Glossary
Abnormal return (excess return): Difference between the actual returns on an
investment and the expected return on that investment, given market returns and
investment's risk..
Accelerated depreciation: A depreciation method where more of the asset is written
off in earlier years and less in later years, over its lifetime, to reflect the aging of the
asset.
Accounting beta: Beta estimated using accounting earnings for a firm and accounting
earnings for the market, rather than stock prices.
Accrual accounting: Accounting approach, where the revenue from selling a good or
service is recognized in the period in which the good is sold or the service is
performed (in whole or substantially). A corresponding effort is made on the expense
side to match expenses to revenues.
Acquisition premium: Difference between the price paid to acquire a firm and the
market price prior to the acquisition.
Acquisition price: Price that will be paid by an acquiring firm for each of the target
firmճ shares.
Adjustable rate preferred stock: Preferred stock where the preferred dividend rate
is pegged to an external index, such as the treasury bond rate.
Agency costs: Costs arising from conflicts of interest between two stakeholders;
examples would be managers & stockholders as well as stockholders & bondholders.
Allocation: Process of distributing a cost that cannot be directly traced to a revenue
center across different units, projects or divisions.
American options: An option that can be exercised any time until maturity.
Amortizable life: A period of time over which an intangible asset is written off.
Annual percentage rate (APR): A rate that has to be cited with loans and mortgages
in the United States. The rate incorporates an amortization of any fixed charges that
have to be paid up front for the initiation of the loan.
Annuity: A stream of constant cash flows that occur at regular intervals for a fixed
period of time.
Arbitrage position: A riskless position that yields a return that exceeds the riskfree
rate.
Arbitrage principle: Assets that have identical cash flows cannot sell at different
prices.
Asset beta: The beta of the assets of investments of a firm, prior to financial leverage.
Can be computed from the regression beta (top-down) or by taking a weighted
average of the betas of the different businesses (bottom-up).
Asset-backed borrowing: Bonds or debt secured by assets of any type. Mortgage
bonds and collateral bonds are special cases.
Assets-in-place: The existing investments of a firm.
Bad debts: Portion of loans that cannot be collected (if you are the lender) or will not
be paid (if you are the borrower).
Balance sheet: A summary of the assets owned by a firm, the book value of these
assets and the mix of financing, debt and equity, used to finance these assets at a point
in time.
Balloon payment bonds: Bonds where no principal repayment is made during the
life of the bond but the entire principal is repaid at maturity.
Bankrupt: The state in which a firm finds itself if it is unable to meet its contractual
commitments.
Barrier options: An option where the payoff on, and the life of, the option are a
function of whether the underlying asset price reaches a certain level during a
specified period.
Baumol model: Model for estimating an optimal cash balance, given the cost of
selling securities and the interest rate that can be earned on marketable securities, for
firms with certain cash inflows and outflows.
Best efforts guarantee: Underwriting agreement on a security issue where the
investment banker does not guarantee a fixed offering price.
Beta: A measure of the exposure of an asset to risk that cannot be diversified away
(also called market risk). It is standardized around 1. (Average = 1, Above average
risk >1)
Binomial option pricing model: Option pricing model based upon the assumption
that stock prices can move to only one of two levels at each point in time.
Book value: Accounting estimate of the value of an asset or liability, usually from the
balance sheet of the firm.
Bottom-up betas: Beta computed by taking a weighted average of the betas of the
businesses that a firm is in. These betas, in turn, are estimated by looking at firms that
operate only or primarily in each of these businesses.
Building the book: Process of polling institutional investors prior to pricing an initial
offering, to gauge the extent of the demand for an issue.
Call market: A market where an auctioneer (or a market maker) holds an auction at
certain times in the trading day and sets a market-clearing price, based upon the
orders grouped together at that time.
Callable bonds (debt): Debt (bonds), where the borrower has the right to pay the
bonds back at any time. The option to pay back will generally be used if interest rates
decrease.
Cap: The maximum interest rate on a floating rate bond.
Capital expenses: Expenses that are expected to generate benefits over multiple
periods. Accounting rules generally require that these expenses be depreciated or
amortized over the multiple periods.
Capital lease: The lessee assumes some of the risks of ownership and enjoys some
of the benefits. Consequently, the lease, when signed, is recognized both as an asset
and as a liability (for the lease payments) on the balance sheet.
Capital rationing: Situation that occurs when a firm is unable to invest in projects
that earn returns greater than the hurdle rates because it has limited capital (either
because of internal or external constraints).
Capped call: A call where the payoff is restricted on the upside. If the price rises
above this level, the call owner does not get any additional payoff.
Cash flow to equity investors: Cash flows generated by the asset after all expenses
and taxes, and also after payments due on the debt.
Cash flow to the firm: Cash flows generated by the asset for both the equity investor
and the lender. This cash flow is before debt payments but after operating expenses
and taxes.
Cash slack: Combination of excess cash and limited project opportunities in a firm.
Cashflow return on investment (CFROI): Internal rate of return on the existing
investments of the firm, estimated in real terms, using the original investment in the
assets, their remaining life and expected cash flows.
Catastrophe bond: A bond that allows for the suspension of coupon payments and/or
the reduction of principal, in the event of a specified catastrophe.
Certainty equivalent (cash flow): A guaranteed cash flow that you would agree to
accept in exchange for a much larger and riskier cash flow.
Chapter 11: Legal process governing bankruptcy proceedings.
Clientele effect: Clustering of stockholders in companies with dividend policies that
match their preferences for dividends.
Collateral bond: Bond secured with marketable securities
Combination leases: A lease that shares characteristics with both operating and
capital leases.
Commercial paper: Short term notes issued by corporations to raise funds.
Commodity bond: A bond whose coupon rate is tied to commodity prices.
Competitive risk: Risk that the cash flows on projects will vary from expectations
because of actions taken by competitors.
Compound options: An option on an option.
Compounding: The process of converting cash flows today into cash flows in the
future.
Concentration banking: System where firms pick banks around the country to
process checks, allowing for the faster clearing of checks
Consol bond: A bond with a fixed coupon rate that has no maturity (infinite life).
Consolidation (in mergers): A combination of two firms where a new firm is created
after the merger, and both the acquiring firm and target firm stockholders receive
stock in this firm.
Consolidation (in accounting statements): The accounting approach used to show
the income from ownership of securities in another firm, where it is a majority, active
investment. The balance sheets of the two are merged and presented as one balance
sheet. The income statements, likewise, represent the combined income statements of
the two firms.
Contingent liabilities: Potential liabilities that will be incurred under certain
contingencies, as is the case, for instance, when a firm is the defendant in a lawsuit.
Contingent value rights: Securities where holders receive the right to sell the shares
in the firm at a fixed price in the future; it is a long term put option on the equity of
the firm.
Continuing value: present value of the expected cash flows from continuing an
existing investment through the end of its life.
Continuous market: A market where prices are determined through the trading day
as buyers and sellers submit their orders.
Continuous price process: Price process where price changes becoming
infinitesimally small as time periods become smaller.
Conversion premium: Excess of convertible bond market value over its conversion
value.
Convertible bond: A bond that can be converted into a pre-determined number of
shares of the common stock, at the discretion of the bondholder
conversion ratio (in convertible bond): Number of shares of stock for which a
convertible bond may be exchanged.
Convertible preferred stock:: Preferred stock that can be converted into common
equity, at the discretion of the preferred stockholder.
Cost of capital: Weighted average of the costs of the different sources of financing
used by a firm.
Cost of debt (pre-tax): Interest rate, including a default spread, that a borrower has to
pay to borrow money.
Cost of debt (after-tax): Interest rate, including a default spread, that a borrower has
to pay to borrow money, adjusted for the tax deductibility of interest.
Cost of equity: The rate of return that equity investors in a firm expect to make on
their investment, given its riskiness.
Cumulative abnormal (excess) returns (cars): Difference between the actual return
on an investment and the expected return, given market returns and stock's risk,
cumulated over a period surrounding an event (such as an earnings announcement).
Current assets: Short-term assets of the firm, including inventory of both raw
material and finished goods, receivables (summarizing moneys owed to the firm) and
cash.
Current PE: Ratio of price per share to earnings per share in most recent financial
year.
Debentures: Unsecured bonds issued by firms with a maturity greater than 15 years.
Debt Exchangeable for Common Stock (decs).: Debt that can be exchanged for
common stock, with the conversion rate depending upon the stock price.
Debt: Any financing vehicle that has a contractual claim on the cash flows and assets
of the firm, creates tax deductible payments, has a fixed life, and has priority claims
on the cash flows in both operating periods and in bankruptcy.
Default risk: Risk that a promised cash flow on a bond or loan will not be delivered.
Default spread: Premium over the riskless rate that you would pay (if you were a
borrower) because of default risk.
Deferred tax asset: Asset created when companies pay more in taxes than the taxes
they report in the financial statements.
Depreciation: Accounting adjustments to the book value of an asset for the aging and
subsequent loss of earning power on it. Applies when you have a capital expenditure.
Direct cost of bankruptcy: Costs include the legal and administrative costs, once a
firm declares bankruptcy, as well as the present value effects of delays in paying out
the cash flows.
Cost of bankruptcy (direct): Costs include the legal and administrative costs, once a
firm declares bankruptcy, as well as the present value effects of delays in paying out
the cash flows.
Disbursement float: Lag between when a check is written and the time it is cleared,
when the firm is writing the check.
Discount rate: the rate used to move cash flows from the future to the present, in
discounting, or from the present to the future, in compounding.
Discounting: the process of converting cash flows in the future to cash flows today.
Divestiture value: Value of an asset to the highest potential bidder for it.
Divestiture: Sale of asset, assets or division of a firm to third party.
Dividend capture (arbitrage): Strategy of buying stock before the ex-dividend day,
selling it after it goes ex-dividend and collecting the dividend.
Dividend declaration date: Date on which the board of directors declares the dollar
dividend that will be paid for that quarter (or period).
Dividend payment date: Date on which dividends are paid to stockholders.
Dividend payout ratio: Ratio of dividends to net income (or dividends per share to
earnings per share).
Dividend yield: Ratio of dividends, usually annualized, to current stock price.
Down-and-out option: A call option that ceases to exist if the underlying asset rises
above a certain price.
Dual currency bond: Bond with some cash flows (eg. Coupons) in one currency and
other cash flows (eg. Principal) in another.
Duration: Weighted maturity of all the cash flows on an asset or liability.
Economic exposure: Effect of exchange rate changes on the value of a firm with
exposure to foreign currencies.
Economic order quantity (EOQ): The order quantity that minimizes the total costs
of new orders and the carrying cost of inventory.
Economic Value Added (EVA): Measure of dollar surplus value created by a firm or
project. It is defined to be the difference between the return on capital and the cost of
capital multiplied by the capital invested.
Efficient Frontier: The line connecting efficient portfolios, i.e. Portfolios that yield
the highest expected return for each level of risk (standard deviation).
Enterprise value: Market value of debt and equity of a firm, net of cash.
Equity approach: The accounting approach used to show the income from ownership
of securities in another firm, where it is a minority, active investment. A proportional
share (based upon ownership proportion) of the net income and losses made by the
firm in which the investment was made, is used to adjust the acquisition cost.
Equity carve out (ECO): Action where a firm separates out assets or a division,
creates shares with claims on these assets, and sells them to the public. Firm generally
retains control of the carved out asset.
Equity risk: Measure of deviation of actual cash flows from expected cash flows.
Equity: Any financing vehicle that has a residual claim on the firm, does not create a
tax advantage from its payments, has an infinite life, does not have priority in
bankruptcy, and provides management control to the owner.
Eurobonds: Bonds issued in the local currency but offered in foreign markets.
Eurodollar and Euroyen bonds are examples.
Eurodollar bonds: Bonds denominated in U.S. dollars and offered to investors
globally.
European options: An option that can be exercised only at maturity.
Euroyen bonds: Bonds denominated in Japanese Yen and offered to investors
globally.
Excess return (abnormal return): Difference between the actual returns on an
investment and the expected return, given market returns and investment's risk.
Ex-dividend date: Date by which investors have to have bought the stock in order to
receive the dividend
Exercise Price (Strike Price): Price at which the underlying asset in an option can be
bought (if it is a call) or sold (if it is a put).
Exit value: Estimated value of a private firm in a year in which the owners plan to
sell it to someone else or to take it public.
Ex-rights price: Stock price without the rights attached to the stock, in a rights
offering.
External financing: Cash flows raised outside the firm whether from private sources
or from financial markets.
Factor beta: A measure of the exposure of an asset to a specified macroeconomic
factor (such as inflation or interest rates) or an unspecified market factor.
FIFO: An inventory valuation method, where the cost of goods sold is based upon the
cost of material bought earliest in the period, while the cost of inventory is based upon
the cost of material bought later in the year.
Financing expenses: Expenses arising from the non-equity financing used to raise
capital for the business
Firm: any business large or small, privately run or publicly traded, and engaged in
any kind of operation - manufacturing, retail or service.
Firm-specific risk: Risk that affects one or a few firms, and is thus risk that can be
diversified away in a portfolio.
Fixed (exchange) rates: Exchange rate set and backed up by a government, rather than
by demand and supply.
Fixed assets: Long term and tangible assets of the firm, such as plant, equipment,
land and buildings.
Fixed-rate bond: Bond with a coupon rate that is fixed for the life of the bond.
Float: Lag between when the check is written and the time it is cleared.
Floating (exchange) rates: Exchange rates determined by demand and supply for the
currency, and thus change over time.
Floating rate bond: Bond with a coupon rate that is reset each period, depending
upon a specified market interest rate (prime or LIBOR).
Floor: The minimum interest rate on a floating rate bond.
Forward contracts: A contract to buy or sell an asset, security or currency in the
future at a fixed price (specified at the time of the contract)
Forward PE: Ratio of price per share to expected earnings per share in next financial
year.
Forward price (rate): The price or rate quoted in a forward contract.
Free cash flow to equity: cash left over after operating expenses, net debt payments
and reinvestments.
Free cash flow to the firm: Cash flow left over after operating expenses, taxes and
reinvestment needs, but before any debt payments (interest or principal payments).
Free cash flows (Jensen): Cash flows from operations over which managers have
discretionary spending power.
Futures contract: Like a forward contract, it is an agreement to buy or sell an
underlying asset at a specified time in the future. However, it differs from a forward
because it is usually traded, requires daily settlement of differences and has no default
risk.
Golden parachute: A provision in an employment contract that allows for the
payment of a lump-sum or cash flows over a period, if the manager covered by the
contract loses his or her job in a takeover.
Goodwill: The difference between the market value of an acquired firm and the book
value of its assets; arises only when purchase accounting is used in an acquisition.
Gordon growth model: Stable-growth dividend discount model, where the value of a
stock is the present value of expected dividends, growing at a constant rate forever.
Greenmail: Buying out the existing stake of a hostile acquirer in the firm, generally
at a price much greater than the price paid by the acquirer. In return, the acquirer
usually agrees not to go through with the takeover or buy additional stock in the firm
for a period of time (standstill agreement).
Growing annuity: A cash flow that occurs at regular interval and grows at a constant
rate for a specified period of time.
Growing perpetuity: A cash flow that is expected to grow at a constant rate forever.
Growth assets: Investments yet to be made by the firm; often markets will
incorporate their expectation of the value of these assets into the market value.
Historical (risk) premium: Difference between returns on risky investments (usually
stocks) and riskless investments (usually government securities) over a specified past
time period.
Historical cost: The original price paid for an asset, when acquired, adjusted upwards
for improvements made to the asset since purchase and downwards for the loss in
value associated with the aging of the asset
Holder-of-record date: Date on which company closes its stock transfer books and
makes up a list of the shareholders.
Hurdle rate: a minimum acceptable rate of return on projects; used to determine
whether to invest in a project or not.
Hybrid securities: Securities that share some characteristics with debt and some with
equity. Examples would be preferred stock and convertible debt.
Implied premium: The premium estimated based upon the current level of stock
prices and expected cash flows from buying stocks. The internal rate of return that
would make the present value of the cash flows equal to today's stock prices is the
expected return on equity. Subtracting out the riskless rate yields the implied
premium.
Income bonds: Bond on which interest payments are due only if the firm has positive
earnings.
Income statement: A statement which provides information on the revenues and
expenses of the firm, and the resulting income made by the firm, during a period.
Incremental cash flows: Cash flows that arise as a consequence of a new investment.
It is the difference between the cash flow a firm would have had without the new
investment and the cash flow with the new investment.
Indirect costs of bankruptcy: Costs associated with the perception that a firm may
go bankrupt - lost sales, drop in employee morale, tighter supplier creditɮ
Inflation rate: Change in purchasing power in a currency from period to period.
Inflation-indexed treasury bond: A government bond that guarantees a real interest
rate, rather than a nominal rate.
In-process R&D: Portion of an acquired firm's value that is attributed to past
research. This amount is usually written off right after the acquisition.
Intangible assets: Assets that do not have a physical presence but have value (either
because they generate cash or can be sold). Examples would include assets like
patents and trademarks as well as uniquely accounting assets such as goodwill that
arise because of acquisitions made by the firm
Interest rate parity: Equation that relates the differential between forward and spot
rates to interest rates in the domestic and foreign market.
Internal equity: Cash flows generated by the existing assets of a firm that are
reinvested back into the firm.
Internal rate of return (IRR): Discount rate that makes the net present value zero. It
can be considered a time-weighted, cash flow, rate of return on an investment.
International Fisher Effect: Specifies the relationship between changes in exchange
rates and differences in nominal interest rates in two countries.
Jump price proces: Price process where price changes stay large even as the period
gets shorter.
Knockout option: An option that ceases to exist if the underlying asset reaches a
certain price.
Kurtosis:: Measure of the likelihood of large jumps in a distribution, captured in the
tails of the distribution.
Leveraged buyout: An acquisition of a firm by its own managers or a private entity,
financed primarily with debt.
Leveraged recapitalization: Using new debt to repurchase equity and increasing
debt ratio substantially in the process.
Levered beta: Beta of a firm, reflecting its financial leverage. This will change as
leverage changes.
LIFO reserve: Difference in inventory valuation between FIFO and LIFO. Firms that
choose the LIFO approach to value inventories have to specify in a this difference.
LIFO: An inventory valuation method where the cost of goods sold is based upon the
cost of material bought towards the end of the period, resulting in inventory costs that
closely approximate current costs.
Line of credit: A financing arrangement, under which the firm can draw on only if it
needs financing, up to the agreed limit.
Liquidating dividends: Dividends in excess of the retained earnings of a firm. This
is viewed as return of capital in the firm and taxed differently.
Liquidation value: net cash flow that the firm will receive from selling an asset
today.
Lockbox system: System where customer checks are directed to a post office box,
rather than to the firm
Major bracket investment bankers: Investment bankers in the top tier, based upon
reputation and national focus.
Majority active investment: Categorization of ownership of securities by one firm in
another firm are treated, if the securities represent more than 50% of the overall
ownership of that firm.
Management buyouts: An acquisition of a publicly traded firm by its own managers.
Marginal investor: The investor or investors most likely to be involved in the next
trade on the securities issued by a firm. Not necessarily the largest investor in the
firm.
Marginal return on equity (capital): Measures quality of marginal investments,
rather than average investments. Computed as the change in income (net income or
operating income) divided by the change in equity or capital invested.
Marginal tax rate: Tax rate on the last dollar of income (or the next dollar of
income). Usually determined by the tax codes.
Market capitalization (market cap): Market value of equity in a firm.
Market conversion value: Current market value of the shares for which a convertible
bond can be exchanged.
Market efficiency: A measure of how much the price of an asset deviates from a
firmճ true value. The smaller and less persistent the deviations are, the more efficient
a market is.
Market risk: Risk that affects many or all investments in a market. This risk cannot
be diversified away in a portfolio.
Market value: Estimate of how much an asset would be worth if sold in the market
today. If the asset is a traded asset, this is obtained by looking at the last traded price.
Markowitz portfolios: The set of portfolios, composed entirely of risky assets, that
yield the highest expected returns for each level of risk (standard deviation).
Merger: A combination of two firms where the boards of directors of two firms agree
to combine and seek stockholder approval for the combination. In most cases, at least
50% of the shareholders of the target and the bidding firm have to agree to the
merger. The target firm ceases to exist and becomes part of the acquiring firm.
Mezzanine bracket: Smaller investment banks that operate nationally.
Miller-Orr model: Model for estimating an optimal cash balance, given the cost of
selling securities and the interest rate that can be earned on marketable securities, for
firms with uncertain cash inflows and outflows.
Minority interest: The share of the firm that is owned by other investors, when one
firm owns a majority, active interest in another firm (more than 50%). The minority
interest is shown on the liability side of the balance sheet. Shows up only in the event
of consolidation.
Minority, active investment: Categorization of ownership of securities by one firm
in another firm are treated, if the securities represent between 20% and 50% of the
overall ownership of that firm. Usually get accounted for using the equity approach.
Modified internal rate of return (MIRR): Internal rate of return estimated with the
assumption that intermediate cash flows are reinvested at the cost of equity or capital
instead of the internal rate of return.
Mortgage bond: A bond secured by real property, such as land or buildings.
Mutually exclusive (projects): A set of projects where only one of the set can be
accepted by a firm.
Equivalent annuities: Annuity equivalent of the NPV of a multi-year project.
Near-cash investments: Investments that earn a market return, with little or no risk,
and can be quickly converted into cash.
Negative pledge clause: Clause in a bond issue that specifies that the bond is backed
only by the earning power of the firm, rather than specific assets.
Net debt payments: Difference between debt repaid and new debt issued by a firm
during a period.
Net float: Difference between the disbursement and processing float.
Net lease: A capital lease where the lessor is not obligated to pay insurance and taxes
on the asset, leaving these obligations up to the lessee; the lessee consequently
reduces the lease payments.
Net operating losses (nols): Accumulated losses over time that can be used to offset
income and save taxes in future periods.
Net present value (NPV): Sum of the present values of all of the cash flows on an
investment, netted against the initial investment.
Net present value profile: A graph that records the net present value as the discount
rate changes.
Nominal cash flow: A cash flow in nominal terms, or an expected cash flow that
includes the effects of inflation (higher prices for both inputs and output).
Nominal interest rate: Interest rate on a bond that incorporates expected inflation.
Non-cash working capital: Difference between non-cash current assets and non-debt
current liabilities.
Notes: Unsecured bonds issued by firms with maturity less than 15 years.
Offering price: Price of a stock at the initial public offering.
Open market repurchase: Stock repurchase where firms buy shares in securities
markets at the prevailing market price, and do not have to offer the premiums required
for tender offers.
Operating expenses: Expenses that provide benefits only for the current period
Operating exposure: Economic exposure that measures the effects of exchange rate
changes on expected future cash flows and discount rates, and, thus, on total value.
Operating lease: The lessor (or owner of the asset) transfers only the right to use the
property to the lessee. At the end of the lease period, the lessee returns the property to
the lessor. The lease expense is treated as an operating expense in the income
statement and the lease does not affect the balance sheet.
Operating leverage: A measure of the proportion of the costs that are fixed costs; the
higher the proportion the greater the operating leverage.
Opportunity costs: Costs associated with the use of resources that a firm may
already own.
Option delta: Number of units of the underlying asset that are needed to create the
replicating portfolio for an option.
Option: Right to buy or sell an underlying asset at a fixed price sometime during the
option's life (American option) or at the end of the option life (European option).
Original-issue deep discount bond: Bond with a coupon rate that is much lower than
the market interest rate at the time of the issue. This bond will be priced well below
par.
Payback: Period of time over which the initial investment on a project will be
recovered.
PEG ratio: Ratio of PE ratio to expected growth rate in earnings.
Perpetuity: A stream of constant cash flows that occur at regular intervals forever.
Poison pills: Securities, the rights or cash flows on which are triggered by hostile
takeovers. The objective is to make it difficult and costly to acquire control
Pooling accounting: Accounting approach for acquisitions where the book values of
the two firm involved in the acquisition are added up, and the market value of the
acquisition is not shown on the balance sheet.
Preferred stock: Security that pays a fixed dividend, which is usually not tax
deductible, and has an infinite life; usually has no or limited voting rights;
Preferred stock: Security which a fixed dollar dividend that is usually not tax
deductible to the firm; if the firm does not have the cash to pay the dividend, the
dividend is cumulated and paid in a period when there are sufficient earnings.
Price/book value: Ratio of price per share to book value of equity per share.
Price/earnings ratio (PE): Ratio of price per share to earnings per share.
Price/sales ratio (PS): Ratio of price per share to sales per share.
Principal exchange linked bonds (perls): Bonds where coupons and principal are
payable in US dollars, but the amount of the payment is determined by the exchange
rate between the US dollar and a foreign currency.
Private equity: Equity provided by private investors to companies, often with the
intent of taking the company from public to private status.
Private placement: An arrangement where securities are sold directly to one or a few
investors.
Privately negotiated repurchases: Stock repurchase negotiated with a stockholder
who owns a substantial percentage of the shares.
Probit: Statistical technique used to estimate probability of an event occurring.
Processing float: Lag between when the check is written and the time it is cleared,
when the customer is writing the check to the firm.
Product cannibalization: The effect that the introduction of a new product may have
on a firmճ existing product sales.
Profitability index: Ratio of net present value to initial investment in a project. Often
used when a firm faces capital rationing.
Project risk: Risk that affects the cash flows of a project will differ from
expectations, due to estimation errors or unanticipated events.
Purchase accounting: Accounting approach for acquisitions where the market value
paid for the acquired firm is shown on the balance sheet, and goodwill, which is the
difference between the book value and market value of the acquired firm, is shown as
an asset.
Purchase of assets: An action where one firm acquires the assets of another, though a
formal vote by the shareholders of the firm being acquired is still needed.
Purchasing power parity: Equation that relates changes in exchange rates to
differences in inflation. Based upon the assumption that a specific basket of goods
should sell for the same price across different countries
Pure play: Beta or other input estimated for a project by looking at the betas of firms
that are involved only or primarily in similar investments.
Put-call parity: Arbitrage relationship governing the prices of a call and put option,
with the same strike price, same exercise price and on the same underlying asset.
Puttable bonds: Debt (bonds), where bond buyers are allowed to put their bonds
back to the firm and receive face value, in the event of an occurrence like a leveraged
buyout.
Rainbow options: An option that is exposed to more than one type of uncertainty.
Real cash flow: A cash flow that is corrected for the loss of buying power over time,
associated with inflation.
Real interest rate: Interest rate on a bond after taking out the expected inflation
component.
Real interest rate: The compensation, in real goods, that has to be offered to get
lenders to postpone consumption and allow you to use their savings.
Nominal interest rate: The compensation that has to be offered to lenders to induce
them to lend you money; the nominal component captures expected inflation.
Real options: An option on a real asset, as opposed to a financial asset.
Recapitalization: Changing financing mix by using new equity to retire debt or new
debt to reduce equity.
Red herring: Preliminary prospectus issued by a firm going public, while the
registration is being reviewed by the SEC.
Regular dividend: Dividend paid at regular intervals to stockholders.
Reinvestment rate: Proportion of after-tax operating income reinvested back into the
firm.
Replicating portfolio: A portfolio of the underlying asset and the riskless asset that
has the same cash flows as an option.
Repo rate: Implied interest rate in a repurchase agreement, calculated based upon the
difference between the price at which a security is bought and the price at which it
will be sold back.
Repurchase agreement (repo): The sale of a security, with an agreement that the
security will be bought back at a specified price at the end of the agreement period
Repurchase tender offer: Stock repurchase where firm specifies a price at which it
will buy back shares, the number of shares it intends to repurchase, and the period of
time for which it will keep the offer open.
Reverse repurchase agreement (reverse repo): The buying of a security, with an
agreement that the security will be soldback at a specified price at the end of the
agreement period.
Rights offering: Offering where existing investors in the firm are given the right to
buy additional shares, in proportion to their current holdings, at a price generally
much lower than the current market price (subscription price).
Rights-on price: Stock price with the rights attached to the stock, in a rights offering.
Riskless rate: Expected rate of return on an asset with guaranteed returns.
Road shows: Stage in the public offering process that the investment banker and
issuing firm will present information to prospective investors in a series of
presentations.
Safety inventory: Extra inventory cover the demand while an order is being
replenished
Scenario analysis: Analysis where earnings, cash flows or other variables can be
forecast under a variety of different scenarios, some positive and some negative.
Sector risk: Risk that the cash flows on projects will vary from expectations because
of events that affect an entire sector.
Secured debt: Bonds or debt with priority in claims on the assets of the firm, in the
event of bankruptcy.
Seed-money venture capital: Venture capital provided to start-up firms that want to
test a concept or develop a new product.
Serial bonds: Bonds where a percentage of the outstanding bonds mature each year,
and the maturity is specified on the serial bond.
Sinking funds: A fund into which a fixed amount is set aside each year to repay
outstanding bonds when they come due.
Skewness: Bias towards positive or negative returns in a distribution.
Special dividend: Dividends paid in addition to regular dividend infrequently.
Spin off: Action that separates out assets or a division and creates new shares with
claims on this portion of the business. Existing stockholders in the firm receive these
shares in proportion to their original holdings. Firm usually gives up control over the
assets.
Split off: Action that separates out assets or a division and creates new shares with
claims on this portion of the business. Existing stockholders are given the option to
exchange their parent company stock for these new shares.
Split up: Action where firm splits into different business lines, distributes shares in
these business lines to the original stockholders in proportion to their original
ownership in the firm, and then ceases to exist.
Spot rate: Current market rate; Often used in the context of commodities or foreign
currency.
Standard deviation: Measure of the squared deviations of actual returns from the
expected returns. This is the square root of the variance.
Stand-by guarantees: Underwriting agreement where the investment banker
provides back-up support, in case the actual price falls below the offering price.
Standstill agreement: An agreement entered into between a hostile acquirer and a
firm, where the hostile acquirer (in return for a payment) agrees not to buy additional
stock in the firm for a period of time.
Start-up venture capital: Venture capital that allows firms that have established
products and concepts to develop and market them.
Statement of cash flows: A statement which specifies the sources of cash to the firm
from both operations and new financing, and the uses of this cash, during a period.
Step-down floating rate bond: A floating rate bond where the spread over the
market interest rate decreases over time instead of remaining fixed over the bondճ
life.
Step-up floating rate bond: A floating rate bond where the spread over the market
interest rate increases over time instead of remaining fixed over the bondճ life.
Stock dividends: Dividend that takes the form of additional stock (in proportion to
existing holdings) in the firm.
Stock split: Action where additional shares are given to each stockholder in the firm,
in proportion to holdings in the firm.
Straight line depreciation: A depreciation method where an equal amount of the
asset is written off each year, over an estimated lifetime, to reflect its aging.
Strike Price (Exercise Price): Price at which the underlying asset in an option can be
bought (if it is a call) or sold (if it is a put).
Subordinated debentures: Unsecured bond with claims against assets that are
subordinated to the claims of other lenders.
Subscription price: Price at which a rights offering is made by a firm.
Super-majority amendment: an amendment requiring an acquirer to acquire more
than the 51% that would normally be required to gain control of a firm.
Synergy: Increase in value arising from the combination of two firms, projects or
assets that would not arise if the firms, projects or assets were independently run.
Synthetic rating: Bond rating estimated using a financial ratio or ratios for a firm.
This is in contrast to an actual rating that is usually provided by a ratings agency.
Tender offer: A solicitation where one firm offers to buy the outstanding stock of the
other firm at a specific price and communicates this offer in advertisements and
mailings to stockholders.
Terminal price (value): Expected value of an asset at the end of forecast period. For
instance, if you forecast cash flows for 10 years, the terminal value is the value at the
end of the 10th year.
Time line: A line depicting the magnitude and timing of cash flows on an investment.
Tobinճ Q: Ratio of firm value to replacement cost of the assets owned by the firm.
Tombstone advertisement: Advertisement containing details of an initial public
offering, the name of the lead investment banker, and the names of other investment
bankers involved in the issue.
Tracking stock: Stock issued on a division of a firm. The owner is entitled to the
earnings and cash flows of the division, and the stock trades on that basis. Generally,
the parent company continues to maintain full control over the division.
Trailing PE: Ratio of price per share to earnings per share over the most recent four
quarters.
Transactions exposure: Economic exposure faced by a firm because of exchange
rate movements which affect cash inflows and outflows on transactions entered into
by the firm.
Translation exposure: Effect of exchange rate changes on the current income
statement and the balance sheet of a firm with exposure to foreign currencies.
Treasury bills: Short-term obligations issued by the U.S. government.
Treasury stock approach: Approach for dealing with options in valuation, where the
exercise value of the options is added to the value of the equity in the firm, and the
total amount is divided by the number of shares outstanding, including those covered
by the options.
Trust preferred stock: Preferred stock, structured in such a way that the fixed
dividend that is tax deductible to the firm.
Underwriting guarantee: Guarantee of a fixed price (offering price) offered by an
investment banker in a public offering of securities.
Unlevered beta: The beta of a firm, under the scenario that it is all equity-financed. It
is determined by the businesses that the firm is in, and the operating leverage it
maintains in these businesses. Can be computed from the regression beta (top-down)
or by taking a weighted average of the betas of the different businesses (bottom-up).
Unsecured bonds: Bonds with the lowest claim on the cash flows and assets of the
firm.
Up-and-out option: A put option that ceases to exist if the underlying asset falls
below a certain price.
Value ratio: Ratio of PBV Ratio to return on equity of a firm.
Value/sales ratio (VS),: Ratio of value per share to sales per share.
Variance: Measure of the squared deviations of actual returns from the expected
returns.
Venture capital method: Value estimated by applying a price-earnings multiple to
the earnings of the private firm are forecast in a future year, when the company can be
expected to go public.
Venture capitalist: An entity that provides equity financing to small and often risky
businesses in return for a share of the ownership of the firm.
Warrants: Securities where holders receive the right to buy shares in the company at
a fixed price in the future; it is a long term call option on the equity of the firm.