Financial Terms Glossary

E

Earnings Per Share (EPS)

Earnings Per Share, or EPS, is simply the profit of the firm per outstanding share. The higher the value of EPS, the more profitable the company is.

The calculation for EPS is simply Net Income dividend by number of shares outstanding.

An example of calculating earnings per share is as follows:

  • Firm has net income of $100 million
  • There are 40 million shares outstanding
  • EPS would be $100,000,000 / 40,000,000 = $2.5

Usually, number of shares is calculated as a weighted average. For example if a the firm had 35 million shares for Q1 and then 40 million shares for the rest of the year, the weighted average number of shares would be:

  • 35,000,000 x 0.25 + 40,000,000 x 0.75 = 38,750,000

If this was the case, actual EPS would be $100,000,000 / 38,750,000 = $2.58 which is a 3% increase over the previous calculation so it is important to take care.

Economies Of Scale (EOS)

Economies of Scale (EOS) is a term used to describe the increase in efficiency gained through an increase in the scale of operation. This is usually reflected either in increased productivity or through lower costs. For example, a car company may experience economies of scale if it increases in size and sets up a new factory in a new location, thereby reducing transport costs.

Equity

In finance the word equity has two main meanings:

  • A share or any other security which represents partial ownership of a firm
  • The value of a firm which has been contributed by the shareholders

In share terms, whenever you buy a share in a company you hold equity in that company. Companies can raise money by issuing equity, although this is usually deemed as being more expensive than using borrowed cash.

Shareholder's Equity is denoted on the Balance Sheet in conjunction with liabilities to show the total amount of money injected into the company by shareholders.

Venture Capital firms frequently purchase large amounts of equity (i.e. take ownership of a percentage of the company) in start-up companies as a way to inject money and to stake a claim on a percentage of the profits.

Eurobond

A Eurobond has two different meanings:

An international bond that is denominated in a currency other than that of the country in which it was issued:

  • These can be traded on the global markets
  • Named after the currency they are issued in (i.e. Eurodollar, Euroyen)

A bond issued by the European Monetary Fund:

  • Investors are effectively loaning the EMF money, which it then uses to help financially distressed counties within the Eurozone
  • First proposed in mid-2011 as a result of the Eurozone debt crisis
Exchange Rate

An exchange rate is simply the price of one currency denominated in another. It is always expressed as a currency pair. For example, the price of 1 Euro in US Dollars would be written as EUR/USD and would take a value of something like 1.4, which would mean it costs $1.4 to buy EU1.

Exchange rates can appreciate or depreciate, but the movement in the currency pair is counterintuitive. If the US dollar depreciates against the British pound, GBP/USD will go UP because 1 pound buys more dollars (and 1 dollar buys less pounds).

Exchange rates are affected by a vast amount of factors including politics, war, economics, sentiment and more.

Execution

Execution is the term used for when any trade has been fully completed. If the order is going through a broker, the broker has the ability to determine (but also the legal obligation to obtain) the best possible method of execution for their investor.

If an order is placed but not filled, it has not been executed; the same goes for if the order is only partially filled.

F

Federal Reserve

The Federal Reserve is the central bank of the United States of America. The main responsibilities of the Fed are:

  • Ensuring stability in the financial system
  • Regulation of the banking industry
  • Protecting the rights and deposits of customers
  • Implement monetary policy
  • Finance the US government

The Federal Reserve sets interest rates, controls the money supply, enforces regulation and acts as a lender of last resort.

Fiat Money

Fiat money is any form of currency that is in itself worthless, but because it has the backing of a government is deemed to have value. For example, the paper used to print US dollars is essentially worthless, but the dollar bill is worth money. Almost all printed currency is fiat money.

If an asset such as gold or silver backs the currency, then it actually has value as it is a contract, but fiat money itself is based purely on the faith that the government will support the currency bills.

Fibonacci

Fibonacci was a mathematician and the term applies to his number sequence. The Fibonacci sequence is used in technical analysis to determine levels of support and resistance.

The analysis used suggests that price trends will change around levels determined by Fibonacci analysis.

Financial Statements

Financial statements are reports issued by a company that describe the financial activities of the company.

The financial statements are broken down into three different statements:

  • Income Statement - shows the income and expenditure of the company, including things such as depreciation, income tax, interest income etc.
  • Balance Sheet - shows the assets, liabilities and shareholders equity of a firm; it must always balance (i.e. assets = liabilities + shareholders equity).
  • Cash Flow Statement - shows the inflows and outflows of cash and shows whether the firm is actually making or losing money.

Financial statements are usually issued on a quarterly and / or yearly basis and are audited by independent firms. The future performance of a firm is modeled using the financial statements and projecting into the future using appropriate assumptions.

Floating Interest Rate

A floating interest rate is one that is not fixed, but rather is free to float around with whatever the prevailing interest rate is at the time. When two parties agree a loan at a fixed interest rate each one is taking on some interest rate risk. The lender is assuming that interest rates will rise in the future whilst the borrower is expecting interest rates to fall.

Forex

Forex stands for Foreign Exchange, which refers to the trading of currencies on a market. Forex trading is one of the most popular forms of trading in the world, and as such it is the largest market in the world (nearly $2 trillion traded per day) and one of the most liquid.

There are 2 main reasons why the forex market is so popular to trade:

  • Open for longer hours than any other market - 24 hours a day, 5 days a week
  • Often tends to follow trends, making trend-trading very popular

Every single currency in the world can be traded and currencies are always traded against each other in pairs. Some of the most commonly traded currency pairs are:

  • GBP/USD
  • EUR/USD
  • USD/JPY
  • GBP/EUR
  • USD/CHF
Fractional Banking

Fractional banking is a type of banking commonly used throughout the Western world. It describes a bank which only holds a fraction of its assets as deposits. For example, if a bank has $10,000,000 worth of customer deposits yet has $1,000,000,000 in assets and loans then this bank would be acting fractionally.

The reasoning behind using fractional banking is that at any given time only a small percentage of customers actually need access to their money, so the bank is free to loan out and invest the rest. The problem is when a greater-than-expected number of customers attempt to withdraw their cash and the bank cannot pay them. This is called a bank run.

Almost all commercial banks nowadays run a fractional banking system, albeit heavily monitored and regulated.

Future

A future is a derivative which can be traded on financial markets. It is a contract that means the buyer (seller) is obligated to buy (sell) an asset at a pre-determined date at a pre-determined price. Futures can be settled either in cash or in actual delivery of the asset.

A future is an example of a leveraged instrument. For example, if one was to buy a future for 1000 barrels of oil, they would not need to pay the full price of 1000 barrels, but it would be giving the holder exposure to that much oil.

This is an example of the performance of futures:

  • Investor A sells Investor B a futures contract for 100 shares of Apple at $400 per share, and the cost of the contract is $20.
  • At expiration date, Investor A is obliged to sell Investor B (who is also obliged to buy) 100 shares of Apple for $400 for a total of $40,000.
  • If the market value of Apple shares is under $400, say $380, then Investor B has to buy the shares at a cost of $40,000 and will have made a loss of $2,020 ($38,000 - $20 - $40,000).
  • If the market value of Apple shares is above $400, say $450, then Investor B will buy from Investor A at a cost of $40,000, sell them in the market at $450 and will have made a profit of $4,980 ($45,000 - $40,000 - $20).