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Glossary of business and finance terms

Dr. Simon Moss

This glossary of business and finance terms could assist psychologists in many instances. First, knowledge about business and finance language is vital in corporate settings, enabling psychologists to communicate effectively with key personnel. Second, such knowledge is important for psychologists who need to work in private practice or in other business settings.

AAA credit ratings: The highest credit rating, bestowed by agencies that analyze debts such as Standard and Poors and Moody's. If a corporation or government is bestowed this rating, they can usually borrow at a lower interest rate, because the risk of default is low.

Absolute priority rule: In the context of bankruptcy, a rule that permits senior creditors to be paid completely before other creditors or shareholders are paid at all.

Accelerated amortization: The process of restructuring an existing mortgage, permitting the individuals to increase the monthly payment to pay the loan sooner.

Accrual based accounting: Method of accounting in which the income and expenses are recorded when earned or incurred. This method contrasts with case based accounting in which the income and expenses are recorded when the cash is received or paid.

Acid-test ratio: An index used to estimate the capacity of companies to pay their liabilities. This ratio attempts to estimate the extent to which assets are cash or liquid. The acid-test ration, also called the quick ratio, is the difference between current assets and inventory-that is purchased merchandise-divided by the current liabilities. When current assets that are not inventory exceed current liabilities, the ration is considered acceptable, although the optimal ratio varies across industries.

Agflation: An increase in the price of food that emanates from escalating demands in both human consumption and use of these products as a source of energy. That is, biofuel demands soybeans and corn, for example, increasing demands on these products. When consumers switch to other sources of food, the price of these products also increases.

Air pocket stock: A stock that suddenly drops in price, like a plane clashing with an air pocket. The drop usually represents an overreaction to adverse news or a market correction.

Amortization: When computing expenses in accounting, process in which the residual value of some intangible assert-such as the value of intellectual property-is subtracted from the acquisition cost.

Annuity: A regular payment, such as monthly payments, of money for a specific duration or over the life of an individual.

Authorized shares: Total number of shares that can issued, as authorized by the charter of this corporation.

Automated clearing house: An electronic facility, established to process the exchange of electronic transfers, between depository institutions in lieu of paper checks.

Balance sheet: Summary of the assets, equity, and liabilities of a person or organization at a specific point in time. Assets include cash, inventories, accounts receivable, prepaid expenses, property, real estate, intangible assets-intellectual property, goodwill, and knowledge activities-and financial assets. Liabilities include accounts payable, provisions for warranties, financial liabilities like promissory notes, and tax liabilities.

Bank cheque: A cheque, issued by the bank in the name of this bank-with no individual or company name. Bank cheques can be purchased at banks, for a fee.

Bank draft: Like a bank cheque, but usually in a foreign currency for overseas use.

Bank reconciliation: Comparisons between two records of transactions, one maintained by the bank and the other maintained by the firm.

Beta: Degree to which the return on some investment is sensitive to the market portfolio--which represent all the assets in the economy. This index is the gradient of a scatterplot that relates the return of one investment to the return of all stocks, aggregated over the market.

Big Mac PPP: Survey, conducted by The Economist, that ascertains whether the exchange rate of a company is undervalued or not. For example, suppose the cost of a Big Mac in Australia dollars is twice the cost of a Big Mac in US dollars. According to the purchase power parity theory-in which currencies should adjust according to changes in purchasing power-the exchange rate should be 2$ Australian dollars for 1 US dollar.

Black knight: A company the plans a hostile takeover of another firm-a takeover that is usually resisted by this firm. These hostile takeovers often reduce morale in employees, at least for a while.

Black swan: Event or incident that diverges from the usual fluctuations across time and cannot be predicted.

Book value: The net value of a firm, as measured on the balance sheet as the difference betwee assets and liabilities. This book value does not include going-concern value--what the company could earn in the near future--and thus does not equal the actual or market value of a company.

Call option: A contract written by a seller, conferring the buyer the right, but not obligation, to purchase a specific asset at some future time. In return, the seller receives a payment from the buyer. If the buyer decides to purchase this option, the seller must fulfill the terms of the contract. A trader, for example, who feels that a share price might rise could buy the right to purchase this stock later. Likewise, a trader who feels that a share price might diminish could can sell a call option.

Camouflage compensation: Compensation that is granted to senior directors, consultants, or managers that is difficult to detect in company filings. Examples might include stock options, supplementary executive retirement plans, stock appreciation rights, and share grants

Capital asset: A class of assets that cannot be sold readily in the regular course of a business to generate cash. These assets are owned primarily to enhance profitability and, on the balance sheet, include property, plant, and equipment. These assets might be liquidated during times of financial difficulty.

Capital rationing: Restricting the level of additional investments or projects, either by stimulating a cap on the budget or elevating the costs of capital. Capital rationing often follows low returns on investment. For example, suppose the cost of capital is 10%. If many projects are incomplete, return on investment might drop below 10%. Raising the cost of capital to 15% would curb additional projects to override this problem.

Cash based accounting: Method of accounting in which the income and expenses are recorded when the cash is received or paid. This method contrasts with accrual based accounting in which the income and expenses are recorded when earned or incurred.

Cash management trust: A unit trust in which investors, called unit holders, pool their money into money market instruments-instruments that are usually accessible only to professional investors. These trusts are governed by a trust deed, a trustee who overseas activities, and a company responsible for the investment strategy.

Clearing house: An entity-often, but not always, a division of a stock exchange-that is responsible for ensuring that futures and other derivatives are delivered and settled appropriately. Clearing houses are also called clearing organizations.

Cost accrual ratio: Total average cost per person per unit time, such as the average cost per day per employee-useful in calculations of risk management.

Cover note: A temporary certificate, issued by an insurance company to demonstrate immediate insurance cover. This note is eventually replaced by a formal document.

Credit file: A file, maintained by agencies such as Baycorp Credit Advantage, to demonstrate the credit history of individuals: loan applications that were not approved, defaults on loans, bankruptcy, and other adverse events. These credit files, although maintain by credit agencies, can be accessed by other financial institutions.

Debenture: Fixed interest security, often issued by financial companies and other large organizations. The company issues a debenture to the general public as a means to gain funds.

Debt to equity ratio: Also called the loan to value ration, loan amount divided by the value of asset purchased with the loan, as a percentage.

Demutualization: When a mutual company, which is an organization owned by its users or members, becomes a company that is owned by shareholders. In practice, the users and members exchange their rights for shares. After demutualization, ownership is separated from the right to use the services the company provides.

Depreciation recapture: To illustrate, suppose some equipment costs $5000 and depreciates by $4000 over 5 years of use. The cost minus the depreciation is $1000. In this sense, the equipment is worth $1,000. Suppose, however, the equipment is then sold for $3000. This amount is $2000 more than one estimate of the cost. This $2000 is called the depreciation recapture-and must be reported as taxable income.

Derivative: Financial instrument, enabling the trading of rights or obligations on some product, not the direct transfer of this property-and includes futures, options, and swaps. Future contracts, for example, are derivatives of actual property contracts, whereas options are derivatives of future contracts.

Dilution: A reduction in the rate of earnings per share, after additional shares are issued or convertible securities are converted. When the number of shares outstanding rises, the value of securities for existing shareholders usually diminishes. Dividends are paid across a broader number of shares.

Dividend discount model: Estimate of the appropriate share price of a stock, which assumes the market value equals the present value of all future dividends. In practice, simplifying assumptions are usually included, such as the prediction of constant growth. When this simple assumption is added, the share price is equivalent to the first dividend, divided by the difference between the rate of return and growth rate.

Dividend imputation: System of tax, in which dividends paid by a company to shareholders, are assigned a credit for the tax that company has already paid on its profits. As a consequence, the shareholders are bestowed a reduction in the tax they need to pay.

Dow Jones Industrial Average: Index of the investment performance of 30 large industrial firms. Each firm is weighted evenly, and hence this index is not optimal, but is maintained because of its familiarity to the public.

Drawer: The person who writes a cheque to pay for goods or services.

DuPont Identity: A formula that demonstrates how return on equity is the product of three facets-operating efficiency (profit / sales)& asset use efficiency (sales / assets), and financial leverage (assets / equity).

Earnings per share: Net income after deducting preferred stock dividends divided by the weighted average of the number of outstanding shares.

EBIT or earnings before interest and taxes: Measure of profit that excludes interest and income tax. EBIT is equivalent to the non-operating income and the operating revenue minus the operating expenses, such as costs of materials, administration, depreciation, and amortization-acquisition cost minus the residual value of intangible asserts, such as the intellectual property.

Efficient capital market: Financial market in which the price of securities, such as shares, almost immediately reflects all relevant information about the values of assets. In other words, all securities are priced fairly, given the information available to investors.

Employee stock options: An option granted to some employees to purchase shares in the company at a specific price, if they choose. Unlike other options, they are not traded on an exchange. Accordingly, employees will be motivated to increase the price of shares. However, if the share price diminishes, employees will be disappointed, but the owners will not be as influenced extensively.

Equity multiplier: Equals assets divided by equity, which is a measure of financial leverage.

Exchange-traded options: A specific class of call or put options-which are contracts written by one party, which confer another party, the right to purchase or sell some asset in the future. Specifically, the contracts must include particular features that enable trade on public exchanges. Exchange-traded options differ from over-the-counter options, which are traded between private parties.

Fixed exchange rate: Exchange rate in which the government or central bank of a country equates the exchange rate to the price of gold-or to some other currency. Also called a pegged exchange rate, this regime differs from a floating exchange rate and offers more certainty to exporters and importers.

Floating exchange rate: Exchange rate in which the value of a currency depends on the demand and supply of this currency. Thus, trading in the foreign exchange, or forex, market depends on the value of a currency. This regime differs from a fixed exchange rate. Central banks might buy or sell the currency to intervene and affect the value of its currency. The benefit is the currency will become less expensive to purchase when trade diminishes-thus serving as a form of balance.

Franked dividend: A dividend that is distributed by a company from the profits on which company tax has already been paid.

Friendly takeover: A takeover in which the board and management of the target company agree to the merger or acquisition by another company. That is, the board approves a public offer by the acquiring firm. The shareholders will then need to vote on this proposal. Shareholders usually approve provided the share price exceeds market price to a sufficient degree.

Futures contract: An agreement to purchase or sell a commodity some time in the future-at a specific price. Futures contracts differ from options, in which the delivery is not obligatory to the buyer.

Gadfly: An investor who attends annual shareholders meetings to criticize corporate executives.

Gearing: Ratio of debts to equity finance

Going concern value: Difference between the market value and the book value--that is, the difference between the assets and liabilities--of a company. Going concern value arises from intangible assets, future investments, and the capacity of companies to earn more than an adquate rate of return, usually as a consequence of improvements in productivity and efficiency.

Goodwill: Perceived value of a business, after physical assets are deducted, representing a payment to access existing clients and the corresponding future profits.

Gross Margin: Equals difference between the total sales revenue and the cost of these goods, divided by the total sales revenue. This measure represents the percentage of sales the company retains after direct costs with producing these goods and services are incurred. This money can then be directed towards other obligations, such as administrative expenses, tax, and dividends. The gross margin does tend to differ across industries.

Hedge fund: Private investment fund-accessible to a limited range of professional or wealthy investors-permitted by regulators to engage in a broader range of activities than many other funds, from shares and debts to works of art. Hedge funds are often exempt from some regulations. Performance fees are paid to investment managers. The term is now applied not only to funds that apply short selling, but funds that apply a broad range of activities to increase, not reduce, risk.

Holding company: A company that owns part, if not all, the outstanding stock of a company. The company itself, however, seldom produces good or offers services, but merely owns shares of other companies. Holding companies enable owners to afford some control over several companies. In the US, for example, Berkshire Hathaway is a large holding company that owns insurance companies, manufacturers, and retailers.

Hostile takeover: Attempt to takeover a firm that attempts to resist these changes in ownership. These hostile takeovers often reduce morale in employees, at least for a while.

Inalienable: Something that cannot be sold, transferred or assigned to another entity.

Initial public offering: The situation in which a company-either a smaller organization or a large company that is privately owned-first issues shares to the public for the first time. Typically, an investment bank will act as an underwriter, who receive a commission on the number of shares sold.

Joint venture: The cooperation of two or more individuals or businesses in an enterprise. Each party shares profit, loss, and control. Usually, these ventures are taxed as partnerships rather than merging to form a company.

Junk bond: A bond that is very high in risk as well as 3 to 4% higher in interest rate than other government issues. They receive credit ratings of BB or lower& C is the lowest possible rating. These junk bonds are also known as speculative bonds or high yield bonds. Angel bonds, in contrast, receive credit ratings of BBB or above.

Liquidation value: Proceeds that a company would realize if they sold all their assets and payed their creditors. Successful companies should be worth more than merely their liquidation value--because the role of companies is to yield more profit from these assets.

Liquidity ratio: Current assets divided by current liabilities.

Macaroni defense: Attempt to prevent a takeover, in which the target firm issues many bonds with an interesting condition: the bonds must be redeemed at a higher price if the target firm is taken over. The black knight-that is, the company striving to takeover the firm-might refrain from this position, because the redemption price of the bonds increase like macaroni.

Managed fund: An investment fund, combining the contributions of many investors, to invest in a variety of securities, including shares, property trusts, bonds, and cash.

Market capitalization: A measure or index of corporate size or economic size. This measure is equal to the share price multiplied by the number of shares outstanding-applicable only to public companies. Market capitalization represents the public opinion of the net worth of a company.

Market value balance sheet: Financial statement in which market value is used to estimate the assets and liabilities.

Memorandum of association: A legal document, stimulating the objectives and regulations of a registered company. Together with the article of association, which stipulates the internal organization, is the fundamental document that underpins company registrations.

Money order: Like a bank draft, but usually issued and payable at both a bank or post office.

Naked short selling: Activity in which securities that an entity does not own are sold, without first receiving approval to borrow this security.

Negative gearing: Means to reduce taxes if the expenses of some investment-such as the interest paid on a home mortgage-exceed the income derived from that investment-such as the rent.

Net income: Revenues minus expenses, which is also called profit or earnings. Also, called the bottom line, because this number often appears at the bottom of income statements.

Net interest margin: Difference between the interest income generated by banks, or other financial institutions, and interest cost, paid to lenders.

October effect: The assumption that shares decline during October. This effect could arise because crashes in 1929 and 1987 transpired during October, and hence investors may be nervous during these times. Nevertheless, in general, this assumption is not supported by the share prices.

Operating leverage: Operating income as a percentage of the gross income-regarded as an index of the earning strength of firms. Gross income equals operating income plus non-operating income. Non-operating income includes revenue from sales that are not recurring, such as the sale of real estate.

Opportunity cost of capital: Estimate of the rate of return that a person or company will not receive because they have invested in something else.

Over-the-counter options: A specific class of call or put options-which are contracts written by one party, which confer another party, the right to purchase or sell some asset in the future. Specifically, the contracts are traded between private parties, often large institutions, that have agreed on their own trading and clear arrangements. Over-the-counter options differ from exchange-traded options, which are traded on public exchanges.

Pac man: Attempt to prevent a takeover, in which the target firm attempts to takeover a black knight-that is, the very company that is attempting to takeover the target firm.

Parent company: A holding company that owns enough stock in another firm, which is called the subsidiary, to control management and operations. Often, a parent company will entirely own another company.

Perpetuity: A regular payment, such as monthly payments, of money that lasts forever.

Preferred stock or shares: A class of ownership that is bestowed preference to owners of common stock to assets and earnings. A fixed dividend is usually paid to owners of common stock before owners of preferred stock. However, owners of preferred stock are often not granted voting rights.

Price-earnings multiple: The ratio of share price to earnings per share. For example, shares with a low price earnings multiple is often considered a suitable putchase for investors, because the share price is low for the earnings that are likely to be accumulated.

Profit and loss (P&L) statement: In accounting, financial statement that specifies the revenue and costs to calculate the net income over a period of time-in contrast to the balance sheet, which represents one moment in time. This statement includes operating revenue, general and administrative expenses-for example, salaries, office rent, office supply, fees, utilities, insurance, or depreciation in equipment-selling expenses-sales salaries, commissions, advertising, or freight-R& D expenses, and depreciation on fixed assets. The statement also includes non-operating revenue, such as rent or unusual gains, such as sales of securities as well as other irregular items, like change in accounting principles.

Profit margin: Equals profit divided by sales, which is regarded as an index of operating efficiency

Proprietary company: Business owned by 2 to 50 individuals, restricting the rights of shareholders to transfer shares. These legal entities must include Pty Ltd after the name.

Put option: A contract written by a seller, conferring the buyer the right, but not obligation, to sell a specific asset at some future time. In return, the seller receives a payment from the buyer. If the buyer decides to purchase this option, the seller must fulfill the terms of the contract. A trader, for example, who feels that a share price might diminish could buy the right to sell this stock later at a fixed price. Likewise, a trader who feels that a share price might rise can sell a put option.

Return on assets: Profit-or net income-divided by total assets. This index presents an indication of efficiency-that is, the capacity of organizations to generate income from assets.

Return on capital employed (ROCE): EBIT divided by the difference between assets and liabilities. In other words, ROCE is the profit before income tax and interests are deducted, over the equity.

Return on equity (ROE): Profit-or net income- divided by shareholder equity. This index is a measure of profitability.

Return on investment (ROI): Profit of an investment-that is the gains minus the costs-over the costs of some investment.

Revlon rule: Legal precedence that obligates a board of directors to accept the highest bid when a takeover is forthcoming, at least in certain conditions. This rule arose when directors of Revlon accepted a lower bid from a white knight-that is, an approved or friendly takeover-that offered by a black knight-that is, an attempted hostile takeover. The ruling indicated the directors had not fulfilled their fiduciary responsibility to shareholders.

Rights issue: A right bestowed on shareholders of a company to purchase more shares-to raise additional funds.

Sale-buyback: A financial arrangement in which developers sell a property to an investor. Then, under a long term sales contract, purchase this property from the investor in the future.

Secured asset: Any asset that borrowers could, with the permission of the lender, sell to recoup part of the loan hat was not repaid.

Security: Securities include banknotes, bonds, debentures, shares, options, partnership units, and indeed any fungible instrument that represents financial value. They may be represented by certificates or electronic entries

Sensitivity analysis: Analysis of the effects of adjustments to sales, costs, and other key factors on projected profitability. For example, the analyst might compute the projected profit for pessimistic, likely, and optimistic forecasts of sales. This analysis determines the implications that might ensue if the projections of revenue and costs are incorrect.

Shares outstanding: Common shares-authorized, issued, and purchased by investors. Common shares differ from treasury shares, which are common shares that have been repurchased by the corporation.

Short selling: The practice of selling a security, such as shares, that sellers do not own. Usually, the seller sells the securities, planning to later repurchase these securities at a lower price. Usually, they pay the owner an amount to borrow the shares. Sometimes, short selling is used more broadly to represent an investments that gain from a decline in the price of a security, and include put options.

Short squeeze: A rapid increase in the price of a stock, as a consequence of escalating demand and limited supply-which arises when short sellers decide they do not want to repurchase the security.

Standard and Poor's Composite index: Also called the S & P 500, this index reflects the investment performance of 500 major firms in the US. This index represents about 70% of the stock value that is traded and is weighted according to the size of each firm. Hence, this index is more informative than is the Dow.

Stock appreciation rights (SARs): A right that employees can be bestowed, in which they will receive a bonus that is related to the appreciation in company share prices. For example, suppose an employee receives 1000 SARs. If the share price increases by, for example, 2$ in a year, the employee might receive $2000. Employees do not need to purchase anything to receive these proceeds.

Supplemental executive retirement plan (SERP): Retirement plan for executives and other senior personnel, affording benefits that exceed other retirement plans. SERPs are funded by the employer and often criticized by shareholder advocates.

Supply side economics: A theory, assuming that tax reductions can stimulate investment and savings, to increase economic growth.

Swap: Financial contractual agreement in which two parties exchange or swap securities-such as currency swaps and interest rate swaps.

Total asset turnover: Equals sales divided by assets& regarded as a measure of the efficiency of asset use.

Triangular arbitrage: The practice in which an investor converts Currency 1 to Currency 2, then Currency 2 to Currency 3, and finally Currency 3 to Currency 1, in a short time to generate money. Although demanding advanced models and programs to perform effectively, such opportunities to arise occasionally because of interesting combinations of exchange rtes.

White label product: Products manufactured by one company, but packaged and sold by other companies with various brand names. Usually, consumers are unaware of the manufacturer, as in the case of home brand products at supermarkets.

WorldCom: Now known as MCI, a massive telecommunications company, but filed for bankruptcy protection in 2002 after executives exaggerated the assets by many billions of dollars. CEO Bernard Ebbers was sentenced to 25 years in prison

Yellow knight: A company that, although initially planning to takeover a company, has instead decided to discuss a merger.

Yield curve: A graph that plots the interest rates of various bonds, at a specific point in time, as a function of their maturity date. Usually, these various bond correspond to the same credit quality& otherwise, the comparison would be meaningless. Usually, the interest rate or yield rises but then plateaus over time. That is, the future is associated with risk and uncertainty& higher rates are needed to attract individuals. When recession is near, however, the interest rate or yield falls with time.

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Last Update: 6/17/2016