A
Adjusted present value (APV) Net present value of an asset if financed solely by equity plus the present value of any financing side effects.
Agency costs Costs that arise when an agent (e.g., a manager) does not act solely in the interests of the principal (e.g., the shareholder).
Annual percentage rate (APR) The interest rate per period (e.g., per month) multiplied by the number of periods in a year.
Annuity Investment that produces a level stream of cash flows for a limited number of periods.
Annuity due Annuity whose payments occur at the start of each period.
Annuity factor Present value of $1 paid for each of t periods.
APR Annual percentage rate.
APT Arbitrage pricing theory.
APV Adjusted present value.
Arbitrage Purchase of one security and simultaneous sale of another to give a risk-free profit. Often used loosely to describe the taking of offsetting positions in related securities, e.g., at the time of a takeover bid.
Arbitrage pricing theory (APT) Model in which expected returns increase linearly with an asset’s sensitivity to a small number of pervasive factors.
Asked price (offered price) Price at which a dealer is willing to sell (cf. bid price).
Asset beta The beta of the firm if it were unlevered.
Automated Clearing House (ACH) Private electronic system run by banks for high-volume, low-value payments.
B
Banker’s acceptance (BA) Written demand that has been accepted by a bank to pay a given sum at a future date (cf. trade acceptance).
Basis risk Residual risk that results when the two sides of a hedge do not move exactly together.
Beta Measure of market risk.
Binomial method Method for valuing options that assumes there are only two possible changes in the asset price in any one period.
Bridge loan Short-term loan to provide temporary financing until more permanent financing is arranged.
C
Call option Option to buy an asset at a specified exercise price on or before a specified exercise date (cf. put option).
CAPEX Capital expenditure.
Capital asset pricing model (CAPM) Model in which expected returns increase linearly with an asset’s beta.
Capital budget List of planned investment projects, usually prepared annually.
Capital lease Financial lease.
Capital structure Mix of different securities issued by a firm.
CAPM Capital asset pricing model.
Carve-out Public offering of shares in a subsidiary.
Certainty equivalent A certain cash flow that has the same present value as a specified risky cash flow.
Closed-end fund Company whose assets consist of investments in a number of industrial and commercial companies.
Commercial draft (bill of exchange) Demand for payment.
Commercial paper (CP) Unsecured notes issued by companies and maturing within nine months.
Company cost of capital The expected return on a portfolio of all the firm’s securities.
Compound interest Reinvestment of each interest payment on money invested to earn more interest (cf. simple interest).
Concentration account If the firm’s customers make payments to a regional collection center. the deposits can be automatically transferred to a centralized concentration account.
Conglomerate merger Merger between two companies in unrelated businesses (cf. horizontal merger, vertical merger).
Consumer credit Bills awaiting payment from final customer to a company.
Conversion price Par value of a convertible bond divided by the number of shares into which it may be exchanged.
Conversion ratio Number of shares for which a convertible bond may be exchanged.
Convertible bond Bond that may be converted into another security at the holder’s option. Similarly convertible preferred stock.
Corporation A business that is legally separate from its owners.
Cost of (equity) capital Opportunity cost of capital.
Coupon (1) Specifically, an attachment to the certificate of a bearer security that must be surrendered to collect interest payment; (2) more generally, interest payment on debt.
Covariance Measure of the co-movement between two variables.
D
DCF Discounted cash flow.
Death-spiral convertible Convertible bond exchangeable for shares with a specified market value.
Debenture Unsecured bond.
Decision tree Method of representing alternative sequential decisions and the possible outcomes from these decisions.
Degree of operating leverage (DOL) The percentage change in profits for a 1% change in sales.
Direct lease Lease in which the lessor purchases new equipment from the manufacturer and leases it to the lessee (cf. sale and lease-back).
Discount factor Present value of $1 received at a stated future date.
Discounted cash flow (DCF) Future cash flows multiplied by discount factors to obtain present value.
Dividend discount model Model showing that the value of a share is equal to the discounted value of future dividends.
Dividend yield Annual dividend divided by share price.
Du Pont formula Formula expressing relationship between return on assets, sales-to-assets, profit margin, and measures of leverage.
Duration The average number of years to an asset’s discounted cash flows.
E
Economic depreciation Decline in present value of an asset.
Economic income Cash flow plus change in present value.
Economic value added (EVA) A measure of residual income implemented by the consulting firm Stern Stewart.
Efficient portfolio Portfolio that offers the lowest risk (standard deviation) for its expected return and the highest expected return for its level of risk.
Equipment trust certificate Form of secured debt generally used to finance railroad equipment. The trustee retains ownership of the equipment until the debt is repaid.
ETF Exchange-traded fund.
Eurobond (1) Bond that is denominated in one country’s currency but marketed internationally outside that country. (2) Also used to refer to suggested sovereign bond issues that would be guaranteed by all Eurozone governments.
EVA Economic value added.
Evergreen credit Revolving credit without maturity.
Exchange-traded fund (ETF) A stock designed to track a stock market index.
Expectations theory Theory that forward interest rate (forward exchange rate) equals expected spot rate.
F
Face value Principal.
Factor (1) A common influence on security prices (e.g., the level of interest rates or oil prices); (2) a business providing factoring.
Financial assets Claims on real assets.
Financial engineering Combining or dividing existing instruments to create new financial products.
Financial intermediary An organization that raises money from many investors and provides financing to individuals, corporations, and other organizations.
Financial lease (capital lease, full-payout lease) Long-term, noncancelable lease (cf. operating lease).
Financial leverage (gearing) Use of debt to increase the expected return on equity. Financial leverage is measured by the ratio of debt to debt plus equity (cf. operating leverage).
Financial markets Markets in which securities are issued and traded.
Floating-price convertible Death-spiral convertible.
Forward contract Agreement to buy or sell an asset in the future at an agreed-upon price.
Forward exchange rate Exchange rate fixed today for exchanging currency at some future date (cf. spot exchange rate).
Forward price Agreed-upon price for a forward contract.
Free cash flow (FCF) Cash not required for operations or for reinvestment.
Full-payout lease Financial lease.
Full-service lease (rental lease) Lease in which the lessor promises to maintain and insure the equipment (cf. net lease).
Futures contract A contract to buy a commodity or security on a future date at a price that is fixed today. Unlike forward contracts, futures are traded on organized exchanges and are marked to market daily.
Futures exchange Exchange where futures contracts are traded.
G
Generally accepted accounting principles (GAAP) Procedures for preparing financial statements.
H
Hedge fund An investment fund charging a performance fee and open to a limited range of investors. Funds often follow complex strategies including short sales.
Hedge ratio (delta, option delta) The number of shares to buy for each option sold to create a safe position; more generally, the number of units of an asset that should be bought to hedge one unit of a liability.
High-yield bond Junk bond.
Horizontal merger Merger between two companies that manufacture similar products (cf. vertical merger, conglomerate merger).
I
Indenture Formal agreement, e.g., establishing the terms of a bond issue.
Initial public offering (IPO) A company’s first public issue of common stock.
Internal rate of return (IRR) Discount rate at which investment has zero net present value.
IPO Initial public offering.
J
Junk bond (high-yield bond) Debt that is rated below an investment-grade bond.
K
Keiretsu A network of Japanese companies organized around a major bank.
L
Lease Long-term rental agreement.
Lessee User of a leased asset (cf. lessor).
Lessor Owner of a leased asset (cf. lessee).
Leveraged buyout (LBO) Acquisition in which (1) a large part of the purchase price is debt-financed and (2) the remaining equity is privately held by a small group of investors.
Leveraged lease Lease in which the lessor finances part of the cost of the asset by an issue of debt secured by the asset and the lease payments.
Limited liability Limitation of a shareholder’s losses to the amount invested.
Liquidity Ability to sell an asset on short notice at close to the market price.
Lockbox system Form of concentration banking. Customers send payments to a post office box. A local bank collects and processes the checks and transfers surplus funds to the company’s principal bank.
London interbank offered rate (LIBOR) The interest rate at which major international banks in London borrow from each other. (LIBID is London interbank bid rate; LIMEAN is mean of bid and offered rate.)
M
Management buyout (MBO) Leveraged buyout whereby the acquiring group is led by the firm’s management.
Margin Cash or securities set aside by an investor as evidence that he or she can honor a commitment.
Marked to market An arrangement whereby the profits or losses on a futures contract are settled up each day.
Market capitalization Market value of outstanding share capital.
Market capitalization rate Expected return on a security.
Market risk (systematic risk) Risk that cannot be diversified away.
Market value added Difference between market value and book value of firm’s equity.
Market-to-book ratio Ratio of market value to book value of firm’s equity.
MBO Management buyout.
Medium-term note (MTN) Debt with a typical maturity of 1 to 10 years offered regularly by a company using the same procedure as commercial paper.
Money market Market for short-term safe investments.
Monte Carlo simulation Method for calculating the probability distribution of possible outcomes, e.g., from a project.
Mortgage bond Bond secured against plant and equipment.
Mutual fund Managed investment fund whose shares are sold to investors.
Mutually exclusive projects Two projects that cannot both be undertaken.
N
Negotiable certificate of deposit (CD) A certificate for a time deposit of $1 million or more that can be sold before maturity.
Net lease Lease in which the lessee promises to maintain and insure the equipment (cf. full-service lease).
Net present value (NPV) A project’s net contribution to wealth—present value minus initial investment.
Net working capital Current assets minus current liabilities.
Note Unsecured debt with a maturity of up to 10 years.
O
Operating lease Short-term, cancelable lease (cf. financial lease).
Operating profit margin After-tax operating income as a percentage of sales.
Opportunity cost of capital (hurdle rate, cost of capital) Expected return that is foregone by investing in a project rather than in comparable financial securities.
P
Payback period Time until the cumulative cash flow equals the initial investment.
Payback rule Requirement that project should recover its initial investment within a specified time.
Payout ratio Dividend as a proportion of earnings per share.
Pension fund Investment plan set up by an employer to provide for employees’ retirement.
Perpetuity Investment offering a level stream of cash flows in perpetuity (cf. consol).
Preferred stock Stock that takes priority over common stock in regard to dividends. Dividends may not be paid on common stock unless the dividend is paid on all preferred stock (cf. cumulative preferred stock). The dividend rate on preferred is usually fixed at time of issue.
Present value (PV) Discounted value of future cash flows.
Principal Amount of debt that must be repaid.
Private equity Equity that is not publicly traded and that is used to finance business start-ups, leveraged buyouts, etc.
Privatization Sale of a government-owned company to private investors.
Profitability index Ratio of a project’s NPV to the initial investment.
Project finance Debt that is largely a claim against the cash flows from a particular project rather than against the firm as a whole.
Prospectus Summary of the registration statement providing information on an issue of securities.
Put option Option to sell an asset at a specified exercise price on or before a specified exercise date (cf. call option).
Put-call parity The relationship between the prices of European put and call options.
PVGO Present value of growth opportunities.
R
Rate of return Total income and capital appreciation per period per dollar invested.
Real assets Tangible assets and intangible assets used to carry on business (cf. financial assets).
Real option The flexibility to modify, postpone, expand, or abandon a project.
Registration statement A detailed document prepared for the Securities and Exchange Commission that presents information about a firm’s proposed financing and the firm’s history, existing business, and plans for the future.
Rental lease Full-service lease.
Replicating portfolio Package of assets whose returns exactly replicate those of an option.
Return on assets (ROA) After-tax operating income as a percentage of total assets.
Return on capital (ROC) After-tax operating income as a percentage of long-term capital.
Return on equity (ROE) Usually, equity earnings as a proportion of the book value of equity.
Revolving credit Legally assured line of credit with a bank.
ROE Return on equity.
S
Sale and lease-back Sale of an existing asset to a financial institution that then leases it back to the user (cf. direct lease).
Scenario analysis Analysis of the profitability of a project under alternative economic scenarios.
Securities Claims on real assets.
Security market line (SML) Line representing the relationship between expected return and market risk.
Self-liquidating loan Loan to finance current assets. The sale of the current assets provides the cash to repay the loan.
Specific risk (residual risk, unique risk, unsystematic risk) Risk that can be eliminated by diversification.
Spin-off Distribution of shares in a subsidiary to the company’s shareholders so that they hold shares separately in the two firms.
Spot exchange rate Exchange rate on currency for immediate delivery (cf. forward exchange rate).
Spot price Price of asset for immediate delivery (in contrast to forward or futures price).
Spot rate Interest rate fixed today on a loan that is made today (cf. forward interest rate).
Standard deviation Square root of the variance—a measure of variability.
Stripped bond (strip) Bond that is subdivided into a series of zero-coupon bonds.
T
Term loan Medium-term, privately placed loan, usually made by a bank.
Term structure of interest rates Relationship between interest rates on loans of different maturities (cf. yield curve).
Trade acceptance Written demand that has been accepted by an industrial company to pay a given sum at a future date (cf. banker’s acceptance).
Trade credit Accounts receivable.
Trust deed Agreement between trustee and borrower setting out terms of a bond.
V
Variance Mean squared deviation from the expected value; a measure of variability.
Vertical merger Merger between a supplier and its customer (cf. horizontal merger, conglomerate merger).
W
WACC Weighted-average cost of capital.
Warrant Long-term call option issued by a company.
Weighted-average cost of capital (WACC) Expected return on a portfolio of all the firm’s securities. Used as hurdle rate for capital investment.
Working capital Current assets less current liabilities. The term is commonly used as synonymous with net working capital.
Y
Yield to maturity Internal rate of return on a bond.