COMMERCIAL PAPER: An unsecured, short-term debt …



FINANCIAL TERMS/VOCABULARY (INVESTOPEDIA)MEASURES OF FINANCIAL PERFORMANCE ARE MARKED BY **ACCRUED INTEREST: 1. A term used to describe an accrual accounting method when interest that is either payable or receivable has been recognized, but not yet paid or received. Accrued interest occurs as a result of the difference in timing of cash flows and the measurement of these cash flows. 2. The interest that has accumulated on a bond since the last interest payment up to, but not including, the settlement date.Explanation: 1. For example, accrued interest receivable occurs when interest on an outstanding receivable has been earned by the company, but has not yet been received. A loan to a customer for goods sold would result in interest being charged on the loan. If the loan is extended on October 1 and the lending company's year ends on December 31, there will be two months of accrued interest receivable recorded as interest revenue in the company's financial statements for the year.2. Accrued interest is added to the contract price of a bond transaction. Accrued interest is that which has been earned since the last coupon payment. Because the bond hasn't expired or the next payment is not yet due, the owner of the bond hasn't officially received the money. If he or she sells the bond, accrued interest is added to the sale price.ksACCUMULATED DEPRECIATION: The cumulative depreciation of an asset up to a single point in its life. Regardless of the method used to calculate it, the depreciation of an asset during a single period is added to the previous period's accumulated depreciation to get the current accumulated depreciation. An asset's carrying value on the balance sheet is the difference between its purchase price and accumulated depreciation.Explanation: A company buys an asset for $5,000 that has a five-year lifespan and zero salvage value. The company uses straight-line depreciation, and the asset depreciates at a rate of $1,000 per year. In year one, depreciation will be $1,000, as will accumulated depreciation, and carrying value of the asset will be $4,000. In year two, depreciation will be $1,000, accumulated depreciation will be $2,000 ($1,000 from the current year + $1,000 accumulated from previous years) and carrying value will be $3,000. Each subsequent year will follow the same process.ARBITRAGE: A hedge fund strategy in which the stocks of two merging companies are simultaneously bought and sold to create a riskless profit. A merger arbitrageur looks at the risk that the merger deal will not close on time, or at all. Because of this slight uncertainty, the target company's stock will typically sell at a discount to the price that the combined company will have when the merger is closed. This discrepancy is the arbitrageur's profit. Explanation: A regular portfolio manager may focus only on the profitability of the merged entity. In contrast, merger arbitrageurs care only about the probability of the deal being approved and how long it will take the deal to close. Also known as “merger arbitrage”. **BOTTOM LINE: Refers to a company's net earnings, net income or earnings per share (EPS). Bottom line also refers to any actions that may increase/decrease net earnings or a company's overall profit. A company that is growing its net earnings or reducing its costs is said to be "improving its bottom line". Explanation: The reference to "bottom" describes the relative location of the net income figure on a company's income statement; it will almost always be the last line at the bottom of the page. This reflects the fact that all expenses have already been taken out of revenues, and there is nothing left to subtract. This stands in contrast to revenues, which are considered the "top line" figures.Most companies aim to improve their bottom lines through two simultaneous methods: growing revenues (i.e., generate top-line growth) and increasing efficiency (or cutting costs).The bottom line refers to the last line on a company’s income statement.? This line shows net profit after all expenses, depreciation and taxes have been deducted from revenue.? This is in contrast to gross revenue, which is sometimes referred to as “top line”.For instance, look at a simple income statement for BL, Inc.BL, Inc. Income StatementYearGross Sales5,000,000Cost of Goods Sold-2,500,000Gross Margin3,000,000??Operating Expenses-2,000,000Net Income Before Taxes & Depreciation1,000,000Taxes-250,000Depreciation-100,000Net Profit650,000The top line number is the $5 million in sales.? After deductions are made for cost of goods sold, operating expenses, taxes and depreciation, what is left over on the bottom line of the income statement is $650,000 in net profit. Often, the bottom line becomes an important metric for evaluating a corporate decision.? A manager will ask, “How will this affect the bottom line?”? Obviously, if the action decreases the bottom line, it’s likely bad.? If it increases the bottom line, it’s good.There are generally two ways to increase the bottom line. Cutting expenses to increase company efficiency is the easiest way, although excessive cuts can eventually reduce productivity, and lead to a decrease of the bottom line.? The other way to improve the bottom line is to increase the top line revenue numbers by selling more goods or services, but this can raise operating expenses. Thus, maintaining a healthy bottom line is considered a balancing act.CAPITAL BUDGETING or INVESTMENT APPRAISAL: The process in which a business determines whether projects such as building a new plant or investing in a long-term venture are worth pursuing. Oftentimes, a prospective project's lifetime cash inflows and outflows are assessed in order to determine whether the returns generated meet a sufficient target benchmark.Explanation: Ideally, businesses should pursue all projects and opportunities that enhance shareholder value. However, because the amount of capital available at any given time for new projects is limited, management needs to use capital budgeting techniques to determine which projects will yield the most return over an applicable period of time.Popular methods of capital budgeting include net present value (NPV), internal rate of return (IRR), discounted cash flow (DCF) and payback period.CAPITALIZATION: 1. In accounting, it is where costs to acquire an asset are included in the price of the asset. 2. The sum of a corporation's stock, long-term debt and retained earnings. Also known as "invested capital". 3. A company's outstanding shares multiplied by its share price, better known as "market capitalization".Explanation: 1. For example, if a machine has a price of $1 million this value would be recorded in the assets, if there was also a $20,000 charge for shipping the machine then this cost would be capitalized and included in assets. 2. The capitalization of a firm can be overcapitalized and undercapitalized, both of which are potential negatives. 3. If a company has 1,000,000 shares and is currently trading at $10 a share, their market capitalization is $10,000,000.CAPITAL STOCK: The common and preferred stock a company is authorized to issue, according to their corporate charter. Capital stock represents the size of the equity position of a firm and can be found on the balance sheet (or notes) of a typical financial statement. Firms can both issue more capital stock, or buyback shares that are currently owned by shareholders.Explanation: In financial statement analysis, an increasing capital stock account tends to be a sign of economic health, since the company can use the additional proceeds to invest in projects or machinery that will increase corporate profits and/or efficiency. On the other hand, however, firms that continually issue secondary issues of capital stock may be doing so to raise funds, due to poor company performance.**CASH FLOW FROM OPERATING ACTIVITIES (CFO): An accounting item indicating the money a company brings in from ongoing, regular business activities, such as manufacturing and selling goods or providing a service. Cash flow from operating activities does not include long-term capital or investment costs. It does include earnings before interest and taxes plus depreciation minus taxes.Also called operating cash flow or net cash from operating activities, it can be calculated as follows:Cash Flow From Operating Activities = EBIT + Depreciation – TaxesExplanation: Cash flow from operating activities is reported on the cash flow statement in a company's quarterly and annual reports. Cash flow from operating activities also includes changes in working capital (current assets minus current liabilities), such as increases or decreases in inventory, short-term debt, accounts receivable and accounts payable. Income that a company receives from investment activities is reported separately, since it is not from business paring cash flow from operating activities with EBITDA can give insights into how a company finances short-term capital. Also, investors will examine a company’s cash flow from operating activities separately from the other two components of cash flow -?investing and financing activities -?to determine from where a company is really getting its money. Investors want to see positive cash flow because of positive income from recurring operating activities. Positive cash flow that results from the company selling off all its assets, or because it has recently issued new stocks or bonds, results in one-time gains and is not an indicator of financial health. Investors will also examine the company’s balance sheet and income statement to get a fuller picture of company performance. Similarly, cash flow from operating activities excludes dividends paid to stockholders and money spent to purchase long-term capital, such as equipment and facilities, because these are also one-time or infrequent expenses.COLLATERALIZED MORTGAGE OBLIGATION (CMO): is a type of complex debt security that repackages and directs the payments of principal and interest from a collateral pool to different types and maturities of securities, thereby meeting investor needs.From WikipediaCOMMAND ECONOMY: A system where the government, rather than the free market, determines what goods should be produced, how much should be produced and the price at which the goods will be offered for sale. The command economy is a key feature of any communist society. China, Cuba, North Korea and the former Soviet Union are examples of countries that have command economies. Explanation: Also known as a planned economy, command economies are unable to efficiently allocate goods because of the knowledge problem - the central planner's inability to discern how much of a good should be produced. Shortages and surpluses are a common consequence of command economies. A free-market price system, on the other hand, signals to producers what they should be creating and in what quantities, resulting in a much more efficient allocation of MERCIAL PAPER: 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 paper rarely range any longer than 270 days. The debt is usually issued at a discount, reflecting prevailing market interest rates.Explanation: Commercial paper is not usually backed by any form of collateral, so only firms with high-quality debt ratings will easily find buyers without having to offer a substantial discount (higher cost) for the debt issue.A major benefit of commercial paper is that it does not need to be registered with the Securities and Exchange Commission (SEC) as long as it matures before nine months (270 days), making it a very cost-effective means of financing. The proceeds from this type of financing can only be used on current assets (inventories) and are not allowed to be used on fixed assets, such as a new plant, without SEC POUND ANNUAL GROWTH RATE (CAGR): CAGR isn't the actual return in reality. It's an imaginary number that describes the rate at which an investment would have grown if it grew at a steady rate. You can think of CAGR as a way to smooth out the returns.Don't worry if this concept is still fuzzy to you - CAGR is one of those terms best defined by example. Suppose you invested $10,000 in a portfolio on Jan 1, 2005. Let's say by Jan 1, 2006, your portfolio had grown to $13,000, then $14,000 by 2007, and finally ended up at $19,500 by 2008.Your CAGR would be the ratio of your ending value to beginning value ($19,500 / $10,000 = 1.95) raised to the power of 1/3 (since 1/# of years = 1/3), then subtracting 1 from the resulting number:1.95 raised to 1/3 power = 1.2493. (This could be written as 1.95^0.3333).1.2493 - 1 = 0.2493Another way of writing 0.2493 is 24.93%.Thus, your CAGR for your three-year investment is equal to 24.93%, representing the smoothed annualized gain you earned over your investment time horizon.COVERED CALL: An options strategy whereby an investor holds a long position in an asset and writes (sells) call options on that same asset in an attempt to generate increased income from the asset. This is often employed when an investor has a short-term neutral view on the asset and for this reason hold the asset long and simultaneously have a short position via the option to generate income from the option premium.For example, let's say that you own shares of the TSJ Sports Conglomerate and like its long-term prospects as well as its share price but feel in the shorter term the stock will likely trade relatively flat, perhaps within a few dollars of its current price of, say, $25. If you sell a call option on TSJ for $26, you earn the premium from the option sale but cap your upside. One of three scenarios is going to play out:a) TSJ shares trade flat (below the $26 strike price) - the option will expire worthless and you keep the premium from the option. In this case, by using the buy-write strategy you have successfully outperformed the stock.b) TSJ shares fall - the option expires worthless, you keep the premium, and again you outperform the stock.c) TSJ shares rise above $26 - the option is exercised, and your upside is capped at $26, plus the option premium. In this case, if the stock price goes higher than $26, plus the premium, your buy-write strategy has underperformed the TSJ shares.**DEBT/EQUITY RATIO: A measure of a company's financial leverage calculated by dividing its total liabilities by stockholders' equity. It indicates what proportion of equity and debt the company is using to finance its assets.Note: Sometimes only interest-bearing, long-term debt is used instead of total liabilities in the calculation. Also known as the Personal Debt/Equity Ratio, this ratio can be applied to personal financial statements as well as corporate ones.Explanation: A high debt/equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in volatile earnings as a result of the additional interest expense.If a lot of debt is used to finance increased operations (high debt to equity), the company could potentially generate more earnings than it would have without this outside financing. If this were to increase earnings by a greater amount than the debt cost (interest), then the shareholders benefit as more earnings are being spread among the same amount of shareholders. However, the cost of this debt financing may outweigh the return that the company generates on the debt through investment and business activities and become too much for the company to handle. This can lead to bankruptcy, which would leave shareholders with nothing.The debt/equity ratio also depends on the industry in which the company operates. For example, capital-intensive industries such as auto manufacturing tend to have a debt/equity ratio above 2, while personal computer companies have a debt/equity of under 0.5.To learn how D/E ratios can help value investors, check out our tutorial on?Stock-Picking Strategies: Value Investing.DEBT FINANCING: When a firm raises money for working capital or capital expenditures by selling bonds, bills, or notes to individual and/or institutional investors. In return for lending the money, the individuals or institutions become creditors and receive a promise that the principal and interest on the debt will be repaid. The other way of raising capital is to issue shares of stock in a public offering. This is called equity financing.DEFERRED TAX LIABILITY: An account on a company's balance sheet that is a result of temporary differences between the company's accounting and tax carrying values, the anticipated and enacted income tax rate, and estimated taxes payable for the current year. This liability may or may not be realized during any given year, which makes the deferred status appropriate.DERIVATIVE: A HYPERLINK "" security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterized by high HYPERLINK "" leverage.Futures contracts, HYPERLINK "" forward contracts, options and swaps are the most common types of derivatives. Derivatives are contracts and can be used as an underlying asset. There are even HYPERLINK "" derivatives based on weather data, such as the amount of rain or the number of sunny days in a particular region.Derivatives are generally used as an instrument to HYPERLINK "" hedge risk, but can also be used for speculative purposes. For example, a European investor purchasing shares of an American company off of an American exchange (using U.S. dollars to do so) would be exposed to exchange-rate risk while holding that stock. To hedge this risk, the investor could purchase currency futures to lock in a specified exchange rate for the future stock sale and currency conversion back into Euros.DIVESTITURE: The partial or full disposal of a business unit through sale, exchange, closure or bankruptcy. Divestiture may result from a management decision to no longer operate a business unit because it is not part of a core competency. It may also occur if a business unit is deemed redundant after a merger or acquisition, if jettisoning a unit increases the resale value of the firm or if a court requires the sale of a business unit to improve market competition.Explanation: Divestitures are a way for a company to manage its portfolio of assets. As companies grow they may find they are trying to focus on too many lines of business, and that they must close some operational business units in order to focus on more profitable lines. This is a problem that conglomerates may face. Companies may also sell off business lines if they are under financial duress. For example, an automobile manufacturer that sees a significant and prolonged drop in competitiveness may sell off its financing division in order to pay for the development of a new line of vehicles.One of the most famous cases of court-ordered divestiture involves the breakup of the Bell System in 1982. The United States government determined that Bell controlled too large a portion of telephone service, and brought anti-trust charges in 1974. The divestiture created several new telephone companies, including AT&T and the “Baby Bells” as well as new equipment manufacturers.Business units that are divested may be spun off into their own companies rather than shuttered.?DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT:A compendium of federal regulations, primarily affecting financial institutions and their customers, that the Obama administration passed in 2010 in an attempt to prevent the recurrence of events that caused the 2008 financial crisis. The Dodd-Frank Wall Street Reform and Consumer Protection Act, commonly referred to as simply "Dodd-Frank", is supposed to lower risk in various parts of the U.S. financial system. It is named after U.S. Senator Christopher J. Dodd and U.S. Representative Barney Frank because of their significant involvement in the act’s creation and passage.Explanation: Dodd-Frank established new government agencies such as the Financial Stability Oversight Council and Orderly Liquidation Authority, which monitors the performance of companies deemed “too big to fail” in order to prevent a widespread economic collapse. The new Orderly Liquidation Fund provides money to assist with the liquidation of financial companies that have been placed in receivership because of their financial weakness. Additionally, the council can break up large banks that may pose a risk to the financial system because of their size. It can also quickly and neatly liquidate or restructure firms it deems too financially weak. Similarly, the new Federal Insurance Office identifies and monitors insurance companies that may pose a systemic risk.?The new Consumer Financial Protection Bureau (CFPB) is tasked with preventing predatory mortgage lending, improving the clarity of mortgage paperwork for consumers and reducing incentives for mortgage brokers to push home buyers into more expensive loans. The CFPB has also changed the way credit card companies and other consumer lenders disclose their terms to consumers. It requires loan terms to be presented in a new, easy-to-read-and-understand format.?The Volcker Rule, another key component of Dodd-Frank, restricts the ways banks can invest and regulates trading in derivatives.?The goal of the new SEC Office of Credit Ratings is to improve the accuracy of ratings provided by the agencies that evaluate the financial strength of businesses and governments.**EARNINGS PER SHARE: The portion of a company's profit allocated to each outstanding share of common stock. Earnings per share serves as an indicator of a company's profitability.Explanation: Earnings per share is generally considered to be the single most important variable in determining a share's price. It is also a major component used to calculate the price-to-earnings valuation ratio.For example, assume that a company has a net income of $25 million. If the company pays out $1 million in preferred dividends and has 10 million shares for half of the year and 15 million shares for the other half, the EPS would be $1.92 (24/12.5). First, the $1 million is deducted from the net income to get $24 million, then a weighted average is taken to find the number of shares outstanding (0.5 x 10M+ 0.5 x 15M = 12.5M).An important aspect of EPS that's often ignored is the capital that is required to generate the earnings (net income) in the calculation. Two companies could generate the same EPS number, but one could do so with less equity (investment) - that company would be more efficient at using its capital to generate income and, all other things being equal, would be a "better" company. Investors also need to be aware of earnings manipulation that will affect the quality of the earnings number. It is important not to rely on any one financial measure, but to use it in conjunction with statement analysis and other measures.**EBITDA (Earnings before Interest, Taxes, Depreciation and Amortization): EBITDA is essentially net income with interest, taxes, depreciation, and amortization added back to it, and can be used to analyze and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions.Explanation: This is a non-GAAP measure that allows a greater amount of discretion as to what is (and is not) included in the calculation. This also means that companies often change the items included in their EBITDA calculation from one reporting period to the next.EBITDA first came into common use with leveraged buyouts in the 1980s, when it was used to indicate the ability of a company to service debt. As time passed, it became popular in industries with expensive assets that had to be written down over long periods of time. EBITDA is now commonly quoted by many companies, especially in the tech sector - even when it isn't warranted.A common misconception is that EBITDA represents cash earnings. EBITDA is a good metric to evaluate profitability, but not cash flow. EBITDA also leaves out the cash required to fund working capital and the replacement of old equipment, which can be significant. Consequently, EBITDA is often used as an accounting gimmick to dress up a company's earnings. When using this metric, it's key that investors also focus on other performance measures to make sure the company is not trying to hide something with EBITDA.**EFFICIENCY RATIOS: Ratios that are typically used to analyze how well a company uses its assets and liabilities internally. Efficiency Ratios can calculate the turnover of receivables, the repayment of liabilities, the quantity and usage of equity and the general use of inventory and machinery.Explanation: Some common ratios are accounts receivable turnover, fixed asset turnover, sales to inventory, sales to net working capital, accounts payable to sales and stock turnover ratio. These ratios are meaningful when compared to peers in the same industry and can identify business that are better managed relative to the others. Also, efficiency ratios are important because an improvement in the ratios usually translate to improved profitability. Other ratios include:Operating margin, price earning, ROA, ROE, Inventory turnover, cash conversion cycle, current ratio and debt to equity.ENTERPRISE MULTIPLE or just MULITPLE(S): A ratio used to determine the value of a company. The enterprise multiple looks at a firm as a potential acquirer would, because it takes debt into account - an item which other multiples like the P/E ratio do not include. Enterprise multiple is calculated as:?Also known as the EBITDA Multiple.Explanation: A low ratio indicates that a company might be undervalued. The enterprise multiple is used for several reasons: 1) It's useful for transnational comparisons because it ignores the distorting effects of individual countries' taxation policies. 2) It's used to find attractive takeover candidates. Enterprise value is a better metric than market cap for takeovers. It takes into account the debt which the acquirer will have to assume. Therefore, a company with a low enterprise multiple can be viewed as a good takeover candidate.Keep in mind that enterprise multiples can vary depending on the industry. Therefore, it's important to compare the multiple to other companies or to the industry in general. Expect higher enterprise multiples in high growth industries (like biotech) and lower multiples in industries with slow growth (like railways).ENTERPRISE VALUE: Enterprise Value, or EV for short, is a measure of a company's total value, often used as a more comprehensive alternative to equity?market capitalization. The market capitalization of a company is simply its share price multiplied by the number of shares a company has outstanding. Enterprise value is calculated as the market capitalization plus debt, minority interest and preferred shares, minus total cash and cash equivalents. Often times, the?minority?interest and preferred equity is effectively zero, although this need not be the case.EV = market value of common stock + market value of preferred equity?+ market value of debt + minority interest - cash and investmentsEQUITY FINANCING: The process of raising capital through the sale of shares in an enterprise. Equity financing essentially refers to the sale of an ownership interest to raise funds for business purposes. Equity financing spans a wide range of activities in scale and scope, from a few thousand dollars raised by an entrepreneur from friends and family, to giant initial public offerings (IPOs) running into the billions by household names such as Google and Facebook. While the term is generally associated with financings by public companies listed on an exchange, it includes financings by private companies as well. Equity financing is distinct from debt financing, which refers to funds borrowed by a business.EXPLANATION: Equity financing involves not just the sale of common equity, but also the sale of other equity or quasi-equity instruments such as preferred stock, convertible preferred stock and equity units that include common shares and warrants.A startup that grows into a successful company will have several rounds of equity financing as it evolves. Since a startup typically attracts different types of investors at various stages of its evolution, it may use different equity instruments for its financing needs.For example, angel investors and venture capitalists – who are generally the first investors in a startup – are inclined to favor convertible preferred shares rather than common equity in exchange for funding new companies, since the former have greater upside potential and some downside protection. Once the company has grown large enough to consider going public, it may consider selling common equity to institutional and retail investors. Later on, if it needs additional capital, the company may go in for secondary equity financings such as a rights offering or an offering of equity units that includes warrants as a “sweetener.”The equity-financing process is governed by regulation imposed by a local or national securities authority in most jurisdictions. Such regulation is primarily designed to protect the investing public from unscrupulous operators who may raise funds from unsuspecting investors and disappear with the financing proceeds. An equity financing is therefore generally accompanied by an offering memorandum or prospectus, which contains a great deal of information that should help the investor make an informed decision about the merits of the financing. Such information includes the company's activities, details on its officers and directors, use of financing proceeds, risk factors, financial statements and so on.Investor appetite for equity financings depends significantly on the state of financial markets in general and equity markets in particular. While a steady pace of equity financings is seen as a sign of investor confidence, a torrent of financings may indicate excessive optimism and a looming market top. For example, IPOs by dot-coms and technology companies reached record levels in the late 1990s, before the “tech wreck” that engulfed the Nasdaq from 2000 to 2002. The pace of equity financings typically drops off sharply after a sustained market correction due to investor risk-aversion during this period.**EQUITY MULTIPLIER: The ratio of a company's total assets to its stockholder's equity. The equity multiplier is a measurement of a company's financial leverage. Companies finance the purchase of assets either through equity or debt, so a high equity multiplier indicates that a larger portion of asset financing is being done through debt. The multiplier is a variation of the debt ratio.Explanation: The ratio is calculated fairly simply. For example, a company has assets valued at $3 billion and stockholder equity of $1 billion. The equity multiplier value would be 3.0 ($3 billion / $1 billion), meaning that one third of a company’s assets are financed by equity.The equity multiplier gives investors an insight into what financing methods a company may be able to use to finance the purchase of new assets. It's also an indicator of potential threats a company may face from economic conditions that affect the debt-equity mix.A high equity multiplier is not necessarily better than a low multiplier. In order to develop a better picture of a company’s financial health, investors should take into account other financial ratios and metrics, such as net profit margin or asset turnover. If it is cheaper to borrow than issue new shares, financing asset purchases through debt may be more cost-effective than a secondary issue.**FIXED CHARGE COVERAGE RATIO: A ratio that indicates a firm's ability to satisfy fixed financing expenses, such as interest and leases. It is calculated as the following:Explanation: For example, since leases are a fixed charge, the calculation determining a company's ability leases would be (EBIT + Lease Expenses) / (Lease Expenses + Interest).**FREE CASH FLOW (FCF): A measure of financial performance calculated as operating cash flow minus capital expenditures. Free cash flow (FCF) represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value. Without cash, it's tough to develop new products, make acquisitions, pay dividends and reduce debt. FCF is calculated as:EBIT(1-Tax Rate) + Depreciation & Amortization - Change in Net Working Capital - Capital Expenditure. It can also be calculated by taking operating cash flow and subtracting capital expenditures.Explanation: Some believe that Wall Street focuses myopically on earnings while ignoring the "real" cash that a firm generates. Earnings can often be clouded by accounting gimmicks, but it's tougher to fake cash flow. For this reason, some investors believe that FCF gives a much clearer view of the ability to generate cash (and thus profits).It is important to note that negative free cash flow is not bad in itself. If free cash flow is negative, it could be a sign that a company is making large investments. If these investments earn a high return, the strategy has the potential to pay off in the long run.FCF is a better indicator than the P/E Ratio and here's why - Read Free Cash Flow Yield: The Best Fundamental Indicator and FCF: Free,?But Not Always EasyHURDLE RATE: The minimum rate of return on a project or investment required by a manager or investor. In order to compensate for risk, the riskier the project, the higher the hurdle rate. In the hedge fund world, hurdle rate refers to the rate of return that the fund manager must beat before collecting incentive fees.Explanation: In capital budgeting, projects are evaluated either by discounting future cash flows to the present by the hurdle rate, so as to ascertain the net present value of the project, or by computing the internal rate of return (IRR) on the project and comparing this to the hurdle rate. If the IRR exceeds the hurdle rate, the project would most likely go ahead.For example, a company with a hurdle rate of 10% for acceptable projects, would most likely accept a project if it has an internal rate of return of 14% and does not have a significantly higher degree of risk. Alternately, discounting the future cash flows of this project by the hurdle rate of 10% would lead to a large and positive net present value, which would also lead to the project's acceptance.INTEREST RATE RISK: The risk that an investment's value will change due to a change in the absolute level of interest rates, in the spread between two rates, in the shape of the yield curve or in any other interest rate relationship. Such changes usually affect securities inversely and can be reduced by diversifying (investing in fixed-income securities with different durations) or hedging (e.g. through an interest rate swap).Explanation: Interest rate risk affects the value of bonds more directly than stocks, and it is a major risk to all bondholders. As interest rates rise, bond prices fall and vice versa. The rationale is that as interest rates increase, the opportunity cost of holding a bond decreases since investors are able to realize greater yields by switching to other investments that reflect the higher interest rate. For example, a 5% bond is worth more if interest rates decrease since the bondholder receives a fixed rate of return relative to the market, which is offering a lower rate of return as a result of the decrease in rates.INTERNAL RATE OF RETURN: The discount rate often used in capital budgeting that makes the net present value of all cash flows from a particular project equal to zero. Generally speaking, the higher a project's internal rate of return, the more desirable it is to undertake the project. As such, IRR can be used to rank several prospective projects a firm is considering. Assuming all other factors are equal among the various projects, the project with the highest IRR would probably be considered the best and undertaken first.Explanation: You can think of IRR as the rate of growth a project is expected to generate. While the actual rate of return that a given project ends up generating will often differ from its estimated IRR rate, a project with a substantially higher IRR value than other available options would still provide a much better chance of strong growth.IRRs can also be compared against prevailing rates of return in the securities market. If a firm can't find any projects with IRRs greater than the returns that can be generated in the financial markets, it may simply choose to invest its retained earnings into the market.INVESTMENT GRADE: A rating that indicates that a municipal or corporate bond has a relatively low risk of default. Bond rating firms, such as Standard & Poor's, use different designations consisting of upper- and lower-case letters 'A' and 'B' to identify a bond's credit quality rating. 'AAA' and 'AA' (high credit quality) and 'A' and 'BBB' (medium credit quality) are considered investment grade. Credit ratings for bonds below these designations ('BB', 'B', 'CCC', etc.) are considered low credit quality, and are commonly referred to as "junk bonds".Explanation: Investors should note that government bonds, or Treasuries, are not subject to credit quality ratings. These securities are considered to be of the very highest credit quality. In the case of municipal and corporate bond funds, fund company literature, such as the fund prospectus and independent investment research reports will report an "average credit quality" for the fund's portfolio as a whole.Investors should be aware that an agency downgrade of a company's bonds from 'BBB' to 'BB' reclassifies its debt from investment grade to "junk" status with just a one-step drop in quality. The repercussions of such an event can be highly problematic for the issuer and can also adversely affect bond prices for investors. Safety-conscious fund investors should pay attention to a bond fund's portfolio credit quality breakdown.JUNK BOND: Bond with a low credit rating of BB or lower. Junk bonds are issued by new companies or those who are questionable. They are more volatile and pay higher yields than investment grade bonds. Speculators and risk-oriented investors trade them. P. 109LIBOR (London Inter-bank offered rate): Rate that the most creditworthy international banks dealing in Eurodollars charge each other for large loans. The LIBOR rate is usually the base for other large Eurodollar loans to less creditworthy corporate and government borrowers.LOAN-TO-VALUE-RATIO: A lending risk assessment ratio that financial institutions and others lenders examine before approving a mortgage. Typically, assessments with high LTV ratios are generally seen as higher risk and, therefore, if the mortgage is accepted, the loan will generally cost the borrower more to borrow or he or she will need to purchase mortgage insurance. Calculated as:?Explanation: For example, Jim needs to borrow $92,500 to purchase a $100,000 property. The LTV ratio yields a value of about 92.5%. Since bankers usually require a ratio at a maximum of 75% for a mortgage to be approved, it may prove difficult for Jim to get a mortgage.LONG POSITION:1. The buying of a security such as a stock, commodity or currency, with the expectation that the asset will rise in value.2. In the context of options, the buying of an options contract.1. For example, an owner of shares in McDonald's Corp. is said to be "long McDonald's" or "has a long position in McDonald's."2. For example, buying a call (or put) options contract from an options writer entitles you the right, not the obligation to buy (or sell) a specific commodity or asset for a specified amount at a specified date.MARKET ECONOMY: An economic system in which economic decisions and the pricing of goods and services are guided solely by the aggregate interactions of a country's citizens and businesses and there is little government intervention or central planning. This is the opposite of a centrally planned economy, in which government decisions drive most aspects of a country's economic activity.Explanation: Market economies work on the assumption that market forces, such as supply and demand, are the best determinants of what is right for a nation's well-being. These economies rarely engage in government interventions such as price fixing, license quotas and industry subsidizations.While most developed nations today could be classified as having mixed economies, they are often said to have market economies because they allow market forces to drive most of their activities, typically engaging in government intervention only to the extent that it is needed to provide stability. Although the market economy is clearly the system of choice in today's global marketplace, there is significant debate regarding the amount of government intervention considered optimal for efficient economic operations.MARKET OR SYSTEMATIC RISK: Common to all securities of the same class (stocks and bonds) and cannot be eliminated by portfolio diversification. P. 110.MARKET VALUE: The price an asset would fetch in the marketplace. Market value is also commonly used to refer to the market capitalization of a publicly-traded company, and is obtained by multiplying the number of its outstanding shares by the current share price. Market value is easiest to determine for exchange-traded instruments such as stocks and futures, since their market prices are widely disseminated and easily available, but is a little more challenging to ascertain for over-the-counter instruments like fixed income securities. However, the greatest difficulty in determining market value lies in estimating the value of illiquid assets like real estate and businesses, which may necessitate the use of real estate appraisers and business valuation experts respectively.Explanation: A company’s market value is a good indication of investors’ perceptions of its business prospects. The range of market values in the marketplace is enormous, ranging from less than $1 million for the smallest companies to hundreds of billions for the world’s biggest and most successful companies.Market value is determined by the valuations or multiples accorded by investors to companies, such as price-to-sales, price-to-earnings, enterprise value-to-EBITDA, and so on. The higher the valuations, the greater the market value.Market value can fluctuate a great deal over periods of time, and is substantially influenced by the business cycle. Market values plunge during the bear markets that accompany recessions, and rise during the bull markets that are a feature of economic expansion.Market value is also dependent on numerous other factors, such as the sector in which the company operates, its profitability, debt load and the broad market environment. For example, Company?X and Company B may both have $100 million in annual sales, but if?X is a fast-growing technology firm while B is a stodgy retailer, X’s market value will generally be significantly higher than that of Company B.In the example above, Company?X may be trading at a sales multiple of 5, which would give it a market value of $500 million, while Company B may be trading at a sales multiple of 2, which would give it a market value of $200 million.Market value for a firm may diverge significantly from book value or shareholders’ equity. A stock would generally be considered undervalued if its market value is well below book value, which means the stock is trading at a deep discount to book value per share. This does not imply that a stock is overvalued if it is trading at a premium to book value, as this again depends on the sector and the extent of the premium in relation to the stock’s peers.MASTER LIMITED PARTNERSHIP (MLP) : A type of limited partnership that is publicly traded. There are two types of partners in this type of partnership: The limited partner is the person or group that provides the capital to the MLP and receives periodic income distributions from the MLP's cash flow, whereas the general partner is the party responsible for managing the MLP's affairs and receives compensation that is linked to the performance of the venture.Explanation: One of the most crucial criteria that must be met in order for a partnership to be legally classified as an MLP is that the partnership must derive most (~90%) of its cash flows from real estate, natural resources and commodities.The advantage of an MLP is that it combines the tax benefits of a limited partnership (the partnership does not pay taxes from the profit - the money is only taxed when unitholders receive distributions) with the liquidity of a publicly traded company.MULTIPLIER EFFECT (DEPOSIT MULTIPLIER): The expansion of a country's money supply that results from banks being able to lend. The size of the multiplier effect depends on the percentage of deposits that banks are required to hold as reserves. In other words, it is money used to create more money and is calculated by dividing total bank deposits by the reserve requirement.Explanation: The multiplier effect depends on the set reserve requirement. So, to calculate the impact of the multiplier effect on the money supply, we start with the amount banks initially take in through deposits and divide this by the reserve ratio. If, for example, the reserve requirement is 20%, for every $100 a customer deposits into a bank, $20 must be kept in reserve. However, the remaining $80 can be loaned out to other bank customers. This $80 is then deposited by these customers into another bank, which in turn must also keep 20%, or $16, in reserve but can lend out the remaining $64. This cycle continues - as more people deposit money and more banks continue lending it - until finally the $100 initially deposited creates a total of $500 ($100 / 0.2) in deposits. This creation of deposits is the multiplier effect.The higher the reserve requirement, the tighter the money supply, which results in a lower multiplier effect for every dollar deposited. The lower the reserve requirement, the larger the money supply, which means more money is being created for every dollar deposited.**NET DEBT: A metric that shows a company's overall debt situation by netting the value of a company's liabilities and debts with its cash and other similar liquid assets.Calculated as:?Explanation: When investing in a company, one of the most important factors you need to consider is how much debt the company is carrying. Here are some questions to ask yourself when analyzing a company's debt: How much debt really exists? What kind of debt is it (long/short-term maturities)? What is the debt for (repay or refinance old debts)? Can the company afford the debt if it runs into financial trouble? And, finally, how does it compare to the debt levels of competing companies?NET WORTH: The amount by which assets exceed liabilities. Net worth is a concept applicable to individuals and businesses as a key measure of how much an entity is worth. A consistent increase in net worth indicates good financial health; conversely, net worth may be depleted by annual operating losses or a substantial decrease in asset values relative to liabilities. In the business context, net worth is also known as book value or shareholders' equity.Consider a couple with the following assets - primary residence valued at $250,000, an investment portfolio with a market value of $100,000 and automobiles and other assets valued at $25,000.Liabilities are primarily an outstanding mortgage balance of $100,000 and a car loan of $10,000.The couple's net worth would be therefore be $265,000 ([$250,000 + $100,000 + $25,000] - [$100,000 + $10,000]).Assume that five years later, the couple's financial position is as follows - residence value $225,000, investment portfolio $120,000, savings $20,000, automobile and other assets $15,000; mortgage loan balance $80,000, car loan $0 (paid off). The net worth would now be $300,000.In other words, the couple's net worth has gone up by $35,000 despite the decrease in the value of their residence and car, because this decline is more than offset by increases in other assets (such as the investment portfolio and savings) as well as the decrease in their liabilities.Explanation: People with a substantial net worth are known as high net worth individuals, and form the prime market for wealth managers and investment counselors. Investors with a net worth (excluding their primary residence) of at least $1 million - either alone or together with their spouse - are considered as "accredited investors" by the Securities and Exchange Commission, for the purpose of investing in unregistered securities offerings.A company that is consistently profitable will have a rising net worth or book value, as long as these earnings are not fully distributed to shareholders but are retained in the business. For public companies, rising book values over time may be rewarded by an increase in stock market value.?If you want to save some time in calculating your personal net worth, use our free HYPERLINK "" Net Worth Tracker which allows you to calculate, analyze and record your net worth for free.NOPAT: Net Operating profit after tax. A company's potential cash earnings if its capitalization were unleveraged (that is, if it had no debt). NOPAT is frequently used in economic value added (EVA) calculations. Calculated as:NOPAT = Operating Income x (1 - Tax Rate) Explanation: NOPAT is a more accurate look at operating efficiency for leveraged companies. It does not include the tax savings many companies get because they have existing debt. OVERHEAD COSTS: An accounting term that refers to all ongoing business expenses not including or related to direct labor, direct materials or third-party expenses that are billed directly to customers. Overhead must be paid for on an ongoing basis, regardless of whether a company is doing a high or low volume of business. It is important not just for budgeting purposes, but for determining how much a company must charge for its products or services to make a profit.Explanation: For example, a service-based business that operates in a traditional white-collar office setting would have overhead expenses such as rent, utilities and insurance.Overhead expenses can be fixed, meaning they are the same from month to month, or variable, meaning they increase or decrease depending on the business's activity level. They can also be semi-variable, meaning that some portion of the expense will be incurred no matter what, and some portion depends on the level of business activity. Overhead can also be general, meaning that it applies to the company's operations as a whole, or applied, meaning that it can be allocated to a specific project or department. These expenses are typically found on a company's income statement.Read more: HYPERLINK "" \l "ixzz3ZtjgptII" Follow us: HYPERLINK "" \t "_blank" @Investopedia on Twitter**PAID UP CAPITAL: The amount of a company's capital that has been funded by shareholders. Paid-up capital can be less than a company's total capital because a company may not issue all of the shares that it has been authorized to sell. Paid-up capital can also reflect how a company depends on equity financing.Explanation: Paid-up capital is money that a company has received from the sale of its shares, and represents money that is not borrowed. A company that is fully paid-up has sold all available shares, and thus cannot increase its capital unless it borrows money through debt or is authorized to sell more shares.PARTNERSHIP: A business organization in which two or more individuals manage and operate the business. Both owners are equally and personally liable for the debts from the business.Explanation: Partnership doesn't always mean two people. There are many large partnerships who have thousands of partners. General and Limited partnerships are the 2 main types.PREFERED STOCK: Company stock with dividends that are paid to shareholders before common stock dividends are paid out. In the event of a company bankruptcy, preferred stock shareholders have a right to be paid company assets first. Preference shares typically pay a fixed dividend, whereas common stocks do not. And unlike common shareholders, preference share shareholders usually do not have voting rights.Explanation: There are four types of preference shares: Cumulative preferred, for which dividends must be paid including skipped dividends; non-cumulative preferred, for which skipped dividends are not included; participating preferred, which give the holder dividends plus extra earnings based on certain conditions; and convertible, which can be exchanged for a specified number of shares of common stock.PREPAID EXPENSE: A type of asset that arises on a balance sheet as a result of business making payments for goods and services to be received in the near future. While prepaid expenses are initially recorded as assets, their value is expensed over time as the benefit is received onto the income statement, because unlike conventional expenses, the business will receive something of value in the near future.Explanation: Due to the nature of certain goods and services, they must be prepaid expenses. For example, insurance is a prepaid expense, because the purpose of purchasing insurance is to buy proactive protection in case something unfortunate happens. Clearly, no insurance company would sell insurance that covers the occurrence of an unfortunate event, after the fact, so insurance expenses must be pre-paid.An example of expensing prepaid expenses would be if a company had a one-year insurance policy cost of $1200. As each month elapses, $100 of prepaid insurance would be expensed to the income statement until the account is empty at the end of the year.PRESENT VALUE: The current worth of a future sum of money or stream of cash flows given a specified rate of return. Future cash flows are discounted at the discount rate, and the higher the discount rate, the lower the present value of the future cash flows. Determining the appropriate discount rate is the key to properly valuing future cash flows, whether they be earnings or obligations. Also referred to as "discounted value".Explanation: This sounds a bit confusing, but it really isn't. The basis is that receiving $1,000 now is worth more than $1,000 five years from now, because if you got the money now, you could invest it and receive an additional return over the five years.The calculation of discounted or present value is extremely important in many financial calculations. For example, net present value, bond yields, spot rates, and pension obligations all rely on the principle of discounted or present value. Learning how to use a financial calculator to make present value calculations can help you decide whether you should accept a cash rebate, 0% financing on the purchase of a car or to pay points on a mortgage.**PRICE-EARNINGS RATIO (PE RATIO): For example, if a company is currently trading at $43 a share and earnings over the last 12 months were $1.95 per share, the P/E ratio for the stock would be 22.05 ($43/$1.95).EPS is usually from the last four quarters (trailing P/E), but sometimes it can be taken from the estimates of earnings expected in the next four quarters (projected or forward P/E). A third variation uses the sum of the last two actual quarters and the estimates of the next two quarters.EAlso sometimes known as "price multiple" or "earnings multiple."Explanation: In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E. However, the P/E ratio doesn't tell us the whole story by itself. It's usually more useful to compare the P/E ratios of one company to other companies in the same industry, to the market in general or against the company's own historical P/E. It would not be useful for investors using the P/E ratio as a basis for their investment to compare the P/E of a technology company (high P/E) to a utility company (low P/E) as each industry has much different growth prospects.The P/E is sometimes referred to as the "multiple", because it shows how much investors are willing to pay per dollar of earnings. If a company were currently trading at a multiple (P/E) of 20, the interpretation is that an investor is willing to pay $20 for $1 of current earnings.It is important that investors note an important problem that arises with the P/E measure, and to avoid basing a decision on this measure alone. The denominator (earnings) is based on an accounting measure of earnings that is susceptible to forms of manipulation, making the quality of the P/E only as good as the quality of the underlying earnings number.Things to RememberGenerally a high P/E ratio means that investors are anticipating higher growth in the future.The average market P/E ratio is 20-25 times earnings.The P/E ratio can use estimated earnings to get the forward looking P/E panies that are losing money do not have a P/E ratio.PRICE RISK: is the chance that a holder of a position will experience an unexpected change in the value of the position due to a change in the price level. Managing risk involves 3 steps: 1. Identify the risk; 2. Quantify the risk; 3. Manage the risk. p. 110PRICE-TO-SALES RATIO: A valuation ratio that compares a company’s stock price to its revenues. The price-to-sales ratio is an indicator of the value placed on each dollar of a company’s sales or revenues. It can be calculated either by dividing the company’s market capitalization by its total sales over a 12-month period, or on a per-share basis by dividing the stock price by sales per share for a 12-month period. Like all ratios, the price-to-sales ratio is most relevant when used to compare companies in the same sector. A low ratio may indicate possible undervaluation, while a ratio that is significantly above the average may suggest overvaluation. Abbreviated as the P/S ratio or PSR, this ratio is also known as a “sales multiple” or “revenue multiple.”Explanation: The 12-month period used for sales in the price-to-sales ratio is generally the past four quarters (also called trailing 12 months or ttm), or the most recent or current fiscal year. A price-to-sales ratio that is based on forecast sales for the current year is called a forward ratio.Consider the quarterly sales for Acme Co. shown in the table below. The sales for fiscal year 1 (FY1) are actual sales, while sales for FY2 are analysts’ average forecasts (assume that we are currently in Q1 of FY2). Acme has 100 million shares outstanding, with the shares presently trading at $10. ?At the present time, Acme’s P/S ratio on a trailing 12-month basis would be calculated as follows –Sales for past 12 months (ttm) = $455 million (sum of all FY1 values)Sales per share (ttm) = $4.55P/S ratio = $10 / $4.55 = 2.20Acme’s P/S ratio for the current fiscal year would be calculated as follows –Sales for current fiscal year (FY2) = $520 millionSales per share = $5.20P/S ratio = $10 / $5.20 = 1.92If Acme’s peers – which we assume are based in the same sector and are of similar size in terms of market capitalization – are trading at an average P/S ratio (ttm) of 1.5, compared with Acme’s 2.2, it suggests a premium valuation for the company. One reason for this could be the 14.2% revenue growth that Acme is expected to post in the current fiscal year ($520 million vs. $455 million), which may be better than what's expected for its peers.As with any other ratio, the P/S ratio cannot be viewed in isolation, since it only presents a very narrow view of a company or stock. This ratio is particularly useful for comparing the valuation of early-stage companies that have revenues but are not yet profitable.PRIVATE PLACEMENT: The sale of securities to a relatively small number of select investors as a way of raising capital. Investors involved in private placements are usually large banks, mutual funds, insurance companies and pension funds. Private placement is the opposite of a public issue, in which securities are made available for sale on the open market.Explanation: Since a private placement is offered to a few, select individuals, the placement does not have to be registered with the Securities and Exchange Commission. In many cases, detailed financial information is not disclosed and a the need for a prospectus is waived. Finally, since the placements are private rather than public, the average investor is only made aware of the placement after it has occurred.PRIVATE SECTOR: The part of the economy that is not state controlled, and is run by individuals and companies for profit. The private sector encompasses all for-profit businesses that are not owned or operated by the government. Companies and corporations that are government run are part of what is known as the public sector, while charities and other nonprofit organizations are part of the voluntary sector.Explanation: In most free-market economies, the private sector is the sector where most jobs are held. This differs from countries where the government exerts considerable power over the economy, like in the People's Republic of China. The Bureau of Labor Statistics tracks and reports both private and public unemployment rates for the U.S.PRODUCTIVITY: An economic measure of output per unit of input. Inputs include labor and capital, while output is typically measured in revenues and other GDP components such as business inventories. Productivity measures may be examined collectively (across the whole economy) or viewed industry by industry to examine trends in labor growth, wage levels and technological improvement.Explanation: Productivity gains are vital to the economy because they allow us to accomplish more with less. Capital and labor are both scarce resources, so maximizing their impact is always a core concern of modern business. Productivity enhancements come from technology advances, such as computers and the internet, supply chain and logistics improvements, and increased skill levels within the workforce.Productivity is measured and tracked by many economists as a clue for predicting future levels of GDP growth. The productivity measure commonly reported through the media is based on the ratio of GDP to total hours worked in the economy during a measuring period; this productivity measure is produced by the Bureau of Labor Statistics four times per year.PROSPECTUS: A formal legal document, which is required by and filed with the Securities and Exchange Commission, that provides details about an investment offering for sale to the public. A prospectus should contain the facts that an investor needs to make an informed investment decision. Also known as an "offer document."Explanation: There are two types of prospectuses for stocks and bonds: preliminary and final. The preliminary prospectus is the first offering document provided by a securities issuer and includes most of the details of the business and transaction in question. Some lettering on the front cover is printed in red, which results in the use of the nickname "red herring" for this document. The final prospectus is printed after the deal has been made effective and can be offered for sale, and supersedes the preliminary prospectus. It contains finalized background information including such details as the exact number of shares/certificates issued and the precise offering price.In the case of mutual funds, which, apart from their initial share offering, continuously offer shares for sale to the public, the prospectus used is a final prospectus. A fund prospectus contains details on its objectives, investment strategies, risks, performance, distribution policy, fees and expenses, and fund management.SECURITIZATION: The process through which an issuer creates a financial instrument by combining other financial assets and then marketing different tiers of the repackaged instruments to investors. The process can encompass any type of financial asset and promotes liquidity in the marketplace.Explanation: Mortgage-backed securities are a perfect example of securitization. By combining mortgages into one large pool, the issuer can divide the large pool into smaller pieces based on each individual mortgage's inherent risk of default and then sell those smaller pieces to investors. The process creates liquidity by enabling smaller investors to purchase shares in a larger asset pool. Using the mortgage-backed security example, individual retail investors are able to purchase portions of a mortgage as a type of bond. Without the securitization of mortgages, retail investors may not be able to afford to buy into a large pool of mortgages.SHORT POSITION:1. The sale of a borrowed security, commodity or currency with the expectation that the asset will fall in value.2. In the context of options, it is the sale (also known as "writing") of an options contract.1. For example, an investor who borrows shares of stock from a broker and sells them on the open market is said to have a short position in the stock. The investor must eventually return the borrowed stock by buying it back from the open market. If the stock falls in price, the investor buys it for less than he or she sold it, thus making a profit.2. For example, selling a call (or put) options contract to a buyer entitles the buyer the right, not the obligation to buy from (or sell to) you a specific commodity or asset for a specified amount at a specified date.SHORT SQUEEZE: Situation when prices of a stock or commodity futures contract start to move up sharply and many traders with short positions are forced to buy stocks or futures to cover their short positions and prevent losses. This sudden surge of buying leads to even higher prices, further aggravating the losses of short sellers who have not covered their positions.SUBSIDIARY: A company whose voting stock is more than 50% controlled by another company, usually referred to as the parent company or holding company. A subsidiary is a company that is partly or completely owned by another company that holds a controlling interest in the subsidiary company. If a parent company owns a foreign subsidiary, the company under which the subsidiary is incorporated must follow the laws of the country where the subsidiary operates, and the parent company still carries the foreign subsidiary's financials on its books (consolidated financial statements). For the purposes of liability, taxation and regulation, subsidiaries are distinct legal entities.The purchase of a controlling interest differs from a merger and the parent corporation can acquire the controlling interest with a smaller investment. Additionally, stockholder approval is not required in the formation of a subsidiary as it would be in the event of a merger. Famous investor Warren Buffett's Berkshire Hathaway, Inc. has a long and diverse list of subsidiaries, including Clayton Homes, the Pampered Chef, GEICO Auto Insurance and Helzberg Diamonds.TANGIBLE ASSET: Assets that have a physical form. Tangible assets include both fixed assets, such as machinery, buildings and land, and current assets, such as inventory. The opposite of a tangible asset is an intangible asset. Nonphysical assets, such as patents, trademarks, copyrights, goodwill and brand recognition, are all examples of intangible assets.Explanation: Certain types of assets receive special treatment for accounting purposes. For tangible assets with an anticipated useful life of more than one year, a company uses a process called depreciation to allocate part of the asset's expense to each year of its useful life, instead of allocating the entire expense to the year in which the asset is purchased.TERMINAL VALUE: The value of a bond at maturity, or of an asset at a specified, future valuation date, taking into account factors such as interest rates and the current value of the asset, and assuming a stable growth rate. In addition to bond and asset applications, terminal value can also refer to the value of an entire company at a specified future valuation date. Two common approaches are used to evaluate the terminal value of an asset: the "perpetuity growth model" and the "exit approach." Also called continuing value or horizon value.Explanation: The terminal value of an asset is its anticipated value on a certain date in the future. It is used in multi-stage discounted cash flow analysis and the study of cash flow projections for a several-year period. The perpetuity growth model is used to identify ongoing free cash flows. The exit or terminal multiple approach assumes the asset will be sold at the end of a specified time period, helping investors evaluate risk/reward scenarios for the asset. A commonly used value is enterprise value/EBITDA (earnings before interest, tax, depreciation and amortization) or EV/EBITDA. An asset's terminal value is a projection that is useful in budget planning, and also in evaluating the potential gain of an investment over a specified time period.TRAILING TWELVE MONTHS (TTM): The timeframe of the past 12 months used for reporting financial figures. A company's trailing 12 months is a representation of its financial performance for a 12-month period, but typically not at its fiscal year end. Since quarterly reports rarely report how the company has done in the past 12 months, TTM tends to be calculated manually or found on various websites.Explanation: Trailing 12 months figures can be calculated by subtracting the previous year's results from the same quarter as the most recent quarter reported and adding the difference to the latest fiscal year end results. TTM figures are also often used to calculate financial ratios. For example, the price/earnings ratio is often quoted as P/E (ttm), meaning they're using the EPS from the past 12 months.TREASURY BOND: A marketable, fixed-interest U.S. government debt security with a maturity of more than 10 years. Treasury bonds make interest payments semi-annually and the income that holders receive is only taxed at the federal level.Explanation: Treasury bonds are issued with a minimum denomination of $1,000. The bonds are initially sold through auction in which the maximum purchase amount is $5 million if the bid is non-competitive or 35% of the offering if the bid is competitive. A competitive bid states the ratethat the bidder is willing to accept; it will be accepted depending on how it compares to the set rate of the bond. A non-competitive bid ensures that the bidder will get the bond but he or she will have to accept the set rate. After the auction, the bonds can be sold in the secondary market.UNEARNED REVENUE: When an individual or company receives money for a service or product that has yet to be fulfilled. Unearned revenue can be thought of as a "pre-payment" for goods or services which a person or company is expected to produce to the purchaser. As a result of this prepayment, the seller now has a liability equal to the revenue earned until delivery of the good or service.Explanation: From an accounting perspective, unearned revenue is a double-edged sword. The early cash flow to the firm is advantageous for any number of activities, such as paying interest on debt to purchasing more inventory. However, by accepting unearned revenue, the firm has then entered a legal obligation to deliver on the terms of the payment. For example, with a prepayment on a lease contract, the revenue is a liability until it has been earned.WEIGHTED AVERAGE COST OF CAPITAL: A calculation of a firm's cost of capital in which each category of capital is proportionately weighted. All capital sources - common stock, preferred stock, bonds and any other long-term debt - are included in a WACC calculation. All else equal, the WACC of a firm increases as the beta and rate of return on equity increases, as an increase in WACC notes a decrease in valuation and a higher risk.The WACC equation is the cost of each capital component multiplied by its proportional weight and then summing:?Where:Re = cost of equityRd = cost of debtE = market value of the firm's equityD = market value of the firm's debtV = E + DE/V = percentage of financing that is equityD/V = percentage of financing that is debtTc = corporate tax rateBusinesses often discount cash flows at WACC to determine the Net Present Value (NPV) of a project, using the formula:NPV = Present Value (PV) of the Cash Flows discounted at WACC.Explanation: Broadly speaking, a company's assets are financed by either debt or equity. WACC is the average of the costs of these sources of financing, each of which is weighted by its respective use in the given situation. By taking a weighted average, we can see how much interest the company has to pay for every dollar it finances.A firm's WACC is the overall required return on the firm as a whole and, as such, it is often used internally by company directors to determine the economic feasibility of expansionary opportunities and mergers. It is the appropriate discount rate to use for cash flows with risk that is similar to that of the overall firm.YIELD CURVE: A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity dates. The most frequently reported yield curve compares the three-month, two-year, five-year and 30-year U.S. Treasury debt. This yield curve is used as a benchmark for other debt in the market, such as mortgage rates or bank lending rates. The curve is also used to predict changes in economic output and growth.The shape of the yield curve is closely scrutinized because it helps to give an idea of future interest rate change and economic activity. There are three main types of yield curve shapes: normal, inverted and flat (or humped). A normal yield curve (pictured here) is one in which longer maturity bonds have a higher yield compared to shorter-term bonds due to the risks associated with time. An inverted yield curve is one in which the shorter-term yields are higher than the longer-term yields, which can be a sign of upcoming recession. A flat (or humped) yield curve is one in which the shorter- and longer-term yields are very close to each other, which is also a predictor of an economic transition. The slope of the yield curve is also seen as important: the greater the slope, the greater the gap between short- and long-term rates. ................
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