

Limited liability partnership A form of business in which the owners have limited liability.

Limited partnership A partnership that has at least one general partner and one limited partner, where the business is conducted by the general partner and the limited partner or partners have a limited interest in the profits and losses of the business.

Liquidity In the context of a market, the presence of buyers and sellers ready to trade. In the context of a business enterprise, the ability of a business enterprise to satisfy its short-term obligations.

Liquidity premium The additional compensation for the risk associated with being able to sell a security for close to its true value.

Liquidity risk The risk associated with the ability to sell a security at a value close to its true value.

Liquidity theory The theory that purports that the higher rates for longermaturity securities in an upward-sloping yield curve represents compensation for liquidity and, therefore, the forward rates derived from the yield curve are not unbiased estimates of future interest rates.

Listed The situation in which an issuer of securities has selected to have its securities traded in the market.

LLC See Limited liability company. LLP See Limited liability partnership.

Loan amortization An arrangement in which the principal amount of a loan is paid off over time, with more principal repaid in each successive payment.

London Interbank Offered Rate The rate major international banks are willing to offer on Eurodollar deposits to each other.

Long call position An investment position that involves buying call options.

Long futures See Long position in futures.

Long position in futures The investment position in which the investor buys a futures contract.

Long put position An investment position that involves buying put options.

Long-run planning See Long-term planning.

Long-term liability Obligations due beyond one year.

Long-term planning Financial planning for future periods, usually three to five years in the future.

Lower partial moment risk measure A safety-first rule that uses both the investor’s risk aversion and a target rate of return.

MACRS See Modified Cost Recovery System. MAD See Mean-absolute deviation.

Maintenance margin The minimum level that an investor’s equity may fall from adverse price movements before the investor is required to deposit additional funds.

Mandated project A project that is required by an outside party, such as a government agency.

Marginal tax rate The tax rate on the next dollar of taxable income. Market anomaly A strategy that can generate abnormal returns.

Market cap See Market capitalization.

Market capitalization The total value of stock outstanding, which is calculated as the product of the market price per share and the number of shares outstanding.

Market conversion premium per share The difference between the market conversion price for a convertible security and the current market price of the stock that can be obtained through conversion.

Market conversion premium ratio The market conversion premium, stated as a percentage of the market value of the stock for which a convertible security can be exchanged.

Market conversion price The effective value per share of stock in conversion of a convertible security; the ratio of the market price of a convertible bond to the conversion ratio.

Market risk The risk related to the overall movement of the market.

Market segmentation theory The theory that purports that the shape of the yield curve is due to preferred maturities of investors.

Market structure The mechanism in which buyers and sellers interact to determine the price and quantity in an exchange.

Market value added A measure of the difference between the market value of capital and the amount of invested capital.

Marketable securities Securities that can be some quickly.

Markowitz diversification See Diversification.

Master limited partnership A limited partnership with limited partner interests traded on a public exchange.

Maturity spread The spread between any two maturities in a sector of a market.

Maturity value The amount of a loan due at the end of the loan period. Mean-absolute deviation A measure of dispersion that is based on the absolute

value of deviations from the mean.

Mean-standard deviation See Standard deviation.

Mean-variance analysis See Mean-variance portfolio analysis.

Mean-variance efficient portfolio See Efficient portfolio.

Mean-variance portfolio analysis The theory proposed by Harry Markowitz that focuses on assets’ mean and variance as criteria for portfolio selection.

Merchant banking An investment bank that commits its own capital in lending or taking an equity stake in a business entity.

Minority interest In a balance sheet, the proportion of a company’s assets not owned by the parent company. In an income statement, the earnings of a company representing the interest not owned by the parent company.

MLP See Master limited partnership.

Modern portfolio theory The theory developed by Harry Markowitz that focuses on the role of diversification within a portfolio in affecting the risk and return of a portfolio of invested assets.

Modified Accelerated Cost Recovery System A depreciation system used for U.S. taxes that is based on an accelerated method of depreciation.

Modified Cost Recovery System A system of depreciation prescribed by the U.S. Tax Code.

Modified internal rate of return The return on an investment, considering a specific reinvestment rate.

Money management See Investment management. Money management See Portfolio management. Money manager See Portfolio manager.

Money market The market for short-term securities.

Money market demand account An account in which funds are deposited and earn interest, though restrictions may be placed on withdrawals.

Money-weighted rate of return See Dollar-weighted rate of return.

Monitoring costs Costs associated with monitoring or limiting the actions of an agent in an agency relationship.

Mortgage-backed securities Securities that are backed, or secured with mortgages.

MPT See Modern portfolio theory.

Municipal yield ratio The ratio of the municipal bond yield to a comparablematurity Treasury security.

Muni-Treasury yield ratio See Municipal yield ratio

560 GLOSSARY

Mutual fund A regulated investment company that solicits funds from investors and then invests these funds in a portfolio of investments, with the opportunity for investors to redeem shares and to invest additional funds.

Mutually exclusive projects Projects for which the acceptance of one precludes the acceptance of the other(s).

MVA See Market value added. National market See Internal market. NCF See Net cash flow.

Nearby futures contract The futures contract with the closest settlement date to the particular contract.

Negotiable CD See Negotiable certificate of deposit.

Negotiable certificate of deposit A promissory note of a bank that can be bought and sold by investors.

Net cash flow The sum of operating and investment cash flows in a given period of an investment’s economic life.

Net operating cycle See Cash conversion cycle.

Net plant and equipment Cost of physical assets, less accumulated depreciation.

Net present value The value today of all cash flows of a project, discounted at the project’s cost of capital.

Net present value profile See Investment profile.

Net profit margin The ratio of net income to revenues.

Net property, plant, and equipment See Net plant and equipment.

Net working capital The short-term assets that would remain if current liabilities are satisfied; the difference between current assets and current liabilities.

Net working capital to sales ratio The current assets available, after meeting current obligations, per dollar of sales.

Next futures contract The futures contract with a settlement date just after a particular contract’s settlement date.

Noncore risk Risks that are incidental to the operations of a business.

Nondiversifiable risk factors See Systematic risk factors.

Nonlinear payoff A payoff on an investment such that the downside risk is different than the upside potential.

Nonsystematic risk The risk that can be diversified away.

Note Indebtedness that does not have an indenture agreement. In general use, a debt with an original maturity less than or equal to 10 years.

Notes payable Indebtedness in the firm of a security.

Notional amount See Notional principal amount.

Notional principal amount Principal amount that serves as the basis for the determination of cash flows in a swap agreement.

NPV See Net present value.

Number of days of credit See Days sales outstanding.

Number of days of inventory See Days sales in inventory.

Number of days of purchases See Days payables outstanding. OCF See Operating cash flows.

Offshore market See External market.

Open interest The number of contracts entered into but not yet liquidated.

Open-end fund See Mutual fund.

Operating cash flows The cash flows related to the revenues, expenses, and depreciation of assets involved in a capital project.

Operating cycle The length of time it takes to turn the investment of cash into goods and services for sale back into cash in the form of collections from customers.

Operating profit margin The ratio of operating profit to revenues.

Operating risk The degree of uncertainty concerning operating cash flows that arises from the particular mix of fixed and variable operating costs.

Operational budgeting Short-term financial planning.

Optimal capital structure The mix of debt and equity financing the company that maximizes the value of the company.

Optimal portfolio The best portfolio of the set of portfolios on the efficient frontier; the point of tangency of the efficient frontier and an investor’s utility curve.

Option premium The cost of an option.

Option price See Option premium.

Option writer The seller of an option.

Order-driven market structure A market in which centralized bid-matching matches the orders of the buyers and sellers.

Ordinary annuity An even series of cash flows occurring at even intervals of time, with cash flows occurring at the end of each period.

OTC See Over-the-counter market.

Out-of-the-money option The situation in which a call option’s exercise price is greater than the underlying’s value or a put option’s exercise price is less than the underlying’s value.

Outside directors Members of the board of directors who are not employees of the corporation.

Over-the-counter market A market that does not have a physical existence, but which trades securities or other assets through a network of dealers.

Owners’ equity See Equity.

Par value A stated amount of a security. In the case of a bond, the par value is the bond’s maturity value.

Parity value See Conversion value.

Partnership A business owned by more than one party. Partnership share Ownership unit in a partnership.

Passive funds See Indexed funds.

Passive portfolio strategy A process of managing a portfolio that is focused on the construction of a portfolio that is consistent with the portfolio objectives,

but without significant management of investments after the construction of the portfolio.

Passive strategy An investment strategy that does not involve active management of a portfolio, and involves minimal trading of securities in the portfolio.

Payback period The time it takes for the cash inflows from a project to add up to the initial cash outflow.

Payment date The date, determined by the board of directors, on which a dividend distribution is made.

Performance evaluation The measurement of the return on a portfolio, considering the portfolio’s benchmark’s return and the portfolio’s risk.

Performance shares Share of stock given to employees, based on some measure of operating performance.

Perpetuity A uniform series of cash flows occurring at even intervals of time forever.

PI See Profitability index.

Plan sponsor An entity that establishes a pension plan, such as a business or a union.

Plowback ratio See Retention ratio.

Policy asset allocation The long-term asset mix of a portfolio.

Porter’s Five Forces Forces that affect the ability of companies in an industry to generate economic profits: bargaining power of suppliers, bargaining power of buyers, threat of new entrants, threat of substitute products, and rivalry.

Portfolio Set of investments that are managed for the benefit of the client or clients.

Portfolio management The process of managing investments.

Portfolio manager The person who manages a portfolio by selecting investments, monitoring the portfolio’s performance, and measuring and evaluating the portfolio’s performance.

Positively sloped yield curve See Upward-sloping yield curve.

Postpayback duration The economic life of a project beyond its payback period.

Preferred habitat theory The theory that purports that yields in a yield curve represent both future interest rates, but also a premium for risk.

Preferred stock An ownership interest in a corporation that has a superior claim to the income and assets of a company relative to common stock owners, which may have a fixed maturity or may be a perpetual security.

Premium In the context of insurance, the amount paid to receive protection against an occurrence of an event.

Prepayment The option that a borrower has to prepay a portion or all of the loan prior to maturity.

Price discovery The process of determining a price of an asset by the interactions of buyers and sellers.

Price efficiency A characteristic of markets which describes asset prices as reflecting available information, such that it is not possible to earn returns in excess of that considering the asset’s future cash flows and risk.

Primary market The market in which an issuer first issues a security to investor, receiving funds in exchange for the security.

Principal The person or group of persons the agent represents in an agency relationship.

Private plan A pension plan sponsored by a business entity for its employees. Pro forma balance sheet A projected balance sheet, which summarizes expected

amounts of assets, liabilities, and equity.

Pro forma income statement A projected income statement which summarizes expected income and expenses.

Probability distribution A set of probabilities for each possible outcome for a random variable.

Professional corporation A form of business in which owners have unlimited liability, but which is treated as a partnership for tax purposes.

Profitability index The ratio of the present value of the cash inflows to the present value of cash outflows of a project.

Profitability ratios Ratios that provide information on what is left of revenues after expenses.

Prospect theory A theory of decision making under uncertainty, describing behavior as involving a heuristic: first, individuals consider the possible investments and decide which ones are similar and which ones are different; second, the individuals then evaluate the possible outcomes and probabilities, selecting the investment that has the highest utility.

Public corporation See Publicly held corporation.

Publicly held corporation A corporation with ownership interests sold outside of a close group.

Pure expectations theory The theory that purports that forward rates are expected future interest rates.

Put provision A provision of a security that allows the investor to sell the security back to the issuer at a specified price.

Putable bond A debt obligation that may be sold back to the issuer at a specified price.

Quick ratio A liquidity ratio that measures the company’s ability to meet its current obligations, calculated as the ratio of current assets, less inventory, divided by current liabilities.

Quote-driven market structure A market in which intermediaries, such as market makers, provide quotes for purchase and sales, and stand ready to buy or sell at these quotes.

Rate of return The dollar return on an investment, expressed as a percentage of the initial investment.

Rating agencies Companies that evaluate and rate the default risk of debt obligations.

Real interest rate The rate of interest that would exist in the economy in the absence of inflation.

Record date See Date of record.

Regression analysis The application of statistical techniques to gauge the relation between two of more variables.

Regression line A statistical depiction of the average relationship between two (or more) variables.

Regulated investment company A financial intermediary that sells shares to the public and invests those proceeds in a diversified portfolio of securities.

Reinvestment risk The risk that the investor may face yields on reinvested cash flows that are lower than the yield to maturity of a security.

Relative return Difference between the realized return and the expected return. Relative valuation A method of valuing a stock or a company that requires using multiples of similar or comparable companies, and applying these

multiples to the stock or company.

Reoffering price The price at which an investment bank offers securities that it is underwriting to investors.

Replacement project A project that involves the maintenance of existing assets to continue the current level of operating activity.

Repo See Repurchase agreement.

Repo rate The interest rate charged in a repurchase agreement. Repurchase agreement A short-term loan backed by specific collateral.

Required rate of return The return expected by the suppliers of capital for the risk of the investment.

Required reserve Dollar amount of funds required to be maintained on hand, based on the reserve ratio.

Required yield The return that investors demand, which relates to the time value of money and the uncertainty of the security’s cash flows.

Reserve ratio Percentage of deposits that a bank must maintain on hand. Residual loss The agency costs other than monitoring costs and bonding costs. Restricted stock grant The grant of shares of stock to the employee at low or

no cost, conditional on the shares not being sold for a specified time. Retained earnings The accumulation of earnings over time, less dividends paid

over time.

Retention ratio The proportion of earnings retained by the company during a period.

Return See Rate of return.

Reverse cash-and-carry trade A futures position in which the investor buys futures, sells the asset, and lends funds at the inception of the contract, and then buys the asset and has the loan paid off at the end of the contract.

Reverse stock split A reduction of the number of shares of stock, specified as the number of shares post-split to the number of shares presplit, e.g., 1:4.

RIC See Regulated investment company.

Risk Uncertainty regarding a future outcome.

Risk appetite The amount of risk that an entity is willing to accept or retain. Risk control The process of identifying, evaluating, monitoring, and managing

the risk of an business enterprise.

Risk finance The management of the retained risk of an enterprise.

Risk management The process of identifying risks and managing those risks through acceptance, mitigation, and transference.

Risk management culture The environment in which the entity has an approach to dealing with risks and that approach is part of the business’s management culture.

Risk neutralization A risk management policy in which the management of an entity pursues a risk management policy to mitigate an expected loss without transferring the associated risk to another party.

Risk premium Additional compensation required by investors for bearing risk. Risk retention The amount of risk an enterprise is willing to assume.

Risk tolerance The amount of risk that is tolerated, with any risk exceeding this tolerance triggering action to reduce risk.

Risk transfer management The transfer of risk by management to a third party via insurance, derivatives, structured financial products, or some other means.

Risk-free asset An asset whose expected return is known with certainty.

Riskless asset See Risk-free asset.

Safety-first rules Decision rules that seek to maximize the probabilities of producing returns above some benchmark return.

Salary A direct payment of cash of a fixed amount per period.

Sales risk The degree of uncertainty related to the number of units that will be sold and the price of the good or service.

Salvage value The expected value of an asset at the end of its economic life. Savings deposit Funds deposited with a bank that earn interest and can gener-

ally be withdrawn by the depositor upon demand.

Secondary market The market in which investors trade securities or other assets.

Securities finance The borrowing or lending of securities.

Securities lending transaction The lending of securities by one party to an investor in need of those securities on a temporary basis.

Security A financial asset that represents a claim on future cash flows, such as a bond or a stock.

Security market line The line depicting the relation between the return on a stock to its market risk.

Selling group A group of investment banks and others that market a security issue.

Semi-strong form of market efficiency The degree of market efficiency in which current prices reflect all available public information.

566 GLOSSARY

Semivariance A measure of dispersion that considers only the possible outcomes below the expected value.

Separately managed account A professionally managed portfolio tailored to the investor’s objectives.

Settlement date The designated date of the transaction in a futures contract. Share Ownership interest in a corporation.

Shareholder Owner of an interest in a corporation. Shareholders’ equity The ownership interest in a corporation.

Short call position An investment position that involves selling or writing call options.

Short futures See Short position in futures.

Short position in futures The investment position in which the investor sells a futures contract.

Short put position An investment position that involves selling or writing put options.

Silo structure The structure of a business enterprise in which each part of the business is operated independently of the other parts of the business.

Simple interest An arrangement in which interest is paid only on the principal amount.

SML See Security market line.

Sole proprietorship A business owned by a single individual.

Spot market See Cash market.

Spread The difference in interest rates or yields, generally expressed in terms of basis points.

Standard deviation of a random variable A measure of dispersion or possible outcomes around the expected value, calculated as the square root of the variance.

Stated conversion price The ratio of the par value of a convertible bond to the conversion ratio.

Stated value See Par value.

Stock appreciation right A cash payment based on the amount by which the value of a specified number of shares has increased over a specified period of time.

Stock dividend Distribution of additional shares of stock to shareholders, generally specified in terms of the proportion of new shares to the number of existing shares, e.g., 25%.

Stock option The right to buy a specified number of shares of stock in the company at a stated price—referred to as an exercise price at some time in the future. The exercise price may be above, at, or below the current market price of the stock.

Stock split Distribution of additional shares of stock to shareholders, generally specified in terms of the ratio of shares after the distribution to the number of existing shares, e.g., 2:1.

Straight value The value of a bond without considering the value of any embedded option.

Straight-line depreciation Depreciation in which the same proportion of an asset’s cost is depreciated each period.

Strategic plan The path that the company intends to follow to achieve its objective.

Strategy A direction the company intends to take to reach an objective. Strike price The price at which the option buyer can buy the underlying asset,

in the case of a call option, or sell the underlying asset, in the case of a put option.

Strong form of market efficiency The degree of market efficiency in which current prices reflect all public and private information.

Structure of interest rates The relationship among interest rates of debt instruments based on a number of factors, including risk and maturity.

Structured finance Securities created for specific risk and return profiles, such as asset securitization and structured notes.

Style box A method developed by Morningstar to characterize securities based on two dimensions; for stocks these dimensions are market capitalization and style, whereas for bonds they are credit quality and maturity.

Sum-of-year’s digits method A depreciation method that uses a declining rate applied to the asset’s depreciable basis, with this rate as ratio of the remaining years divided by the sum of the years.

Supranational An organization that extends beyond a single country’s boundaries, which shares in decision making of the organization.

Sustainability risk A broad spectrum of the risk of a business enterprise that includes social and environmental responsibilities.

Swap An agreement whereby two parties (called counterparties) agree to exchange periodic payments.

Swap curve See Swap rate yield curve.

Swap rate The fixed rate paid by the fixed-rate counterparty in a swap. Swap rate yield curve The rates for different maturities that reflect the average

credit risk of banks that provide interest rate swaps.

Syndicated bank loan A bank loan in which a group of banks lends funds to a borrower.

Systematic risk See Market risk.

Systematic risk factors Factors that affect the risk of an investment that cannot be diversified away.

Tactical asset allocation A form of dynamic asset allocation that is based on opportunities to capture abnormal returns.

Taft-Hartley plan A pension plan sponsored by a union on the behalf of its members.

Tangible asset An asset with physical properties, such as a machine or inventory.

568 GLOSSARY

Tender offer An offer, made directly to shareholders, to purchase shares of a company.

Three-stage dividend discount model A multiphase dividend discount model that assumes that there are three distinct phases of growth in a stock’s dividends in the future.

Time deposit Funds deposited with a financial institution that have a fixed maturity date and earn interest. More commonly referred to as certificates of deposit.

Time premium The difference between an option’s price and the intrinsic value; the value of an option attributed to the possibility that the option may become more valuable in the time remaining to expiration.

Time value of an option See Time premium.

Time-weighted rate of return The geometric mean of subperiod rates of return. Total asset turnover The ratio of revenues to assets; a measure of the effec-

tiveness of putting assets to use to generate revenues.

Treasury bill A short-term security issued by a government. In the United States, these bills have maturities of four weeks, three months, and six months.

Treasury securities Securities issued by a government.

Treasury spot rates The theoretical rates that would exist for a given yield curve that represent what the U.S. Treasury would have to pay if the securities are zero-coupon securities.

Treasury stock Stock of a company that is bought back by the company for use in executive stock options and other purposes.

Two-parameter model See Mean-variance portfolio analysis. Underlying See Underlying asset.

Underlying The basis of a derivative contract, which may be a stock, a bond, or any other asset.

Underlying asset The asset or security specified in a derivative instrument, such that the value and or cash flows of the derivative instrument depend on the specified asset or security.

Underwriting syndicate A group of investment banks that underwrite an issue. Unfunded retained risk An assumed risk for which losses are not financed until

they occur.

Unit investment trust A regulated investment that has a finite life and a fixed portfolio of investments.

Unsystematic risk factors Risks that can be reduced or eliminated through diversification.

Unvalued contract An insurance arrangement in which the value of the insured property is not fixed.

Upward-sloping yield curve A yield curve in which the rates of longer-maturity securities are higher than those of shorter-maturity securities.

Useful life See Economic life.

Utility function A series of values assigned to possible choices that an entity faces.

Value at risk A safety-first rule that focuses on the maximum loss at a specified probability level over a specified time horizon.

Valued contract An insurance arrangement in which the value of the insured property is fixed.

VaR See Value at risk.

Variance of a random variable A measure of dispersion or possible outcomes around the expected value.

Variation margin The amount of margin beyond the initial margin, generally required in cash.

Vertical common-size analysis The restatement and comparison of accounts relative to a benchmark account’s value for that period; for a balance sheet, this benchmark is total assets, and for an income statement this benchmark is revenues.

Weak form of market efficiency The degree of market efficiency in which current prices reflect all of the information available in past prices.

Wealth management See Investment management.

Working capital Current assets, which serve to meet the needs of the day-to- day operations of a business.

Yankee market The foreign market in the United States.

Yield curve The yields on Treasury securities at a point in time for securities with different maturities.

Yield curve spread See Maturity spread.

Yield-to-first call The yield on a callable security, assuming that the security will be called by the issuer at the first available call date.

Yield to maturity The expected return on a security, based on the security’s current value, maturity value, and expected cash flows, such as coupon payments.

Yield-to-par call See Yield-to-first call.

Yield to worst The lower of a callable security’s yield to maturity and yield to call.

Zero-coupon bond A bond that does not pay interest; rather, the investor receives a return from buying the security at a discount from the bond’s face value.