Glossary

Note: A l l - o r - n o n e u n d e r w r i t i n g An arrangement whereby a 1. Italicized words are listed elsewhere in the glossary. issue is canceled if the underwriter is unable to 2. A number of Web sites contain comprehensive financial resell the entire issue. glossaries. See, for example, www.finance-glossary.com A l p h a Measure of portfolio return adjusted for effect of and www.duke.edu/~ charvey/Classes/wpg/glossary.htm . market. A Alternative minimum tax (AMT) A separately calculated minimum amount of tax that must be paid by A b n o r m a l r e t u r n Part of return that is not due to corporations or individuals. marketwide price movements. American depository receipt (ADR) A certificate issued Absolute priority Rule in bankruptcy proceedings in the United States to represent shares of a foreign whereby senior creditors are required to be paid in full company. before junior creditors receive any payment. A m e r i c a n o p t i o n Option that can be exercised any time Accelerated depreciation Any depreciation method that before the final exercise date (cf. European option ). produces larger deductions for depreciation in the early years of a project’s life. A m e x American Exchange. Accounts payable (payables, trade debt) Money owed to Amortization (1) Repayment of a loan by installments; suppliers. (2) allowance for depreciation. Accounts receivable (receivables, trade credit) Money A M T Alternative minimum tax. owed by customers. A n g e l i n v e s t o r Wealthy individual who provides capital A c c r u e d i n t e r e s t Interest that has been earned but not for small start-up businesses. yet paid. Annual percentage rate (APR) The interest rate per A C H Automated Clearing House. period (e.g., per month) multiplied by the number of Acid-test ratio Quick ratio. periods in a year. Adjusted present value (APV) of an asset A n n u i t y Investment that produces a level stream of cash if financed solely by equity plus the present value of any flows for a limited number of periods. financing side effects. Annuity due Annuity whose payments occur at the start A D R American depository receipt. of each period. Adverse selection A situation in which a pricing policy Annuity factor Present value of $1 paid for each of t periods. causes only the less desirable customers to do business, Anticipation Arrangement whereby customers who pay e.g., a rise in insurance prices that leads only the worst before the final date may be entitled to deduct a normal risks to buy insurance. rate of interest. A f f i r m a t i v e c o v e n a n t Loan covenant specifying certain A p p r a i s a l r i g h t s A right of shareholders in a merger to actions that the borrower must take. demand the payment of a fair price for their shares, as Agency costs Losses that arise when an agent (e.g., determined independently. a manager) does not act solely in the interests of the Appropriation request Formal request for funds for a principal (e.g., the shareholder). capital investment project. A g e n c y t h e o r y Theory of the relationship between A P R Annual percentage rate. a principal, e.g., a shareholder, and an agent of the principal, e.g., the company’s manager. A P T Arbitrage pricing theory. Aging schedule Summary of age of receivables that are A P V Adjusted present value. outstanding from each customer. A r b i t r a g e Purchase of one security and simultaneous sale A I B D Association of International Dealers. of another to give a risk-free profit.

G Glossary G-1

“Arbitrage” or “risk arbitrage” Often used loosely B a c k w a r d a t i o n Condition in which spot price of to describe the taking of offsetting positions in related commodity exceeds price of future (cf. contango ). securities, e.g., at the time of a bid. Balloon payment Large final payment (e.g., when a loan Arbitrage pricing theory (APT) Model in which expected is repaid in installments). returns increase linearly with an asset’s sensitivity to a B a n k d i s c o u n t Interest deducted from the initial amount small number of pervasive factors. of a loan. A r r a n g e r Lead underwriter to a syndicated loan. Banker’s acceptance (BA) Written demand that has been Articles of incorporation Legal document establishing a accepted by a bank to pay a given sum at a future date (cf. corporation and its structure and purpose. trade acceptance ). Asian currency units Dollar deposits held in Singapore B a r r i e r o p t i o n Option whose existence depends on asset or other Asian centers. price hitting some specified barrier (cf. down-and-out option, down-and-in option ). A s i a n o p t i o n Option based on the average price of the asset during the life of the option. B a s e l A c c o r d International agreement on the amount of capital to be maintained by large banks to support their Asked price (offered price) Price at which a dealer is risky loans. willing to sell (cf. bid price ). Basis point (bp) .01%. Asset-backed securities Securities issued by a special- purpose company that holds a package of assets whose B a s i s r i s k Residual risk that results when the two sides of cash flows are sufficient to service the bonds. a hedge do not move exactly together. A s s e t s t r i p p e r Acquirer who takes over firms in order to B e a r e r s e c u r i t y Security for which primary evidence of sell off a large part of their assets. ownership is possession of the certificate (cf. registered security ). Asymmetric information Difference in information B e a r m a r k e t Widespread decline in security prices (cf. available to two parties, e.g., a manager and investors. bull market ). At-the-money option Option whose exercise price equals Behavioral finance Branch of finance that stresses the current asset price (cf. in-the-money option, out-of-the- aspects of investor irrationality. money option ). B e n c h m a r k m a t u r i t y Maturity of a newly issued Treasury A u c t i o n m a r k e t Securities exchange in which prices are bond. determined by an auction process, e.g., NYSE (cf. dealer Benefit–cost ratio One plus profitability index. market ). B e r m u d a o p t i o n Option that is exercisable on discrete Auction-rate preferred A variant of floating-rate dates before maturity. where the dividend is reset every 49 days by auction. B e s t - e f f o r t s u n d e r w r i t i n g An arrangement whereby underwriters do not commit themselves to selling a security Authorized share capital Maximum number of shares issue but promise only to use best efforts. that a company can issue, as specified in the firm’s articles of incorporation. B e t a Measure of market risk. Automated Clearing House (ACH) Private electronic Bid price Price at which a dealer is willing to buy system run by banks for high-volume, low-value payments. (cf. asked price ). Automatic debit Direct payment. Big Board Colloquial term for the New York Stock Exchange. Availability float Checks deposited by a company that have not yet been cleared. B i l l o f e x c h a n g e General term for a document demanding payment. A v a l Bank guarantee for debt purchased by forfaiter. B i l l o f l a d i n g Document establishing ownership of goods in transit. B B i n o m i a l m e t h o d Method for valuing options that B A Banker’s acceptance. assumes there are only two possible changes in the asset price in any one period. Backdating Discredited practice of using hindsight to select a grant date for at-the-money executive stock options Blue-chip company Large and creditworthy company. when the stock price (and therefore exercise price ) were B l u e - s k y l a w s State laws covering the issue and trading unusually low. of securities. G-2 Glossary

B o i l e r p l a t e Standard terms and conditions, e.g., in a Call provision Provision that allows an issuer to buy back debt contract. the bond issue at a stated price. B o n d Long-term debt. C a p An upper limit on the interest rate on a floating-rate note. Bond rating Rating of the likelihood of bond’s default. C A P E X Capital expenditure. B o o k b u i l d i n g The procedure whereby underwriters gather nonbinding indications of demand for a new issue. Capital asset pricing model (CAPM) Model in which Book entry Registered ownership of stock without issue expected returns increase linearly with an asset’s beta. of stock certificate. C a p i t a l b u d g e t List of planned investment projects, B o o k r u n n e r The managing underwriter for a new issue. usually prepared annually. The book runner maintains the book of securities sold. C a p i t a l i z a t i o n Long-term debt plus preferred stock plus net B o u g h t d e a l Security issue where one or two underwriters worth. buy the entire issue. Capital lease Financial lease. B P Basis point. C a p i t a l m a r k e t Financial market (particularly the market B r a c k e t A term signifying the extent of an underwriter’s for long-term securities). commitment in a new issue, e.g., major bracket, minor C a p i t a l m a r k e t l i n e A plot of the set of portfolios with bracket. the highest Sharpe ratio. The line passes through the risk- B r e a k - e v e n a n a l y s i s Analysis of the level of sales at free interest rate and the tangent efficient portfolio of risky which a project would just break even. assets. B r i d g e l o a n Short-term loan to provide temporary Capital rationing Shortage of funds that forces a financing until more permanent financing is arranged. company to choose between worthwhile projects. Bull–bear bond Bond whose principal repayment is linked Mix of different securities issued by a to the price of another security. The bonds are issued in firm. two tranches: In the first the repayment increases with the C A P M Capital asset pricing model. price of the other security; in the second the repayment decreases with the price of the other security. Captive finance company Subsidiary whose function is to provide finance for purchases from the parent Bulldog bond Foreign bond issue made in London. company. Bullet payment Single final payment, e.g., of a loan C a p u t o p t i o n Call option on a put option. (in contrast to payment in installments). C A R Cumulative abnormal return. B u l l m a r k e t Widespread rise in security prices (cf. bear market ). CARDs (Certificates for Amortizing Revolving Debt) Pass-through securities backed by credit card receivables. B u t t e r f l y s p r e a d The purchase of two call options with different exercise prices and simultaneous sale of two calls Carried interest A proportion of the profits to which exercisable at the average of these two exercise prices. partnerships, etc. are entitled. Provides a bet that the share price will stay within a Carry trade Borrowing in country with low interest rate narrow range. to relend in another country with a higher rate. Bund Long-term German government bond. CARs (Certificates of Automobile Receivables) Pass-through B u y b a c k Repurchase agreement. securities backed by automobile receivables. C a r v e - o u t of shares in a subsidiary. C C a s c a d e Rational herding in which each individual deduces that previous decisions by others may have been C a b l e The exchange rate between U.S. dollars and based on extra information. sterling. Cash and carry Purchase of a security and simultaneous C a l l o p t i o n Option to buy an asset at a specified sale of a future, with the balance being financed with a exercise price on or before a specified exercise date loan or repo. (cf. put option ). C a s h b u d g e t Forecast of sources and uses of cash. C a l l p r e m i u m (1) Difference between the price at which a company can call its bonds and their face value; (2) price of Cash cow Mature company producing a large free cash a call option. flow. Glossary G-3

Cash cycle The time from a firm’s payment for raw C M O s Collateralized mortgage obligations. materials until the payment for the finished product from C O D Cash on delivery. the customer. C o l l a r An upper and lower limit on the interest rate on a Cash-deficiency arrangement Arrangement whereby floating-rate note. a project’s shareholders agree to provide the operating company with sufficient net working capital. C o l l a t e r a l Assets that are given as security for a loan. Catastrophe bond (CAT bond) Bond whose payoffs are Collateralized loan obligation (CLO) A security backed linked to a measure of catastrophe losses such as insurance by a pool of loans and issued in tranches with different claims. levels of . C A T b o n d Catastrophe bond. Collateralized mortgage obligations (CMOs) A variation on the mortgage pass-through security in which the cash C B D Cash before delivery. flows from a pool of mortgages are repackaged into several C D Certificate of deposit. tranches of bonds with different maturities. C D S Credit default swap. Collateral trust bonds Bonds secured by common or C E O Chief executive officer. other securities that are owned by the borrower. Certainty equivalent A certain cash flow that has the Collection float Customer-written checks that have not same present value as a specified risky cash flow. been received, deposited, and added to the company’s available balance (cf. payment float ). C e r t i f i c a t e o f d e p o s i t ( C D ) A certificate providing evidence of a bank time deposit. Commercial draft (bill of exchange) Demand for payment. C F T C Commodity Futures Trading Commission. Commercial paper Unsecured notes issued by companies C F O Chief financial officer. and maturing within nine months. C h a e b o l A Korean conglomerate. Commitment fee Fee charged by bank on an unused line Chapter 7 Bankruptcy procedure whereby a debtor’s of credit. assets are sold and the proceeds are used to repay Common-size financial statements Balance sheet creditors. where entries are expressed as proportion of total assets C h a p t e r 1 1 Bankruptcy procedure designed to reorganize and income statement where entries are expressed as a and rehabilitate defaulting firm. proportion of revenues. Check conversion When customer writes a check, Common stock Security representing ownership of a information is automatically captured and his bank corporation. account immediately debited. Company The expected return on a C h e c k 2 1 Check Clearing for the 21st Century Act portfolio of all the firm’s securities. allows banks to process checks electronically. Compensating balance Non-interest-bearing demand C H I P S Clearinghouse Interbank Payments System. deposits to compensate banks for bank loans or services. C h o o s e r o p t i o n Holder decides whether it is a call option Competitive bidding Means by which public utility or put option. holding companies are required to choose their underwriter (cf. negotiated ). Clean price (flat price) Bond price excluding accrued interest (cf. dirty price ). Completion bonding Insurance that a construction Clearinghouse Interbank Payments System (CHIPS) An contract will be successfully completed. international wire transfer system operated by a group of C o m p o s i t i o n Voluntary agreement to reduce payments major banks for high-value dollar payments. on a firm’s debt. C L O Collateralized loan obligation. Also CDO C o m p o u n d i n t e r e s t Reinvestment of each interest (collateralized debt obligation) and CMO (collateralized payment on money invested to earn more interest mortgage obligation). (cf. simple interest ). Closed-end fund Company whose assets consist of C o m p o u n d o p t i o n Option on an option. investments in a number of industrial and commercial Concentration banking System whereby customers make companies. payments to a regional collection center. The collection Closed-end mortgage Mortgage against which no center pays the funds into a regional bank account and additional debt may be issued (cf. open-end mortgage ). surplus money is transferred to the company’s principal bank. G-4 Glossary

C o n d i t i o n a l s a l e Sale in which ownership does not pass C o v e n a n t Clause in a loan agreement. to the buyer until payment is completed. C o v e r e d o p t i o n Option position with an offsetting Conglomerate merger Merger between two companies in position in the underlying asset. unrelated businesses (cf. horizontal merger, vertical merger ). C r a m d o w n Action by a bankruptcy court to enforce a C o n s o l Name of a perpetual bond issued by the British plan of reorganization. government. Sometimes used as a general term for Credit default swap (CDS) Credit derivative in which one perpetuity. party makes fixed payments while the payments by the C o n t a n g o Condition in which spot price of a commodity other party depend on the occurrence of a loan default. is below that of the future (cf. backwardation ). Credit derivative Contract for hedging against loan Contingent claim Claim whose value depends on the default or changes in credit risk (e.g., credit default swap ). value of another asset. C r e d i t r a t i n g Debt rating assigned by a rating agency Contingent project Project that cannot be undertaken such as Moody’s or Standard & Poor’s. unless another project is also undertaken. Credit scoring A procedure for assigning scores to Continuous compounding Interest compounded borrowers on the basis of the risk of default. continuously rather than at fixed intervals. C r o s s - d e f a u l t c l a u s e Clause in a loan agreement C o n t r o l l e r Officer responsible for budgeting, accounting, stating that the company is in default if it fails to meet its and auditing in a firm (cf. treasurer ). obligation on any other debt issue. Convenience yield The extra advantage that firms derive C u m d i v i d e n d With dividend. from holding the commodity rather than the future. C u m r i g h t s With rights. Conversion price Par value of a divided by the number of shares into which it may be exchanged. Cumulative preferred stock Stock that takes priority over common stock in regard to dividend payments. Dividends Conversion ratio Number of shares for which a may not be paid on the common stock until all past convertible bond may be exchanged. dividends on the preferred stock have been paid. C o n v e r t i b l e b o n d Bond that may be converted into Cumulative voting Voting system under which a another security at the holder’s option. Similarly stockholder may cast all of his or her votes for one convertible preferred stock. candidate for the board of directors (cf. majority voting ). C o n v e x i t y In a plot of a bond ’s price against the interest Current asset Asset that will normally be turned into rate, convexity measures the curvature of the line. cash within a year. Corporate venturing Practice by which a large Current liability Liability that will normally be repaid manufacturer provides financial support to new within a year. companies. Current ratio Current assets divided by current liabilities —a C o r p o r a t i o n A business that is legally separate from its measure of liquidity. owners. Current yield Bond coupon divided by price. Correlation coefficient Measure of the closeness of the relationship between two variables. Cost company arrangement Arrangement whereby the D shareholders of a project receive output free of charge but Data mining (data snooping) Excessive search to find agree to pay all operating and financing charges of the interesting (but probably coincidental) behavior in a body project. of data. Cost of (equity) capital Opportunity cost of capital. D C F . C o u n t e r p a r t y Party on the other side of a derivative D D M Dividend discount model. contract. D e a l e r m a r k e t Securities exchange in which dealers post C o u p o n (1) Specifically, an attachment to the certificate offers to buy or sell, e.g., Nasdaq (cf. auction market ). of a bearer security that must be surrendered to collect interest payment; (2) more generally, interest payment on Dealer paper Commercial paper sold through a dealer debt. rather than directly by the company. C o v a r i a n c e Measure of the co-movement between two Death spiral convertible Convertible bond exchangeable variables. for shares with a specified market value. Glossary G-5

D e b e n t u r e Unsecured bond. Discounted cash flow (DCF) Future cash flows multiplied by discount factors to obtain present value. Debtor-in–possession financing (DIP financing) Debt issued by a company in Chapter 11 bankruptcy. D i s c o u n t f a c t o r Present value of $1 received at a stated future date. D e c i s i o n t r e e Method of representing alternative sequential decisions and the possible outcomes from these decisions. D i s c o u n t r a t e Rate used to calculate the present value of future cash flows. D e f e a s a n c e Practice whereby the borrower sets aside cash or bonds sufficient to service the borrower’s debt. D i s c o u n t e d p a y b a c k r u l e Requirement that discounted Both the borrower’s debt and the offsetting cash or bonds values of cash flows should be sufficient to pay back are removed from the balance sheet. initial investment within a specified time. Degree of operating leverage (DOL) The percentage Discriminatory price auction Auction in which change in profits for a 1% change in sales. successful bidders pay the price that they bid (cf. uniform price auction ). D e l t a Hedge ratio. D i s i n t e r m e d i a t i o n Withdrawal of funds from a financial Depository transfer check (DTC) Check made out institution in order to invest them directly (cf. intermediation ). directly by a local bank to a particular company. D i v i d e n d Payment by a company to its stockholders. D e p r e c i a t i o n (1) Reduction in the book or market value of an asset; (2) portion of an investment that can be Dividend discount model Model showing that the value of deducted from taxable income. a share is equal to the discounted value of future dividends. D e r i v a t i v e Asset whose value derives from that of some D i v i d e n d r e i n v e s t m e n t p l a n ( D R I P ) Plan that allows other asset (e.g., a future or an option ). shareholders to reinvest dividends automatically. Designated market maker Member of NYSE responsible Dividend yield Annual dividend divided by share price. for market in specified securities (formerly called D O L Degree of operating leverage. “specialist”). Double-declining-balance depreciation Method of D i f f Differential swap. accelerated depreciation. Differential swap (diff, quanto swap) Swap between D o u b l e - t a x a g r e e m e n t Agreement between two countries two LI BOR rates of interest, e.g., yen LIBOR for dollar that taxes paid abroad can be offset against domestic taxes LIBOR. Payments are in one currency. levied on foreign dividends. D i g i t a l o p t i o n Option paying fixed sum if asset price is D o w n - a n d - i n o p t i o n Barrier option that comes into the right side of exercise price, otherwise zero. existence if asset price hits a barrier. D i l u t i o n Diminution in the proportion of income to D o w n - a n d - o u t o p t i o n Barrier option that expires if asset which each share is entitled. price hits a barrier. DIP financing Debtor-in–possession financing. D R I P Dividend reinvestment plan. D i r e c t d e p o s i t The firm authorizes its bank to deposit D r o p l o c k An arrangement whereby the interest rate on a money in the accounts of its employees or shareholders. floating-rate note or preferred stock becomes fixed if it falls to a specified level. Direct lease Lease in which the lessor purchases new equipment from the manufacturer and leases it to the lessee D T C Depository transfer check. (cf. sale and lease-back ). D u a l - c l a s s e q u i t y Shares with different voting rights. Direct payment (automatic debit, direct debit) The firm’s D u a l - c u r r e n c y b o n d Bond with interest paid in one customers authorize it to debit their bank accounts for the currency and principal paid in another. amounts due (cf. direct deposit). DuPont formula Formula expressing relationship Direct quote For foreign exchange, the number of U.S. between return on assets, sales-to-assets, profit margin, dollars needed to buy one unit of a foreign currency and measures of leverage. (cf. indirect quote ). D u r a t i o n The average number of years to an asset’s Dirty price Bond price including accrued interest, i.e., the discounted cash flows. price paid by the bond buyer (cf. clean price ). Dutch auction In a Dutch auction investors submit the D i s c o u n t b o n d Debt sold for less than its principal value. prices at which they are prepared to buy (or sell) the security. If a discount bond pays no interest, it is called a “pure” The purchase price is the lowest price that allows the firm to discount, or zero-coupon, bond. sell (or buy) the specified amount of the security. G-6 Glossary

E E u r o b o n d Bond that is marketed internationally. E B I T Earnings before interest and taxes. Eurocurrency Deposit held outside the currency’s issuing country (e.g., euroyen, or eurodollar deposit) E B I T D A Earnings before interest, taxes, depreciation, and amortization. E u r o d o l l a r d e p o s i t Dollar deposit with a bank outside the United States. E B P P Electronic bill presentment and payment. E u r o p e a n o p t i o n Option that can be exercised only on Economic depreciation Decline in present value of an final exercise date (cf. American option ). asset. E V A . E c o n o m i c e x p o s u r e Risk that arises from changes in real exchange rates (cf. transaction exposure, translation exposure ). E v e n t r i s k The risk that an unanticipated event (e.g., a takeover) will lead to a debt default. E c o n o m i c i n c o m e Cash flow plus change in present value. E v e r g r e e n c r e d i t Revolving credit without maturity. Economic rents Profits in excess of the competitive level. E x c h a n g e o f a s s e t s Acquisition of another company by Economic value added (EVA) A measure of residual income purchase of its assets in exchange for cash or shares. implemented by the consulting firm Stern Stewart. Exchange of stock Acquisition of another company by E f f i c i e n t m a r k e t Market in which security prices reflect purchase of its stock in exchange for cash or shares. information instantaneously. Exchange-traded fund (ETF) A stock designed to track a Efficient portfolio Portfolio that offers the lowest risk stock market index. (standard deviation ) for its expected return and the highest expected return for its level of risk. E x d i v i d e n d Purchase of shares in which the buyer is not entitled to the forthcoming dividend (cf. with dividend, cum E F T Electronic funds transfer. dividend ). Electronic bill presentment and payment (EBPP) Allows Exercise price (strike price) Price at which a call option or companies to bill customers and receive payments via the put option may be exercised. Internet. E x p e c t a t i o n s t h e o r y Theory that forward interest rate Electronic funds transfer (EFT) Transfer of money ( forward exchange rate ) equals expected spot rate. electronically (e.g., by Fedwire ). E x p e c t e d r e t u r n Employee stock ownership plan (ESOP) A company Average of possible returns weighted by contributes to a trust fund that buys stock on behalf of their probabilities. employees. E x r i g h t s Purchase of shares that do not entitle the Entrenching investment An investment that makes owner to buy shares in the company’s (cf. with particular use of the skills of existing management. rights, cum rights, rights on ). E P S Earnings per share. Extendable bond Bond whose maturity can be extended at the option of the lender (or issuer). Equipment trust certificate Form of secured debt generally used to finance railroad equipment. The trustee retains External finance Finance that is not generated by the ownership of the equipment until the debt is repaid. firm: new borrowing or an issue of stock (cf. internal finance ). E q u i t y (1) Common stock and preferred stock. Often used to refer to common stock only. (2) Net worth. E x t r a d i v i d e n d Dividend that may or may not be repeated (cf. regular dividend ). E q u i t y - l i n k e d b o n d Bond whose payments are linked to a stock market index. Equivalent annual cash flow (or cost) Annuity with F the same present value as the company’s proposed Face value Par value. investment. F a c t o r i n g Arrangement whereby a financial institution E S O P Employee stock ownership plan. buys a company’s accounts receivable and collects the debt. E T F Exchange-traded fund. Fair price provision Appraisal rights. E u r i b o r Euro interbank offered rate. Fallen angel Junk bond that was formerly investment grade. Euro interbank offered rate (Euribor) The interest rate at F A S B Financial Accounting Standards Board. which major international banks in Europe lend euros to each other. F C I A Foreign Credit Insurance Association. Glossary G-7

F D I C Federal Deposit Insurance Corporation. Forward interest rate Interest rate fixed today on a loan to be made at some future date (cf. spot interest rate ). Federal funds Non-interest-bearing deposits by banks at the Federal Reserve. Excess reserves are lent by banks to Forward rate agreement (FRA) Agreement to borrow each other. or lend at a specified future date at an interest rate that is fixed today. F e d w i r e A wire transfer system for high-value payments operated by the Federal Reserve System (cf. CHIPS ). F R A Forward rate agreement. Field warehouse Warehouse rented by a warehouse Cash not required for operations or for company on another firm’s premises (cf. public warehouse ). reinvestment. Financial assets Claims on real assets. Free-rider problem The temptation not to incur the costs of participating in a decision when one’s influence Financial engineering Combining or dividing existing on that decision is small. instruments to create new financial products. F R N Floating-rate note. Financial lease (capital lease, full-payout lease) Long- term, noncancelable lease (cf. operating lease ). Full-payout lease Financial lease. Financial leverage (gearing) Use of debt to increase the Full-service lease (rental lease) Lease in which the lessor expected return on equity. Financial leverage is measured by promises to maintain and insure the equipment (cf. net the ratio of debt to debt plus equity (cf. operating leverage ). lease ). F i r m c o m m i t m e n t Arrangement whereby the underwriter F u n d a m e n t a l a n a l y s i s Security analysis that seeks to guarantees to sell the entire issue. detect misvalued securities by an analysis of the firm’s business prospects (cf. technical analysis ). Fiscal agency agreement An alternative to a bond trust deed. Unlike the trustee, the fiscal agent acts as an agent of Funded debt Debt maturing after more than one year the borrower. (cf. unfunded debt ). Flat price Clean price. Futures contract A contract to buy a commodity or security on a future date at a price that is fixed today. F l i p p i n g Buying shares in an IPO and selling immediately. Unlike forward contracts, futures are traded on organized F l o a t See availability float, collection float, payment float. exchanges and are marked to market daily. F l o a t i n g l i e n General lien against a company’s assets or against a particular class of assets. G Floating-price convertible Death spiral convertible. G A A P Generally accepted accounting principles. Floating-rate note (FRN) Note whose interest payment varies with the short-term interest rate. G a m m a A measure of how the option delta changes as the asset price changes. Floating-rate preferred Preferred stock paying dividends that vary with short-term interest rates. G e a r i n g Financial leverage. F l o o r p l a n n i n g Arrangement used to finance inventory. General cash offer Issue of securities offered to all A finance company buys the inventory, which is then held investors (cf. rights issue ). in trust by the user. G i l t A British government bond. F l o w - t o - e q u i t y m e t h o d Discounted value of cash flows Golden parachute A large termination payment due to to equityholders. a company’s officers if they lose their jobs as a result of a F o r e i g n b o n d A bond issued on the domestic capital merger. market of another country. G o o d w i l l The difference between the amount paid for a F o r e x Foreign exchange. firm in a merger and its book value. F o r f a i t e r Purchaser of promises to pay (e.g., bills of G o v e r n a n c e The oversight of a firm’s management. exchange or promissory notes ) issued by importers. G r a y m a r k e t Purchases and sales of securities that occur Forward cover Purchase or sale of forward foreign before the issue price is set. currency in order to offset a known future cash flow. G r e e n m a i l Situation in which a large block of stock Forward exchange rate Exchange rate fixed today for is held by an unfriendly company, forcing the target exchanging currency at some future date (cf. spot exchange company to repurchase the stock at a substantial premium rate). to prevent a takeover. G-8 Glossary

G r e e n s h o e o p t i o n Option that allows the underwriter for a Income stock Common stock with high dividend yield and new issue to buy and resell additional shares. few profitable investment opportunities (cf. growth stock ). Growth stock Common stock of a company that has I n d e n t u r e Formal agreement, e.g., establishing the terms an opportunity to invest money to earn more than the of a bond issue. opportunity cost of capital (cf. income stock ). I n d e x e d b o n d Bond whose payments are linked to an index, e.g., a consumer price index (see TIPS ). H I n d e x f u n d Investment fund designed to match the returns on a stock market index. H a i r c u t An additional margin of collateral for a loan. Indirect quote For foreign exchange, the number of units H e d g e f u n d An investment fund charging a performance of a foreign currency needed to buy one U.S. dollar fee and open to a limited range of investors. Funds often (cf. direct quote ). follow complex strategies including short sales. Industrial revenue bond (IRB) Bond issued by local Hedge ratio (delta, option delta) The number of shares government agencies on behalf of corporations. to buy for each option sold to create a safe position; more generally, the number of units of an asset that should be (IPO) A company’s first public bought to hedge one unit of a liability. issue of common stock. H e d g i n g Buying one security and selling another to I n s i d e d i r e c t o r Director who is also employed by the reduce risk. A perfect hedge produces a riskless portfolio. company. H e l l - o r - h i g h - w a t e r c l a u s e Clause in a lease agreement In-substance defeasance Defeasance whereby debt is that obligates the lessee to make payments regardless of removed from the balance sheet but not canceled what happens to the lessor or the equipment. (cf. novation ). Highly leveraged transaction (HLT) Bank loan to a Intangible asset Nonmaterial asset, such as technical highly leveraged firm (formerly needed to be separately expertise, a trademark, or a patent (cf. tangible asset ). reported to the Federal Reserve Board). Integer programming Variant of linear programming H i g h - y i e l d b o n d Junk bond. whereby the solution values must be integers. H L T Highly leveraged transaction. Interest cover Times interest earned. Holding company Company whose sole function is to Interest rate parity Theory that the differential between the hold stock in the firm’s subsidiaries. forward exchange rate and the spot exchange rate is equal to the differential between the foreign and domestic interest rates. H o r i z o n t a l m e r g e r Merger between two companies that manufacture similar products (cf. vertical merger, I n t e r m e d i a t i o n Investment through a financial conglomerate merger ). institution (cf. disintermediation ). H o r i z o n t a l s p r e a d The simultaneous purchase and sale Internal finance Finance generated within a firm by of two options that differ only in their exercise date (cf. retained earnings and depreciation (cf. external finance ). vertical spread ). Internal growth rate The maximum rate of firm growth Hurdle rate Minimum acceptable rate of return on a project. without external finance (cf. sustainable growth rate ). Internal rate of return (IRR) Discount rate at which I investment has zero net present value. International banking facility (IBF) A branch that an I B F International banking facility. American bank establishes in the United States to do I M M International Monetary Market. eurocurrency business. I m m u n i z a t i o n The construction of an asset and a International Monetary Market (IMM) The financial liability that have offsetting changes in value. futures market within the Chicago Mercantile Exchange. Implied volatility The volatility implied by option prices. Interval measure The number of days that a firm can finance operations without additional cash income. Imputation tax system Arrangement by which investors who receive a dividend also receive a tax credit for In-the-money option An option that would be worth corporate taxes that the firm has paid. exercising if it expired immediately (cf. out-of-the-money option ). I n c o m e b o n d Bond on which interest is payable only if I n v e s t m e n t - g r a d e b o n d Bond rated at least Baa by earned. Moody’s or BBB by Standard and Poor’s or Fitch. Glossary G-9

IOSCO International Organization of Securities Liabilities, total liabilities Total value of financial Commissions. claims on a firm’s assets. Equals (1) total assets or (2) total assets minus net worth. I P O Initial public offering. L I B O R London interbank offered rate. I R B Industrial revenue bond. L i e n Lender’s claims on specified assets. I R R Internal rate of return. Limited liability Limitation of a shareholder’s losses to I R S Internal Revenue Service. the amount invested. I S D A International Swap and Derivatives Association. L i m i t e d p a r t n e r s h i p Partnership in which some partners I S M A International Securities Market Association. have limited liability and general partners have unlimited liability. Issued share capital Total amount of shares that are in issue (cf. outstanding share capital ). Limit order Order to buy (sell) securities within a maximum (minimum) price (cf. market order). Linear programming (LP) Technique for finding the J maximum value of some objective function subject to J u n i o r d e b t . stated linear constraints. Junk bond (high-yield bond) Debt that is rated below an L i n e o f c r e d i t Agreement by a bank that a company may investment-grade bond. borrow at any time up to an established limit. J u s t - i n - t i m e System of inventory management that Liquid asset Asset that is easily and cheaply turned into requires minimum inventories of materials and very cash—notably cash itself and short-term securities. frequent deliveries by suppliers. L i q u i d a t i n g d i v i d e n d Dividend that represents a return of capital. L i q u i d a t o r Person appointed by unsecured creditors in K the United Kingdom to oversee the sale of an insolvent K e i r e t s u A network of Japanese companies organized firm’s assets and the repayment of debts. around a major bank. Liquidity-preference theory Theory that investors demand a higher yield to compensate for the extra risk of long-term bonds. L L i q u i d i t y p r e m i u m (1) Additional return for investing L B O Leveraged . in a security that cannot easily be turned into cash; (2) difference between the forward interest rate and the L e a s e Long-term rental agreement. expected spot interest rate. Legal capital Value at which a company’s shares are Liquid yield option note (LYON) Zero-coupon, callable, recorded in its books. puttable, convertible bond. L e g a l d e f e a s a n c e Novation. Loan origination fee Up-front fee charged by the lending L e s s e e User of a leased asset (cf. lessor ). bank. L e s s o r Owner of a leased asset (cf. lessee ). L o c k b o x s y s t e m Form of concentration banking. Customers send payments to a post office box. A local L e t t e r o f c r e d i t Letter from a bank stating that it has bank collects and processes the checks and transfers established a credit in the company’s favor. surplus funds to the company’s principal bank. Letter stock Privately placed common stock, so called London interbank offered rate (LIBOR) The interest because the SEC requires a letter from the purchaser that rate at which major international banks in London lend the stock is not intended for resale. to each other. (LIBID is London interbank bid rate; L e v e r a g e See financial leverage, operating leverage. LIMEAN is mean of bid and offered rate.) (LBO) Acquisition in which (1) a large part Long hedge Purchase of a hedging instrument (e.g., a of the purchase price is debt-financed and (2) the remaining future ) to hedge a short position in the underlying asset equity is privately held by a small group of investors. (cf. short hedge). Leveraged lease Lease in which the lessor finances part Longevity bonds Bonds that pay a higher rate of interest of the cost of the asset by an issue of debt secured by the if a high proportion of the population survives to a asset and the lease payments. particular age. G-10 Glossary

L o o k b a c k o p t i o n Option whose payoff depends on the M i s m a t c h b o n d Floating-rate note whose interest rate is highest asset price recorded over the life of the option. reset at more frequent intervals than the rollover period (e.g., a note whose payments are set quarterly on the basis L P Linear programming. of the one-year interest rate). L Y O N Liquid yield option note. Modified accelerated cost recovery system (MACRS) Schedule of depreciation deductions allowed for M tax purposes. M o d i f i e d I R R Internal rate of return calculated by first M A C R S Modified accelerated cost recovery system. discounting later cash flows back to earlier periods so that Maintenance margin Minimum margin that must be there remains only one change in the sign of the cash flows. maintained on a futures contract. M o m e n t u m Characteristic of stocks showing persistent M a j o r i t y v o t i n g Voting system under which each director recent high returns. is voted upon separately (cf. cumulative voting ). M o n e y c e n t e r b a n k A major U.S. bank that undertakes a Management buyout (MBO) Leveraged buyout whereby the wide range of banking activities. acquiring group is led by the firm’s management. M o n e y m a r k e t Market for short-term safe investments. Mandatory convertible Bond automatically convertible into Money-market deposit account (MMDA) A bank account equity, usually with a limit on the value of stock received. paying money-market interest rate. M a r g i n Cash or securities set aside by an investor as M o n e y - m a r k e t f u n d Mutual fund that invests solely in evidence that he or she can honor a commitment. short-term safe securities. Marked to market An arrangement whereby the profits M o n o l i n e Insurance company that insures debtholders or losses on a futures contract are settled up each day. against the risk of default. M a r k e t c a p i t a l i z a t i o n Market value of outstanding share Monte Carlo simulation Method for calculating the capital. probability distribution of possible outcomes, e.g., from a M a r k e t c a p i t a l i z a t i o n r a t e Expected return on a security. project. Market model Model suggesting a linear relationship M o r a l h a z a r d The risk that the existence of a contract between actual returns on a stock and on the market will change the behavior of one or both parties to portfolio. the contract; e.g., an insured firm may take fewer fire precautions. Market order Order to buy or sell securities at the prevailing market price (cf. limit order). Mortality bonds Bonds that pay a higher rate of interest if there is a sharp rise in the death rate. Market risk (systematic risk) Risk that cannot be diversified away. M o r t g a g e b o n d Bond secured against plant and equipment. Market-to-book ratio Ratio of market value to book value of firm’s equity. M T N Medium-term note. M a r k e t v a l u e a d d e d Difference between market value Multiple-discriminant analysis (MDA) Statistical and book value of firm’s equity. technique for distinguishing between two groups on the basis of their observed characteristics. Maturity factoring Factoring arrangement that provides collection and insurance of accounts receivable. M u t u a l f u n d Managed investment fund whose shares are sold to investors. M B O Management buyout. Mutually exclusive projects Two projects that cannot M D A Multiple-discriminant analysis. both be undertaken. 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. N M e r g e r (1) Acquisition in which all assets and liabilities are absorbed by the buyer (cf. exchange of assets, exchange of stock ); N a k e d o p t i o n Option held on its own, i.e., not used for (2) more generally, any combination of two companies. hedging a holding in the asset or other options. MIP (Monthly income preferred security) Preferred N a s d a q National Association of Security Dealers stock issued by a subsidiary located in a tax haven. The Automated Quote System. A U.S. stock exchange whose subsidiary relends the money to the parent. dealers tend to specialize in high-tech stocks. Glossary G-11

Negative pledge clause Clause under which the borrower Operating cycle The time from a firm’s initial purchase agrees not to permit an exclusive lien on any of its assets. of raw materials until the payment from the customer for the finished product. Negotiated underwriting Method of choosing an underwriter. Most firms may choose their underwriter by Operating lease Short-term, cancelable lease (cf. financial negotiation (cf. competitive bidding ). lease ). Net lease Lease in which the lessee promises to maintain Operating leverage Fixed operating costs, so called and insure the equipment (cf. full-service lease ). because they accentuate variations in profits (cf. financial Net present value (NPV) A project’s net contribution to leverage ). wealth—present value minus initial investment. Opportunity cost of capital (hurdle rate, cost of Net working capital Current assets minus current liabilities. capital) Expected return that is foregone by investing in a project rather than in comparable financial securities. Net worth Book value of a company’s common stock, surplus, and retained earnings. O p t i o n See call option, put option. Nominal interest rate Interest rate expressed in money Option delta Hedge ratio. terms (cf. real interest rate ). Original issue discount debt (OID debt) Debt that is Nonrefundable debt Debt that may not be called in order initially offered at a price below face value. to replace it with another issue at a lower interest cost. O T C Over-the-counter. N O P A T Net operating profit after tax. Out-of-the-money option An option that would not be N o r m a l d i s t r i b u t i o n Symmetric bell-shaped distribution worth exercising if it matured immediately (cf. in-the-money that can be completely defined by its mean and standard option ). deviation. Outstanding share capital Issued share capital less the N o t e Unsecured debt with a maturity of up to 10 years. par value of shares that are held in the company’s treasury. Novation (legal defeasance) Defeasance whereby the firm’s debt is canceled (cf. in-substance defeasance ). O v e r s u b s c r i p t i o n p r i v i l e g e In a rights issue, arrangement by which shareholders are given the right to apply for any N P V Net present value. shares that are not taken up. N Y S E New York Stock Exchange. Over-the-counter (OTC) Informal market that does not involve a securities exchange. O OAT (Obligation assimilable du Trésor) French P government bond. P a r t n e r s h i p Joint ownership of business whereby general Odd lot A trade of less than 100 shares (cf. round lot ). partners have unlimited liability. Off-balance-sheet financing Financing that is not shown Par value (face value) Value of a security shown on the as a liability in a company’s balance sheet. certificate. Offer price Asked price. P a s s - t h r o u g h s e c u r i t i e s Notes or bonds backed by a O I D d e b t Original issue discount debt. package of assets (e.g., mortgage pass-throughs, CARs, CARDs ). Old-line factoring Factoring arrangement that provides collection, insurance, and finance for accounts receivable. Path-dependent option Option whose value depends on the sequence of prices of the underlying asset rather than On the run The most recently issued (and, therefore, just the final price of the asset. typically the most liquid) government bond in a particular maturity range. P a y a b l e s Accounts payable. Open account Arrangement whereby sales are made with P a y b a c k r u l e Requirement that project should recover its no formal debt contract. The buyer signs a receipt, and the initial investment within a specified time. seller records the sale in the sales ledger. Pay-in-kind bond (PIK) Bond that allows the issuer O p e n - e n d m o r t g a g e Mortgage against which additional to choose to make interest payments in the form of debt may be issued (cf. closed-end mortgage ). additional bonds. O p e n i n t e r e s t The number of currently outstanding Payment float Company-written checks that have not yet futures contracts. cleared (cf. availability float ). G-12 Glossary

Payout ratio Dividend as a proportion of earnings per Primary issue Issue of new securities by a firm (cf. share. secondary issue ). P B G C Pension Benefit Guarantee Corporation. P r i m e r a t e Benchmark lending rate set by U.S. banks. P/E ratio Share price divided by earnings per share. P r i n c i p a l Amount of debt that must be repaid. PERC (Preferred equity redemption cumulative Principal–agent problem Problem faced by a principal stock) Preferred stock that converts automatically into (e.g., shareholder) in ensuring that an agent (e.g., manager) equity at a stated date. A limit is placed on the value of the acts on his or her behalf. shares that the investor receives. P r i v a t e e q u i t y Equity that is not publicly traded and P e r p e t u i t y Investment offering a level stream of cash that is used to finance business start-ups, leveraged flows in perpetuity (cf. consol ). , etc. P I K Pay-in-kind bond. Issue of bonds or stock that is placed privately with a few investors and is not then publicly P N Project note. traded. P o i s o n p i l l Includes a variety of takeover defenses, notably Privileged subscription issue Rights issue. the right of existing shareholders to acquire stock at a discount if a bidder acquires a minimum number of shares. Production payment Loan in the form of advance payment for future delivery of a product. Poison put A covenant allowing the bond holder to demand repayment in the event of a hostile merger. Profitability index Ratio of a project’s NPV to the initial investment. Pooling of interest Method of accounting for mergers (no longer available in the USA). The consolidated balance Pro forma Projected. sheet of the merged firm is obtained by combining Debt that is largely a claim against the the balance sheets of the separate firms (cf. purchase cash flows from a particular project rather than against accounting ). the firm as a whole. Position diagram Diagram showing the possible payoffs P r o j e c t n o t e ( P N ) Note issued by public housing or urban from a derivative investment. renewal agencies. P o s t a u d i t Evaluation of an investment project after it P r o m i s s o r y n o t e Promise to pay. has been undertaken. P r o s p e c t t h e o r y A theory of asset pricing suggested by P r a e c i p i u m Arrangement fee for syndicated loan. the observation of behavioral psychologists that investors Preemptive right Common stockholder’s right to have a particular aversion to losses even if very small. anything of value distributed by the company. P r o s p e c t u s Summary of the registration statement Preferred stock Stock that takes priority over common providing information on an issue of securities. stock in regard to dividends. Dividends may not be paid on Protective put Put option that is combined with holding common stock unless the dividend is paid on all preferred in the underlying asset . stock (cf. cumulative preferred stock ). The dividend rate on preferred is usually fixed at time of issue. P r o x y v o t e Vote cast by one person on behalf of another. P r e n e g o t i a t e d b a n k r u p t c y Chapter 11 bankruptcy where Public warehouse (terminal warehouse) Warehouse only principal creditors have agreed to the reorganization operated by an independent warehouse company on its plan before filing (cf. prepackaged bankruptcy ). own premises (cf. field warehouse ). P r e p a c k Prepackaged bankruptcy. P u r c h a s e a c c o u n t i n g Method of accounting for mergers. The assets of the acquired firm are shown at market value Prepackaged bankruptcy (prepack) Bankruptcy on the balance sheet of the acquirer (cf. pooling of interest ). proceedings intended to confirm a reorganization plan that has already been agreed to informally. P u r c h a s e f u n d Resembles a sinking fund except that money is used only to purchase bonds if they are selling Present value Discounted value of future cash flows. below their par value. Present value of growth opportunities (PVGO) Net present P u t – c a l l p a r i t y The relationship between the prices of value of investments the firm is expected to make in the European put and call options. future. P u t o p t i o n Option to sell an asset at a specified exercise P R I D E Similar to a PERC except that as the equity price price on or before a specified exercise date (cf. call option ). rises beyond a specified point, the investor shares in the stock appreciation. P V G O Present value of growth opportunities. Glossary G-13

Pyramid Created by forming a holding company whose R e g i s t e r e d s e c u r i t y Security whose ownership is only asset is a controlling interest in a second holding recorded by the company’s registrar (cf. bearer security ). company, which in turn has a controlling interest in an R e g i s t r a r Financial institution appointed to record issue operating company. and ownership of company securities. R e g i s t r a t i o n Process of obtaining SEC approval for a Q public issue of securities. q Ratio of the market value of an asset to its replacement R e g r e s s i o n a n a l y s i s In statistics, a technique for finding cost. the line of best fit. Q I B s Qualified institutional buyers. R e g u l a r d i v i d e n d Dividend that the company expects to maintain in the future. Quadratic programming Variant of linear programming whereby the equations are quadratic rather than linear. Regulation A issue Small security issues that are partially exempt from SEC registration requirements. Qualified Institutional buyers (QIBs) Institutions that are allowed to trade unregistered stock among themselves. R E I T Real estate investment trust. Q u a n t o s w a p Differential swap. Rental lease Full-service lease. Quick ratio (acid-test ratio) Measure of liquidity: (cash ϩ Replicating portfolio Package of assets whose returns marketable securities ϩ receivables) divided by current liabilities. exactly replicate those of an option. R e p o Repurchase agreement. Repurchase agreement (RP, repo, buy-back) Purchase R of Treasury securities from a securities dealer with an Range forward A forward exchange rate contract that agreement that the dealer will repurchase them at a places upper and lower bounds on the cost of foreign specified price. exchange. R e s i d u a l i n c o m e After-tax profit less the opportunity Ratchet bonds Floating-rate bonds whose coupon can cost of capital employed by the business (see also Economic only be reset downward. Value Added ). Rate-sensitive bonds Bonds whose coupon rate changes R e s i d u a l r i s k Specific risk. as issuer’s credit-rating changes. Retained earnings Earnings not paid out as dividends. R e a l a s s e t s Tangible assets and intangible assets used to R e t u r n o n e q u i t y Usually, equity earnings as a carry on business (cf. financial assets ). proportion of the book value of equity. Real estate investment trust (REIT) Trust company Return on investment (ROI) Generally, book income as a formed to invest in real estate. proportion of net book value. Real interest rate Interest rate expressed in terms of real R e v e n u e b o n d Municipal bond that is serviced out of the goods, i.e., nominal interest rate adjusted for inflation. revenues from a particular project. R e a l o p t i o n The flexibility to modify, postpone, expand, Reverse convertible Bond that gives the issuer the right or abandon a project. to convert it into common stock. R e c e i v a b l e s Accounts receivable. Reverse FRN (yield curve note) Floating-rate note whose R e c e i v e r A bankruptcy practitioner appointed by payments rise as the general level of interest rates falls and secured creditors in the United Kingdom to oversee the vice versa. repayment of debts. Reverse split Action by the company to reduce the R e c o r d d a t e Date set by directors when making dividend number of outstanding shares by replacing two or more of payment. Dividends are sent to stockholders who are its shares with a single, more valuable share. registered on the record date. R e v o l v i n g c r e d i t Legally assured line of credit with a bank. R e c o u r s e Term describing a type of loan. If a loan is with Rights issue (privileged subscription issue) Issue of recourse, the lender has a general claim against the parent securities offered to current stockholders (cf. general cash company if the collateral is insufficient to repay the debt. offer ). Red herring Preliminary prospectus. R i g h t s o n With rights. R e f u n d i n g Replacement of existing debt with a new issue R i s k p r e m i u m Expected additional return for making a of debt. risky investment rather than a safe one. G-14 Glossary

R o a d s h o w Series of meetings between a company and S e n i o r d e b t Debt that, in the event of bankruptcy, must potential investors before the company decides on the be repaid before subordinated debt receives any payment. terms of a new issue. Sensitivity analysis Analysis of the effect on project R O I Return on investment. profitability of possible changes in sales, costs, and so on. R o l l - o v e r C D A package of successive certificates of deposit. Serial bonds Package of bonds that mature in successive years. Round lot A trade of 100 shares (cf. odd lot ). S e r i e s b o n d Bond that may be issued in several series R P Repurchase agreement. under the same indenture. R squared ( R2 ) Square of the correlation coefficient —the Shark repellant Amendment to company charter proportion of the variability in one series that can be intended to protect against takeover. explained by the variability of one or more other series. Sharpe ratio Ratio of portfolio’s risk premium to its risk R u l e 1 4 4 a SEC rule allowing qualified institutional buyers (standard deviation ). to buy and trade unregistered securities. S h e l f r e g i s t r a t i o n A procedure that allows firms to file one registration statement covering several issues of the S same security. Sale and lease-back Sale of an existing asset to a S h o g u n b o n d Dollar bond issued in Japan by a nonresident. financial institution that then leases it back to the user Short hedge Sale of a hedging instrument (e.g., a future ) to (cf. direct lease ). hedge a long position in the underlying asset (cf. long hedge ). Salvage value Scrap or resale value of plant and equipment. S h o r t s a l e Sale of a security the investor does not own. S a m u r a i b o n d A yen bond issued in Tokyo by a non- Sight draft Demand for immediate payment (cf. time Japanese borrower (cf. bulldog bond, Yankee bond ). draft ). S B I C Small Business Investment Company. S i g n a l Action that demonstrates an individual’s S c e n a r i o a n a l y s i s Analysis of the profitability of a unobservable characteristics (because it would be unduly project under alternative economic scenarios. costly for someone without those characteristics to take the action). Season datings Extended credit for customers who order goods out of the peak season. Simple interest Interest calculated only on the initial investment (cf. compound interest ). Seasoned issue Issue of a security for which there is an existing market (cf. unseasoned issue ). S i m u l a t i o n Monte Carlo simulation. S E C Securities and Exchange Commission. S i n k e r Sinking fund. Secondary issue (1) Procedure for selling blocks of Sinking fund (sinker) Fund established by a company to seasoned issues of stock; (2) more generally, sale of already retire debt before maturity. issued stock. SIV (structured investment vehicle) A fund that typically S e c o n d a r y m a r k e t Market in which one can buy or sell invested in mortgage-backed securities, which it financed seasoned issues of securities. by issuing senior and junior tranches of asset-backed commercial paper and longer-term notes. S e c u r e d d e b t Debt that, in the event of default, has first claim on specified assets. S k e w e d d i s t r i b u t i o n Probability distribution in which an unequal number of observations lie below and above the Securitization Substitution of tradable securities for mean. privately negotiated instruments. S P E Special-purpose entity. S e c u r i t y m a r k e t l i n e Line representing the relationship between expected return and market risk. Special dividend (extra dividend) Dividend that is unlikely to be repeated. S e l f - l i q u i d a t i n g l o a n Loan to finance current assets. The sale of the current assets provides the cash to repay the loan. Specialist Designated market maker. S e l f - s e l e c t i o n Consequence of a contract that induces S p e c i a l - p u r p o s e e n t i t y Partnerships established by only one group (e.g., low-risk individuals) to participate. companies to hold certain assets and obtain funding. May be used to obtain off-balance-sheet debt for the parent. Semistrong-form efficient market Market in which security prices reflect all publicly available information Specific risk (residual risk, unique risk, unsystematic (cf. weak-form efficient market and strong-form efficient market ). risk) Risk that can be eliminated by diversification. Glossary G-15

Spinning The underwriter of an IPO unethically allots a Sunk costs Costs that have been incurred and cannot be portion of offering to senior management of a client company. reversed. S p i n - o f f Distribution of shares in a subsidiary to the S u p e r m a j o r i t y Provision in a company’s charter company’s shareholders so that they hold shares separately requiring a majority of, say, 80% of shareholders to in the two firms. approve certain changes, such as a merger. S p o t e x c h a n g e r a t e Exchange rate on currency for S u s h i b o n d A eurobond issued by a Japanese immediate delivery (cf. forward exchange rate ). corporation. Spot price Price of asset for immediate delivery (in S u s t a i n a b l e g r o w t h r a t e Maximum rate of firm growth contrast to forward or futures price). without increasing financial leverage (cf. internal growth S p o t r a t e Interest rate fixed today on a loan that is made rate ). today (cf. forward interest rate ). S w a p An arrangement whereby two companies lend to S p r e a d Difference between the price at which an each other on different terms, e.g., in different currencies, underwriter buys an issue from a firm and the price at or one at a fixed rate and the other at a floating rate. which the underwriter sells it to the public. S w a p t i o n Option on a swap. Staggered board Board whose directors are elected Sweep program Arrangement whereby bank invests a periodically, instead of at one time. company’s available cash at the end of each day. Standard deviation Square root of the variance —a Swingline facility Bank borrowing facility to provide measure of variability. finance while the firm replaces U.S. commercial paper with Standard error In statistics, a measure of the possible eurocommercial paper. error in an estimate. Syndicated loan A large loan provided by a group of Standby agreement In a rights issue, agreement that the banks. underwriter will purchase any stock not purchased by S y s t e m a t i c r i s k Market risk. investors. S t e p - u p b o n d Bond whose coupon is stepped up over time (also step-down bond). T S t o c k d i v i d e n d Dividend in the form of stock rather than Take-or-pay In project finance, arrangement where parent cash. company agrees to pay for output of project even if it chooses not to take delivery. Stock split “Free” issue of shares to existing shareholders. Take-up fee Fee paid to underwriters of a rights issue on S t r a d d l e The combination of a put option and a call option any stock they are obliged to purchase. with the same exercise price. Tangent efficient portfolio The portfolio of risky assets Straight-line depreciation An equal dollar amount of offering the highest risk premium per unit of risk (standard in each period. depreciation deviation ). Strike price Exercise price of an option. Tangible asset Physical asset, such as plant, machinery, Stripped bond (strip) Bond that is subdivided into a series and offices (cf. intangible asset ). of zero-coupon bonds. Tax-anticipation bill Short-term bill issued by the U.S. Strong-form efficient market Market in which security Treasury that can be surrendered at face value in payment prices reflect instantaneously all information available to of taxes. investors (cf. weak-form efficient market and semistrong-form T - b i l l Treasury bill. efficient market ). T e c h n i c a l a n a l y s i s Security analysis that seeks to Structured debt Debt that has been customized for the detect and interpret patterns in past security prices buyer, often by incorporating unusual options. (cf. fundamental analysis ). Subordinated debt (junior debt) Debt over which T E D s p r e a d Difference between LIBOR and U.S. takes priority. In the event of bankruptcy, Treasury bill rate. subordinated debtholders receive payment only after senior debt is paid off in full. General offer made directly to a firm’s shareholders to buy their stock. Subprime loans The most risky category of loans. 1 0 - K Annual financial statements as filed with the SEC. Sum-of-the-years’-digits depreciation Method of accelerated depreciation. 1 0 - Q Quarterly financial statements as filed with the SEC. G-16 Glossary

T e n o r Maturity of a loan. Trust deed Agreement between trustee and borrower setting out terms of a bond. Terminal warehouse Public warehouse. Trust receipt Receipt for goods that are to be held in T e r m l o a n Medium-term, privately placed loan, usually trust for the lender. made by a bank. T u n n e l i n g Actions by a controlling shareholder to Term structure of interest rates Relationship between transfer wealth out of the firm (e.g., by supplying goods at interest rates on loans of different maturities (cf. yield curve ). an inflated price). Throughput arrangement Arrangement by which shareholders of a pipeline company agree to make sufficient use of pipeline to enable the pipeline company U to service its debt. U n d e r p r i c i n g Issue of securities below their market value. T i c k Minimum amount the price of a security may Underwriter Firm that buys an issue of securities from a change. company and resells it to investors. Time draft Demand for payment at a stated future date Unfunded debt Debt maturing within one year (cf. funded (cf. sight draft ). debt ). Times-interest-earned (interest cover) Earnings before Uniform price auction Auction in which all successful interest and tax, divided by interest payments. bidders pay the same price (cf. discriminatory price auction). TIPS (Treasury Inflation Protected Securities) U.S. U n i q u e r i s k Specific risk. Treasury bonds whose coupon and principal payments are linked to the Consumer Price Index. Unseasoned issue Issue of a security for which there is no existing market (cf. seasoned issue ). T o e h o l d Small investment by a company in the shares of a potential takeover target. U n s y s t e m a t i c r i s k Specific risk. Tolling contract In project finance, arrangement whereby parent company promises to deliver materials to project V for processing and then to repurchase them. V a l u e a d d i t i v i t y Rule that the value of the whole must T o m b s t o n e Advertisement listing the underwriters to a equal the sum of the values of the parts. security issue. Value at risk (VAR) The probability of portfolio losses Trade acceptance Written demand that has been exceeding some specified proportion. accepted by an industrial company to pay a given sum at a future date (cf. banker’s acceptance ). Value stock A stock that is expected to provide steady income but relatively low growth (often refers to stocks T r a d e c r e d i t Accounts receivable. with a low ratio of market-to-book value). T r a d e d e b t Accounts payable. Vanilla issue Issue without unusual features. T r a n c h e Portion of a new issue sold at a point in time V A R Value at risk. different from the remainder or that has different terms. Variable-rate demand bond (VRDB) Floating-rate bond T r a n s a c t i o n e x p o s u r e Risk to a firm with known future that can be sold back periodically to the issuer. cash flows in a foreign currency that arises from possible changes in the exchange rate (cf. economic exposure, V a r i a n c e Mean squared deviation from the expected translation exposure ). value; a measure of variability. Transfer agent Individual or institution appointed by a V a r i a t i o n m a r g i n The daily gains or losses on a futures company to look after the transfer of securities. contract credited to the investor’s margin account. T r a n s l a t i o n e x p o s u r e Risk of adverse effects on a firm’s V e g a A measure of how the option price changes as the financial statements that may arise from changes in asset’s volatility changes. exchange rates (cf. economic exposure, transaction exposure ). Venture capital Capital to finance a new firm. T r e a s u r e r Principal financial manager (cf. controller ). V e r t i c a l m e r g e r Merger between a supplier and its Treasury bill (T-bill) Short-term discount debt maturing customer (cf. horizontal merger, conglomerate merger ). in less than one year, issued regularly by the government. V e r t i c a l s p r e a d Simultaneous purchase and sale of two Treasury stock Common stock that has been repurchased options that differ only in their exercise price (cf. horizontal by the company and held in the company’s treasury. spread ). Glossary G-17

V I X A measure of the implied volatility of stocks in the With rights (cum rights, rights on) Purchase of shares in S&P 500 Index. which the buyer is entitled to the rights to buy shares in the company’s rights issue (cf. ex rights ). V R D B Variable rate demand bond. Working capital Current assets and current liabilities. The term is commonly used as synonymous with net working W capital. W A C C Weighted-average cost of capital. W o r k o u t Informal arrangement between a borrower and Warehouse receipt Evidence that a firm owns goods creditors. stored in a warehouse. W r i t e r Option seller . W a r r a n t Long-term call option issued by a company. Weak-form efficient market Market in which security X prices instantaneously reflect the information in the history of security prices. In such a market security prices x d Ex dividend. follow a random walk (cf. semistrong-form efficient market x r Ex rights. and strong-form efficient market ). Weighted-average cost of capital (WACC) Expected return on a portfolio of all the firm’s securities. Used as hurdle Y rate for capital investment. Y a n k e e b o n d A dollar bond issued in the United States by W h i t e k n i g h t A friendly potential acquirer sought out by a non-U.S. borrower (cf. bulldog bond, Samurai bond ). a target company threatened by a less welcome suitor. Yield curve Term structure of interest rates. W i . When issued. Yield curve note Reverse FRN. Winner’s curse Problem faced by uninformed bidders. For example, in an initial public offering uninformed Y i e l d t o m a t u r i t y Internal rate of return on a bond. participants are likely to receive larger allotments of issues that informed participants know are overpriced. Z With dividend (cum dividend) Purchase of shares in which the buyer is entitled to the forthcoming dividend Z e r o - c o u p o n b o n d Discount bond making no coupon (cf. ex dividend ). payments. Withholding tax Tax levied on dividends paid abroad. Z - s c o r e Measure of the likelihood of bankruptcy.