Financial Terms Glossary

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Accounts Payable

Accounts Payable is an accounting term that represents a company's short-term debt. It is found under Current Liabilities on a Balance Sheet and Operating Activities on the Cash Flow Statement.

Accounts Payable can be thought of as an IOU and is typically used when the firm has received a service or product (i.e. parts order, management consultation etc) but has not yet paid for it.

Accounts Receivable

Accounts Receivable is an accounting term that represents a company's short-term credit. It is found under Current Assets on a Balance Sheet and Operating Activities on the Cash Flow Statement.

Accounts Receivable is when a customer owes money to the firm because they have received a good or service but have not yet paid for it. For example, purchasing a car on credit would come under Accounts Receivable for the firm you bought it from, as you have received the car but have not yet paid for all of it.

Acquisition

An acquisition is an action by a corporation to assume control of a target firm. This is done by buying either all or most of the target's ownership stakes. Acquisitions can either be friendly (the target firm agrees to be acquired) or hostile (the target firm does not agree and the acquirer has to buy large amounts of the target to assume control).

Typically acquisitions are undertaken in order to expand into a new sector or to grow within the sector. For example, if a technology firm has a key supplier for an essential part, they may decide to acquire the supplier both to ensure a consistent supply of parts and to reduce the amount available to competitors.

The acquiring company will usually offer a premium to the target company (the difference between the acquisition value and the market value of the target) in order to provide incentive to the existing shareholders to sell and this premium will often be roughly equal to the value of intangible assets and goodwill in the target company.

Algorithm

Simply put, an algorithm is a set of rules for completing something in a certain way, which can be repeated endless times.

Algorithms are frequently used in electronic trading to determine the timing, quantity and pricing of stock orders. They are very commonly associated with high frequency trading, which is mostly automated by algorithmic systems.

Amortization

Amortization is the reduction of a debt or asset over a specific period of time.

When referring to debt, amortization is simply the debt payment schedule. Amortization is found on the Income Statement and Cash Flow Statement and is used for loss of value on intangible assets.

For assets the concept is similar to depreciation, except amortization is only applied to intangible assets (patents, contracts, trademarks) whereas depreciation is used for tangible assets (property, plants, equipment etc).

An example of amortization of an intangible is if a company owns a patent for 10 years worth $20 million, it would be assumed that each year the value of the patent would decrease by $2 million so as to be worthless after expiry.

Amortization is found both on the Income Statement and the Cash Flow Statement.

Annuity

An annuity is a product that is sold by financial institutions to investors. The investors pay in a certain amount of money over a period of time, and then at a given time (called annuitization), the annuity starts to pay out money to the investor for a given period of time.

The firm using the annuities uses the money investors pay in to grow the funds in order to pay for the cash payments in the future. This is similar to a mutual fund, except that the returns are guaranteed.

Investors wishing to set aside money for their retirement frequently use annuities. The individual investor is assuming they will live long enough for the annuity to pay more than they invested whereas the firm is betting on the fact that the investor will claim less than they paid in.

Arbitrage

Arbitrage is the technique of investing in two assets (going long one and short the other) and assuming that the prices will converge over time. This is made possible as a result of market inefficiencies, although as technology advances more and more these inefficiencies are likely to be smaller and to be eliminated faster.

True arbitrage is meant to be risk free profit but in reality it very very rarely is. Due to the fact that any profit from arbitrage is likely to be small, traders and investors will put in vast amounts of money to magnify returns.

The most famous example of arbitrage is that of Long Term Capital Management, the quant-based hedge fund which started off selling new US government bonds and buying older ones, and taking the profits as the prices converged. Hedge funds which operate an event driven strategy will often work on the basis of merger arbitrage, i.e. that the stock prices of companies will converge if they complete a merger deal.

Asset

An asset is any resource with value that is held by a company, individual or country. Assets add to value and are bought either to increase value or to benefit the firm.

There are two main ways in which the term asset is used:

  • To refer to items on the balance sheet of a company which add value
  • Items traded in financial markets

All assets are listed on a company's balance sheet and are defined as either current (held for less than one year) or long term (held for more than one year). The most common kinds of assets found on a balance sheet are listed below:

Current Assets

  • Cash & Cash Equivalents
  • Short-Term Investments
  • Accounts Receivable
  • Inventory
  • Deferred Tax Assets
  • Prepaid Expenses

Long Term Assets

  • Long-Term Investments
  • Plants, Property & Equipment (PP&E)

Intangible Assets

  • Goodwill
  • Patents
  • Trademarks

Assets traded in the financial markets are also known to as securities and include instruments such as shares, bonds, derivatives, ETFs etc.

Associate

An Associate is the second lowest ranking of the front-office roles within an investment bank. The responsibilities are similar to those of an analyst, except with more emphasis on managing the Analysts and making sure the work of the Vice Presidents is done properly.

Associates are either promoted from a 3rd year analyst position, hired laterally after 2-3 years in the finance industry or out of business school.

Associates also work extremely long hours, usually 70+ hours a week and earn between $150,000 and $300,000 in total compensation. After working for 3-4 years, an Associate will be promoted to Vice President if they have shown suitable leadership and management skills.

Audit

Auditing is a service provided by financial service firms (i.e. Deloitte, PriceWaterHouse Cooper, KPMG, Ernst & Young). It requires a lot of accounting skills and knowledge and can be a way to break into investment banking as an Associate (although this is quite hard).

Audit is essentially an assessment of the financial statements issued by a firm to verify their accuracy and thoroughness through a process of due diligence. Audit is almost always carried out by an external firm due to the conflict of interest of a firm auditing its own finances.

B

Balance Sheet

A balance sheet is one of the three financial statements that are used to value a company and to show what it owns or owes. The Balance Sheet lists all assets, liabilities and shareholder's equity attributed to the company. It is always a snapshot of one point in time.

The Balance Sheet is split into three sections:

  • Assets - what the company owns or is owed
  • Liabilities - any money the company may owe
  • Shareholder's Equity - what the shareholders own

One of the most fundamental rules of accounting and finance is that a balance sheet MUST balance (hence the name). Assets will always be equal to Liabilities + Shareholder's Equity.

It is often possible to get a basic understanding of how a company is funded just by looking at the balance sheet. For example, if Long Term Debt and PP&E are both rising every year, it is reasonable to assume that the company is borrowing long-term money in order to finance investments in PP&E. Similarly, if the short term debt is fluctuating along with inventory then it is probable that the company is borrowing to pay suppliers (which it would do if the borrowing rate was very low and it could earn more by investing its cash, and if the company received payment for products before it had to pay back the loans).

A Balance Sheet is constructed either by pulling information and figures directly from a company's filings or by using the Cash Flow Statement and Income Statement to tie back into the Balance Sheet.

Bank Run

A bank run is a situation when the customers of a commercial bank all attempt to withdraw their deposits within a very short space of time due to a lack of confidence in the solvency of the bank. If, as is the case with most modern banks, the bank is operating as a fractional bank then the reserves held will not be enough to cover the deposits.

This will create a vicious cycle. The customers attempt to withdraw deposits because they think the bank will be unable to pay them if they wait, the bank is unable to fully pay them due to lack of accessible reserves, more customers panic and attempt to withdraw and then the bank is insolvent.

Bear

A 'bear' is any investor or firm which believes that the financial markets (or any asset within them) is going to fall in value. They are typically seen as the pessimists of the financial world.

In the long term, the U.S. stock market has always risen on average so bears are usually wrong in the very long term (as far as historical data shows us so far).

Blue Chip

A blue chip company is one that is large, globally recognized and financially stable. They typically sell products that are widely used and high quality. Usually, blue chip companies are seen as being low growth, low risk firms and do not suffer as much in poor economic conditions as smaller firms and often follow the performance of the main stock index (S&P500, FTSE100 etc.).

The name blue chip comes from the blue chips used in poker, which have the highest value.

Bond

A bond is a financial product that allows an investor to lend money to a company or government. The company or government issues a bond that is essentially an IOU, which is then purchased by investors. Investors will receive the full amount (principal) at the expiration of the bond (maturity), along with an interest rate for the duration of the bond (coupon).

Bonds are used for financing purposes and the most commonly known ones are:

  • Corporate Bonds - issued by companies
  • Municipal Bonds - issued by a city or local government
  • Government Bonds - issued by governments, i.e. US Treasury Bills

The maturity on a bond can range from 3 months to 30 years and the interest rate usually increases with the maturity of the bond (known as the yield curve).

Bond prices and interest rates are negatively correlated so as the price of a bond falls, the relative yield rises ($5 interest payments on a $80 bond yield relatively more than on a $100 bond). Regardless of the actual value of the bond, it is always referred to as 'par', and all future prices are denoted accordingly as a percentage of the original value.

Boutique

Boutique investment banks are smaller than the large global banks and tend to focus on one or two areas of investment banking. Typically, they act in an advisory role for M&A although some also offer asset management.

The size of a boutique investment bank can vary considerably, as can where they operate. Some of the larger boutiques have a global presence (Evercore, Lazard etc) whilst the smaller ones may have as few as 5 people employed. It is not uncommon for boutique investment banking firms to be set up by executives from bulge bracket banks who have left (i.e. Frank Quattrone and Qatalyst).

The structure and hierarchy of a boutique investment bank is usually less strict than at the bulge bracketbanks, and the salary is comparable (or in some cases better).

Some of the more well known boutique investment banks are listed below:

  • Evercore
  • Jefferies & Co
  • Lazard
  • Moelis
  • Piper Jaffray
  • Qatalyst Partners
Bull

A 'bull' is any investor or firm which believes that the financial markets (or any asset within them) is going to rise in value. They are typically seen as the optimists of the financial world.

In the long term, the U.S. stock market has always risen on average so bulls are usually right in the very long term (as far as historical data shows us so far).

Buyback

A buyback is a corporate action undertaken by a firm where it repurchases some of its shares outstanding from the market. This is done for one of 3 reasons:

  • Increase the value of the shares (less supply, same demand = higher price).
  • Invest in themselves; owning more shares in the company allows them to experience a higher percentage of the profits.
  • Reduce the threat of any takeover by reducing the percentage of the company which is up for sale on the markets.