Dictionary of Financial Terms

Dictionary of Financial Terms ABC inventory system: Inventory management technique that divides inventory into three groups – A, B and C - in descending order of importance and level of monitoring, on the basis of the dollar investment in each. ability to service debts: The ability of a firm to make the contractual payments required on a scheduled basis over the life of a debt. accept-reject approach: The evaluation of capital expenditure proposals to determine whether they meet the firm‘s minimum acceptance criterion. accounting exposure: The risk resulting from the effects of changes in foreign exchange rates on the translated value of a firm‘s financial statement accounts denominated in a given foreign currency. Accounting Standards Board (AcSB): The accounting profession‘s rule-setting body, part of the CICA, that authorizes generally accepted accounting principles (GAAP). accounts payable management: Management by the firm of the time that elapses between its purchase of raw materials and its mailing payment to the supplier. accrual basis: Recognizes revenue at the point of sale and recognizes expenses that were incurred to earn that revenue (matching principle). accruals: Liabilities for services received for which payment has yet to be made and for which invoice has not been received. ACH (automated clearinghouse) credits: Deposits of payroll directly into the payees‘ (employees‘) accounts. Sacrifices disbursement float but may generate goodwill for the employer. ACH (automated clearinghouse) debits: Preauthorized electronic withdrawal from the payer‘s account and deposit into the payee‘s account via a settlement among banks by the automated clearinghouse. acquiring company: The firm in a merger transaction that attempts to acquire another firm. active business income: Income derived from the normal business activities of the corporation. activity ratios: Used to measure the effectiveness of managing accounts receivable, inventory, accounts payable, fixed assets, and total assets. adjustable-rate (or floating-rate) preferred share (ARPS): Preferred share whose dividend rate is tied to interest rates on specific government securities. after tax proceeds from sale of old asset: Found by subtracting applicable taxes from the proceeds from the sale of an old asset. agency costs: Costs borne by shareholders to prevent or minimize agency problems and to contribute to the maximization of the owners‘ wealth. They include monitoring and bonding expenditures, opportunity costs, and structuring expenditures. agency problem: The likelihood that managers may place personal goals ahead of corporate goals. aggressive funding strategy: A funding strategy under which the firm finances its seasonal needs, and possibly some of its permanent needs, with short-term debt and its permanent needs with long-term debt. aging of accounts receivable: A credit-monitoring technique that uses a schedule that indicates the percentages of the total accounts receivable balance that have been outstanding for specified periods of time. all-current-rate method: The method by which the functional currency--denominated financial statements of an MNC‘s subsidiary— is translated into the parent company‘s currency. American Depository Receipts (ADRs): Claims issued by U.S. banks representing ownership of shares of a foreign company‘s stock held on deposit by the U.S. bank in the foreign market and issued in dollars to U.S. investors. amortization: The systematic expensing of a portion of the cost of a fixed asset against sales revenue. annual cleanup: The requirement that for a certain number of days during the year, borrowers under a line of credit carry a zero loan balance (i.e., owe the bank nothing). annual report: The report that corporations must provide to common shareholders that summarizes and documents the firm‘s financial activities during the past year. annualized net present value (ANPV) approach: An approach to evaluating unequal-lived projects that converts the net present value of unequal-lived, mutually exclusive projects into an equivalent (in NPV terms) annual amount. annual percentage rate (APR): The nominal annual rate of interest interest rate, found by multiplying the periodic rate by the number of periods in a year. annuity: A finite stream of equal and periodic (regular) cash flows. These cash flows can be inflows of returns earned on investments or outflows of funds invested to earn future returns. annuity due: An annuity for which the payments occur at the beginning of each period. Ken Hartviksen – Lakehead University, 2004 assignment: A voluntary liquidation procedure by which a firm‘s creditors pass the power to liquidate the firm‘s assets to an adjustment bureau, a trade association, or a third party, which is designated the assignee. asymmetric information: The situation in which managers of a firm have more information about operations and future prospects than do investors. authorized shares: The number of shares of common stock that a firm‘s corporate charter allows without further shareholder approval. average age of inventory: Measures the effectiveness of the company‘s management of inventory; it is the average length of time inventory is held by the company. average collection period: The average amount of time needed to collect accounts receivable. average payment period: The average amount of time needed to pay accounts payable. average tax rate: A firm‘s taxes divided by its taxable income. balance sheet: Summary statement of the firm‘s financial position at a given point in time. balloon payment: At the maturity of a loan, a large lump-sum payment representing the entire loan principal if the periodic payments represent only interest. banking group: Includes the lead underwriter and, in most larger deals, a number of other large investment dealers. Bank of Canada: The central bank in Canada whose main function is to manage monetary policy. bank rate: the interest rate the Bank of Canada charges on one-day loans to financial institutions (chartered banks and investment dealers) as the lender of last resort. banker’s acceptances: Short-term, low-risk marketable securities arising from bank guarantees of business transactions; are sold by banks at a discount from their maturity value and provide yields slightly below those on negotiable CDs and commercial paper, but higher than those on Government of Canada treasury bills. bankruptcy: Business failure that occurs when a firm‘s liabilities exceed the fair market value of its assets. bar chart: The simplest type of probability distribution; shows only a limited number of outcomes and associated probabilities for a given event. basic EPS: Earnings per share (EPS) calculated without regard to any contingent securities. Baumol model: A model that provides for costefficient transactional cash balances; assumes that the demand for cash can be predicted with certainty and determines the economic conversion quantity (ECQ). bearer bonds: Bonds for which payments are made to the bearer. benchmarking: A type of cross-sectional analysis in which the firm‘s ratio values are compared to those of a key competitor or group of competitors, primarily to identify areas for improvement. best efforts agreement: An underwriting agreement where the syndicate agrees to try to sell the issue, but the sale is not guaranteed. beta coefficient: A measure of nondiversifiable (systematic) risk. An index of the degree of movement of an asset‘s return in response to a change in the market return. bird-in-the-hand argument: The belief, in support of dividend relevance theory, that current dividend payments (―a bird in the hand‖) reduce investor uncertainty and ultimately result in a higher value for the firm‘s shares. blue skying: An investment industry term referring to the approval of the final prospectus by provincial securities commissions. board of directors: Group elected by the firm‘s shareholders and having ultimate authority to guide corporate affairs and make general policy. bond: Long-term debt instrument used by business and government to raise large sums of money, generally from a diverse group of lenders. In the case of business bond issuers, a specific asset or assets are pledged as collateral. bond indenture: A complex and lengthy legal document stating the conditions under which a bond has been issued. bond-refunding decision: The decision facing firms, when bond interest rates drop, whether to refund (refinance) existing bonds with new bonds at the lower interest rate. book value: The strict accounting value of an asset, calculated by subtracting its accumulated depreciation from installed cost. Also, the total value of common equity at the date of the balance sheet. book value per share: The amount per share of common stock that would be received if all of the firm‘s assets were sold for their exact book (accounting) value and the proceeds remaining after paying all liabilities (and preferred shares) were divided among the common shareholders. book value weights: Weights that use accounting values to measure the proportion of each type of capital in the firm‘s financial structure; used in calculating the weighted average cost of capital. bought deal: The lead underwriter(s) purchase the total amount of the new security issue from the issuing Dictionary of Financial Terms D-3 company with the intention of quickly selling the issue to investors. branch: A business run by an MNC that is operated directly within a foreign country without incorporating; it is not separate from the parent, but part of the same entity. breadth of a market: A characteristic of a ready market, determined by the number of participants (buyers) in the market. break-even analysis (cost-volume-profit analysis): Indicates the level of operations necessary to cover all operating costs and the profitability associated with various levels of sales. break-even cash inflow: The minimum level of cash inflow necessary for a project to be acceptable (i.e., NPV>$0.) break point: The level of total new financing at which the cost of one of the financing components rises, thereby causing an upward shift in the marginal cost of capital (MCC). business risk: The risk to the firm of being unable to cover operating costs. CCA: Capital Cost Allowance. This is the method of depreciation (amortization) required by Canada Customs and Revenue Agency (CCRA). It is a noncash expense that increases cash flow. CCRA: Canada Customs and Revenue Agency. Formerly known as Revenue Canada. CCA rates: Rates set by Canada Customs and Revenue Agency (CCRA) that are used to calculate CCA on an asset class: the rates range from 4 percent to 100 percent. call feature: A feature that is included in almost all corporate bond issues that gives the issuer the opportunity to repurchase bonds prior to maturity at a stated price. call option: An option to purchase 100 common shares of a specific company on or before a specified future date at a stated price. call premium: The amount by which a bond‘s call price exceeds its par value. call price (bond): The stated price at which a bond may be repurchased, by use of a call feature, prior to maturity. call price (preferred): The repurchase price for a preferred share issue. Generally the stated value plus a call premium. Canadian-controlled private corporation (CCPC): A small corporation whose first $200,000 of taxable income qualifies for the small business deduction offered by the federal government. CCPC rate reduction: A 7 percent reduction in the general federal tax rate for Canadian-controlled private corporations on taxable income of between $200,000 and $300,000. capital: The long-term funds of the firm; all items on the right-hand side of the firm‘s balance sheet, excluding current liabilities. capital asset: A fixed asset that is amortized; land; or financial asset (common shares, preferred shares, and fixed income securities like bonds) held by a corporation. capital asset pricing model (CAPM): The basic theory that links together risk and return for all assets. The CAPM predicts a relationship between the required return, or cost of common equity capital, and the nondiversifiable risk of the firm as measured by the beta coefficient. capital budgeting: The process of evaluating and selecting long-term investments (expected life of greater than one year) that are consistent with the firm‘s goal of owner wealth maximization. capital budgeting process: Consists of five distinct but interrelated steps: proposal generation, review and analysis, decision making, implementation, and follow-up. capital cost allowance (CCA): The term for the amortization system that must be used for income tax purposes when reporting to Canada Customs and Revenue Agency. It is a non-cash expense that increases cash flow. capital expenditure: An outlay of funds by the firm that is expected to produce benefits over a period of time greater than one year. capital gain: The positive difference between the selling price of a capital asset and the asset‘s original cost plus the costs incurred to sell the asset. capital impairment rule: The legal rule governing Canadian companies that prevents the payment of dividends from the value of common shares on the balance sheet. capital market: The market that trades long-term debt securities and common and preferred equity securities. capital rationing: The financial situation in which a firm has only a fixed number of dollars for allocation among competing capital expenditures. capital structure: The mix of long-term debt and equity maintained by the firm. capitalization ratios: Show how a firm has financed the investment in assets. There are three capitalization alternatives: debt, preferred equity and common equity. capitalized lease: A financial (capital) lease that has the present value of all its payments included as an asset and corresponding liability on the firm‘s balance D I C T I O N A R Y Ken Hartviksen – Lakehead University, 2004 sheet, as required by generally accepted accounting principles as set out in the CICA Handbook. carrying costs: The variable costs per unit of holding an item in inventory for a specified time period. cash: The ready currency to which all liquid assets can be reduced. cash bonuses: Bonus money paid to management for achieving certain performance goals. cash budget (cash forecast): A statement of the firm‘s planned inflows and outflows of cash that is used to estimate the timing and magnitude of projected cash surpluses and deficits. cash concentration: The process used by the firm to bring lockbox and other deposits together into one bank, often called the concentration bank. cash conversion cycle (CCC): The amount of time a firm‘s resources are tied up; calculated by subtracting the average payment period from the operating cycle. cash disbursements: All cash outlays by the firm during a given financial period. Includes any cash outflow including payments on accounts payable, wages and salaries, taxes, purchase of fixed assets. Amortization or depreciation is never as cash disbursement. cash discount: A percentage deduction from the purchase price; available to the credit customer who pays its account within a specified period of time. cash discount period: The number of days after the beginning of the credit period during which the cash discount is available. cash basis: Recognizes revenues and expenses only with respect to actual inflows and outflows of cash. The cash basis is the main focus of the finance discipline. cash flow pattern: An initial outflow followed by a series of inflows. This is typical of the cash flows found in a bond and in a capital project. cash grants: One form of government incentive used to encourage corporate capital expenditures involving direct cash payments by any level of government to the company. cash receipts: All items from which the firm receives cash inflows during a given financial period. Includes cash sales, collections on accounts receivable, net proceeds on the sale of assets, as well as interest and/or dividend income. certainty equivalents (CEs): Risk-adjustment factors that represent the percent of estimated cash inflows that investors would be satisfied to receive for certain, rather than the cash inflows that are possible for each year. change in net working capital: The difference between the change in current assets and current liabilities associated with an investment project. clearing float: The delay between deposit of a payment and when spendable funds become available to the firm. This refers to the time it takes for a cheque to clear. Clearing House Interbank Payment System (CHIPS): The most important wire transfer service; operated by international banking consortia. clientele effect: The argument that a firm attracts shareholders whose preferences with respect to the payment and stability of dividends correspond to the payment pattern and stability of the firm itself. closely owned company: All common shares of a firm owned by a small group of investors such as a family. coattail provision: In the event of a takeover offer for the company, this provision allows the holders of the non-voting or restricted voting shares the right to convert their shares into an equal number of the superior voting shares. coefficient of variation (CV): A measure of relative dispersion used in comparing the risk of assets with differing expected returns. It is the ratio of the standard deviation divided by the mean (or expected return). It tells you the number of units of risk per unit of return. collateral: The items used by a borrower to back up a loan; any assets against which a lender has a legal claim if the borrower defaults on some provision of the loan. collection float: The delay between the time when a payer or customer deducts a payment from its checking account ledger and the time when the payee or vendor actually receives the funds in a spendable form. collection policy: The procedures for collecting a firm‘s accounts receivable when they are due. commercial finance companies: Lending institutions that make only secured loans--both short-term and long-term--to businesses. commercial paper: A short-term, unsecured promissory note issued by a corporation that has a very high credit standing, having a yield above that paid on Government of Canada treasury bills and comparable to that available on negotiable CDs with similar maturities. A money market financial instrument. Sometimes referred to as corporate paper. commitment fee: The fee that is normally charged on a revolving credit agreement, it often applies to the average unused balance of the borrower‘s credit line. common equity: The total investment made by the company‘s owners consisting of the value of common shares plus retained earnings. common equity ratio: Measures the proportion of total assets financed by common shareholders. Dictionary of Financial Terms D-5 common shares: Collectively, units of ownership interest, or equity, in a corporation. The purest and most basic form of corporate ownership. Common shareholders have residual claims against the corporation on earnings and on assets upon dissolution. common stock equivalents (CSEs): All contingent securities that derive a major portion of their value from their conversion privileges or common stock characteristics. common-size income statement: An income statement in which each item is expressed as a percentage of sales. compensating balance: A required checking account balance equal to a certain percentage of the amount borrowed from a bank under a line-of-credit or revolving credit agreement. competitive bidding: A method of choosing an investment banker in which the banker or group of bankers that bids the highest price for a security issue is awarded the issue. composition arrangement: Is an agreement with creditors to avoid bankruptcy that involves a pro rata cash settlement of creditor claims by the debtor firm; a uniform percentage of each dollar owed is paid to each creditor. compounded interest: Interest earned on a given deposit that has become part of the principal at the end of a specified period. concentration banking: A collection procedure in which payments are made to regionally dispersed collection centers, then deposited in local banks for quick clearing. Reduces collection float by shortening mail and clearing float. conflicting rankings: Conflicts in the ranking of a given project by NPV and IRR resulting from differences in the magnitude and timing of cash flows. congeneric merger: A merger in which one firm acquires another firm that is in the same general industry but neither in the same line of business nor a supplier or customer. conglomerate merger: A merger combining firms in unrelated businesses. conservative funding strategy: A funding strategy under which the firm finances both its seasonal and its permanent requirements with long-term debt. consolidation: The combination of two or more firms to form a completely new corporation. constant growth model: A widely cited dividend valuation approach that assumes that dividends will grow at a constant rate that is less than the required return. constant growth dividend valuation (Gordon) model: Assumes that the value of a share of stock equals the present value of all future dividends (assumed to grow at a constant rate) that it is expected to provide over an infinite time horizon. The model assumes that dividends will grow at a rate that is less than the required rate of return. constant-payout-ratio dividend policy: A dividend policy based on the payment of a certain percentage of earnings to owners in each dividend period. contingent securities: Convertibles, warrants, and stock options. Their presence affects the reporting of a firm‘s earnings per share (EPS). continuous compounding: Compounding of interest an infinite number of times per year at intervals of microseconds. continuous probability distribution: A probability distribution showing all the possible outcomes and associated probabilities for a given event. controlled disbursing: The strategic use of mailing points and bank accounts to lengthen mail float and clearing float, respectively. controller: The officer responsible for the firm‘s accounting activities, such as tax management, data processing, and cost and financial accounting. conventional cash flow pattern: An initial outflow followed by a series of inflows. conversion feature: An option that is included as part of a long-term debt or a preferred share issue that allows its holder to change the security into a stated number of common shares. conversion price: The per-share price that is effectively paid for common shares as the result of conversion of a convertible security. conversion ratio: The ratio at which a convertible security can be exchanged for common shares. conversion (or stock) value: The value of a convertible security measured in terms of the market price of the common shares into which it can be converted. convertible bond: A bond that can be changed into a specified number of common shares at the option of the bondholder. convertible preferred shares: Preferred shares that can be changed into a specified number of common shares. corporate bond: A certificate indicating that a corporation has borrowed a certain amount of money from an institution or an individual and promises to repay it in the future under clearly defined terms. corporate governance: The set of actions and procedures common shareholders use to ensure they receive a reasonable return on their investment in the company. D I C T I O N A R Y Ken Hartviksen – Lakehead University, 2004 corporate restructuring: The activities involving expansion or contraction of a firm‘s operations or changes in its asset or financial (ownership) structure. corporation: a business entity created by law. It has the powers under the law of an individual: it can sue and be sued, make and be party to contracts, acquire property and incur debts in its own name. correlation: A statistical measure of the relationship, if any, between two series of numbers representing data of any kind. If two series move in the same direction they are said to be positively correlated. If two series move in opposite directions, they are said to be negatively correlated. correlation coefficient: A measure of the degree of correlation or comovement between two series of numbers. The correlation coefficient can have a value from +1 (perfect positive correlation) to –1 (perfect negative correlation). cost of a new issue of common stock: Determined by calculating the cost of common stock after considering both the amount of underpricing and the associated flotation costs. cost of capital: The minimum rate of return that a firm must earn on its project investments to maintain its market value and attract needed funds. This rate of return is based on the mix of debt and common equity financing. cost of common equity: The rate at which investors discount the expected dividends of the firm to determine its share value: the required rate of return investors demand for holding the common shares of the company. cost of giving up a cash discount: The implied rate of interest paid to delay payment of an account payable for an additional number of days. cost of long-term debt: The after tax cost today of raising long-term funds through borrowing. cost of new asset: The net outflow required to acquire a new asset. cost of preferred stock: The relationship between the cost of the preferred equity and the amount o funds provided by the preferred share issue: found by dividing the annual preferred share dividend, by the net proceeds from the sale of the preferred stock. cost of retained earnings: Since reinvested profits are common shareholders‘ money, these funds have a cost which is the cost of common equity, ks. coupon rate: The interest rate on a long-term debt issue which is set at the time of the original issue and is constant for the full term of the issue. coverage ratios: Ratios that measure the firm‘s ability to pay certain fixed financing charges. Includes times interest earned ratio and the fixedcharge coverage ratio. credit analysis: The evaluation of credit applicants. credit monitoring: The ongoing review of a firm‘s accounts receivable to determine whether customers are paying according to the stated credit terms. credit period: The number of days after the beginning of the credit period until the payment of the account is due. credit policy: The determination of credit selection, credit standards, and credit terms. credit scoring: A credit selection method commonly used with high-volume/small dollar credit requests; relies on a credit score determined by applying statistically derived weights to a credit applicant‘s scores on key financial and credit characteristics. credit selection: The decision whether to extend credit to a customer and how much credit to extend. credit standards: The minimum requirements for extending credit to a customer. credit terms: The terms of sale for customers who have been extended credit by the firm. cross-over rate: The discount rate where NPV profiles intersect meaning the NPVs of the two projects are equal, and where the ranking decision for the projects changes. cross-sectional analysis: The comparison of different firms‘ financial ratios at the same point in time; involves comparing the firm‘s ratios to those of other firms in its industry or to industry averages. cumulative feature: Missed dividend payments on preferred shares accumulate, meaning that dividends in arrears must be paid with the current dividend prior to the payment of dividends to common shareholders. cumulative preferred stock: Preferred stock for which all passed (unpaid) dividends in arrears must be paid along with the current dividend before payment of dividends to common shareholders. cumulative translation adjustment: Equity reserve account on parent company‘s books in which translation gains and losses are accumulated. cumulative voting system: The system under which each share of common stock is allotted a number of votes equal to the total number of corporate directors to be elected and votes can be given to any director(s). current assets: Short-term assets, expected to be converted into cash within one year or less. current expenditure: An outlay of funds by the firm resulting in benefits received within one year. current liabilities: Short-term liabilities, expected to be paid within one year or less. current rate method: All financial transactions are measured in the currency of the foreign operations and consolidation occurs by converting all balance sheet accounts at the exchange rate in effect at the close of Dictionary of Financial Terms D-7 the fiscal year and all income statement accounts at the average exchange rate for the fiscal year. current ratio: A measure of liquidity calculated by dividing the firm‘s current assets by its current liabilities. date of invoice: Indicates that the beginning of the credit period is the date on the invoice for the purchase. date of record (dividends): The date, set by the firm‘s directors, on which every person whose name is recorded as a shareholder will, at a specified future time, receive a declared dividend. date of record (rights): The last date on which the recipient of a right must be the legal owner indicated in the company‘s stock ledger. day loans: Loans made by chartered banks to investment dealers who are major holders of treasury bills. debenture: A long-term debt security that is backed by the general earnings potential of the corporation. An unsecured bond. See Table 6.4, page 258. debt capital: All long-term borrowing incurred by the firm. debt ratio: Measures the proportion of total assets financed by the firm‘s creditors. debt-equity ratio: Measures the ratio of long-term debt to common equity. degree of financial leverage (DFL): The numerical measure of the firm‘s financial leverage. Measured at a base level of EBIT. Lowest value is 1. The higher the value of DFL the greater the risk, but also the greater the potential return if EBIT increases. degree of indebtedness: Measures amount of debt relative to other significant balance sheet amounts. degree of operating leverage (DOL): The numerical measure of the firm‘s operating leverage. Measured at a base sales level. The closer the sales level to the breakeven point, the greater the DOL. degree of total leverage (DTL): The numerical measure of the firm‘s total leverage. Equal to the product of the DOL and DFL. depository transfer check (DTC): An unsigned check drawn on one of the firm‘s bank accounts and deposited in another. depreciable life: Time period over which an asset is depreciated. depreciation: The systematic charging of a portion of the costs of fixed assets against annual revenues over time. depth of a market: A characteristic of a ready market, determined by its ability to absorb the purchase or sale of a large dollar amount of a particular security. derivative security: A financial security that is neither debt nor equity but derives its value from an underlying asset that is other another security; called ―derivative‖ for short. double taxation: A situation where the same income is taxed in two separate countries; to reduce double taxation, many countries have negotiated tax treaties that override domestic law. diluted EPS: Earnings per share (EPS) calculated under the assumption that all contingent securities that would have dilutive affects are converted into common shares. dilution of ownership: Occurs when a new share issue results in each present shareholder having a claim on a smaller part of the firm‘s earnings than previously. direct lease: A lease under which a lessor owns or acquires the assets that are leased to a given lessee. direct send: A collection procedure in which the payee presents payment checks directly to the banks on which they are drawn, thus reducing clearing float. disbursement float: The lapse between the time when a firm deducts a payment from its checking account ledger (disburses it) and the time when funds are actually withdrawn from its account. discount: The amount by which a bond sells at a value that is less than its par, or face, value. discount loans: Loans on which interest is paid in advance by being deducted from the amount borrowed. discounting cash flows: The process of finding present values; the inverse of compounding interest. diversifiable risk: The portion of an asset‘s risk that is attributable to firm-specific, random causes; can be eliminated through diversification. divestiture: The selling of some of a firm‘s assets for various strategic motives. dividend irrelevance theory: A theory put forth by Miller and Modigliani that, in a perfect world, the value of a firm is unaffected by the distribution of dividends and is determined solely by the earning power and risk of its assets. dividend payout ratio: Indicates the percentage of each dollar earned that is distributed to the owners in the form of cash; calculated by dividing the firm‘s cash dividend per share by its earnings per share. dividend policy: The firm‘s plan to be followed when making the dividend decision. dividend reinvestment plans (DRPs): Plans that enable shareholders to use dividends received on the firm‘s shares to acquire additional full or fractional shares at no transaction (brokerage) cost. dividend relevance theory: The theory, attributed to Gordon and Lintner, that shareholders prefer current D I C T I O N A R Y Ken Hartviksen – Lakehead University, 2004 dividends and that there is a direct relationship between a firm‘s dividend policy and its market value. dividends: Periodic distributions of earnings to the owners of stock in a firm paid only at the discretion of the board of directors. dividend valuation model (DVM): The value of common shares is dependent upon the sum of the present value of the dividends received over an infinite time horizon. double taxation: Occurs when the already once-taxed earnings of a corporation are distributed as cash dividends to its shareholders, who are then taxed again on these dividends. due diligence: The process completed by the underwriter to ensure there is no misrepresentation and that the prospectus contains full and true disclosure of all material information that might affect the value of the security offered for sale. Dun & Bradstreet (D&B): The largest mercantile credit-reporting agency in the United States. DuPont formula: Multiplies the firm‘s net profit margin by its total asset turnover to calculate the firm‘s return on total assets (ROA). DuPont system of analysis: The system used by management to dissect the firm‘s financial statements and to assess its financial condition. Dutch auction bid: A variation of the fixed-price tender bid where the company specifies the number of shares it wishes to repurchase and a range of prices at which it will purchase the shares. Dutch auction preferred shares: Similar to money market securities with no stated maturity; the dividend rate is reset on a regular basis through a Dutch auction process. earnings per share (EPS): The amount earned during the period on each outstanding share of common stock, calculated by dividing the period‘s total earnings available for the firm‘s common shareholders by the number of shares of common shares outstanding. EBIT-EPS approach: An approach for selecting the capital structure that maximizes earnings per share (EPS) over the expected range of earnings before interest and taxes (EBIT). economic conversion quantity (ECQ): The costminimizing quantity in which to convert marketable securities to cash. economic exposure: The risk resulting from the effects of changes in foreign exchange rates on the firm‘s value. economic order quantity (EOQ) model: An inventory management technique for determining an item‘s optimal order quantity, which is the size that minimizes the total of its order costs and carrying costs. economic value added (EVA): a popular measure, used by many firms to determine whether an investment contributes positively to the owners‘ wealth; calculated by subtracting the cost of funds used to finance an investment from its after-tax operating profits. effective (true) annual rate: The rate of interest actually paid or earned. effective interest rate (international context): The rate equal to the nominal rate plus (or minus) any forecast appreciation (or depreciation) of a foreign currency relative to the currency of the MNC parent. efficient market: A market that allocates funds to their most productive uses due to competition among wealth-maximizing investors; it determines and publicizes prices that are believed to be close to their true or intrinsic value (inherent worth). It is an assumed ―perfect market‖ in which there are many small invewstors, each having the same information and expectations with respect to securities; there are no restrictions on investment, no taxes, and no transaction costs; and all investors are rational, view securities similarly, and are risk-averse, preferring higher returns and lower risk. efficient market hypothesis: Theory describing the behaviour of an assumed ―perfect‖ market in which securities are typically in equilibrium, security prices fully reflect all public information available and react swiftly to new information, and, since stocks are fairly priced, investors need not waste time looking for mispriced securities. A market that allocates funds to their most productive uses as a result of competition among wealth-maximizing investors that determines and publicizes prices that are believed to be close to their true value. An assumed ―perfect‖ market in which there are many small investors, each having the same information and expectations with respect to securities; there are no restrictions on investment, no taxes, and no transaction costs; and all investors are rational, they view securities similarly, and they are risk-averse, preferring higher returns and lower risk. efficient portfolio: A portfolio that maximizes return for a given level of risk or minimizes risk for a given level of return. end of month (EOM): Indicates that the credit period for all purchases made within a given month begins on the first day of the month immediately following. ending cash: The sum of the firm‘s beginning cash and its net cash flow for the period. equity capital: The long-term funds provided by the firm‘s owners, the shareholders. Dictionary of Financial Terms D-9 escape clauses: Provisions in the underwriting agreement that allow the syndicate to not buy the issue from the organization if specific conditions exist. ethics: Standards of conduct or moral judgment. euro: A single currency adopted on January 1, 1999, by 12 of the 15 EU nations, who switched to a single set of euro bills and coins on January 1, 2002. Eurobond: A bond issued by an international borrower and sold to investors in countries with currencies other than the currency in which the bond is denominated. An international bond that is sold primarily in countries other than the country of the currency in which the issue is denominated. Eurocurrency loan market: A large number of international banks that make long-term, floating rate, hard-currency (typically U.S. dollar-denominated) loans in the form of lines of credit to international corporate and government borrowers. Eurocurrency market: The market for short-term bank deposits denominated in U.S. dollars or other easily convertible currencies. International equivalent of the domestic money market. The portion of the Euromarket that provides short-term, foreign-currency financing to subsidiaries of MNCs. Eurodollar deposits: Deposits of currency not native to the country in which the bank is located; negotiable, usually pay interest at maturity, and are typically denominated in units of $1 million. Provide yields above nearly all other marketable securities with similar maturities. Euroequity market: The capital market around the world that deals in international equity issues; London has become the center of Euro-equity activity. Euromarket: The international financial market that provides for borrowing and lending currencies outside their country of origin. European Open Market: The transformation of the European Union into a single market at year-end 1992. European Union (EU): A significant economic force currently made up of 15 nations that permit free trade within the union. ex ante calculation: A calculation that forecasts a result. Examples include the yield to maturity on a bond or the internal rate of return on a capital project. Ex ante means before-the-fact. ex dividend: Period beginning two business days prior to the date of record during which a stock will be sold without the right to receive the current dividend. ex rights: Period beginning two business days prior to the date of record during which a share will be sold without announced rights being attached to it. excess cash balance: The (excess) amount available for investment by the firm if the period‘s ending cash is greater than the desired minimum cash balance; assumed to be invested in marketable securities. exchange rate risk: The danger that an unexpected change in the exchange rate between the dollar and the currency in which a project‘s cash flows are denominated can reduce the market value of that project‘s cash flow. exchange rate risk: The risk caused by varying exchange rates between two currencies. exchange rate risk (capital budgeting):danger that an unexpected change in the exchange rate between the dollar and the currency in which the project‘s cash flows are denominated can reduce the market value of that project‘s cash flow. exercise (or option) price: The price at which holders of warrants can purchase a specified number of shares of common shares. expectations hypothesis: Theory suggesting that the yield curve reflects investor expectations about future interest rates; an increasing inflation expectation results in an upward-sloping yield curve and a decreasing inflation expectation results in a downward-sloping yield curve. expected return: The return that is expected to be earned each period on a given asset over an infinite time horizon. expected value of a return: The most likely return on a given asset. ex post calculation: A calculation done to analyze something that has already happened. The holding period return on a stock is an example of an ex post calculation. Ex post means after-the-fact. extendible bonds (notes): Bonds with short terms to maturity, typically 1 to 5 years, that can be renewed for a similar period at the option of the holders. See Table 6.4. extension: An arrangement whereby the firm‘s creditors receive payment in full, although not immediately. external forecast: A sales forecast based on the relationships observed between the firm‘s sales and certain key external economic indicators. external funds required (“plug” figure): Under the judgmental approach for developing a pro forma balance sheet, the amount of external financing needed to bring the statement into balance. extra dividend: An additional dividend optionally paid by the firm if earnings are higher than normal in a given period. factor: A financial institution that specializes in purchasing accounts receivable from businesses. factoring accounts receivable: The outright sale of accounts receivable at a discount to a factor or other financial institution to obtain funds. D I C T I O N A R Y Ken Hartviksen – Lakehead University, 2004 FASB No. 52: Statement issued by the FASB requiring U.S. multinationals first to convert the financial statement accounts of foreign subsidiaries into their functional currency and then to translate the accounts into the parent firm‘s currency using the allcurrent-rate method. federal agency issues: Low-risk securities issued by government agencies but not guaranteed by the U.S. Treasury, having generally short maturities, and offering slightly higher yields than comparable U.S. Treasury issues. federal funds: Loan transactions between commercial banks in which the Federal Reserve banks become involved. fidelity bond: A contract under which a bonding company agrees to reimburse a firm for up to a stated amount if a specified manager‘s dishonest act results in a financial loss to the firm. finance: The art and science of managing money. finance company paper: Short-term secured promissory notes issued by sales finance companies. A money market financial instrument. financial (or capital) lease: A longer-term lease than an operating lease that is noncancelable and obligates the lessee to make payments for the use of an asset over a predefined period of time; the total payments over the term of the lease are greater than the lessor‘s initial cost of the leased asset. Financial Accounting Standards Board (FASB): The U.S. accounting profession‘s rule-setting body, which authorizes generally accepted accounting principles (GAAP). Financial Accounting Standards Board (FASB) Standard No. 52: Ruling by FASB--the policysetting body of the U.S. accounting profession--that mandates that U.S.-based companies must translate their foreign-currency-denominated assets and liabilities into dollars using the current rate (translation) method. financial break-even points: The level of EBIT necessary just to cover all fixed financial costs; the level of EBIT for which EPS=$0. financial engineering: Designing new financial securities or processes due to changing market conditions and/or investor preferences. financial forecasting: The process used to estimate a company‘s requirement for financing for a future time period. financial institution: An intermediary that allow for the efficient transfer of the savings of individuals, businesses, and governments into loans or investments. financial (or capital) lease: A longer-term lease than an operating lease that is noncancellable and obligates the lessee to make payments for the use of an asset over a predefined period of time; the total payments over the term of the lease are greater than the lessor‘s initial cost of the leased asset. financial lever: The use of fixed assets in the company‘s operation and/or use of debt financing in the capital structure. financial leverage: The magnification of risk and return introduced through the use of fixed-cost financing such as debt and preferred stock. The potential use of fixed financial costs to magnify the effects of changes in earning before interest and taxes (EBIT) on the firm‘s earnings per share (EPS). financial leverage multiplier (FLM): The ratio of the firm‘s total assets to shareholders‘ equity. financial manager: Actively manages the financial affairs of any type of business, whether financial or nonfinancial, private or public, large or small, profitseeking or not-for-profit. financial markets: Provide a forum in which suppliers of funds and demanders of loans and investments can transact business directly. financial merger: A merger transaction undertaken with the goal of restructuring the acquired company to improve its cash flow and unlock its hidden value. financial planning process: Planning that begins with long-term (strategic) financial plans that in turn guide the formulation of short-term (operating) plans and budgets. financial risk: The risk to the firm of being unable to cover required financial obligations (interest, lease payments, preferred share dividends). financial services: The part of finance concerned with design and delivery of advice and financial products to individuals, business, and government. financial supermarket: An institution at which the customer can obtain a full array of the financial services now allowed under federal bank, trust and insurance company legislation. financial structure: The entire right hand side of the balance. Refers to the mix of long-term and shortterm financing. financing flows: Cash flows that result from debt and equity-financing transactions; includes incurrence and repayment of debt, cash inflow from the sale of share, and cash outflows to repurchase stock or pay cash dividends. finished goods inventory: Items that have been produced but not yet sold. firm agreement: An underwriting agreement where the syndicate agrees to buy all of the securities at the stated price, guaranteeing the issuing firm receives the required amount of money. Dictionary of Financial Terms D - 11 five C’s of credit: The five key dimensions-character, capacity, capital, collateral, and conditions-used by a firm‘s credit analysts in their analysis of an applicant‘s creditworthiness. fish-and-bait test: A description for the payback period since it concentrates on recovering the bait (the initial investment) paying no attention to the size of the fish (Present Value of all cash inflows). fixed asset turnover: Measures the efficiency with which the firm has been using its net fixed, or earning, assets to generate sales. fixed (or semi-fixed) relationship: The constant (or relatively constant) relationship of a currency to one of the major currencies, a combination (basket) of major currencies, or some type of international foreign exchange standard. fixed-charge coverage ratio: Measures the firm‘s ability to meet all fixed-payment obligations. fixed-price tender bid: An offer by a company to purchase a certain percentage of its own shares at a stated price that is well above the current market price within a specified period of time; termed a substantial issuer bid. fixed-rate loan: A loan with a rate of interest that is determined at a set increment above the prime rate at which it remains fixed until maturity. flat yield curve: A yield curve that reflects relatively similar borrowing costs for both short- and longerterm loans. float: Funds that have been sent by the payer but are not yet usable funds to the payee. floatation costs: The total costs of issuing and selling a security. Includes the underwriters discount, legal, accounting fees and fees paid to regulators. floating inventory lien: A secured short-term loan against inventory under which the lender‘s claim is on the borrower‘s inventory in general. floating rate bonds: bonds where the stated interest rate is adjusted periodically within stated limits in response to changes in specified money or capital market rates. See Table 6.4. floating relationship: The fluctuating relationship of the values of two currencies with respect to each other. floating-rate loan: A loan with a rate of interest initially set at a state premium above the prime rate and allowed to ―float,‖ or vary, as the prime rate varies until maturity. floating rate preferreds: The quarterly dividend paid is based on interest rates in the market and will float with these rates. floor rate: The yield on federal government debt or any maturity. flotation costs: The total costs of issuing and selling a security. forecasting risk: The possibility that the estimated cash flows are wrong (either too high or too low) and, as a result, a wrong decision made. foreign affiliate: A foreign corporation in which the MNC owns at least 10 percent of the common shares. foreign bond: A bond issued in a host country‘s financial market, in the host country‘s currency, by a foreign borrower. An international bond that is sold primarily in the country of the currency of the issue. foreign direct investment: The transfer by a multinational firm of capital, managerial, and technical assets from its home country to a host country. foreign direct investment (FDI): The transfer, by a multinational firm, of capital, managerial, and technical assets from its home country to a host country. foreign exchange manager: The manager responsible for monitoring and managing the firm‘s exposure to loss from currency fluctuations. foreign exchange rate: The value of two currencies with respect to each other. foreign subsidiary: An incorporated business established by an MNC that is completely separate from the parent. forward exchange rate: The rate of exchange between two currencies at some specified future date. four C’s of credit: The four key dimensions of credit – character, capacity, capital, and conditions – used by credit analysts to provide a framework for in-depth credit analysis. Free Trade Area of the Americas: A trading bloc that would extend the NAFTA and the Mercosur Group to create a free trade zone from the Arctic to Cape Horn. friendly merger: A merger transaction endorsed by the target firm‘s management, approved by its shareholders, and easily consummated. fully diluted EPS: Earnings per share (EPS) calculated under the assumption that all contingent securities are converted and exercised and are therefore common stock. functional currency: The currency of the economic environment in which a business entity primarily generates and expends cash and in which its accounts are maintained. future value: The value of a present amount at a future date found by applying compound interest over a specified period of time. future-value interest factor: The multiplier used to calculate at a specified interest rate, the future value of a present amount as of a given time. D I C T I O N A R Y Ken Hartviksen – Lakehead University, 2004 future-value interest factor for an annuity: The multiplier used to calculate the future value of an ordinary annuity at a specified interest rate over a given period of time. General Agreement on Tariffs and Trade (GATT): A treaty that has governed world trade throughout most of the postwar era; it extends free trading rules to broad areas of economic activity and is policed by the World Trade Organization (WTO). generally accepted accounting principles (GAAP): The practice, procedure, and standards used to prepare and maintain financial records, reports and statements; authorized by the Canadian Institute of Chartered Accountants (CICA) Handbook. GIGO (garbage in, garbage out) in capital budgeting: If cash inflows are overestimated and/or the cost of capital underestimated, then decisions that prove to be very costly for the firm and the shareholders can result; poor forecasts can result in poor capital budgeting decisions. Giro system: System through which retail transactions are handled in association with a foreign country‘s national postal system. golden parachutes: Provisions in the employment contracts of key executives that provide them with sizable compensation if the firm is taken over; deters hostile takeovers to the extent that the cash outflows required are large enough to make the takeover unattractive. goodwill: The amount paid for a business in excess of the value of the assets acquired. Gordon model: A common name for the constant growth model that is widely cited in dividend valuation. government security dealer: An institution that purchases for resale various government securities and other money market instruments. greenmail: A takeover defense under which a target firm repurchases through private negotiation a large block of stock at a premium from one or more shareholders to end a hostile takeover attempt by those shareholders. green sheet: A document prepared by the underwriter that summarizes key information in the prospectus. gross margin: Measures the percentage of each sales dollar remaining after the firm has paid the direct costs of the products sold (Cost of Goods Sold). hedging strategies: Techniques used to offset or protect against risk; in the international context these include borrowing or lending in different currencies, undertaking contracts in the forward, futures, and/or options markets, and also swapping assets/liabilities with other parties. historic weights: Either book or market value weights based on actual capital structure proportions; used in calculating the weighted average cost of capital. holders of record: Owners of the firm‘s shares on the date of record. holding company: A corporation that has voting control of one or more other corporations. horizontal merger: A merger of two firms in the same line of business. hostile merger: A merger transaction not supported by the target firm‘s management, forcing the acquiring company to try to gain control of the firm by buying shares in the marketplace. hostile takeover: The acquisition of the firm (the target) by another firm or group (the acquisitor) that is not supported by the management of the target firm. hybrid security: A form of debt or equity financing that possesses characteristics of both debt and equity. implied price of a warrant: The price effectively paid for each warrant attached to a bond. incentive plans: Management compensation plans that tend to tie management compensation to share price; most popular incentive plan involves the grant of stock options. income bonds: Bonds that pay interest only when earnings are available. See Table 6.4. income statement: Provides a financial summary of the firm‘s operating results during a specified period. incremental cash flows: The additional cash flows-outflows or inflows--that are expected to result from a proposed capital expenditure. incremental cost of a new asset: The total of all costs incurred to get an asset to the point of being able to produce cash inflows for the company, less the proceeds from the sale of an old asset, often the asset being replaced. independent projects: Projects whose cash flows are unrelated or independent of one another; the acceptance of one does not eliminate the others from further consideration. informational content: The information provided by the dividends of a firm with respect to future earnings, which causes owners to bid the price of the firm‘s shares up or down. initial investment: The relevant cash outflow required now, at time zero, for a capital budgeting project. initial public offering (IPO): Referred to as going public, the process of offering common shares of a privately owned company to the general public for the first time. insolvency rule: The legal rule governing Canadian companies that states a company cannot pay dividends Dictionary of Financial Terms D - 13 while insolvent or if the payment of dividends will make the company insolvent. installation cost: Costs incurred to place equipment or machinery into operation. installed cost of new asset: The cost of the asset plus its installation costs; equals the asset‘s depreciable value. institutional investors: Financial intermediaries such as mutual funds, pension funds, and life insurance companies. integrated foreign subsidiary: An operation that is financially or operationally interdependent with the parent company. intercorporate dividends: Dividends received on common and preferred stock held in other corporations. They are included in income for tax purposes, but if the they are received from a taxable Canadian corporation, the full amount of the dividend is not taxable and can flow through the receiving company to their shareholders without tax consequences. This avoids the triple taxation. intangible assets: Assets that cannot be seen or touched, but are valuable to a company. Examples include the value of trademarks, patents, franchise rights, and goodwill. intercorporate dividends: Dividends received by a corporation from investments in common and preferred shares held in other corporations. interest: The return paid on debt financing. Interest income is taxable in the hands of the investor at their personal marginal tax rate. Interest expense is usually a tax-deductible expense of the corporate borrower. interest equivalent factor: A tax-related adjustment that must be made that allows the before-tax dividend yield on equity securities to be compared to the before-tax yield on debt securities. interest rate: The cost of money. The greater the risk of the debt security, the higher the interest rate lenders will require. The compensation paid by the borrower of funds to the lender; from the borrower‘s point of view, the cost of borrowing funds. interest rate buydowns: One form of government incentive used to encourage corporate capital expenditures involving Government payments of interest on a loan on behalf of a company. interest rate risk: The chance that interest rates will change and thereby change the required return and bond value. Rising rates, which result in decreasing bond values, are of greatest concern. intermediate cash inflows: Cash inflows received before the termination of a project. internal forecast: A sales forecast based on a buildup, or consensus, of forecasts through the firm‘s own sales channels. internal rate of return (IRR): The discount rate that equates the present value of cash inflows with the initial cost of a capital budgeting project; the discount rate that makes the NPV of the project equal to $0. internal rate of return approach: An approach to capital rationing that involves the graphic plotting of project IRRs in descending order against the total dollar investment to determine the group of acceptable projects. international bond: A bond that is initially sold outside the country of the borrower and often distributed in several countries. international equity market: A vibrant equity market that emerged in the past 20 years to allow corporations to sell large blocks of shares in several different countries simultaneously. intracompany netting technique: A technique used by multinational firms to minimize their cash requirements by transferring across national boundaries only the net amount of payments owed between them. Sometimes bookkeeping entries are substituted for international payment. intrinsic value (common stock): Inherent worth. intrinsic value (warrant): The positive difference between the current market price of a firm‘s common shares and the exercise price of the warrant. inventory turnover: Measures the activity, or liquidity, of a firm‘s inventory. inverted yield curve: A downward-sloping yield curve that indicates generally cheaper long-term borrowing costs than short-term borrowing costs. investment banker: A term for investment dealers when performing the underwriting function. investment flows: Cash flows associated with purchase and sale of both fixed assets and business interests. investment opportunities schedule (IOS): A ranking of investment possibilities from best (highest returns) to worst (lowest returns). The graph that plots project IRRs in descending order against required total dollar investment. investment tax credit (ITC): An incentive for businesses in various regions of the country to purchase certain types of assets or undertake certain types of research and development activities; results in a direct reduction of federal taxes that would otherwise be payable. involuntary reorganization: A petition initiated by an outside party, usually a creditor, for the reorganization and payment of creditors of a failed firm. issued shares: The number of shares of common stock that have been put into circulation; they D I C T I O N A R Y Ken Hartviksen – Lakehead University, 2004 represent the sum of outstanding shares and treasury stock. joint venture: A partnership under which the participants have contractually agreed to contribute specified amounts of money and expertise in exchange for stated proportions of ownership and profit. judgmental approach: A method for developing the pro forma balance sheet in which the values of certain balance sheet accounts are estimated while others are calculated, using the firm‘s external financing as a balancing, or ―plug,‖ figure. junk bonds: long-term secured debt securities that are rated double BB or less. Bonds that are not investment quality. Investment quality bonds are BBB or greater. just-in-time (JIT) system: Inventory management system that minimizes inventory investment by having material arrive at exactly the time they are needed for production. lease-versus-purchase (or lease-versus-buy) decision: The decision facing firms needing to acquire new fixed assets; whether to lease the assets or to purchase them, using borrowed funds or available liquid resources. leasing: The process by which a firm can obtain the use of certain fixed assets for which it must make a series of contractual, periodic, tax-deductible payments. lessee: Has physical control of and uses the assets under a lease contract. lessor: The owner of assets that are being leased. letter of credit: A letter written by a company‘s bank to the company‘s foreign supplier, stating that the bank guarantees payment of an invoiced amount if all the underlying agreements are met. letter to shareholders: Typically the first element of the annual shareholders‘ report following a summary of the company‘s financial performance for the year, and the direct communication from senior management to the firm‘s owners. leverage: The advantage gained by using a lever. It results from the use of fixed-cost assets or funds to magnify returns (or in some cases, losses) to the firm‘s owners. leveraged buyout (LBO): An acquisition technique involving the use of a large amount of debt to purchase a firm; an example of a financial merger. leveraged lease: A lease under which the lessor acts as an equity participant, supplying only about 20 percent of the cost of the asset, while a lender supplies the balance. leveraged recapitalization: A takeover defense in which the target firm pays a large debt-financed cash dividend, increasing the firm‘s financial leverage and deterring the takeover attempt. lien: A publicly disclosed legal claim on collateral. life insurance companies: Federally-regulated financial institutions that invest premiums from life insurance policyholders to ensure sufficient funds are available to pay out the stated value of life insurance upon the death of the policyholder. limited liability: A feature of common equity meaning that investors cannot lose more than they have invested in the firm. limited partnership: A partnership with one or more general partners with unlimited legal liability and one or more limited partners with legal liability limited to the amount they have invested in the business. The limited partners are ‗silent‘ in that their financial investment in the business is the total extent of their involvement with the business. line of credit: An agreement between a chartered bank and a business specifying the amount of unsecured short-term borrowing the bank will make available to the firm over a given period of time. liquidation value per share: The actual amount per share that would be received if all of the firm‘s assets were sold for their market value, liabilities (and preferred shares) are paid, and any remaining money were divided among the common shareholders. liquidity: A firm‘s ability to satisfy its short-term obligations as they come due. liquidity preference theory: Theory suggesting that for any given issuer, long-term interest rates tend to be higher than short-term rates due to the lower liquidity and higher responsiveness to general interest rate movements of longer-term securities; causes the yield curve to be upward-sloping. liquidity preferences: General preferences of investors for shorter-term securities. loan amortization: The determination of the equal annual loan payments necessary to provide a lender with a specified interest return and to repay the loan principal over a specified period. loan amortization schedule: A schedule of equal payments to repay a loan. It shows the allocation of each loan payment to interest and principal. lockbox system: A collection procedure in which customers mail payments to a post office box that is emptied regularly by the firm‘s bank, which processes the payments and deposits them in the firm‘s account. This system speeds up collection time by reducing processing time as well as mail and clearing time. London Interbank Offered Rate (LIBOR): The base interest rate on all Eurocurrency loans. Dictionary of Financial Terms D - 15 long-term debt: A contractual liability between the two parties, the borrower (issuer) and the lender (saver). Examples include bonds and debentures. long-term (strategic) financial plans: Planned financial actions and the anticipated financial impact of those actions over periods ranging from 2 to 10 years. long-term financing: Financing with an initial maturity of more than one year. low-regular-and-extra dividend policy: A dividend policy based on paying a low regular dividend, supplemented by an additional dividend when earnings are higher than normal. macro political risk: The subjection of all foreign firms to political risk (takeover) by a host country because of political change, revolution, or the adoption of new policies. mail float: The time delay between when a payment is placed in the mail and when it is received. maintenance clauses: Provisions normally included in a lease that require one of the parties to maintain the assets and to make insurance and tax payments. majority voting system: The system whereby, in the election of the board of directors, each shareholder is entitled to one vote for each share of stock owned and he or she can vote all shares for each director. Management’s discussion and Analysis (MD&A): MD&A is a supplemental report included in the annual report that allows the reader to look at the company through the eyes of management by providing a current and historical analysis of the business of the company. managerial finance: Concerns the duties of the financial manager in the business firm. manufacturing and processing deduction: A 7 percent reduction from the general federal tax rate that the government allows manufacturing companies. marginal analysis: Economic principle that states that financial decisions should be made and actions taken only when the added benefits exceed the added costs. marginal cost of capital (MCC): The firm‘s weighted average cost of capital (WACC) associated with its next dollar of total new financing. marginal cost of capital (MCC) schedule: Graph that relates the firm‘s weighted average cost of capital (WACC) to the level of total new financing. marginal tax rate: The rate at which additional income is taxed. market premium (convertible securities): The amount by which the market value exceeds the straight or conversion value of a convertible security. market return: The expected return on the market portfolio of all traded securities. Since it is an expected return, it is always greater than the risk-free rate of return because market participants are assumed to be risk-averse wealth maximizers. market risk-return function: A graph of the discount rates associated with each level of project risk. market segmentation theory: Theory suggesting that the market for loans is segmented on the basis of maturity and that the sources of supply and demand for loans within each segment determine its prevailing interest rate; the slope of the yield curve is determined by the general relationship between the prevailing rates in each segment. market stabilization: The process in which an underwriting syndicate places orders to buy the security that it is attempting to sell to keep the demand for the issue, and therefore its price, at the desired level. market value weights: Weights that use market values to measure the proportion of each type of capital in the firm‘s financial structure; used in calculating the weighted average cost of capital. marketable securities: Short-term debt instruments, such as Government of Canada treasury bills, commercial paper, and negotiable certificates of deposit issued by government, business, and financial institutions, respectively. materials requirement planning (MRP) system: Inventory management technique that applies EOQ concepts and a computer to compare production needs to available inventory balances and determine when orders should be placed for various items on a product‘s bill of materials. Mercosur Group: A major South American trading bloc that includes countries that account for more than half of total Latin American GDP. merger: The combination of two or more firms, in which the resulting firm maintains the identity of one of the firms, usually the larger one. micro political risk: The subjection of an individual firm, a specific industry, or companies from a particular foreign country to political risk (takeover) by the host country. Miller-Orr model: A model that provides for costefficient transactional cash balances; assumes uncertain cash flows and determines an upper limit and return point for cash balances. mixed stream: A series of cash flows exhibiting any pattern other than that of an annuity. A stream of cash flows of different amounts. modified DuPont formula: Relates the firm‘s return on total assets (ROA) to its return on equity (ROE) using the financial leverage multiplier (FLM). D I C T I O N A R Y Ken Hartviksen – Lakehead University, 2004 monetary union: The official melding of the national currencies of the EU nations into one currency, the euro, on January 1, 2002. money market: The market where debt securities that will mature within one year are traded. money market mutual funds: Professionally managed portfolios of various popular marketable securities, having instant liquidity, competitive yields, and low transaction costs. mortgage bonds: Long-term debt financing secured by real estate, buildings, manufacturing facilities, or other fixed assets. See Table 6.4. multinational companies (MNCs): Firms that have international assets and operations in foreign markets and draw part of their total revenue and profits from such markets. mutual funds: Investment companies that receive cash from individuals for investment in both money and capital market securities. mutually exclusive projects: Projects that compete with one another, so that the acceptance of one eliminates the others from further consideration. NASDAQ: The National Association of Securities Dealers Automated Quotation System, the best known over-the-counter (OTC) market in the world, that rivals the New York Stock Exchange in trading volumes. national entry control systems: Comprehensive rules, regulations and incentives introduced by host governments to regulate inflows of foreign direct investments from MNCs and at the same time extract more benefits from their presence. near-cash: Marketable securities, which are viewed the same as cash because of their high liquidity. negatively correlated: Descriptive of two series that move in opposite directions. negotiable certificates of deposit (CDs): Negotiable instruments representing specific cash deposits in commercial banks, having varying maturities and yields based on size, maturity, and prevailing money market conditions. Yields are generally above those on U.S. Treasury issues and comparable to those on commercial paper with similar maturities. negotiated offering: A security issue for which the investment banker is merely hired rather than awarded the issue through competitive bidding. net cash flow: The mathematical difference between the firm‘s cash receipts and its cash disbursements in each period. net present value (NPV): A sophisticated capital budgeting technique; found by subtracting a project‘s initial investment from the sum of the present value of its cash inflows discounted at a rate equal to the firm‘s cost of capital. net present value approach: An approach to capital rationing that is based on the use of present values to determine the group of projects that will maximize owners‘ wealth. net present value profiles: A table and/or graph that shows the net present value for a project at various discount rates. net proceeds: Funds actually received by the issuing firm from the sale of a security. This is equal to the selling price to the public less the costs of underwriting and distribution of the securities. net profit margin: Measures the percentage of each sales dollar remaining after all expenses, including taxes, have been deducted. net profits rule: The legal rule governing Canadian companies that dividends can only be paid from current and past earnings. net working capital: A measure of liquidity calculated as the difference between the firm‘s current assets and its current liabilities, or, alternatively, the portion of current assets financed with long-term funds; can be positive or negative. net working capital recapture: A positive cashflow benefit in a capital budgeting analysis that arises with the termination of a project. At termination, sales associated with the project cease, and the company will recover the originally invested net working capital. new issue: An issue of long-term debt, preferred share, or common share issues where the funds raised flow to the company. (ie. Capital formation occurs.) nominal interest rate (international context): The stated interest rate charged on financing when only the MNC parent‘s currency is involved. nominal rate of interest: The actual rate of interest charged by the supplier of funds and paid by the demander. non-cash expense: Expenses deducted from sales on the income statement that do not involve an actual outlay of cash during the period. nonconventional cash flow pattern: A pattern in which an initial outflow is not followed by a series of inflows. noncumulative preferred stock: Preferred stock for which passed (unpaid) dividends do not accumulate. nondiversifiable risk: The relevant portion of an asset‘s risk attributable to market factors that affect all firms and cannot be eliminated through diversification. nonnotification basis: The basis on which a borrower, having pledged an account receivable, continues to collect the account payments without notifying the account customer. Dictionary of Financial Terms D - 17 nonparticipating preferred stock: Preferred stock whose shareholders receive only the specified dividend payments. nonrecourse basis: The basis on which accounts receivable are sold to a factor with the understanding that the factor accept all credit risks on the purchased accounts. non-voting common shares: Common shares that carry no right to vote on issues affecting the company. Issued when the firm wishes to raise capital through the sale of common stock but does not want to relinquish its voting control. normal probability distribution: A symmetrical probability distribution whose shape resembles a bellshaped curve. normal yield curve: An upward-sloping yield curve that indicates generally cheaper short-term borrowing costs than long-term borrowing costs. North American Free Trade Agreement (NAFTA): The treaty establishing free trade and open markets between Canada, Mexico, and the United States. notification basis: The basis on which an account customer whose account has been pledged (or factored) is notified to remit payment directly to the lender (or factor) rather than to the borrower. offshore centers: Certain cities or states (including London, Singapore, Bahrain, Nassau, Hong Kong, and Luxembourg) that have achieved prominence as major centers for Euromarket business. open-market share repurchases: Company purchases of its own shares on a stock exchange at the market price once approval from the stock exchange is received; termed a normal course issuer bid in Canada. operating assets: The difference between the four pincipal current assets (cash, marketable securities, accounts receivable, and inventories) and accounts payable. operating band: a band, one-half of a percentage point wide, with the overnight rate at the centre and the bank rate at the top. operating breakeven point: The level of sales necessary to cover all operating costs; the point at which EBIT=$0. operating cash inflows: The incremental after tax cash inflows resulting from use of a project during its life. operating change restrictions: Contractual restrictions that a bank may impose on a firm as part of a line of credit agreement. operating cycle (OC): The amount of time that elapses from the point at which the firm begins to build inventory to the point at which cash is collected from sale of the resulting finished product. The recurring transition of a firm‘s working capital from cash to inventories to receivables and back to cash. operating flows: Cash flows directly related to production and sale of the firm‘s product and services. operating income: The principal reason a company considers investing in a fixed asset; operating income may increase because sales increase, costs decrease, or both occur. operating lease: A cancellable contractual arrangement whereby the lessee agrees to make periodic payments to the lessor, often for five or fewer years, to obtain the use of an asset; generally, the total payments over the term of the lease are less than the lessor‘s initial cost of the leased asset. operating leverage: The use of fixed operating costs to magnify the effects of changes in sales on the firm‘s earnings before interest and taxes (EBIT). operating margin: Measures the percentage of each sales dollar remaining after all expenses associated with producing and selling the product and operating the company are deducted. operating profit: Earnings before interest and taxes (EBIT). operating unit: A part of a business, such as a plant, division, product line, or subsidiary, that contributes to the actual operations of the firm. opportunity costs: Cash flows that could be realized from the best alternative use of an owned asset. optimal capital structure: The capital structure at which the weighted average cost of capital is minimized, thereby maximizing the firm‘s value. option: An instrument that provides its holder with an opportunity to purchase or sell a specified asset at a stated price on or before a set expiration date. option writer: Creates and sells an option contract. order costs: The fixed costs of placing, receiving and handling an inventory order. ordinary annuity: An annuity for which the cash flow occurs at the end of each period. The first cash flow is assumed to occur one period after time zero. ordinary income: Income earned through the sale of a firm‘s goods or services. organized securities exchanges: Tangible organizations that act as secondary markets in which outstanding securities are resold. outstanding shares: The number of shares of common stock sold to the public. over-the-counter (OTC) exchange: Not an organization but an intangible market consisting of electronic communication links established between securities dealers to permit the purchase and sale of securities not listed on the organized exchanges. For example NASDAQ, D I C T I O N A R Y Ken Hartviksen – Lakehead University, 2004 overdraft system: Automatic coverage by the bank of all checks presented against the firm‘s account, regardless of the account balance. overhanging issue: A convertible security that cannot be forced into conversion by using the call feature. overnight rate: the average interest rate the Bank of Canada wants financial institutions to use when they lend each other money for one day, or ―overnight.‖ oversubscribed issue: A security issue that is sold out. oversubscription privilege: Provides for distribution of shares for which rights were not exercised to interested shareholders on a pro rata basis at the stated subscription price. passive income: Income derived from the property of the corporation such as royalties, rent, interest, or dividends. participating preferred stock: Preferred stock that provides for dividend payments based on certain formulas allowing preferred shareholders to participate with common shareholders in the receipt of dividends beyond a specified amount. partnership: A business owned by two or more people and operated for profit. partnership agreement: The written contract used to formally establish a business partnership. payable-through draft: A draft drawn on the payer‘s checking account, payable to a given payee but not payable on demand; approval of the draft by the payer is required before the bank pays the draft. payback period: The length of time in years it takes for a project‘s yearly incremental after-tax cash inflows to recover the incremental investment in the project. payment date: The actual date on which the firm will mail the dividend payment to the holders of record. pecking order: A hierarchy of financing beginning with retained earnings followed by debt financing and finally external equity financing. pension funds: Investment entities established by employers to provide a pension (retirement income) to employees during their retirement. percent-of-sales method: A method for developing the pro forma income statement that assumes all expenses remain the same percent of sales in the forecast year as they were in the most recent fiscal year. percentage advance: The percent of the book value of the collateral that constitutes the principal of a secured loan. perfectly negatively correlated: Describes two negatively correlated series that have a correlation coefficient of -1. perfectly positively correlated: Describes two positively correlated series that have a correlation coefficient of +1. performance plans: Management compensation plans that compensate management on the basis of proven performance measured by EPS, growth in EPS, and other ratios of return. Performance shares and/or cash bonuses are used as compensation under these plans. performance shares: Shares of stock given to management for meeting stated performance goals. permanent funding requirement: A constant investment in operating assets resulting from constant sales over time. Financing requirements for the firm‘s fixed assets plus the permanent portion of the firm‘s current assets; these requirements remain unchanged over the year. perpetuity: An annuity with an infinite life, involvng equal and periodic (regular) cash flows. playing the float: A method of consciously anticipating the resulting float, or delay, associated with the payment process and using it to keep funds in an interest-earning form for as long as possible. pledge of accounts receivable: The use of a firm‘s accounts receivable as security, or collateral, to obtain a short-term loan. poison pill: A takeover defense in which a firm issues securities that give their holders certain rights that become effective when a takeover is attempted; these rights make the target firm less desirable to a hostile takeover. political risk: Risk that arises from the possibility that a host government might take actions that are harmful to foreign investors or that political turmoil in a country might endanger investments made in that country by foreign nationals. The potential discontinuity or seizure of an MNC‘s operations in a host country due to the host‘s implementation of specific rules and regulations (such as nationalization, expropriation, or confiscation). portfolio: A collection, or group, of assets. positively correlated: Descriptive of two series that move in the same direction. preauthorized check (PAC): A check written by the payee against a customer‘s checking account for a previously agreed-upon amount. Because of prior legal authorization, the check does not require the customer‘s signature. preemptive rights: Allows common shareholders to maintain their proportionate ownership in the corporation when new shares are issued. preferred equity ratio: Measures the proportion of total assets financed by preferred shareholders. Dictionary of Financial Terms D - 19 preferred stock: The third major source of long-term financing for corporations that broadens the firm‘s capital structure, raising financing without giving up ownership or incurring obligations. Preferred shares get their name because they have some form of superior preference to either or both earnings and assets upon corporate dissolution that is superior to (preferred) the common share class. Preferred shares usually carry a stated value, a fixed dividend and a cumulative feature in addition to the aforementioned preferences. preliminary prospectus: The document that provides most of the information investors require to make an informed decision regarding the investment merits of the security issue; however, the preliminary prospectus has only just been prepared and submitted to the provincial securities regulators for final approval, hence public sale of the securities cannot commence based only upon the preliminary prospectus. premium: The amount by which a bond sells at a value that is greater than its par, or face, value. present value: The current dollar value of a future amount. The amount of money that would have to be invested today at a given interest rate over a specified period to equal the future amount. present-value interest factor: The multiplier used to calculate at a specified discount rate the present value of an amount to be received in a future period. present-value interest factor for an annuity: The multiplier used to calculate the present value of an annuity at a specified discount rate over a given period of time. president or chief executive officer (CEO): Corporate official responsible for managing the firm‘s day-to-day operations and carrying out the policies established by the board of directors. price/earnings multiple approach: A technique to estimate the firm‘s share value; calculated by multiplying the firm‘s expected earnings per share (EPS) by the average price/earnings (P/E) ratio. price/earnings (P/E) ratio: Measures the amount investors are willing to pay for each dollar of the firm‘s earnings; the higher the P/E ratio, the greater the investor confidence in the firm. primary EPS: Earnings per share (EPS) calculated under the assumption that all contingent securities that derive the major portion of their value from their conversion privileges or common stock characteristics are converted and exercised, and are therefore common stock. primary market: Market in which financial securities are initially issued and where the issuer receives the proceeds from the sale of the financial security (ie. capital formation occurs). prime rate of interest (prime rate): The lowest rate of interest charged by leading banks on business loans to their most secure business borrowers. principal: The amount of money on which interest is paid. private placement: The sale of a new security issue, typically debt or preferred stock, directly to an investor, institutional investor or group of investors. These securities will not trade on financial markets after issue. privately owned stock: All common shares of a firm owned by a single individual. pro forma statements: Projected, or forecast, financial statements--income statements and balance sheets. probability distribution: A model that relates probabilities to the associated outcomes. probability: The chance that a given outcome will occur. proceeds from sale of old asset: The cash inflows, net of any removal or cleanup costs, resulting from the sale of an existing asset. processing float: The delay between receipt of a check by the payee and its deposit in the firm‘s account. profit margin: Measures the percentage of each sales dollar remaining after all expenses, including financing expenses and taxes have been deducted. profitability: The relationship between revenues and costs generated by using the firm‘s assets--both current and fixed--in productive activities. pro forma statements: projected, or forecast financial statements: the income statement and balance sheet. prompt offering prospectus (POP) system: A filing process for firms meeting certain requirements that allows companies to raise financing within five days of filing. prospectus: A portion of a security registration statement filed with the provincial securities regulator that details the firm‘s operating and financial position, the terms and conditions relating to the proposed security offering and any other information that could materially affect the value of the securities; it must be made available to all potential buyers. proxy battle: The attempt by a nonmanagement group to gain control of the management of a firm by the soliciting a sufficient number of proxy votes. proxy statement: A statement giving the votes of a shareholder or shareholders to another party. public offering: The sale of securities that will be traded on secondary financial markets. D I C T I O N A R Y Ken Hartviksen – Lakehead University, 2004 publicly traded: Companies whose common shares are listed and trade on a stock exchange. publicly owned (company): Common shares of a firm are owned by a broad group of unrelated individual and/or institutional investors. purchase options: Provisions frequently included in both operating and financial leases that allow the lessee to purchase the leased asset at maturity, typically for a prespecified price. put option: An option to sell 100 common shares on or before a specified future date at a stated price. pyramiding: An arrangement among holding companies wherein one holding company controls other holding companies, thereby causing an even greater magnification of earnings and losses. quarterly compounding: Compounding of interest over four periods within the year. quick (acid-test) ratio: A measure of liquidity calculated by dividing the firm‘s current assets minus inventory by current liabilities. range: A measure of an asset‘s risk, which is found by subtracting the pessimistic (worst) outcome from the optimistic (best) outcome. ranking approach: The ranking of capital expenditure projects on the basis of some predetermined measure such as the internal rate of return. ratio analysis: Involves the methods of calculating and interpreting financial ratios to assess the firm‘s performance and status. ratio of exchange: The ratio of the amount paid per share of the target company to the per-share market price of the acquiring firm. ratio of exchange in market price: The ratio of the market price per share of the acquiring firm paid to each dollar of market price per share of the target firm. raw materials inventory: Items purchased by the firm for use in the manufacture of a finished product. real rate of interest: The rate that creates an equilibrium between the supply of savings and the demand for investment funds in a perfect world, without inflation, where funds suppliers and demanders have no liquidity preference and all outcomes are certain. real return bonds (RRB): Bonds that adjust the semiannual coupon payments and the par value for inflation. See Table 6.4. real options (capital budgeting): Opportunities that are embedded in capital projects that enable managers to alter their cash flows and risk in a way that affects project acceptability (NPV). Also called strategic options. recaptured depreciation: The portion of the sale price of a depreciable asset that is greater than the undepreciated capital cost (UCC) of the asset pool (class) and below the initial purchase price of the asset. recovery period: The appropriate depreciable life of a particular asset as determined by MACRS. red herring: Another term for the preliminary prospectus, so called due to the statement, printed in red ink on the first page, stating that the securities have not been approved for sale. red-line method: Unsophisticated inventory management technique in which a reorder is placed when sufficient use of inventory items from a bin exposes a red line drawn inside the bin. regular dividend policy: A dividend policy based on the payment of a fixed-dollar dividend in each period. reinvested profits: Earnings not distributed as dividends; a form of internal financing. relevant cash flows: The incremental after tax cash outflow (investment) and resulting subsequent inflows associated with a proposed capital expenditure. renewal options: Provisions especially common in operating leases that grant the lessee the option to release assets at the expiration of the lease. reorder point: The point at which to reorder inventory, expressed as days of lead time  daily usage. replacement projects: Projects that involve replacing an existing asset with a new asset. repurchase agreement: An agreement whereby a bank of securities dealers sells a firm specific securities and agrees to repurchase them at a specific price and time. required return: The minimum return required by investors given the risk of an investment and the riskfree rate and the market-determined premium for risk. The required return is that rate of return predicted by the CAPM (capital asset pricing model) formula. required total financing: Amount of funds needed by the firm if the ending cash for the period is less than the desired minimum cash balance; typically represented by a line of credit. residual theory of dividends: A theory that the dividend paid by a firm should be the amount left over after all acceptable investment opportunities have been undertaken. retained earnings: The running total of all earnings, net of dividends, that have been retained and reinvested in the firm since its inception. retractable bonds: Bonds that give the bondholder the option to sell the bond back to the issuing company at par ($1,000) either on a specific date, and every 1 to 5 years thereafter, or if the firm is acquired, acquires another company, or issues a large amount of additional debt. Usually carries a lower yield than Dictionary of Financial Terms D - 21 non-retractable debt of the same quality. See Table 6.4. retractable preferreds: The holder has the right to force the issuer to repurchase the preferred share at the stated value. restrictive covenants: Contractual clauses in longterm debt agreement that place certain operating and financial constraints on the borrower. retained earnings: The cumulative total of all earnings, net of dividends, that have been retained and reinvested in the firm since its inception. return: The total gain or loss experienced on an investment over a given period of time; calculated by dividing the asset‘s change in value plus any cash distributions during the period by its beginning-ofperiod investment value. return on equity (ROE): Measures the return earned on the owners‘ (both preferred and common shareholders‘) investment in the firm. return on total assets (ROA): Measures the overall effectiveness of management in generating profits with its available assets; also called return on investment (ROI). reverse stock split: A method used to raise the market price of a firm‘s stock by exchanging a certain number of outstanding shares for one new share of stock. revolving credit agreement: A line of credit guaranteed to a borrower by a chartered bank regardless of the scarcity of money. rights: a negotiable, short-lived derivative security that provide shareholders with the privilege to purchase additional shares of stock in direct proportion to their number of owned shares. risk: The chance of financial loss, or more formally, the variability of returns associated with a given asset. The chance that actual outcomes may differ from those expected. risk (capital budgeting): The chance that the inputs into the analysis of an investment project will prove to be wrong. risk (of technical insolvency): The probability that a firm will be unable to pay its bills as they come due. risk premium: The amount by which the required discount rate for a project exceeds the risk-free rate; or, the additional coupon interest investors will demand based on the risk of the issuer and of the debt issue itself. risk-adjusted discount rate (RADR): The rate of return that must be earned on a given project to compensate for the risk of the project. risk-averse: The attitude toward risk in which a higher return would be required by the investor for an investment that offers greater risk. risk-free rate of interest, RF: The rate of return that one would earn on a virtually riskless investment such as a three-month Government of Canada Treasury bill. Such an investment offers little or no risk of default and very low interest rate (price) risk because of its short term to maturity. risk-free rate: The rate of return that one would earn on a virtually riskless investment such as a Government of Canada Treasury Bill. risk-indifferent: The attitude toward risk in which no change in return would be required for an increase in risk. risk-return tradeoff: The expectation that for accepting greater risk, investors must be compensated with greater returns. risk-seeking: The attitude toward risk in which a decreased return would be accepted for an increase in risk. road show: Presentations, by the issuing company and lead underwriter, promoting the new security issue. These presentations are made to financial analysts, institutional investors and in some cases, the investing public across Canada. safety motive: A motive for holding cash or nearcash--to protect the firm against being unable to satisfy unexpected demands for cash. safety of principal: The ease of salability of a security for close to its initial value. safety stock: Extra inventories that is held to prevent stockouts of important items. sale-leaseback arrangement: A lease under which the lessee sells an asset for cash to a lessor and then leases back the same asset, making fixed periodic payments for its use. sales forecast: The prediction of the firm‘s sales over a given period, based on external and/or internal data, and used as the key input to the short-term financial planning process. salvage value: The net amount received after tax when a project is terminated and an asset is sold. scenario analysis: A behavioral approach that evaluates the impact on return of simultaneous changes in a number of variables. seasonal funding requirement: An investment in operating assets that varies over time as a result of cyclical sales. Financing requirements for temporary current assets, which vary over the course of an operating year. seasoned issue: An additional issue of common shares; the shares sold add to the existing pool of publicly traded common shares. secondary market: The market that allows the owner of a previously created financial security to sell this security, to buy more of this or other securities, or for D I C T I O N A R Y Ken Hartviksen – Lakehead University, 2004 a buyer to express an interest in acquiring a financial security. secondary offering: The sale to the public of a large block of common shares held by the founding owners or a controlling company. Section 1650: The CICA regulation requiring Canadian companies to convert the financial statements of foreign subsidiaries into Canadian dollars for inclusion in the parent company‘s consolidated financial statements. secured creditors: Creditors who have specific assets pledged as collateral and in liquidation of the failed firm receive proceeds from the sale of those assets. secured loan: A loan that has specific assets pledged as collateral. secured short-term financing: Short-term financing (loans) that has specific assets pledged as collateral. Securities and Exchange Commission (SEC): The federal regulatory body that governs the sale and listing of securities in the United States. In Canada, securities regulation is a provincial responsibility. securities exchanges: The secondary marketplace that allows for the subsequent trading of financial securities created in the primary market. security agreement: The agreement between the borrower and the lender that specifies the collateral held against a secured loan. security market line (SML): The depiction of the capital asset pricing model (CAPM) as a graph that reflects the required return for each level of nondiversifiable risk (beta). self-sustaining foreign subsidiary: An operation that is financially and operationally independent of the parent company. selling group: A group of smaller, regional investment dealers who do not assume any of the risks of underwriting, but only attempt to sell a certain portion of the security issue. Cach agrees to sell a portion of a security issue and expects to make a profit on the spread between the price at which they buy and sell the securities. semi-annual compounding: Compounding of interest over two periods within the year. sensitivity analysis: An approach for assessing risk that uses a number of possible return estimates to obtain a sense of the variability among possible outcomes. serial bonds: An issue of bonds of which a certain proportion matures each year. shareholders: the owners of a corporation, whose ownership or ―equity‖ is evidenced by either common shares or preferred shares. share repurchase: Company purchase of its own common shares from investors in the stock market; the company then retires the shares; desired effects of share repurchases are that they enhance shareholder value and/or help to discourage unfriendly takeovers. shark repellents: Antitakeover amendments to a corporate charter that constrain the firm‘s ability to transfer managerial control of the firm as a result of a merger. short-dated bonds: Long-term government bonds that are approaching maturity. short-form prospectus: The document filed for the prompt offering prospectus (POP) system that omits much of the information that is in a ―regular‖ prospectus. This document contains information regarding the proposed new public offering and is intended, together with the annual information form (AIF) to disclose all information normally expected in a full prospectus. short-term financial management: Management of current assets and current liabilities. short-term (operating) financial plans: Planned short-term financial actions and the anticipated financial impact of those actions. short-term self-liquidating loan: An unsecured short-term loan in which the use to which the borrowed money is put provides the mechanism through which the loan is repaid. signal: A financing action by management that is believed to reflect its view with respect to the firm‘s common share value; generally, debt financing is viewed as a positive signal that management believes that the stock is ―undervalued,‖ and a stock issue is viewed as a negative signal that management believes that the stock is ―overvalued.‖ simulation: A statistically based behavioural approach that applies predetermined probability distributions and random numbers to predict the range and likelihood of risky outcomes. single-payment note: A short-term, one-time loan made to a borrower who needs funds for a specific purpose for a short period of time. sinking-fund requirement: A restrictive provision that is often included in a bond indenture providing for the systematic retirement of bonds prior to their maturity. small business deduction: A 16 percent reduction in the general federal tax rate that the government allows Canadian-controlled private corporations (CCPCs). small (ordinary) stock dividend: A stock dividend that represents less than 20 to 25 percent of the common stock outstanding at the time the dividend is declared. sole proprietorship: A business owned by one person and operated for his or her own profit. Dictionary of Financial Terms D - 23 sophisticated approaches to capital budgeting: Capital budgeting techniques that integrate time value procedures, risk and return considerations, and valuation concepts to select capital projects that are consistent with the firm‘s goal of maximizing owners‘ wealth. speculative motive: A motive for holding cash or near-cash--to put unneeded funds to work or to be able to quickly take advantage of unexpected opportunities that may arise. spin-off: A form of divestiture in which an operating unit becomes an independent company by issuing shares in it on a pro rata basis to the parent company‘s shareholders. sponsored American Depositor Receipt (ADR): An ADR for which the issuing (foreign) company absorbs the legal and financial costs of creating and trading a security. spontaneous financing / spontaneous liabilities: Financing that rises and falls with the volume of sales activity from the normal operations of the firm without further negotiation with creditors/lenders. The two major short-term sources of which are accounts payable and accruals. spot exchange rate: The rate of exchange between two currencies on any given day. spread: The difference between the price paid for a security by the investment banker and the sale price. staggered funding: A way to play the float by depositing a certain proportion of a payroll or payment into the firm‘s checking account on several successive days following the actual issuance of checks. stakeholder: Groups such as employees, customers, suppliers, creditors, and others who have a direct economic link to the firm. standard debt provisions: Provisions in long-term debt agreements specifying certain criteria of satisfactory record keeping and reporting, tax payment, and general business maintenance on the part of the borrowing firm; normally, they do not place a burden on the financially sound business. standard deviation: The most common statistical indicator of an asset‘s risk; it measures (in the same units as the expected value) the dispersion of possible values around the expected value. standby arrangement: A formal guarantee that any shares that are not subscribed or sold publicly will be purchased by the investment banker. stated value: The value of of the preferred share on the issue date. Ususally $10, $20, $25, $50 or $100. Preferred shares receive a dividend that is based on the state value and it is constant as long as the preferred share remains outstanding. statement of cash flows: Provides a summary of the firm‘s operating, investment, and financing cash flows and reconciles them with changes in its cash and marketable securities during the period of concern. statement of retained earnings: Reconciles the net income earned during a given year and any cash dividends paid with the change in retained earnings between the start and end of that year. stock dividend: The payment to existing owners of a dividend in the form of stock. stock exchange: A formalized secondary market for financial securities that allows investors to buy and sell preferred and common shares. For example the Toronto Stock Exchange (TSX), NASDAQ, and New York Stock Exchange (NYSE). stock options: An incentive allowing management to purchase stock at the market price set at the time of the grant. Options, generally extended to management, that permit purchase of the firm‘s common stock at a specified price (often at a substantial discount from current market value) over a stated period of time. stock split: A method commonly used to lower the market price of a firm‘s common shares by increasing the number of shares belonging to each shareholder. stock swap transaction: An acquisition method in which the acquiring firm exchanges its shares for shares of the target company according to a predetermined ratio. stock-purchase plans: An employee fringe benefit that allows the purchase of a firm‘s stock at a discount or on a matching basis with a part of the cost absorbed by the firm. stock-purchase warrant: An instrument that gives its holder the right to purchase a certain number of shares of common stock at a specified price over a certain period of time. shareholders: The true owners of the firm by virtue of their equity in the form of preferred and common stock. shareholders’ report: Annual report required of publicly held corporations that summarizes and documents for shareholders the firm‘s financial activities during the past year. straight bond value: The price at which a convertible bond would sell in the market without the conversion feature. straight bond: A bond that is nonconvertible, having no conversion feature. straight preferred shares: Preferred shares that have no conversion feature. strategic merger: A merger transaction undertaken to achieve economies of scale. D I C T I O N A R Y Ken Hartviksen – Lakehead University, 2004 stretching accounts payable: Paying bills as late as possible without damaging the firm‘s credit rating. striking price: The price at which the holder of a call option can buy (or the holder of a put option can sell) common shares at any time prior to the option‘s expiration date. stripped bond: A financial security derived from an ordinary bond by an investment dealer who, for a profit sells claims against the coupon interest or face value of the underlying bond to investors in the marketplace. The financial claim is against a single cash flow that is promised by the original bond issuer many years into the future. Like a zero coupon bond, stripped bonds trade at substantial discounts from the face value (terminal value) of the security. subordinated debentures: an unsecured bond issued only by creditworthy firms. The lenders‘ claims are the same as those of any general creditor, hence are subordinated to other debenture holders and any bond issues that may be outstanding. subordinate voting common shares: Common shares that carry a right to vote on issues affecting the company but the vote is inferior to the votes of other shares in some way. subordination: In a long-term debt agreement, the stipulation that all subsequent or less important creditors agree to wait until all claims of the senior debt are satisfied before having their claims satisfied. subscription price: The price at which stock rights are exercisable for a specified period of time; is set below the prevailing market price. subsidiaries: The companies controlled by a holding company. sunk costs: Cash outlays that have already been made (ie., past outlays) and therefore have no effect on the cash flows relevant to a current decision. supervoting shares: Common shares that carry superior voting privileges to other common shares. takeover defenses: Strategies for fighting hostile takeovers. target capital structure: The desired optimal mix of debt and equity financing that most firms attempt to achieve and maintain. target company: The firm in a merger transaction that the acquiring company is pursuing. target dividend-payout ratio: A policy under which the firm attempts to pay out a certain percentage of earnings as a stated dollar dividend, which it adjusts toward a target payout as proven earnings increases occur. target weights: Either book or market value weights based on desired capital structure proportions; used in calculating the weighted average cost of capital. tax breaks: One form of government incentive used to encourage corporate capital expenditures involving the tax savings associated with being able to claim non-cash expenses like amortization (CCA). The CCA rate can be increased by Order-in-Council in order to increase the tax shield benefits available to companies. taxable capital gain: The percentage of net capital gains (the difference between capital gains and capital losses) that are included as taxable income, currently 50 percent. technical insolvency: Business failure that occurs when a firm is unable to pay its liabilities as they come due. It is an act of bankruptcy. temporal method: The foreign exchange translation method takes all transactions engaged in by the foreign subsidiary and converts them into Canadian dollars using the exchange rate in effect on the date of the original transaction. tender offer: A formal offer to purchase a given number of shares of a firm‘s stock at a specified price. term (long-term) loan: A loan made by a financial institution to a business and having an initial maturity of more than one year. term loan agreement: A formal contract, ranging from a few to a few hundred pages, specifying the conditions under which a financial institution has made a long-term loan. term structure of interest rates: The relationship between the interest rate or rate of return (as measured by the yield to maturity on a bond) and the time to maturity for similar risk debt securities. terminal cash flow: The after tax nonoperating cash flow occurring in the final year of a project, usually attributable to liquidation of the project. terminal loss: This is a positive balance remaining in a capital cost allowance (CCA) pool (asset class) following the disposal of the last physical asset in the class. A terminal loss is a deductible non-cash expense that gives rise to a tax shield benefit for the firm equal to the amount of the terminal loss multiplied by the corporate tax rate. time line: A horizontal line on which time zero is at the leftmost end and future periods are shown as you move from left to right; can be used to depict investment cash flows. time-series analysis: Evaluation of the firm‘s financial performance over time, utilizing financial ratio analysis. times interest earned ratio: Measures the firm‘s ability to make contractual interest payments. Sometimes called the interest coverage ratio. total asset turnover: Indicates the efficiency with which the firm uses all its assets to generate sales. Dictionary of Financial Terms D - 25 total cost of inventory: The sum of the order costs and carrying costs of inventory. total financing required: The change in total assets from the latest fiscal year to the forecast year. total leverage: The use of fixed costs, both operating and financial, to magnify the effect of changes in sales on the firm‘s earnings per share (EPS). total quality management (TQM): The application of quality principles to all aspects of a company‘s operations. total risk: The combination of a security‘s nondiversifiable and diversifiable risk. transactions motive: A motive for holding cash or near-cash--to make planned payments for items such as materials and wages. transfer prices: Prices that subsidiaries charge each other for the goods and services traded between them. treasurer: The officer responsible for the firm‘s financial activities, such as financial planning and fund raising, making capital expenditure decisions, managing cash, managing credit activities, and managing the pension fund. treasury bills: a short-term financial security issued by the Government of Canada issued weekly on an auction basis, having varying maturities, generally under a year, and virtually no risk. trust indenture: The legal document that details the contractual relationship between the borrower and lender. trust receipt inventory loan: A secured short-term loan against inventory under which the lender advances 80 to 100 percent of the cost of the borrower‘s relatively expensive inventory items in exchange for the borrower‘s promise to repay the lender, with accrued interest, immediately after the sale of each item of collateral. trustee: A paid individual, corporation, or commercial bank trust department that acts as the third party to a bond indenture to ensure that the issuer does not default on its contractual responsibilities to the bondholders. two-bin method: Unsophisticated inventorymonitoring technique that is typically applied to C group (see ABC inventory system) items and involves reordering inventory when one of the two binds is empty. two-tier offer: A tender offer in which the terms offered are more attractive to those who tender shares early. UCC: Undepreciated capital cost is the balance in a capital cost allowance pool that remains at the end of the taxation year after capital cost allowance (CCA) has been claimed. This amount will be carried forward to the following taxation year. Also referred to as book value of an asset class. uncorrelated: Describes two series that lack any relationship or interaction and therefore have a correlation coefficient close to zero. underpriced: Stock sold at a price below its current market price. undersubscribed issue: A security issue whose shares are not immediately sold. underwriting: The process in which an investment dealer buys a security issue from the issuing firm at a lower price than that for which he or she plans to sell it, thereby guaranteeing the issuer a specified amount from the issue and assuming the risk of price changes between the time of purchase and the time of sale. Through this process new financial securities are created in the primary market. underwriting syndicate: A group of investment dealers who buy the security issue from the company and then resell it to investors (savers). Each member of the group will underwrite a portion of a large security issue, thus lessening the risk of loss to any single firm. unlimited funds: The financial situation in which a firm is able to accept all independent projects that provide an acceptable return. unlimited liability: The condition imposed by a sole proprietorship (or general partnership) allowing the owner‘s total wealth to be taken to satisfy creditors. unsecured loan: A loan that has no assets pledged as collateral. unsecured, or general, creditors: Creditors who have a general claim against all the firm‘s assets other than those specifically pledged as collateral. unsecured short-term financing: Short-term financing obtained without pledging specific assets as collateral. valuation: The process that links risk and return to determine the worth of an asset. value dating: A procedure used by non-U.S. banks to delay, often for days or even weeks, the availability of funds deposited with them. variable growth model: A dividend valuation approach that allows for a change in the dividend growth rate. vertical merger: A merger in which a firm acquires a supplier or a customer. voluntary reorganization: A petition filed by a failed firm on its own behalf for reorganizing its structure and paying its creditors. voluntary settlement: An arrangement between a technically insolvent or bankrupt firm and its creditors enabling it to bypass many of the costs involved in legal bankruptcy proceedings. D I C T I O N A R Y Ken Hartviksen – Lakehead University, 2004 wage and rent subsidies: One form of government incentive used to encourage corporate capital expenditures involving payments made by the government to the company‘s employees or landlord to reduce the effective cost of proceeding with a project. warehouse receipt loan: A secured short-term loan against inventory under which the lender receives control of the pledged inventory collateral, which is stored by a designated warehousing company on the lender behalf. warrant: A financial instrument that gives its holder the right to purchase a certain number o common shares at a specified price within a certain period of time. warrant premium: The difference between the actual market value and theoretical value of a warrant. weighted average cost of capital (WACC): Reflects the expected average future cost of funds for the upcoming year; found by weighting the cost of each specific type of capital by its proportion in the firm‘s capital structure. white knight: A takeover defense in which the target firm finds an acquirer more to its liking than the initial hostile acquirer and prompts the two to compete to take over the firm. wire transfer: An electronic communication that, via bookkeeping entries, remove funds from the payer‘s bank and deposit them in the payee‘s bank, thereby reducing collection float. work-in-process inventory: All items that are currently in production. working capital: Current assets, which represent the portion of investment that circulates from one form to another in the ordinary conduct of business. World Trade Organization (WTO): International body that polices world trading practices and mediates disputes between member countries. yield curve: A graph of the term structure of interest rates that depicts the relationship between the yield to maturity of a security (y-axis) and the time to maturity (x-axis); it shows the pattern of interest rates on securities of equal quality and different maturity. yield to maturity (YTM): The rate of return investors expect to earn if they buy a bond at a specific price and hold it until it matures. Assumes that issuer makes all scheduled interest and principal payments as promised. Annual rate of interest earned on a security purchased on a given day and held to maturity. This is an ex ante (forecast) calculation that assumes the coupon interest, when received is reinvested at YTM for the remaining term to maturity. It is that discount rate that equates the current price of the bond with the sum of the discounted value of all promised cash flows. zero-balance account: A disbursement account that always has an end-of-day balance of zero because the firm deposits money to cover cheques drawn on the account only as they are presented for payment each day. Zero (or low) coupon bonds: Bonds issued with no (zero) or very low coupon rates and sold at a large discount from par. Canada Customs and Revenue Agency (CCRA) deems the apparent capital gains on such bonds as interest income. zero-growth model: An approach to dividend valuation that assumes a constant, nongrowing dividend stream.