4
401(k): A type of retirement savings plan offered by many employers that allows employees to set aside pre-tax income for retirement.
A
Accreting Swap: An exchange of interest rate payments at regular intervals based upon pre-set indices and notional amounts in which the notional amounts decrease over time.
Accretion: Earnings and asset growth which occur due to business expansion.
Acquiree or Target: A company purchased or otherwise taken-over during an acquisition or merger.
Acquirer or Buyer or Offeror: The company undertaking the merger or acquisition of another company.
Acquisition Premium: The difference between the price paid for a company and its estimated real value.
Acquisition: The purchase of the controlling interest in or ownership of one company by another.
Actuals: Financial instruments that exist in one of the four main asset classes: interest rates, foreign exchange, equities or commodities. Typically, derivatives are used to hedge actual exposure or to take positions in actual markets.
Adjusted Earnings: A method of assessing financial performance which compensates for atypical profits and expenses, such as capital gains, new investments, tax liabilities, loss revenues, etc. By removing such factors—factors that are not a part of a company’s typical financial workings—the adjusted earnings metric is intended to more accurately reflect financial robustness.
All or Nothings: An option whose payout is fixed at the inception of the option contract and for which the payout is only made if the strike price is in-the-money at expiry. If the strike price is out-of-the-money at expiry, there is no payout made to the option holder.
Amalgamation or Consolidation: An amalgamation occurs when two or more companies blend together to form a new entity. It is a distinct from a merger because none of the amalgamating companies survive as independent legal entities.
American Style Option: An option that can be exercised at any time from inception as opposed to a European Style option which can only be exercised at expiry. Early exercise of American options may be warranted by arbitrage. European Style option contracts can be closed out early, mimicking the early exercise property of American style options in most cases.
Arbitrage: The act of taking advantage of differences in price between markets. For example, if a stock is quoted on two different equity markets, there is the possibility of arbitrage if the quoted price (adjusted for institutional idiosyncrasies) in one market differs from the quoted price in the other. The term has been extended to refer to speculators who take positions on the correlation between two different types of instrument, assuming stability to the correlation patterns. Many funds have discovered that correlation is not as stable as it is assumed to be.
Asset Acquisition: A form of acquisition in which the acquirer purchases the assets of a target rather than its stocks.
Asset Allocation: The process of dividing an investment portfolio among different asset classes, such as stocks, bonds, and cash.
Asset Sale: A form of acquisition in which an acquirer purchases a target company’s assets without purchasing the company itself. The seller must therefore settle all existing liabilities and debts before taking the net cash proceeds.
Asset Turnover Ratio: The asset turnover ratio measures a company’s efficiency in using its assets to generate revenue, calculated by dividing its total revenue by its total assets. Formula: Asset Turnover Ratio = Total Revenue / Total Assets
Asset: Anything of value that is owned, such as cash, stocks, bonds, real estate, or a business.
Asset-Based Approach: A company valuation metric in which total liabilities are subtracted from Net Asset Value. Used primarily to determine what it would cost to re-create a business.
Asset-Based Lending: A method of financing in which a business loan is secured using company assets as collateral.
Asset-Liability Management: Closing out exposure to fluctuations in interest rates by matching the timing of cash flows associated with assets and liabilities. This is a technique commonly used by financial institutions and large corporations.
ATM: Automated Teller Machine, a machine that allows individuals to access their bank account for cash withdrawals and other transactions.
At-the-Market: A type of financial transaction in which the order to buy or sell is executed at the current prevailing market price.
At-the-Money Forward: An option whose strike price is equal to the current, prevailing price in the underlying forward market.
At-the-Money: An option whose strike price is equal to the current, prevailing price in the underlying cash spot market.
Average Rate Options: An option whose payout at expiry is determined by the difference between its strike and a calculated average market rate where the period, frequency and source of observation for the calculation of the average market rate are specified at the inception of the contract. These options are cash settled, typically.
Average Strike Options: An option whose payout at expiry is determined by the difference between the prevailing cash spot rate at expiry and its strike, deemed to be equal to a calculated average market rate where the period, frequency and source of observation for the calculation of the average market rate are specified at the inception of the contract. These options are cash settled, typically.
B
Backwardation: A term often used in commodities or futures markets to refer to markets where shorter-dated contracts trade at a higher price than longer-dated contracts. Plotting the prices of contracts against time, with time on the x-axis, shows the commodity price curve as sloping downwards as time increases.
Backward Integration: A form of acquisition in which the target company produces raw materials or other supplies required by the acquirer to operate.
Bank: A financial institution that offers services such as savings and checking accounts, loans, and investment products.
Bankruptcy: A legal process in which an individual or business is unable to pay their debts and seeks relief from creditors.
Barrier Options: An option contract for which the maturity, strike price and underlying are specified at inception in addition to a trigger price. The trigger price determines whether or not the option actually exists. In the case of a knock-in option, the barrier option does not exist until the trigger is touched. For a knock-out option, the option exists until the trigger is touched.
Base Year: The earliest year in a set of years used to calculate a financial trend.
Basket: A collection of securities (typically fifteen or more) grouped together for simultaneous purchase or sale. Often used as a part of program trading.
Benchmarking: A benchmark is a reference point. Benchmarking in financial risk management refers to the practice of comparing the performance of an individual instrument, a portfolio or an approach to risk management to a pre-determined alternative approach.
Black Knight: A company that makes an unwanted takeover offer (hostile takeover) to a target.
Black-Scholes: A closed-form solution (i.e. an equation) for valuing plain vanilla options developed by Fischer Black and Myron Scholes in 1973 for which they shared the Nobel Prize in Economics.
Blue Sky: Any amount paid for a company exceeding combined assets and goodwill.
Bond: A loan made to a company or government that pays periodic interest and returns the principal at maturity.
Book Value: The value of a company as determined by subtracting intangible assets and liabilities from total assets.
Bootstrap Effect: A short-lasting illusory boost in earnings per share which occurs when a company acquires a target trading on a lower price-to-earnings ratio.
Budget: A plan for managing income and expenses, with the goal of saving and achieving financial goals.
Business Cycle: A recurring cycle of economic expansion and contraction, typically taking place over three to four years.
Business Judgement Rule: A legal framework protecting companies from litigation, prosecution, or other legal action resulting from unpopular operational decisions.
Business Valuation: The process of determining the economic value of a company.
C
Call Option: A call option is a financial contract giving the owner the right but not the obligation to buy a pre-set amount of the underlying financial instrument at a pre-set price with a pre-set maturity date.
Cap: A cap is a financial contract giving the owner the right but not the obligation to borrow a pre-set amount of money at a pre-set interest rate with a pre-set maturity date.
Capital Asset Pricing Model: A model used to calculate the necessary rate of return on a potential asset to justify acquiring it.
Capital Gain: The profit made from selling an investment for more than its original purchase price.
Capital Loss: The loss incurred from selling an investment for less than its original purchase price.
Capital Market: The market where long-term financial instruments, such as bonds and stocks, are bought and sold.
Capital Structure: The unique combination of debts, equities, and hybrid securities through which a company finances its assets.
Capital: Money or other assets used for investing, starting a business, or financing other endeavors.
Capitalization Factor or Capitalization Rate or Cap Rate: A value metric representing the income expected from an investment, computed as the inverse of the expected rate of return.
Capitalization Ratio: A series of metrics/indicators which measure the proportion of debt in a company’s total capital structure.
Capitalization: The total sum of a company’s stock, debt, and earnings.
Capitalizing Net Income or Capitalization of Earnings: A method of valuing a business in which the company’s expected future earnings are divided by the Capitalization Factor.
Car Loan: A loan used to purchase a vehicle.
Cash Consideration: The percentage of the purchase price of a company to be paid to the target in cash.
Cash Flow Loan: A type of business loan in which a company’s cash flow is determined by the lending bank to constitute sufficient collateral.
Cash Flow Statement: A financial statement displaying comprehensive data regarding incoming and outgoing cash flows in a business.
Cash Flow: The amount by which a company’s net cash income exceeds its net cash expenses.
Cash Settlement: Some derivatives contracts are settled at maturity (or before maturity at closeout) by an exchange of cash from the party who is out-of-the-money to the party who is in-the-money.
Central Bank: A government-run financial institution that regulates a country’s monetary policy and provides financial services to the government.
Checking Account: A type of bank account used for everyday transactions, such as paying bills or making purchases.
Chooser Option: An option that gives the buyer the right at the choice date (before the option’s expiry) to choose if the option is to be a call or a put.
Circular Merger: One of the three traditional forms of merger, a circular merger occurs when a company acquires targets in the same or related industries in order to diversify its product offering.
Clandestine Takeover: A takeover strategy in which an acquirer slowly and quietly purchasing shares in a target with the ultimate goal of accumulating a controlling stake.
Clean Team: A Clean Team is a group of people who operate under certain protocols prior to regulatory approval and deal closure. This special group of people can assemble, review and analyze sensitive, competitive or other confidential data between the two companies before that information can be widely shared. Clean teams are especially useful in carve-outs or acquisitions of public companies where the acquiring organization is a competitor.
Collar: An investment strategy that limits potential negative outcomes.
Collar: A combination of options in which the holder of the contract has bought one out-of-the money option call (or put) and sold one (or more) out-of-the-money puts (or calls). Doing this locks in the minimum and maximum rates that the collar owner will use to transact in the underlying at expiry.
Commodity: A raw material or primary agricultural product that can be bought and sold, such as gold, oil, or wheat.
Commodity Swap: A contract in which counterparties agree to exchange payments related to indices, at least one of which (and possibly both of which) is a commodity index.
Common Stock: A form of security representing partial ownership of a company. Common stocks are the most basic building blocks of the stock market.
Compensation Manipulation: Occurs when the upper management of a company seeks out mergers and acquisitions with the intent of achieving growth solely in order to receive a corresponding increase in salary.
Competitive Bid: When the decision is made to take a company public, sealed bids—known as competitive bids—are collected from investment banks prior to the initial public offering. The bank who offers the most favorable terms is given the contract to take the company public and broker the IPO.
Compound Interest: Interest earned on an investment that is reinvested, resulting in growing returns over time.
Confidential Business Profile or Confidential Business Review: A confidential marketing document circulated among potential buyers of a for sale company. The CBP gives an overview of the financial workings of the target company and is usually only distributed following the completion of a non-disclosure agreement.
Conglomerate Merger: A merger between two companies in different industries.
Consulting Agreement: A term-of-sale in M&A requiring select staff members of the target company (usually upper management) to stay on as consultants for a predetermined span of time.
Contango: A term often used in commodities or futures markets to refer to markets where shorter-dated contracts trade at a lower price than longer-dated contracts. Plotting the prices of contracts against time, with time on the x-axis, shows the commodity price curve as sloping upwards as time increases.
Continuing Operations: A net income category found in income statements, continuing operations include all expenses necessary to the daily business activities of a company.
Conversion Price: The price at which a common stock can be obtained in trade for other assets, commonly bonds or preferred shares.
Convexity: A financial instrument is said to be convex (or to possess convexity) if the financial instrument’s price increases (decreases) faster (slower) than corresponding changes in the underlying price.
Correlation: Correlation is a statistical measure describing the extent to which prices on different instruments move together over time. Correlation can be positive or negative. Instruments that move together in the same direction to the same extent have highly positive correlations. Instruments that move together in opposite direction to the same extent have highly negative correlations. Correlation between instruments is not stable.
Covenant Not to Compete or Non-Compete Clause: A covenant, often found in acquisition agreements, that prohibits the seller from engaging in future business in competition with the entity being sold.
Covenant: A promise or obligation included in an indenture or other compulsory form of contract. A covenant guarantees that certain actions will or will not be taken out. They are often stipulated by creditors as a part of the business loan process.
Covered Call Option Writing: A technique used by investors to help fund their underlying positions, typically used in the equity markets. An individual who sells a call is said to “write” the call. If this individual sells a call on a notional amount of the underlying that he has in his inventory, then the written call is said to be “covered” (by his inventory of the underlying). If the investor does not have the underlying in inventory, the investor has sold the call “naked”.
Credit Card: A type of financial product that allows an individual to borrow money for purchases, with the obligation to repay the debt over time.
Credit Report: A record of an individual’s credit history, including details about credit accounts and payment history.
Credit Risk: The risk of loss should a borrower default on their debt by failing to make the required payments.
Credit Score: A numerical representation of a person’s creditworthiness, based on their credit history and other factors.
Crown Jewels Defense: A scorched earth hostile takeover defense in which a company sells off its crown jewels in order to forestall an acquisition.
Crown Jewels: The most highly valued aspects of a business as seen in terms of asset value and profitability. The crown jewels are what set a company a part from its peers—its best product, its most powerful service. Sometimes a buyer acquires a target company solely to gain access to its crown jewels, with no intention of integrating the rest of the target’s assets.
Currency: A medium of exchange, such as the US dollar, Euro, or Japanese yen.
Currency Swap: An exchange of interest rate payments in different currencies on a pre-set notional amount and in reference to pre-determined interest rate indices in which the notional amounts are exchanged at inception of the contract and then re-exchanged at the termination of the contract at pre-set exchange rates.
Current Ratio: The current ratio measures a company’s ability to pay its short-term debts, calculated by dividing its current assets by its current liabilities. Formula: Current Ratio = Current Assets / Current Liabilities
D
Dawn Raid: A form of hostile takeover in which the would-be acquirer attempts to buy all outstanding shares of a target’s stock as the market opens in the morning.
Days Sales Outstanding (DSO): The days sales outstanding measures the average number of days it takes for a company to collect payment from its customers after a sale. Formula: DSO = Accounts Receivable / (Annual Sales / 365 Days)
Dead Hand Provision: A special type of poison pill in which the stock position of the bidder is massively diluted by issuing new stock to every shareholder but them.
Deal Structure: The combination of assets with which an acquisition is financed—can include cash, stocks, notes, consulting agreements, etc.
Debit Card: A card linked to a checking account that allows users to make purchases or withdraw cash from ATMs.
Debt Service Coverage Ratio (DSCR): The debt service coverage ratio measures a company’s ability to repay its debt, calculated by dividing its net operating income by its total debt service. Formula: DSCR = Net Operating Income / Total Debt Service
Debt to Asset Ratio (D/A): The debt to asset ratio measures a company’s use of debt to finance its assets, calculated by dividing its total liabilities by its total assets. Formula: D/A = Total Liabilities / Total Assets
Debt to Equity Ratio (D/E): The debt to equity ratio is a measure of a company’s financial leverage, calculated by dividing its total liabilities by its total equity. The higher the ratio, the more debt a company is using to finance its assets. Formula: D/E = Total Liabilities / Total Equity
Debt to Gross Profit Ratio: The debt to gross profit ratio measures how much debt a company has in relation to its gross profit, calculated by dividing its total debt by its gross profit. Formula: Debt to Gross Profit Ratio = Total Debt / Gross Profit
Debt to Income Ratio (D/I): The debt to income ratio measures an individual’s ability to repay their debt, calculated by dividing their total monthly debt payments by their gross monthly income. Formula: D/I = Total Monthly Debt Payments / Gross Monthly Income
Debt: Money owed to another party, such as a lender or creditor.
Defensive Merger: A corporate strategy involving the acquisition of or merger with other firms to forestall a market downturn or impending takeover.
Deferred Financing Cost or Debt Issuance Cost: A fee or commission paid to an investment bank in exchange for their issuance of debt.
Deflation: The rate at which the general level of prices for goods and services is falling, and therefore purchasing power is rising.
Delta: The sensitivity of the change in the financial instrument’s price to changes in the price of the underlying cash index.
Demerger or Corporate Split or Division: A demerger occurs when a branch or division within a business is split off to form its own company. In the case of public companies, some stock is transferred to the new entity.
Derivative: A financial product that derives its value from an underlying asset, such as a stock, commodity, or currency.
Dilution: A reduction in the percentage of company ownership of stock caused by the release of new shares into the market.
Direct Deposit: A method of depositing paychecks or other regular payments directly into a bank account, without the need for physical checks.
Diversification: The process of spreading out investments across multiple assets to reduce risk.
Divestiture: The sale of a segment of a company to an outside party. Distinct from a demerger because the assets in question are liquidated and do not continue to exist as an independent company.
Dividend Yield: The dividend yield measures the return on investment from a stock, calculated by dividing its annual dividend by its current stock price. Formula: Dividend Yield = Annual Dividend / Stock Price
Dividend: A portion of a company’s profits that is distributed to its shareholders.
Documentation Risk: The risk of loss due to an inadequacy or other unforeseen aspect of the legal documentation behind the financial contract.
Dollar-Cost Averaging: An investment strategy of regularly investing the same amount of money into an asset, regardless of the price, over a period of time.
Due Diligence: The formal process by which an acquirer investigates a target company’s finances before signing an acquisition agreement.
Duration: A weighted average of the cash flows for a fixed income instrument, expressed in terms of time.
E
Earnings Per Share (EPS): The earnings per share measures a company’s earnings for each share of stock, calculated by dividing its net income by its total number of shares. Formula: EPS = Net Income / Total Number of Shares
Earnout: A provision included in some acquisition agreements obligating the the acquirer to make additional payments based on the future performance of the company sold.
EBIT: Acronym standing for Earnings Before Interest and Tax. Calculated by subtracting operating costs from total revenue.
EBITDA Margin: The EBITDA margin measures a company’s profitability based on its earnings before interest, taxes, depreciation, and amortization, calculated by dividing its EBITDA by its revenue. Formula: EBITDA Margin = EBITDA / Revenue
Economic Life: The span of time over which an entity expects an asset to remain viable.
Economy of Scale: Term reflecting the proportional decrease in operating costs accomplished by increasing production.
Economy of Scope: Term reflecting the savings realized by manufacturing multiple goods together instead of separately.
Embedded Derivatives: Derivative contracts that exist as part of securities.
Emergency Fund: A savings account set aside for unexpected expenses or financial emergencies.
Empire Building: An acquisition strategy motivated solely by perceived increases in prestige or status implicit in company growth.
Employee Stock Ownership Plan (ESOP): A benefit plan providing workers with a stock interest in the employing company.
Endowment: A type of investment account established by an institution, such as a university or charity, to provide ongoing funding for a specific purpose.
Enterprise Value (EV): The value of a company calculated as market capitalization plus long-term debt minus cash and short-term investments. Intended to represent the total cost an acquirer would pay to take over a business.
Enterprise Value to EBITDA Ratio (EV/EBITDA): The enterprise value to EBITDA ratio measures the value of a company based on its earnings before interest, taxes, depreciation, and amortization, calculated by dividing its enterprise value by its EBITDA. Formula: EV/EBITDA = Enterprise Value / EBITDA
Equity Carve Out or Split-off IPO: A type of demerger in which a company creates a new entity out one of its subgroups to offer in an IPO. The parent company retains management control.
Equity Issuance Fees or Stock Issuance Fees: Fees charged by investment banks to underwrite the release of new stocks to the market.
Equity Swap: A contract in which counterparties agree to exchange payments related to indices, at least one of which (and possibly both of which) is an equity index.
Estate Planning: The process of preparing for the distribution of one’s assets after death, including the creation of a will and other legal documents.
European Style Option: An option that can be exercised only at expiry as opposed to an American Style option that can be exercised at any time from inception of the contract. European Style option contracts can be closed out early, mimicking the early exercise property of American style options in most cases.
Excess Purchase Price: The difference between the price paid for a company and the total sum of its assets.
Exchange Traded Contracts: Financial instruments listed on exchanges such as the Chicago Board of Trade.
Exchange-Traded Fund (ETF): A type of investment fund that tracks an index, a commodity, bonds, or a basket of assets, similar to a mutual fund.
Exercise Price or Strike Price: The price per share at which the owner of a stock is authorized to sell or trade their position. It is the price at which a call’s (put’s) buyer can buy (or sell) the underlying instrument.
Exotic Derivatives: Any derivative contract that is not a plain vanilla contract. Examples include barrier options, average rate and average strike options, lookback options, chooser options, etc.
Expense: Money spent on goods or services, including daily necessities, bills, and leisure activities.
F
Fair Market Value: The price of an asset when both buyer and seller are approaching the transaction from a well-informed and unpressured position.
Financial Advisor: A professional who provides advice and guidance on investment strategies and financial planning.
Financial Buyer: A company primarily interested in acquiring for purposes of increased revenue or cash flow. Contrast with Strategic Buyer.
Financial Literacy: Knowledge and understanding of basic financial concepts, including budgeting, saving, investing, and managing debt.
Financial Market: A marketplace where financial instruments, such as stocks, bonds, and derivatives, are bought and sold.
Financial Planning: The process of setting and achieving financial goals, through budgeting, saving, investing, and managing debt.
Fiscal Policy: The actions taken by the government to influence the economy, such as taxes, spending, and regulation.
Flip-In: A type of poison pill which allows existing shareholders to buy target company stock at a discounted rate in the event of an attempted takeover.
Flip-Over: A poison pill strategy allowing existing target company shareholders to buy acquiring company stock at a discounted rate in the event of a successful takeover.
Floor: A floor is a financial contract giving the owner the right but not the obligation to lend a pre-set amount of money at a pre-set interest rate with a pre-set maturity date.
Foreign Exchange (Forex): The market where currencies are bought and sold.
Forward Contracts: An over-the-counter obligation to buy or sell a financial instrument or to make a payment at some point in the future, the details of which were settled privately between the two counterparties. Forward contracts generally are arranged to have zero mark-to-market value at inception, although they may be off-market. Examples include forward foreign exchange contracts in which one party is obligated to buy foreign exchange from another party at a fixed rate for delivery on a pre-set date. Off-market forward contracts are used often in structured combinations, with the value on the forward contract offsetting the value of the other instrument(s).
Forward or Delayed Start Swap: Any swap contract with a start that is later than the standard terms. This means that calculation of the cash flows does not begin straightaway but at some pre-determined start date.
Forward Integration: An acquisition in which the target company uses or retails goods produced by the acquirer.
Forward Rate Agreements: A forward rate agreement (FRA) is a cash-settled obligation on interest rates for a pre-set period on a pre-set interest rate index with a forward start date. A 3×6 FRA on US dollar LIBOR (the London Interbank Offered Rate) is a contract between two parties obliging one to pay the other the difference between the FRA rate and the actual LIBOR rate observed for that period. An Interest Rate Swap is a strip of FRAs.
Friendly Mergers: Acquisitions and mergers taking place as a result of negotiation and mutual interest rather than hostile takeover.
Fully Diluted Shares Outstanding: The total number of shares outstanding after all convertibles and options are exercised.
Futures: A type of derivative that obligates the buyer to purchase an underlying asset at a predetermined price and date.
Futures Contracts: An exchange-traded obligation to buy or sell a financial instrument or to make a payment at one of the exchange’s fixed delivery dates, the details of which are transparent publicly on the trading floor and for which contract settlement takes place through the exchange’s clearinghouse.
G
Gamma: Gamma (or convexity) is the degree of curvature in the financial contract’s price curve with respect to its underlying price. It is the rate of change of the delta with respect to changes in the underlying price. Positive gamma is favourable. Negative gamma is damaging in a sufficiently volatile market. The price of having positive gamma (or owning gamma) is time decay. Only instruments with time value have gamma.
Godfather Offer: An offer made by an acquirer to a target which is too good to refuse.
Golden Parachute: A large payment or other financial compensation guaranteed to high-level executives should they be dismissed as the result of a merger or takeover.
Goodwill: An intangible benefit resulting when a company acquires a target at a premium.
Gray Knight: A follow-up bidder in a public offering which attempts to take advantage of problems between the target and initial bidder. The gray knight often offers itself as an alternative to the black knight in an attempted hostile takeover.
Greenmail: A form of extortion in which a substantial block of shares in a business is purchased by an unfriendly company, which then forces the target company to repurchase the stock at an inflated price to prevent takeover.
Gross Debt to Equity Ratio: The gross debt to equity ratio measures a company’s debt compared to its equity, calculated by dividing its total debt by its total equity. Formula: Gross Debt to Equity Ratio = Total Debt / Total Equity
Gross Domestic Product (GDP): The total value of goods and services produced in a country over a specific period of time.
Gross Profit Margin: The gross profit margin measures a company’s profitability, calculated by dividing its gross profit by its total revenue. Formula: Gross Profit Margin = Gross Profit / Total Revenue
H
Hedge: A transaction that offsets an exposure to fluctuations in financial prices of some other contract or business risk. It may consist of cash instruments or derivatives.
Hedging: The use of financial instruments, such as options or futures, to reduce the risk of an investment.
Historical Volatility: A measure of the actual volatility (a statistical measure of dispersion) observed in the marketplace.
Holding Company: A company formed to buy or hold majority shares in other companies.
Horizontal Merger: A merger between two companies in the same industry.
Hostile Takeover or Corporate Raid: Any merger or acquisition undertaken without the support of management at the target company.
House of Issue: The investment bank that underwrites an IPO.
Hybrid Security: Any security that includes more than one component. For example, a hybrid security might be a fixed income note that includes a foreign exchange option or a commodity price option.
I
Identifiable Assets: All company assets—both tangible and intangible—which can be assigned a fair value.
Implied Volatility: Option pricing models rely upon an assumption of future volatility as well as the spot price, interest rates, the expiry date, the delivery date, the strike, etc. If we are given simultaneously all of the parameters necessary for determining the option price except for volatility and the option price in the marketplace, we can back out mathematically the volatility corresponding to that price and those parameters. This is the implied volatility.
Income: Money received on a regular basis, either through employment, investment, or other sources.
Index Fund: A type of mutual fund that invests in a basket of stocks that track a specific market index, such as the S&P 500.
Index-Amortizing Swaps: An interest rate swap in which the notional amount for the purposes of calculating cash flows decreases over the life of the contract in a pre-specified manner.
Inflation: The rate at which the general level of prices for goods and services is rising, and therefore purchasing power is falling.
Initial Public Offering (IPO): The first sale of stock by a company to the public, allowing the company to raise capital.
Insurance: A type of financial product that provides protection against financial loss in the event of an unexpected event, such as illness, death, or damage to property.
Intangibles: Non-physical business assets including patents, trademarks, business methodologies, brand recognition and public goodwill.
Interest: The cost of borrowing money, charged as a percentage of the loan amount.
Interest Coverage Ratio: The interest coverage ratio shows how well a company can pay its interest payments on its debt, calculated by dividing its earnings before interest and taxes by its interest expenses. Formula: Interest Coverage Ratio = EBIT / Interest Expense
Interest Rate: The cost of borrowing money, expressed as a percentage of the amount borrowed.
Interest Rate Swap: An exchange of cash flows based upon different interest rate indices denominated in the same currency on a pre-set notional amount with a pre-determined schedule of payments and calculations. Usually, one counterparty will received fixed flows in exchange for making floating payments.
Interlocking Shareholdings or Cross Shareholdings: The mutual exchange of shares between a group of companies—meant to bond the companies together without actually merging them.
In-The-Money-Forward: An option with positive intrinsic value with respect to the prevailing market forward rate. If the option were to mature immediately, the option holder would exercise it in order to capture its economic value. For a call price to have intrinsic value, the strike must be less than the spot price. For a put price to have intrinsic value, the strike must be greater than the spot price.
In-The-Money Spot: An option with positive intrinsic value with respect to the prevailing market spot rate. If the option were to mature immediately, the option holder would exercise it in order to capture its economic value. For a call price to have intrinsic value, the strike must be less than the spot price. For a put price to have intrinsic value, the strike must be greater than the spot price.
International Swaps Dealers’ Association (ISDA) Agreements: In order to minimize the legal risks of transacting with one another, counterparties will establish master legal agreements and sidebar product schedules to govern formally all derivatives transactions into which they may enter with one another.
Intrinsic Value: The value of a company according to a close analysis of its finances rather than its market rate. The economic value of a financial contract, as distinct from the contract’s time value. One way to think of the intrinsic value of the financial contract is to calculate its value if it were a forward contract with the same delivery date. If the contract is an option, its intrinsic value cannot be less than zero.
Inventory Turnover Ratio: The inventory turnover ratio measures how efficiently a company is selling and restocking its inventory, calculated by dividing its cost of goods sold by its average inventory. Formula: Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory
Investment: The allocation of money into assets with the expectation of earning a return.
IRA: An individual retirement account, allowing individuals to save for retirement with tax benefits.
J
Joint Venture: A business arrangement in which multiple parties combine resources in the pursuit of a common interest.
Junk Bond: A high-risk security, typically issued by companies seeking to raise capital quickly, or by those with poor credit history.
K
Killer Bee: Firm or individual who helps a company prepare strategies to prevent hostile takeover.
Kiwisaver: This is a voluntary, work-based retirement savings scheme in New Zealand. KiwiSaver is for all New Zealand citizens and permanent residents living or normally living in New Zealand. Members can still get New Zealand Superannuation when they reach 65.
Knock-in Option: An option the existence of which is conditional upon a pre-set trigger price trading before the option’s designated maturity. If the trigger is not touched before maturity, then the option is deemed not to exist.
Knock-out Option: An option the existence of which is conditional upon a pre-set trigger price trading before the option’s designated maturity. The option is deemed to exist unless the trigger price is touched before maturity.
L
Legal Risk: The general potential for loss due to the legal and regulatory interpretation of contracts relating to financial market transactions.
Leverage: The use of borrowed money to increase the potential return of an investment.
Leveraged Buyout: A form of buyout in which a management team uses their own company’s revenue to secure a loan to buy it.
Liability: A financial obligation, such as a loan or credit card balance, that requires an individual to make payments to another party.
LIBOR: The rate of interest paid on offshore funds in the Eurodollar markets.
Liquidation Value: The cash value available if the assets of a company were sold.
Liquidity Risk: The risk that a financial market entity will not be able to find a price (or a price within a reasonable tolerance in terms of the deviation from prevailing or expected prices) for one or more of its financial contracts in the secondary market. Consider the case of a counterparty who buys a complex option on European interest rates. He is exposed to liquidity risk because of the possibility that he cannot find anyone to make him a price in the secondary market and because of the possibility that the price he obtains is very much against him and the theoretical price for the product.
Loan: Borrowed money that must be repaid, usually with interest.
Lobster Trap: A porcupine provision which prevents any shareholder with a 10% or greater interest in a company from converting their securities into voting stock.
Look-Back Options: An option which gives the owner the right to buy (sell) at the lowest (highest) price that traded in the underlying from the inception of the contract to its maturity, i.e. the most favourable price that traded over the lifetime of the contract.
M
Mandatory Bid Rule: A rule obligating a new majority shareholder in a business interest to offer to buy any outstanding shares at a fair price.
Margin: A credit-enhancement provision to master agreements and individual transactions in which one counterparty agrees to post a deposit of cash or other liquid financial instruments with the entity selling it as a financial instrument that places some obligation on the entity posting the margin.
Mark to Market Accounting: A method of accounting most suited for financial instruments in which contracts are revalued at regular intervals using prevailing market prices. This is known as taking a “snapshot” of the market.
Market-Maker: A participant in the financial markets who guarantees to make simultaneously a bid and an offer for a financial contract with a pre-set bid/offer spread (or a schedule of spreads corresponding to different market conditions) up to a pre-determined maximum contract amount.
Market Risk: The exposure to potential loss from fluctuations in market prices (as opposed to changes in credit status).
Market Timing: An investment strategy of attempting to buy low and sell high by timing investments based on market conditions.
Merchant Banker: The bank which brokers an M&A transaction.
Merger: The fusion of two or more existing companies into one new entity.
Monetary Policy: The actions taken by a central bank to control the supply of money and interest rates in an economy.
Mortgage: A loan used to purchase a home.
Mutual Fund: A type of investment fund that pools money from multiple investors to purchase a diversified portfolio of stocks, bonds, or other assets.
N
Naked Option Writing: The act of selling options without having any offsetting exposure in the underlying cash instrument.
Netting: When there are cash flows in two directions between two counterparties, they can be consolidated into one net payment from one counterparty to the other thereby reducing the settlement risk involved.
Net Asset Value: The value of a company’s assets minus its liabilities. Often calculated on a per share basis.
Net Book Value: The value at which a company records its assets in its accounting records.
Net Profit Margin: The net profit margin measures a company’s profitability after all expenses have been paid, calculated by dividing its net profit by its total revenue. Formula: Net Profit Margin = Net Profit / Total Revenue
Net Worth: The total value of one’s assets minus their liabilities, which represents an individual’s overall financial position.
O
OCC: The Office of the Comptroller of the Currency (US).
Offer Price: The price per share offered by an acquirer to a target.
Open Interest: Exchanges are required to post the number of outstanding long and short positions in their listed contracts. This constitutes the open interest in each contract.
Operating Profit Margin: The operating profit margin measures a company’s profitability from its core operations, calculated by dividing its operating profit by its total revenue. Formula: Operating Profit Margin = Operating Profit / Total Revenue
Operational Risk: The potential for loss attributable to procedural errors or failures in internal control.
Option: A type of derivative that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a predetermined price on a pre-determined expiration date in a pre-set notional amount.
OSFI: Office of the Superintendent of Financial Institutions (Canada).
Out-of-The-Money-Forward: An option with no intrinsic value with respect to the prevailing market forward rate. If the option were to mature immediately, the option holder would let it expire. For a call price to have intrinsic value, the strike must be less than the spot price. For a put price to have intrinsic value, the strike must be greater than the spot price.
Out-of-The-Money Spot: An option with no intrinsic value with respect to the prevailing market spot rate. If the option were to mature immediately, the option holder would let it expire. For a call price to have intrinsic value, the strike must be less than the spot price. For a put price to have intrinsic value, the strike must be greater than the spot price.
Over-the-Counter: Any transaction that takes place between two counterparties and does not involve an exchange is said to be an over-the-counter transaction.
P
Path-Dependent Options: Any option whose value depends on the path taken by the underlying cash instrument.
Payout Ratio: The payout ratio measures the percentage of a company’s earnings that are paid out as dividends to shareholders. Formula: Payout Ratio = Dividends / Earnings
Pension: A retirement plan that provides a fixed income to employees after they retire.
Portfolio: A collection of investments, including stocks, bonds, real estate, and commodities, owned by an individual or institution.
Potential Exposure: An assessment of the future positive intrinsic value in all of the contracts outstanding with an individual counterparty who may choose (or may be unable) to make their obligated payments.
Premium: The cost associated with a derivative contract, referring to the combination of intrinsic value and time value. It usually applies to options contracts. However, it also applies to off-market forward contracts.
Price to Book Ratio (P/B): The price to book ratio measures the value of a stock compared to its book value, calculated by dividing the current stock price by its book value per share. Formula: P/B = Stock Price / Book Value per Share
Price to Cash Flow Ratio (P/CF): The price to cash flow ratio measures the value of a company’s stock compared to its cash flow, calculated by dividing its stock price by its cash flow per share. Formula: P/CF = Stock Price / (Cash Flow / Number of Shares)
Price to Earnings Ratio (P/E): The price to earnings ratio measures the value of a stock compared to its earnings, calculated by dividing the current stock price by the earnings per share. Formula: P/E = Stock Price / Earnings per Share
Price to Sales Ratio (P/S): The price to sales ratio compares a company’s stock price to its revenue, calculated by dividing its stock price by its revenue per share. Formula: P/S = Stock Price / (Revenue / Number of Shares)
Put-Call Parity Theorem: A long position in a put combined with a long position in the underlying forward instrument, both of which have the same delivery date has the same behavioral properties as a long position in a call for the same delivery date. This can be varied for short positions, etc.
Put Option: A put option is a financial contract giving the owner the right but not the obligation to sell a pre-set amount of the underlying financial instrument at a pre-set price with a pre-set maturity date.
Q
Quanto Option: An option the payout for which is denominated in an index other than the underlying cash instrument.
Quick Ratio: The quick ratio measures a company’s ability to pay its short-term debts without selling its inventory, calculated by dividing its current assets minus its inventory by its current liabilities. Formula: Quick Ratio = (Current Assets – Inventory) / Current Liabilities
R
Real Estate Investment Trust (REIT): A type of investment that pools money from multiple investors to purchase and manage income-generating real estate properties.
Real Estate: Property, such as land or buildings, that can be bought, sold, and used as a form of investment.
Regulatory Risk: The potential for loss stemming from changes in the regulatory environment pertaining to derivatives and financial contracts, the utility of these instruments for different counterparties, etc.
Rent: Payment made to use a property owned by someone else.
Retirement Account: A type of investment account, such as an IRA or 401(k), designed to help individuals save for retirement.
Retirement: The period of time when an individual stops working and relies on savings, pensions, and other sources of income to support themselves.
Return on Assets (ROA): The return on assets measures a company’s profitability based on its total assets, calculated by dividing its net income by its total assets. Formula: ROA = Net Income / Total Assets
Return on Equity (ROE): The return on equity measures the efficiency of a company’s use of investment funds, calculated by dividing its net income by its total equity. Formula: ROE = Net Income / Total Equity
Return: The profit or gain made on an investment, expressed as a percentage of the original investment.
Rho: The sensitivity of a financial contract’s value to small changes in interest rates.
Risk: The chance of losing money on an investment, due to factors such as market fluctuations or company performance.
RiskMetrics: A parametric methodology for calculating Value-at-Risk using data conditioned by JP Morgan’s spinoff company RiskMetrics that is most useful for assessing portfolios with linear risks.
Robo-Advisor: A digital platform that provides automated investment management services using algorithms.
S
Savings Account: A type of bank account where money is deposited and earns interest, and can be easily accessible for withdrawals.
Settlement Risk: The risk of non-payment of an obligation by a counterparty to a transaction, exacerbated by mismatches in payment timings.
Social Security: A government-run retirement and disability insurance program for eligible workers and their families.
Speculation: Taking positions in financial instruments without having an underlying exposure that offsets the positions taken.
Spot: The price in the cash market for delivery using the standard market convention. In the foreign exchange market, spot is delivered for value two days from the transaction date or for the next day in the case of the Canadian dollar exchanged against the US dollar.
Spread: The difference in price or yield between two assets that differ by type of financial instrument, maturity, strike or some other factor. A credit spread is the difference in yield between a corporate bond and the corresponding government bond. A yield curve spread is the spread between two government bonds of differing maturity.
Standard Deviation: In finance, a statistical measure of dispersion of a time series around its mean; the expected value of the difference between the time series and its mean; the square root of the variance of the time series.
Stress Testing: The act of simulating different financial market conditions for their potential effects on a portfolio of financial instruments.
Strike Price: The price at which the holder of a derivative contract exercises his right if it is economic to do so at the appropriate point in time as delineated in the financial product’s contract.
Structured Notes: Fixed income instruments with embedded derivative products.
Stock Market: A marketplace where stocks are bought and sold, with prices determined by supply and demand.
Stock: A type of investment that represents ownership in a company, allowing the owner to share in its profits.
Student Loan: A loan used to pay for education expenses, such as tuition and books.
Swap Spread: The difference between the swap yield curve and the government yield curve for a particular maturity, referring to the market prices for the fixed rate in a plain vanilla interest rate swap.
Swaptions: Options on swaps.
T
Tax: A financial obligation imposed by a government on income, goods, and services, used to fund public services and government operations.
Theta: The sensitivity of a derivative product’s value to changes in the date, all other factors staying the same.
Time Value: The premium amount in excess of the intrinsic value of the option. It can be calculated as the difference between the intrinsic value and the premium.
V
Value at Risk: The calculated value of the maximum expected loss for a given portfolio over a defined time horizon (typically one day) and for a pre-set statistical confidence interval, under normal market conditions.
Value of a Basis Point: The change in the value of a financial instrument attributable to a change in the relevant interest rate by 1 basis point (i.e. 1/100 of 1%).
Vega: The sensitivity of a derivative product’s value to changes in implied volatility, all other factors staying the same.
Volatility: In finance, a statistical measure of dispersion of a time series around its mean; the expected value of the difference between the time series and its mean; the square root of the variance of the time series.
W
Working Capital: The working capital measures a company’s short-term financial health, calculated by subtracting its current liabilities from its current assets. Formula: Working Capital = Current Assets – Current Liabilities
Y
Yield: The return earned from an investment, expressed as a percentage of the investment’s cost.
Yield Curve: For a particular series of fixed income instruments such as government bonds, the graph of the yields to maturity of the series plotted by maturity.
Yield Curve Risk: The potential for loss due to shifts in the position or the shape of the yield curve.
Z
Zero Coupon Instruments: Fixed income instruments that do not pay a coupon but only pay principal at maturity; trade at a discount to 100% of principal before maturity with the difference being the interest accrued.
Zero Coupon Yield Curve: For zero coupon bonds, the graph of the yields to maturity of the series plotted by maturity.
