Financial Management Terms

7/31/2019 Financial Management Terms

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Financial Market

Broad term describing any marketplace where buyers and sellers participate in the trade of assetssuch as equities, bonds, currencies and derivatives. Financial markets are typically defined by havingtransparent pricing, basic regulations on trading, costs and fees and market forces determining the

prices of securities that trade.

Some financial markets only allow participants that meet certain criteria, which can be based onfactors like the amount of money held, the investors geographical location, knowledge of themarkets or the profession of the participant.

Primary Market:

A market that issues new securities on an exchange. Companies, governments and other groups

obtain financing through debt or equity based securities. Primary markets are facilitated byunderwriting groups, which consist of investment banks that will set a beginning price range for agiven security and then oversee its sale directly to investors.

Secondary Market

A market where investors purchase securities or assets from other investors, rather than fromissuing companies themselves. The national exchanges - such as the New York Stock Exchange andthe NASDAQ are secondary markets.

Secondary markets exist for other securities as well, such as when funds, investment banks, orentities such as Fannie Mae purchase mortgages from issuing lenders. In any secondary markettrade, the cash proceeds go to an investor rather than to the underlying company/entity directly.

Equity Markets or Stock Market:

The market in which shares are issued and traded, either through exchanges or over-the-countermarkets. Also known as the stock market, it is one of the most vital areas of a market economy

because it gives companies access to capital and investors a slice of ownership in a company withthe potential to realize gains based on its future performance.

2 types

Primary market Secondary market


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Debt Market or Fixed Income Market or Credit Market or Bond Market :

The environment in which the issuance and trading of debt securities occurs. The bond marketprimarily includes government-issued securities and corporate debt securities, and facilitates thetransfer of capital from savers to the issuers or organizations requiring capital for government

projects, business expansions and ongoing operations.

Most trading in the bond market occurs over-the-counter, through organized electronic tradingnetworks, and is composed of the primary market (through which debt securities are issued and soldby borrowers to lenders) and the secondary market (through which investors buy and sell previouslyissued debt securities amongst themselves). Although the stock market often commands moremedia attention, the bond market is actually many times bigger and is vital to the ongoing operationof the public and private sector.

Money Markets:

A segment of the financial market in which financial instruments with high liquidity and very shortmaturities are traded. The money market is used by participants as a means for borrowingand lending in the short term, from several days to just under a year. Money market securitiesconsist of negotiable certificates of deposit (CDs), bankers acceptances, U.S. Treasury bills,commercial paper, municipal notes, federal funds and repurchase agreements (repos).

The money market is used by a wide array of participants, from a company raising money by sellingcommercial paper into the market to an investor purchasing CDs as a safe place to park money in the

short term. The money market is typically seen as a safe place to put money due the highly liquidnature of the securities and short maturities, but there are risks in the market that any investorneeds to be aware of including the risk of default on securities such as commercial paper.

Exchange :

A marketplace in which securities, commodities, derivatives and other financial instruments aretraded. The core function of an exchange - such as a stock exchange - is to ensure fair and orderly

trading, as well as efficient dissemination of price information for any securities trading on thatexchange. Exchanges give companies, governments and other groups a platform to sell securities tothe investing public.

An exchange may be a physical location where traders meet to conduct business or an electronicplatform.

Each exchange will have certain listing requirements for any company or group that wishes to offersecurities for trading. Some exchanges are more rigid than others, but basic requirements for stockexchanges include regular financial reports and audited earnings reports.


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Over the Counter or OTC :

A security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX,etc. The phrase "over-the-counter" can be used to refer to stocks that trade via a dealer network asopposed to on a centralized exchange. It also refers to debt securities and other financial

instruments such as derivatives, which are traded through a dealer network.

In general, the reason for which a stock is traded over-the-counter is usually because the company issmall, making it unable to meet exchange listing requirements. Also known as "unlisted stock", thesesecurities are traded by broker-dealers who negotiate directly with one another over computernetworks and by phone.

Although Nasdaq operates as a dealer network, Nasdaq stocks are generally not classifiedas OTC because the Nasdaq is considered a stock exchange. As such, OTC stocks are generallyunlisted stocks which trade on the Over the Counter Bulletin Board (OTCBB) or on the pink sheets.Be very wary of some OTC stocks, however; the OTCBB stocks are either penny stocks or are offeredby companies with bad credit records.

Instruments such as bonds do not trade on a formal exchange and are, therefore,also considered OTC securities. Most debt instruments are traded by investment banks makingmarkets for specific issues. If an investor wants to buy or sell a bond, he or she must call the bankthat makes the market in that bond and asks for quotes.

Securities :

A security is essentially a contract that can be assigned a value and traded.

Examples of a security include a note, stock, preferred share, bond, debenture, option, future, swap,right, warrant, or virtually any other financial asset.

Stock :

A type of security that signifies ownership in a corporation and represents a claim on part of the corporation's assets and earnings.

There are two main types of stock: common and preferred. Common stock usually entitles theowner to vote at shareholders' meetings and to receive dividends. Preferred stock generally doesnot have voting rights, but has a higher claim on assets and earnings than the common shares. Forexample, owners of preferred stock receive dividends before common shareholders and havepriority in the event that a company goes bankrupt and is liquidated.


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Share Capital/Equity Capital :

Funds raised by issuing shares in return for cash or other considerations. The amount of share capitala company has can change over time because each time a business sells new shares to the public inexchange for cash, the amount of share capital will increase. Share capital can be composed of both

common and preferred shares.

The amount of share capital a company reports on its balance sheet only accounts for the initialamount for which the original shareholders purchased the shares from the issuing company. Anyprice differences arising from price appreciation/depreciation as a result of transactions in thesecondary market are not included.

For example, suppose ABC Inc. raised $2 billion from its initial public offering. Over the next year, thetotal value of its shares increases to $5 billion. In this case, the value of the share capital is still only$2 billion because ABC Inc. had received only $2 billion from the sale of its securities to the investingpublic.

Preference Shares:

Company stock with dividends that are paid to shareholders before common stock dividends arepaid out. In the event of a company bankruptcy, preferred stock shareholders have a right to be paidcompany assets first. Preference shares typically pay a fixed dividend, whereas common stocks donot. And unlike common shareholders, preference share shareholders usually do not have votingrights.

It is a special equity security that has properties of both an equity and a debt instrument and isgenerally considered a hybrid instrument.

Government Bonds:

A debt security issued by a government to support government spending, most often issued in thecountry's domestic currency. Government debt is money owed by any level of government and isbacked by the full faith of the government. Federal government bonds in the United States include:the savings bond, Treasury bond, Treasury inflation-protected securities (TIPS), and others. Beforeinvesting in government bonds, investors need to assess several risks associated with the country

such as: country risk, political risk, inflation risk, and interest rate risk.

Lending to a national government in the country's own sovereign currency, government bonds, arefree of credit risk, because the government can raise taxes or simply print more money to redeemthe bond at maturity. But this does not mean risk-free.

Corporate Bonds:

A debt security issued by a corporation and sold to investors. The backing for the bond is usually thepayment ability of the company, which is typically money to be earned from future operations. In

some cases, the company's physical assets may be used as collateral for bonds.


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Corporate bonds are considered higher risk than government bonds. As a result, interest rates arealmost always higher, even for top-flight credit quality companies.

Corporate bonds, i.e. debt financing, are a major source of capital for many businesses along withequity and bank loans/lines of credit. Generally speaking, a company needs to have some consistentearnings potential to be able to offer debt securities to the public at a favorable coupon rate. Thehigher a company's perceived credit quality, the easier it becomes to issue debt at low rates andissue higher amounts of debt.

Most corporate bonds are taxable with terms of more than one year. Corporate debt that matures inless than one year is typically called "commercial paper".

Debentures:

A type of debt instrument that is not secured by physical asset or collateral. Debentures are backedonly by the general creditworthiness and reputation of the issuer. Both corporations andgovernments frequently issue this type of bond in order to secure capital. Like other types of bonds,debentures are documented in an indenture.

Debentures have no collateral. Bond buyers generally purchase debentures based on the belief thatthe bond issuer is unlikely to default on the repayment. An example of a government debenturewould be any government-issued Treasury bond (T-bond) or Treasury bill (T-bill). T-bonds and T-bills are generally considered risk free because governments, at worst, can print off more money orraise taxes to pay these type of debts.

Treasury Bills or T-Bills:

A short-term debt obligation backed by the U.S. government with a maturity of less than one year. T-bills are sold in denominations of $1,000 up to a maximum purchase of $5 million and commonlyhave maturities of one month (four weeks), three months (13 weeks) or six months (26 weeks).

T-bills are issued through a competitive bidding process at a discount from par, which meansthat rather than paying fixed interest payments like conventional bonds, the appreciation of thebond provides the return to the holder.

For example, let's say you buy a 13-week T-bill priced at $9,800. Essentially, the U.S. government(and its nearly bulletproof credit rating) writes you an IOU for $10,000 that it agrees to pay back inthree months. You will not receive regular payments as you would with a coupon bond, forexample. Instead, the appreciation - and, therefore, the value to you - comes from thedifference between the discounted value you originally paid and the amount you receive back($10,000). In this case, the T-bill pays a 2.04% interest rate ($200/$9,800 = 2.04%) over a three-month period.


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Commercial Papers:

An unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories and meeting short-term liabilities. Maturities on commercial paperrarely range any longer than 270 days. The debt is usually issued at a discount, reflecting prevailing

market interest rates.

Commercial paper is not usually backed by any form of collateral, so only firms with high-qualitydebt ratings will easily find buyers without having to offer a substantial discount (higher cost) for thedebt issue.

A major benefit of commercial paper is that it does not need to be registered with the Securities andExchange Commission (SEC) as long as it matures before nine months (270 days), making it a verycost-effective means of financing. The proceeds from this type of financing can only be used oncurrent assets (inventories) and are not allowed to be used on fixed assets, such as a new plant,without SEC involvement.

Certificates of Deposit:

A savings certificate entitling the bearer to receive interest. A CD bears a maturity date, a specifiedfixed interest rate and can be issued in any denomination. CDs are generally issued by commercialbanks and are insured by the FDIC. The term of a CD generally ranges from one month to five years.

Inter-corporate Deposits:

Securities that are purchased by corporations rather than individual investors. Intercorporateinvestments allow a company to achieve higher growth rates compared to keeping all of its funds incash. These investments can also be used for strategic purposes like forming a joint ventures ormaking acquisitions. Companies purchase securities from other companies, banks and governmentsin order to take advantage of the returns from these securities. Marketable securities that canreadily be exchanged for cash, such as notes and stocks, are usually preferred for this type of investment.

Intercorporate investments are accounted for differently than other funds held by a company. Short-

term investments that are expected to be turned into cash are considered current assets, whileother investments are considered non-current assets. When companies buy intercorporateinvestments, dividend and interest revenue is reported on the income statement.

Mutual Funds :

An investment vehicle that is made up of a pool of funds collected from many investors for thepurpose of investing in securities such as stocks, bonds, money market instruments and similarassets. Mutual funds are operated by money managers, who invest the fund's capital and attempt toproduce capital gains and income for the fund's investors. A mutual fund's portfolio is structured and

maintained to match the investment objectives stated in its prospectus.


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One of the main advantages of mutual funds is that they give small investors access to professionallymanaged, diversified portfolios of equities, bonds and other securities, which would be quite difficult(if not impossible) to create with a small amount of capital. Each shareholder participatesproportionally in the gain or loss of the fund. Mutual fund units, or shares, are issued and cantypically be purchased or redeemed as needed at the fund's current net asset value (NAV) per share,which is sometimes expressed as NAVPS.

Term Loans :

A loan from a bank for a specific amount that has a specified repayment schedule and a floatinginterest rate. Term loans almost always mature between one and 10 years.

For example many banks have term-loan programs that can offer small businesses thecash they need to operate from month to month. Often a small business will use the cash from aterm loan to purchase fixed assets such as equipment used in its production process.

Working Capital:

A measure of both a company's efficiency and its short-term financial health. The working capitalratio is calculated as:

Working Capital Loans:

A loan whose purpose is to finance everyday operations of a company.

Initial Public Offering (IPO):

The first sale of stock by a private company to the public. IPOs are often issued by smaller, youngercompanies seeking the capital to expand, but can also be done by large privately owned companieslooking to become publicly traded.In an IPO, the issuer obtains the assistance of an underwriting firm, which helps it determine whattype of security to issue (common or preferred), the best offering price and the time to bring it tomarket.

Corporate Action:

Any event that brings material change to a company and affects its stakeholders. This includesshareholders, both common and preferred, as well as bondholders. These events are generallyapproved by the company's board of directors; shareholders are permitted to vote on some eventsas well.

Splits, dividends, mergers, acquisitions and spinoffs are all examples of corporate actions. For


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example, a company may decide to split its shares 2:1, leaving shareholders with twice as manyshares as they had before. Bondholders are also subject to the effects of corporate actions, whichmight include calls or the issuance of new debt. For example, if interest rates fall sharply, a companymay call in bonds and pay off existing bondholders, then issue new debt at the current lower interestrates.

Dividend:

A distribution of a portion of a company's earnings, decided by the board of directors, to a class of itsshareholders. The dividend is most often quoted in terms of the dollar amount each share receives(dividends per share). It can also be quoted in terms of a percent of the current market price,referred to as dividend yield.Mandatory distributions of income and realized capital gains made to mutual fund investors.

Dividends may be in the form of cash, stock or property. Most secure and stable companies offerdividends to their stockholders. Their share prices might not move much, but the dividend attemptsto make up for this.

High-growth companies rarely offer dividends because all of their profits are reinvested to helpsustain higher-than-average growth.

Bonus Issue:

An offer of free additional shares to existing shareholders. A company may decide to distributefurther shares as an alternative to increasing the dividend payout.

Stock Split:

A corporate action in which a company's existing shares are divided into multiple shares. Althoughthe number of shares outstanding increases by a specific multiple, the total dollar value of the sharesremains the same compared to pre-split amounts, because no real value has been added as a resultof the split.

In the U.K., a stock split is referred to as a "scrip issue", "bonus issue", "capitalization issue" or "free

issue".

One reason as to why stock splits are performed is that a company's share price has grown so highthat to many investors, the shares are too expensive to buy in round lots.

Rights Issue:

Issuing rights to a company's existing shareholders to buy a proportional number of additionalsecurities at a given price (usually at a discount) within a fixed period.

Interest:


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Compound Interest:

Coupon:

Credit Rating:

Yield:

Present Value:

Future Value:

Annuity:

Perpetuity:

Discounting:

Net Present Value:

Discount Rate:

Risk Free Rate:

Internal Rate of Return or IRR :


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Portfolio:

Diversification:

Derivatives:

Spot Market:

Margin:

Mark to Market:

Arbitrage:

Hedging:

Market Cap:

Inflation:

Leverage:

Employee Stock Options:

Underwriting:

Merchant Banking:


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Primary Dealers:

Lease:

Financial Management Terms

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