Begrippen Corporate Finance
- Corporate finance
- The study of how a firm answers three questions: which long-term investments to make, how to finance them, and how to manage everyday financial activities. It links business decisions to the value of the equity.
- Capital budgeting
- The process of planning and managing a firm's long-term investments, by evaluating the size, timing and risk of the future cash flows they generate.
- Capital structure
- The mixture of long-term debt and equity a firm uses to finance its operations.
- Working capital
- A firm's short-term assets (inventory, receivables, cash) and short-term liabilities (payables). Managing it ensures the firm can continue its daily operations.
- Chief financial officer (CFO)
- Top financial officer who coordinates the treasurer (cash, credit, capital expenditures, financial planning) and the controller (accounting, tax, information systems).
- Residual owners
- Shareholders are entitled only to what is left after employees, suppliers, creditors and other claimants are paid.
- Primary market
- Market in which securities are sold for the first time by the issuer; the money raised goes to the issuing firm (IPO or seasoned offering).
- Secondary market
- Market in which investors trade existing securities with each other; the money goes to the seller. It determines share prices and makes primary issues more attractive.
- Initial public offering (IPO)
- The first public issue of a company's shares.
- Seasoned equity offering (SEO)
- A new issue of shares by a company whose shares are already publicly traded.
- Dealer market (OTC)
- Secondary market in which dealers buy and sell for their own account; for shares and bonds called over-the-counter.
- Auction market
- Exchange with a physical location whose main purpose is to match buyers and sellers, such as the London Stock Exchange.
- Private placement
- A negotiated sale of securities to a specific buyer, such as an insurance company, usually without registration or underwriters.
- Statement of financial position (balance sheet)
- Snapshot of what a firm owns (assets), owes (liabilities) and the difference (equity) at a specific date.
- Net working capital (NWC)
- Current assets minus current liabilities. Positive NWC means enough cash should be available to pay liabilities that fall due within a year.
- Book value
- Value based on accounting figures, usually historical cost under accounting standards.
- Market value
- The price at which an asset or the equity could be sold in the market today; the value that matters for financial decisions.
- Income statement
- Statement that summarises performance over a period: revenue minus expenses equals income.
- Matching principle
- Accounting rule that expenses are recognised in the same period as the revenues they help to produce.
- Non-cash items
- Expenses that reduce income but do not directly affect cash flow, most importantly depreciation.
- EBIT
- Earnings before interest and taxes, also called operating profit.
- EBITDA
- Earnings before interest, taxes, depreciation and amortisation; a rough measure of cash generated from operations.
- Earnings per share (EPS)
- Net income divided by the number of shares outstanding.
- Average tax rate
- Total tax bill divided by taxable income.
- Marginal tax rate
- The tax paid on one additional unit of income; relevant for evaluating new projects.
- Statement of cash flows
- Statement that splits the change in cash into cash flows from operating, investing and financing activities.
- Operating cash flow
- Cash generated by a firm's normal day-to-day business activities.
- Current ratio
- Current assets divided by current liabilities; a liquidity measure.
- Quick (acid-test) ratio
- Current assets minus inventory, divided by current liabilities; a stricter liquidity measure.
- Debt-equity ratio
- Total debt divided by total equity.
- Total debt ratio
- Total debt divided by total assets (debt plus equity).
- Equity multiplier
- Total assets divided by total equity; equals 1 plus the debt-equity ratio.
- Times interest earned (TIE)
- EBIT divided by interest expense; measures how well interest obligations are covered.
- Total asset turnover
- Sales divided by total assets; measures asset use efficiency.
- Profit margin
- Net income divided by sales; measures operating efficiency.
- Return on assets (ROA)
- Net income divided by total assets; profit per unit of (book) assets.
- Return on equity (ROE)
- Net income divided by total equity; the accounting bottom-line measure for shareholders.
- Price-earnings (P/E) ratio
- Price per share divided by EPS; what investors pay per unit of current earnings.
- Shiller P/E (CAPE)
- Price divided by average inflation-adjusted earnings of the past ten years; historically about 17 for the S&P 500.
- Market-to-book ratio
- Market value per share divided by book value per share.
- Tobin's Q
- Market value of a firm's assets divided by their replacement cost.
- Peer group analysis
- Benchmarking a firm's ratios against similar firms in the same markets.
- Time trend analysis
- Benchmarking a firm's ratios against its own history.
- Future value (FV)
- The amount an investment is worth after one or more periods of earning interest.
- Present value (PV)
- The current value of future cash flows discounted at the appropriate discount rate.
- Discounting
- Calculating the present value of a future amount.
- Compounding
- Reinvesting interest so that interest is earned on interest in later periods.
- Simple interest
- Interest earned only on the original principal.
- Compound interest
- Interest earned on both the principal and interest reinvested from earlier periods.
- Future value interest factor (FVIF)
- (1 + r)^t; the factor by which an amount grows in t periods at rate r.
- Present value interest factor (PVIF)
- 1/(1 + r)^t; the reciprocal of the future value factor.
- Annual percentage rate (APR), stated rate
- In week 1 used as the nominal or stated annual rate without compounding; the quoted rate.
- Corporate governance
- How a firm is managed and how that management is monitored, so that decisions serve shareholders rather than managers or a single controlling shareholder.
- Sole proprietorship
- Business owned by one person with unlimited liability; income taxed as personal income.
- Partnership
- Business of two or more owners; general partners have unlimited liability, limited partners are liable only up to their contribution.
- Corporation
- A legal person separate from its owners, with limited liability, transferable ownership and unlimited life; subject to double taxation.
- Double taxation
- Corporate profits are taxed at the firm level and dividends are taxed again at the shareholder level.
- Agency relationship
- A relationship in which a principal hires an agent to act on his or her behalf.
- Type I agency problem
- Possible conflict of interest between shareholders and managers.
- Type II agency problem
- Possible conflict of interest between controlling (majority) and minority shareholders.
- Agency costs
- Costs of the conflict of interest between principals and agents; direct (expenditures, monitoring) or indirect (lost opportunities).
- Related party transaction
- Trade between firms controlled by the same party, possibly on terms that benefit the controlling shareholder at the expense of minority shareholders.
- Proxy
- A grant of authority by a shareholder allowing another person to vote his or her shares.
- Proxy fight
- Attempt by a group of shareholders to collect proxies to replace management by electing their own directors.
- Cumulative voting
- Voting procedure in which a shareholder may cast all votes (shares x seats) for one board candidate; directors are elected all at once.
- Straight voting
- Voting procedure in which a shareholder may cast all votes for each candidate; directors are elected one at a time.
- Staggered elections
- Only part of the board is elected at a time, which reduces the effect of cumulative voting and hinders takeovers.
- Pre-emptive right
- Right of existing shareholders to buy new shares first, protecting their proportional ownership.
- Unitary (one-tier) board
- Single board with executive and non-executive directors, elected by shareholders (UK, US).
- Dual (two-tier) board
- A supervisory board monitors and appoints an executive board (Germany, Netherlands).
- Stakeholder
- Someone other than a shareholder or creditor who potentially has a claim on the firm's cash flows, such as employees or suppliers.
- Common law
- Legal system in which law evolves through court rulings; flexible, better investor protection.
- Civil law
- Legal system based on codes of law set by legislation; judges interpret but cannot change the law.
- Bank-based financial system
- System in which banks are the main channel of funds and actively monitor firms; ownership is concentrated.
- Market-based financial system
- System in which securities markets are at least as important as banks; external market discipline and fragmented ownership.
- Widely held firm
- Firm without a controlling shareholder (no stake above 20%); type I problems dominate.
- Closely held firm
- Firm with a dominant shareholder such as a family, bank or state; type II problems dominate.
- Perpetuity
- A level stream of cash flows that continues forever; PV = C/r.
- Growing perpetuity
- A stream of cash flows growing at a constant rate forever; PV = C/(r - g) with r > g.
- Annuity
- A level stream of cash flows for a fixed number of periods.
- Ordinary annuity
- An annuity whose payments occur at the end of each period.
- Annuity due
- An annuity whose payments occur at the beginning of each period.
- Delayed annuity
- An annuity whose first payment occurs later than one period from now.
- Growing annuity
- A finite stream of cash flows growing at a constant rate.
- Annuity present value factor
- [1 - 1/(1 + r)^T]/r; the PV of 1 per period for T periods.
- Quoted (stated, nominal) rate
- The annual interest rate quoted without taking compounding into account.
- Effective annual rate (EAR)
- The interest rate expressed as if compounded once per year: (1 + q/m)^m - 1.
- Continuous compounding
- Compounding infinitely often; EAR = e^q - 1.
- Annual percentage rate (APR)
- In the EU the legally required effective rate including all costs of a loan; in the US the stated simple rate.
- Pure discount loan
- Loan in which principal and interest are paid in one sum at the end, like a T-bill.
- Interest-only loan
- Loan in which only interest is paid each period and the principal at the end.
- Amortised loan
- Loan repaid with regular equal payments that cover interest and principal.
- Balloon (bullet) payment
- Large final payment in a partially amortised loan, equal to the PV of the remaining scheduled payments.
- Annuity mortgage
- Mortgage with constant total payments; the interest share falls and the repayment share rises over time.
- Linear mortgage
- Mortgage with constant repayments; total payments fall over time as interest decreases.
- Bond
- A (mostly tradable) certificate showing that a borrower owes a specified sum and will pay coupons and principal on set dates; a tradable loan.
- Face value (par value)
- The principal amount repaid at maturity; assume 1,000 if nothing is stated.
- Coupon
- The stated interest payment on a bond.
- Coupon rate
- Annual coupon divided by face value.
- Maturity
- The date on which the face value is repaid.
- Yield to maturity (YTM)
- The discount rate that equates the PV of a bond's promised cash flows with its market price; usually quoted in simple annual terms.
- Current yield
- Annual coupon divided by the bond's price; ignores built-in gains or losses until maturity.
- Zero coupon (pure discount) bond
- Bond that pays no coupons, only the face value at maturity; sold at a deep discount.
- Level coupon (plain vanilla) bond
- Bond that pays a fixed coupon each period and the face value at maturity.
- Consol
- A bond that pays coupons forever and never repays principal; valued as a perpetuity.
- Floating-rate bond (floater)
- Bond whose coupon is adjusted to an interest rate index, often with a floor and cap.
- Premium bond
- Bond selling above face value; coupon rate above market rate.
- Discount bond
- Bond selling below face value; coupon rate below market rate.
- Par bond
- Bond selling at face value; coupon rate equals market rate.
- Interest rate risk
- Risk of a change in a bond's value due to changes in market interest rates; larger for longer maturities and lower coupons.
- Duration
- Weighted average time until a bond's cash flows are received; summarises its interest rate risk.
- Indenture
- Written agreement between the issuing firm and bondholders that sets out the terms of the bond.
- Sinking fund
- Account managed by the bond trustee to retire part of a bond issue before maturity.
- Call provision
- Right of the issuer to repurchase bonds at a stated price before maturity.
- Protective covenant
- Part of the indenture that limits (negative) or requires (positive) certain actions of the borrower to protect lenders.
- Seniority
- Order of priority among creditors in default; subordinated debt is paid after senior debt.
- Nominal interest rate
- Rate not adjusted for inflation; percentage change in the amount of money.
- Real interest rate
- Rate adjusted for inflation; percentage change in buying power.
- Fisher equation
- (1 + nominal) = (1 + real)(1 + inflation); approximately real = nominal - inflation.
- Term structure of interest rates
- Relationship between nominal rates on default-free pure discount bonds and time to maturity.
- Inflation premium
- Part of a nominal rate that compensates for expected future inflation.
- Interest rate risk premium
- Compensation investors demand for bearing interest rate risk.
- Yield curve
- Plot of yields on government coupon bonds against maturity.
- Default risk premium
- Part of a bond yield that compensates for the possibility of default.
- Liquidity premium
- Part of a bond yield that compensates for a lack of liquidity.
- Taxability premium
- Part of a bond yield that compensates for unfavourable tax treatment.
- Bond rating
- Assessment by Moody's, S&P or Fitch of the issuer's creditworthiness (default risk).
- Investment grade
- Bonds rated at least BBB (S&P, Fitch) or Baa (Moody's).
- Junk (high-yield) bond
- Bond rated below investment grade; offers a higher promised yield.
- Dividend yield
- Dividend divided by the share price at the start of the period (D1/P0).
- Capital gain yield
- Price change divided by the initial price; in the constant growth model equal to g.
- Dividend growth model
- P0 = D1/(R - g): share value as a growing perpetuity of dividends.
- Differential growth
- Dividends grow at a high rate for some years and at a lower constant rate afterwards.
- Preference shares
- Equity with priority over ordinary shares for dividends and in liquidation, usually with a fixed dividend and often without votes.
- Cumulative dividends
- Unpaid preference dividends are carried forward and must be paid before ordinary dividends.
- Dealer
- Agent who buys and sells securities from its own inventory, earning the bid-ask spread.
- Broker
- Agent who matches buyers and sellers without holding inventory.
- Net present value (NPV)
- The difference between the present value of an investment's future cash flows and its cost; accept if NPV is zero or positive.
- Discounted cash flow (DCF) valuation
- Valuing an investment by discounting its expected future cash flows.
- Payback period
- Time required for an investment's cash flows to recover its initial cost.
- Discounted payback period
- Time required for an investment's discounted cash flows to equal its initial cost.
- Cut-off period (benchmark)
- Maximum acceptable (discounted) payback period, chosen arbitrarily by the firm.
- Average accounting return (AAR)
- Average net income divided by average book value of an investment.
- Reducing balance depreciation
- Depreciation as a fixed percentage of the remaining book value each year.
- Straight-line depreciation
- Depreciation of an equal amount each year over the asset's life.
- Profitability index (PI)
- PV of future cash flows divided by the initial investment (benefit-cost ratio); accept if at least 1.
- Internal rate of return (IRR)
- Discount rate that makes the NPV of an investment zero; accept if it exceeds the required return (for conventional cash flows).
- NPV profile
- Graph of a project's NPV against the discount rate; it crosses zero at the IRR.
- Investing-type cash flows
- An initial outflow followed by inflows; accept if IRR exceeds the required return.
- Financing-type cash flows
- An initial inflow followed by outflows; the IRR is a rate paid, so accept if IRR is below the required return.
- Multiple rates of return
- More than one IRR, possible when cash flows change sign more than once.
- Mutually exclusive projects
- Projects of which at most one can be accepted.
- Independent projects
- Projects whose acceptance or rejection does not affect other projects.
- Crossover rate
- Discount rate at which the NPVs of two projects are equal; the IRR of the difference in their cash flows.
- Modified IRR (MIRR)
- IRR computed on cash flows adjusted at the required return, so that only one rate results.
- Incremental cash flows
- Differences between a firm's future cash flows with and without a project.
- Stand-alone principle
- Evaluating a project on its own incremental cash flows as if it were a mini-firm.
- Sunk cost
- A cash flow that has already occurred and cannot be recovered; ignore it.
- Opportunity cost
- The most valuable alternative given up (lost revenue) by making the investment; include it.
- Erosion
- Negative side effect: a new product reduces cash flows of existing products (cannibalisation).
- Synergy
- Positive side effect: a new project increases cash flows of existing projects.
- Free cash flow (FCF)
- OCF minus capital expenditure minus change in NWC; cash available to investors.
- Operating cash flow (OCF)
- Cash generated by the day-to-day operations of a project or firm.
- Capital expenditure (CapEx)
- Cash spent on acquiring or upgrading long-term assets; maintenance or growth CapEx.
- Change in net working capital
- Increase (cash tied up) or decrease (cash released) in current assets minus current liabilities.
- Depreciation tax shield
- Tax saving from depreciation: depreciation x tax rate.
- After-tax salvage value
- Salvage value adjusted for tax on the difference between salvage value and book value.
- Fixed costs
- Costs that do not change with the quantity of output in a given period.
- Variable costs
- Costs that change with the quantity of output.
- Contribution margin
- Price minus variable cost per unit (P - v); the amount each unit contributes to covering fixed costs.
- Cash break-even
- Sales level at which OCF is zero: Q = F/(P - v).
- Accounting break-even
- Sales level at which net income is zero: Q = (F + D)/(P - v).
- Financial break-even
- Sales level at which NPV is zero: Q = (F + OCF*)/(P - v).
- Operating leverage
- The degree to which a firm or project relies on fixed costs.
- Degree of operating leverage (DOL)
- Percentage change in OCF relative to the percentage change in quantity sold; DOL = 1 + F/OCF.
- Forecasting risk
- Risk of a wrong decision because of errors in projected cash flows; magnified by high operating leverage.
- Cost of capital
- The minimum return a firm must earn on its investments to satisfy its investors; equal to the required return on investments of similar risk.
- Cost of equity (RE)
- The return equity investors require on their investment in the firm.
- Dividend growth model approach
- Estimating the cost of equity as RE = D1/P0 + g.
- Security market line (SML) approach
- Estimating the cost of equity as RE = Rf + beta x (RM - Rf).
- Market risk premium
- The expected return on the market minus the risk-free rate.
- Beta
- Measure of an asset's systematic risk relative to the market; the slope of a regression of its returns on market returns.
- Cost of debt (RD)
- The return lenders require on the firm's debt, measured by the yield to maturity on its (or similar) bonds.
- After-tax cost of debt
- RD x (1 - TC), because interest is tax deductible.
- Cost of preference shares (RP)
- The fixed dividend divided by the price of the preference share, RP = D/P0.
- Capital structure weights
- Market value proportions of equity (E/V) and debt (D/V) in total firm value V = E + D.
- Weighted average cost of capital (WACC)
- (E/V)RE + (D/V)RD(1 - TC): the overall required return on the firm's assets.
- Pure play approach
- Using a WACC or beta based on firms that operate only in the same line of business as the project.
- Subjective approach
- Placing projects in risk classes and adjusting the firm's WACC up or down per class.
- Flotation costs
- Costs of issuing new securities, such as underwriting, legal and registration fees.
- Weighted average flotation cost (fA)
- (E/V)fE + (D/V)fD; used to gross up the amount that must be raised.
- Private equity
- Equity financing for non-public companies whose shares are not traded.
- Venture capital (VC)
- Financing for new, often high-risk start-ups, by individuals or funds that pool money from institutions.
- Business angel
- Individual venture capitalist who invests his or her own money in start-ups.
- Seed money
- First, small amount of financing to prove a concept or develop a product.
- Prospectus
- Legal document with all relevant financial and business information about a public offering.
- General cash offer
- Public issue of securities offered to the general public.
- Rights issue (rights offer)
- Issue of new shares offered first to existing shareholders, who receive one right per share.
- Underwriter
- Investment bank that helps issue securities, advises on price and sells the issue.
- Firm commitment underwriting
- The underwriter buys the entire issue and bears the risk of unsold securities.
- Best efforts underwriting
- The underwriter sells as much as possible as an agent, without guaranteeing the proceeds.
- Dutch auction underwriting
- Offer price set by competitive bids; all successful bidders pay the same (uniform) price.
- Green shoe option
- Option for underwriters to buy up to 15% extra shares from the issuer at the offer price; also called overallotment option.
- Lock-up agreement
- Clause that prevents insiders from selling shares for a period (usually 180 days) after an IPO.
- Quiet period
- Period around an IPO in which communication with the public is limited to factual matters.
- Underpricing
- Setting the IPO price below the market value, visible as a first-day closing price above the offer price.
- Gross spread (underwriting discount)
- Difference between the offer price and the price the issuer receives.
- Abnormal return (SEO)
- The drop in the share price around the announcement of a new equity issue; an indirect issue cost.
- Dilution
- Loss in existing shareholders' value in terms of ownership, market value, book value or EPS.
- Subscription price
- The price at which existing shareholders can buy new shares in a rights issue.
- Subscription right (SR)
- Right received per old share that, together with others and the subscription price, allows buying a new share.
- Theoretical ex-rights price (TERP)
- Share price after the rights issue: (N x P0 + S)/(N + 1).
- Standby underwriting
- Arrangement in which the underwriter guarantees to buy the shares not taken up in a rights issue, for a standby fee.
- Oversubscription privilege
- Right of existing shareholders to buy shares not subscribed by others in a rights issue.
- Expected return
- Probability-weighted average of the possible returns of an asset in the future.
- Variance (expected returns)
- Probability-weighted average of squared deviations of possible returns from the expected return.
- Standard deviation
- Square root of the variance; the usual measure of volatility (total risk).
- Portfolio
- A group of assets such as equities and bonds held by an investor.
- Portfolio weight
- Percentage of a portfolio's total value invested in a particular asset.
- Surprise (unexpected return)
- The part of a return that was not anticipated, U in R = E(R) + U.
- Systematic risk
- Risk that influences a large number of assets; also called market or non-diversifiable risk.
- Unsystematic risk
- Risk that affects at most a small number of assets; also called unique, idiosyncratic, asset-specific or diversifiable risk.
- Diversification
- Spreading investments over many assets, which eliminates unsystematic risk but not systematic risk.
- Systematic risk principle
- The expected return on a risky asset depends only on its systematic risk.
- Beta coefficient
- Amount of systematic risk of an asset relative to the market; covariance with the market divided by the market variance.
- Portfolio beta
- Weighted average of the betas of the assets in a portfolio.
- Reward-to-risk ratio
- (E(Ri) - Rf)/beta_i: the risk premium per unit of systematic risk.
- Security market line (SML)
- Line of expected return against beta; its slope is the market risk premium.
- Capital market line (CML)
- Line of expected return against standard deviation for efficient portfolios of the risk-free asset and the market portfolio.
- Capital asset pricing model (CAPM)
- E(Ri) = Rf + beta_i(E(RM) - Rf): expected return depends on the time value of money, the reward for systematic risk and the amount of systematic risk.
- Underpriced security
- Security plotting above the SML: expected return too high, price too low; buy.
- Overpriced security
- Security plotting below the SML: expected return too low, price too high; sell or short.
- Capital gains yield
- Price change divided by the price at the start of the period.
- Arithmetic average return
- The return earned in an average year over a multiyear period.
- Geometric average return
- The average compound return earned per year over a multiyear period.
- Siegel's paradox
- Losses and gains are not symmetric: a loss of L requires a gain of L/(1 - L) to recover.
- Blume's formula
- Forecast that weights the geometric and arithmetic averages according to the horizon T and the data length N.
- Historical variance
- Sum of squared deviations from the average return divided by n - 1.
- Normal distribution
- Symmetric bell-shaped distribution: about 68%, 95% and 99% of outcomes within 1, 2 and 3 standard deviations.
- Fat tails
- Extreme outcomes occur more often than the normal distribution predicts.
- Black swan
- An extreme, very unlikely event with large impact, such as Black Monday 1987.
- Risk premium
- Return on a risky asset minus the risk-free return (T-bills).
- Efficient capital market
- Market in which asset prices fully reflect available information.
- Efficient markets hypothesis (EMH)
- Hypothesis that actual capital markets are efficient.
- Weak-form efficiency
- Prices reflect all past price information; technical analysis is useless.
- Semi-strong-form efficiency
- Prices reflect all publicly available information.
- Strong-form efficiency
- Prices reflect all information, public and private.
- Arbitrage
- Exploiting price differences for a riskless profit; arbitrageurs push prices back to fair values.
- Behavioural finance
- Study of how biases, framing and emotions cause systematic deviations from rational behaviour and market efficiency.
- Loss aversion
- The tendency to feel losses more strongly than equal gains.
- Herding
- Investors copying the behaviour of others, which can push prices away from fundamentals.
- Volatility Index (VIX)
- Index of the expected volatility of the S&P 500 over the next 30 days; a barometer of investor fear.
- Risk profile
- Plot showing how the value of a firm is affected by changes in prices or rates.
- Hedging (immunisation)
- Reducing a firm's exposure to price or rate fluctuations.
- Derivative security
- Financial asset that represents a claim to another financial asset (the underlying).
- Underlying
- The asset on which a derivative is written, such as a share, bond, currency or commodity.
- Transactions exposure
- Short-run financial risk from the need to buy or sell at uncertain prices or rates in the near future.
- Economic exposure
- Long-run financial risk from permanent changes in prices or economic fundamentals.
- Forward contract
- Agreement to buy or sell an asset at a future date at a price agreed today; both parties are obligated.
- Payoff profile
- Plot of the gains and losses on a contract resulting from unexpected price changes.
- Settlement date
- The future date on which a forward or futures contract is settled.
- Counterparty (credit) risk
- Risk that the losing party in a contract defaults on its obligation.
- Futures contract
- Standardised, exchange-traded forward contract whose gains and losses are settled daily.
- Marking to market
- Daily settlement of gains and losses on futures contracts.
- Short hedge
- Selling futures to protect against a fall in the price of an asset one owns or will produce.
- Margin call
- Demand by an exchange or broker for extra collateral when a position moves against the holder.
- Swap
- Agreement by two parties to exchange specified cash flows at specified intervals in the future.
- Interest rate swap
- Exchange of fixed-rate for floating-rate interest payments.
- Currency swap
- Exchange of fixed amounts of one currency for another at specified future dates.
- Commodity swap
- Exchange of a fixed amount for payments linked to a commodity price.
- Swap dealer
- Intermediary (usually a bank) that takes the other side of swaps and keeps a balanced book.
- Option
- Contract giving its owner the right, but not the obligation, to buy or sell an asset at a fixed price on or before a given date.
- Strike (exercise) price
- The fixed price at which the option holder may buy or sell the underlying.
- Expiration date
- The last day on which an option can be exercised.
- American option
- Option that can be exercised at any time up to the expiration date.
- European option
- Option that can be exercised only on the expiration date.
- Option premium
- The price paid by the buyer of an option for the right it gives.
- Call option
- Right to buy an asset at a fixed price; value at expiration max(S - K, 0).
- Put option
- Right to sell an asset at a fixed price; value at expiration max(K - S, 0).
- In the money
- An option that would have positive value if exercised now (call: S > K; put: S < K).
- Out of the money
- An option that would be worthless if exercised now.
- Long position
- Having bought a contract; for options, holding rights.
- Short position
- Having sold (written) a contract; for options, bearing obligations.
- Interest rate cap
- Call option on an interest rate that protects a floating-rate borrower against high rates.
- Floor
- Put option on an interest rate.
- Collar
- Combination of buying a cap and selling a floor, keeping the rate within a band.
- Contract for difference (CFD)
- Derivative that pays the price change of an asset, allowing large leveraged gains and losses.
- Survivorship bias
- Drawing conclusions only from the successful survivors, ignoring those who failed.
- Passive fund (index fund, ETF)
- Low-cost fund that tracks a market index instead of trying to beat it.
- Active fund
- Fund whose managers try to beat the market by selecting securities, usually at higher fees.