Financial economics > Glossary

From Citizendium, the Citizens' Compendium

(For definitions not shown below, see the economics glossary [1])

• Agency cost [r]: The cost to the owners (or company shareholders) of an organisation of actions by their agents (or the company management) that are contrary to the owners' interests - and the cost of attempting to prevent such actions. [e]
• Arbitrage [r]: transactions to take advantage of a price differences of a product in different markets by buying where it is cheap and selling where it is dear. The possibility of arbitrage often prevents the occurrence of price differences. [e]
• Basel I & Basel II [r]: international banking regulations put forth by the Basel Committee on Bank Supervision of the Bank for International Settlements requiring banks' minimum capital adequacy ratios to be related to the riskiness of their loans. [e]
• Beta [r]: A measure of the degree to which the rate of return of a share tracks that of the equity market as a whole (defined as the covariance between the share's rate of return and the average market rate, divided by the variance of the market rate). If beta = 1 the share's rate of return moves in line with the market rate; if it is negative, it falls when the market rate rises. [e]
• Bubble (economics) [r]: A surge in prices that raises irrational expectations of further increases, so generating further increases, and so on: a process that continues until confidence falters, the bubble "bursts" and prices suddenly revert to a rationally-based level. [e]
• Capital adequacy ratio [r]: The ratio of a bank's capital to its assets. [e]
• CDO [r]: Collateralised Debt Obligation. A portfolio of corporate bonds, grouped into tranches that are ranked by estimated risk. [e]
• CDS [r]: Credit-Default Swap. An insurance agreement that guarantees protection against a bond default in return for a fee. [e]
• Central Bank [r]: A government agency that is responsible for monetary policy and the support of the banking system (for example the Federal Reserve Bank and the Bank of England). Usually responsible for controlling a country's monetary policy and preserving the value of its currency. [e]
• Corporation [r]: A commercial organisation that is jointly owned by shareholders who participate in its profits but are not personally liable for its debts. A corporation is legally distinct from its owners and may employ people, own assets and lend or borrow money. [e]
• Cost_of_capital [r]: The weighted average of the interest rates paid by a company on its equity (share issue) and on its debt (bonds and commercial borrowing). [e]
• Covariance [r]: The degree to which two variables move together (defined as the average value of the products of the deviations of the corresponding values of the two variables from their respective means, and expressed mathematically as Cov(x,y).) If their covariance is positive, both move in the same direction; if it is negative, then when one increases the other decreases. [e]
• Debt_instrument [r]: a formal obligation assumed by a borrower to replay the lender in accordance with the terms of an agreement. Debt instruments include bonds, debentures, promissory notes, leases and mortgages. [e]
• Derivative [r]: In finance, an asset whose agreed value depends upon the expected value of another asset. A typical example is a futures contract which is an undertaking to buy a stipulated asset at a stipulated price at a stipulated future time. Other examples are options and futures contracts. Some derivatives can be used for hedging against risk. [e]
• Discount_rate [r]: (i) The percentage by which the current value of an asset (to a person or to a commercial organisation) exceeds its value in a year's time. For a person, it is equal to that person’s marginal rate of substitution between consumption in the two successive years. For a financial asset it is the ruling risk-free interest rate. For a commercial organisation, it is equal to that organisation’s cost of capital. (ii) The rate at which banks may borrow at their central bank's discount window. [e]
• Discount window [r]: A facility provided by central banks that enables a bank to make secured short-term loans at its central bank's discount rate". [e]
• Dividend discount model [r]: The value of a share is (definitionally) equal to the total of its discounted future dividend payments. [e]
• Financial_Intermediary [r]: A go-between organisation that obtains finance from investors (or savers) and lends it to corporations (or other borrowers). Financial intermediaries include banks, building societies (or savings and loans associations) , life insurance companies and credit unions. [e]
• Financial_regulator [r]: The United States Securities and Exchange Commission gives as its mission "to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation". Financial regulators in other countries have similar responsibilities. [e]
• Gearing: see Leverage
• Hedging [r]: Protecting against price changes by simultaneously buying(/selling) an asset and making a futures contract to sell(/buy) it. [e]
• Herding (banking) [r]: A tendency to base decisions upon the actions of others - on the part of bankers, depositors or investors see also Panic (banking). [e]
• Interest [r]: The difference between the present and future value of money, expressed as a percentage of current value. [e]
• Leverage [r]: The use of debt to make investments. The ratio of a company's debt to its capital assets. (the same as British "gearing") [e]
• Liquidity [r]: The quantity of available assets in its possession that an organisation could rapidly exchange for cash (assets that cannot be exchanged for cash at a particular time are considered to be "illiquid" at that time). [e]
• Moral hazard [r]: Motivation to take an otherwise unwarranted risk because the cost of an unfavourable outcome would be borne by someone other than the risk-taker. [e]
• Noise_traders [r]: Traders who buy or sell shares for reasons unconnected with information about the issuing companies or the markets in which they operate. [e]
• Option [r]: A right, but not an obligation, to buy (or to sell) an asset, usually at a stipulated price (termed the "exercise price") and at a stipulated time. An option to buy is called a "call option" and an option to sell is called a "put option". [e]
• Panic (banking) [r]: a self-fulfilling fear of default. [e]
• Portfolio insurance [r]: A way of protecting a portfolio against market risk by selling short on the share index futures exchange, or by buying put options on the share index. [e]
• Prime rate [r]: The interest rate that commercial banks charge for loans involving the lowest risk of default - such as loans to large companies. [e]
• Reserve ratio [r]: The ratio of a bank's reserves to its deposits. [e]
• Random_walk [r]: The movement of the price of an asset over time that is entirely unpredictable. [e]
• Risk premium [r]: The ratio of the rate of return from an asset to the rate of return available from a risk-free investment. [e]
• Securitisation [r]: the conversion of a cash flow into a marketable security (usually the offer for sale of claims upon debt repayments, and often categorised according to the expected risk of default. Examples include colateralised debt obligations (CDOs) and structured investment vehicles (SIVs).) [e]
• Selling short [r]: Selling borrowed stock in the expectation that its price will fall, and with the intention of subsequently buying it back and returning it. [e]
• Standard deviation [r]: A statistical measure for the fluctuation of a random variable about its mean value (the square root of the variance). [e]
• Stop loss [r]: An investment policy which requires the automatic sale of a stock if its price falls by a predetermined percentage (see noise trading). [e]
• Subprime lending [r]: Lending at interest rates above the prime rate because of an above-minimal risk of default. [e]
• Swap: see CDS
• Value at risk [r]: The maximum possible loss in the value of an asset within a given time span and at a given confidence level. [e]
• Variance [r]: A statistical measure of the variability of a random quantity (defined as the mean squared deviation from the mean value). [e]