Intermediate Finance Vocab

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average age of inventory: A measure of inventory turnover, calculated by dividing the turnover figure into 365, the number of days in a year.
pure discount bonds: Bonds that pay no interest and sell below par value. Also called zero-coupon bonds.
factoring: The outright sale of receivables to a third-party factor at a discount.
depreciate: A currency depreciates when it buys less of another currency than it did previously.
white knights: "Friendly" acquirers who will top the price of an unwelcome bidder to avoid a hostile takeover.
trustee: In bankruptcy, someone appointed by a judge to replace a firm's current management team and to oversee liquidation or reorganization.
accounts payable management: A short-term financing activity that involves managing the time that elapses between the purchase of raw materials and mailing the payment to the supplier.
backward integration: A merger in which the acquired company provides an earlier step in the production process.
indenture: A legal document stating the conditions under which a bond has been issued.
credit terms: The terms of sale for customers.
economic exposure: The risk that a firm's value will fluctuate due to exchange rate movements.
Monte Carlo simulation: A sophisticated risk assessment technique that provides for calculating the decision variable, such as net present value, using a range or probability distribution of potential outcomes for each of a model's assumptions.
imaging services: Disbursement services offered by banks and other vendors to allow both sides of the check, as well as remittance information, to be converted into digital images. The images can then be transmitted via the Internet or easily stored for future reference. Imaging services are especially useful when incorporated with positive pay services.
currency board arrangement: An exchange rate system in which each unit of the domestic currency is backed by a unit of some foreign currency.
perpetuity: A level or growing cash flow stream that continues forever.
interest rate cap: A call option on interest rates.
adjustable rate preferred stock: A corporate obligation used for short-term investments. These stocks take advantage of the dividend exclusion (of 70 percent or more) for stock in one corporation held by another corporation. In order to make this investment suitable for short-term holdings, the dividend rate paid on the stock is adjusted according to some rate index. This will stabilize the price, even if interest rates change during the forty-five-day holding period required to qualify for the dividend exclusion.
cancellation option: Option held by the venture capitalist to deny or delay additional funding for a portfolio company.
hubris hypothesis of corporate takeovers: Richard Roll (1986) contends that some managers overestimate their own managerial capabilities and pursue takeovers with the belief that they can better manage their takeover target than the target's current management team can.
internal rate of return (IRR): The compound annual rate of return on a project, given its up-front costs and subsequent cash flows.
IPO underpricing: Occurs when the offer price in the prospectus is consistently lower than what the market is willing to bear.
total variable cost of annual sales (TVC): Calculated by multiplying the annual sales in units by the variable cost per unit and used to estimate the average investment in accounts receivable under a stated policy.
time line: A graphical presentation of cash flows over a given period of time.
settlement date: The future date on which the buyer pays the seller and the seller delivers the asset to the buyer.
seasoned equity offering (SEO): An equity issue by a firm that already has common stock outstanding.
bankruptcy: Occurs only when a company enters bankruptcy court and effectively surrenders control of the firm to a bankruptcy judge.
long-term debt: Debt that matures more than one year in the future.
equivalent annual cost (EAC) method: Represents the annual expenditure over the life of each asset that has a present value equal to the present value of the asset's annual cash flows over its lifetime.
New York Stock Exchange: The largest and most prestigious stock exchange in the world.
synergy: An efficiency-enhancing effect resulting from a strategic merger.
price stabilization: Purchase of shares by an investment bank when a new issue begins to falter in the market, keeping the market price at or slightly above the offer price.
average payment period (APP): The average length of time it takes a firm to pay its suppliers, calculated by dividing the firm's accounts payable balance by its average daily purchases.
turnover of accounts receivable (TOAR): Three-hundred-sixty-five divided by the average collection period (ACP). Used to calculate the average investment in accounts receivable (AIAR) when evaluating accounts receivable policies.
cash budget: A statement of a firm's planned inflows and outflows of cash.
yield curve: A graph that plots the relationship between yield to maturity and maturity for a group of similar bonds.
short position: To sell an option or another security.
selling short: Borrowing a security and selling it for cash at the current market price. An investor who sells short must eventually return the security to the lender by purchasing it at the then-current market price. Therefore, a short seller hopes that either (1) the price of the security sold short will fall, or (2) the return on the security sold short will be lower than the return on the asset in which the proceeds from the short sale were invested.
put option: An option that grants the right to sell an underlying asset at a fixed price.
indirect bankruptcy costs: Expenses or economic losses that result from bankruptcy but are not cash outflows spent on the process itself.
order cost: The fixed dollar amount per order that covers the costs of placing and receiving an order, which includes the cost of preparing, processing, and transmitting a purchase order, and the cost of receiving an order and checking it against the invoice. Used in calculating the EOQ.
spot exchange rate: The exchange rate that applies to immediate currency transactions.
Eurobond: A bond issued by an international borrower and sold to investors in countries with currencies other than that in which the bond is denominated.
majority voting system: System that allows each shareholder to cast one vote per share for each open position on the board of directors.
sunk costs: Costs that have already been paid and are therefore not recoverable.
Bankruptcy Reform Act of 1978: The governing bankruptcy legislation in the United States today.
sinking fund: An additional positive covenant included in a bond indenture, the objective of which is to provide for the systematic retirement of bonds prior to their maturity.
conversion price: The market price of a convertible bond, divided by the number of shares of stock that bondholders receive if they convert.
risk premium: The additional return that an investment must offer, relative to some alternative, because it is more risky than the alternative.
incremental cash flows: Cash flows that directly result from a proposed investment. They effectively represent the marginal costs (MC) and marginal benefits (MB) expected to result from undertaking a proposed investment.
reverse merger: A merger in which the acquirer has a lesser market value than the target.
interest rate parity: An equilibrium relationship that predicts that differences in risk-free interest rates in two countries must be tied to differences in currency values on the spot and forward markets.
managerial entrenchment theory of mergers: Shleifer and Vishny (1989) propose that unmonitored managers will try to build corporate empires through the pursuit of negative-NPV mergers, with the motive of making the management team indispensable to the firm because of its greater size and the team's supposed expertise in managing a large company.
private placements: Unregistered security offerings sold directly to accredited investors.
composition: A pro rata cash settlement of creditor claims.
marginal tax rate: The percentage of taxes owed on the next dollar of income.
serial bonds: Bonds of which a certain proportion mature each year.
small business investment companies (SBICs): Federally chartered corporations established as a result of the Small Business Administration Act of 1958.
annual percentage rate (APR): The stated annual rate calculated by multiplying the periodic rate by the number of periods in one year.
loans: Private debt agreements arranged between corporate borrowers and financial institutions, especially commercial banks.
modified accelerated cost recovery system (MACRS): Set forth in the Tax Reform Act of 1986 to define the allowable annual depreciation deductions for various classes of assets.
investment bank: A bank that helps firms acquire external capital.
venture capital limited partnerships: Funds established by professional venture capital firms, and organized as limited partnerships.
Subordination: Agreement by all subsequent or more-junior creditors to wait until all claims of the senior debt are satisfied in full before having their own claims satisfied.
counterparty risk: The risk that the counterparty in an over-the-counter options transaction will default on its obligation.
debt capital: Borrowed money.
coupon yield: The amount obtained by dividing the bond's coupon by its current market price (which does not always equal its par value).
strike price: The price at which an option holder can buy or sell the underlying asset.
money market yield (MMY): The yield for short-term discount instruments such as T-bills and commercial paper is typically calculated using algebraic approximations rather than more precise present value methods.
external funds required: The expected shortage or surplus of financial resources, given the firm's growth objectives.
merchant bank: A bank capable of providing a full range of financial services.
futures contract: Involves two parties agreeing today on a price at which the purchaser will buy a given amount of a commodity or financial instrument from the seller at a fixed date sometime in the future.
political risk: The risk that a government will take an action that negatively affects the values of firms operating in that country.
poison pills: Defensive measures taken to avoid a hostile takeover.
profitability index (PI): A capital budgeting tool, defined as the present value of a project's cash inflows divided by its initial cash outflow.
par value (common stock): An arbitrary value assigned to common stock on a firm's balance sheet.
exchangeable bonds: Bonds issued by corporations which may be converted into shares of a company other than the company that issued the bonds.
syndicated loan: A large loan that is financed by several banks joining together in a syndicate, where each bank provides a small part of the total loan.
gross profit margin: A measure of profitability that represents the percentage of each sales dollar remaining after a firm has paid for its goods.
cash discount: A method of lowering investment in accounts receivable by giving customers a cash incentive to pay sooner.
currency swap: A swap contract in which two parties exchange payment obligations denominated in different currencies.
cross exchange rate: An exchange rate between two currencies calculated by taking the ratio of the exchange rate of each currency, expressed in terms of a third currency.
merger: A transaction in which two or more business organizations combine into a single entity.
excess earnings accumulation tax: A tax levied by the IRS on a firm that has accumulated sufficient excess earnings to allow owners to delay paying ordinary income taxes.
Yankee common stock: Stock issued by foreign firms in the U.S. market.
annuity: A stream of equal periodic cash flows.
premium: A bond that sells for more than its par value.
underinvestment: A situation of financial distress in which default is likely, yet a very profitable but short-lived investment opportunity exists.
mutually exclusive projects: The situation that occurs when the IRRs of several projects exceed the hurdle rate (or the NPVs exceed $0), but only a subset of those projects can be undertaken at the given time.
prospectus: A document that describes the securities being offered for sale and the company offering them.
multinational corporations (MNCs): Businesses that operate in many countries around the world.
Eurocurrency loan market: A large number of international banks that stand ready to make floating-rate, hard-currency loans to international corporate and government borrowers.
quarterly compounding: Interest compounds four times per year.
mixed stream: A series of unequal cash flows reflecting no particular pattern.
public company: A corporation, the shares of which can be freely traded among investors without obtaining the permission of other investors and whose shares are listed for trading in a public security market.
weighted average cost of capital (WACC): The after-tax, weighted average required return on all types of securities issued by a firm, in which the weights equal the percentage of each type of financing in a firm's overall capital structure.
preemptive rights: These hold that shareholders have first claim on anything of value distributed by a corporation.
mixed offerings: Offerings in which some of the shares come from existing shareholders and some are new. Also, a merger financed with a combination of cash and securities.
Securities Act of 1933: The most important federal law governing the sale of new securities.
divestiture: Assets and/or resources of a subsidiary or division are sold to another organization.
collateral: The specific assets pledged to secure a loan.
spread: The difference between the rate that a lender charges for a loan and the underlying benchmark interest rate. Lenders charge higher spreads to less creditworthy borrowers.
risk management: The process of identifying firm-specific risk exposures and managing those exposures by means of insurance products. Also includes identifying, measuring, and managing all types of risk exposures.
capital spending: Investments in long-lived assets such as plant, equipment, and advertising.
operating flows: Cash inflows and outflows directly related to the production and sale of a firm's products or services.
financial leverage: Using debt to magnify both the risk and expected return on a firm's investments. Also, the result of the presence of debt when firms finance their operations with debt and equity, leading to a higher stock beta.
market power: A benefit that might arise from a horizontal merger when competition is too weak (or nonexistent) to prevent the merged company from raising prices in a market at will.
investment flows: Cash flows associated with the purchase or sale of both fixed assets and business equity.
World Trade Organization (WTO): An organization established by GATT to police world trading practices and to settle disputes between GATT member countries.
shark repellents: Antitakeover measures added to corporate charters.
negotiated offer: The issuing firm negotiates the terms of the offer directly with one investment bank.
cannibalization: Loss of sales of an existing product when a new product is introduced.
ownership right agreements: Agreements between venture capital investors and portfolio-company managers allocating ownership stakes and voting rights to venture capitalists, and usually mandating that the VCs will vote together on all contested issues.
corporate focus: A focused firm concentrates its efforts on its core (primary) business; the opposite end of the spectrum from a diversified firm.
greenfield entry: Internal expansion into a new market.
prime rate: The rate of interest charged by the largest U.S. banks on short-term loans to the best business borrowers.
Securities and Exchange Commission Act of 1934: This act, and its amendments, established the U.S. Securities and Exchange Commission (SEC) and laid out specific procedures for both the public sale of securities and the governance of public companies.
average investment in accounts receivable (AIAR): An estimate of the actual amount of cash tied up in accounts receivable at any time during the year.
liquidity ratios: Measure a firm's ability to satisfy its short-term obligations as they come due.
corporate control: The monitoring, supervision, and direction of a corporation or other business organization.
coinsurance of debt: The debt of each combining firm in a merger is insured with cash flows from two businesses.
fixed-for-floating interest rate swap: Typically one party will make fixed-rate payments to another party in exchange for floating-rate payments.
limited partners: One or more totally passive participants in a limited partnership, who do not take any active role in the operation of the business and who do not face personal liability for the debts of the business.
cash-out statutes: Antitrust "all-or-none" rules that disallow a partial tender offer/acquisition of a company and the ability to control that company with less than 100 percent ownership.
maturity date: The date when a bond's life ends and the borrower must make the final interest payment and repay the principal.
lifetime high prices: The highest settlement prices recorded for a contract since its inception.
forward exchange rate: The exchange rate quoted for a transaction that will occur on a future date.
financial intermediary (FI): An institution that raises capital by issuing liabilities against itself. Also, a commercial bank or other entity that lends to corporations.
lessor: The owner of the asset who receives regular payments for its use by the lessee.
corporation: In U.S. law, a separate legal entity with many of the same economic rights and responsibilities as those enjoyed by individuals.
initial public offering (IPO): A corporation offers its shares for sale to the public for the first time; the first public sale of company stock to outside investors.
actively managed: An approach to running a mutual fund in which the fund manager does research to identify under valued and over valued stocks.
general cash offerings: Most equity sales in the United States fall under this category.
depository transfer check (DTC): A method for transferring cash from the depository banks to the concentration bank. An unsigned check is drawn on one of the firm's bank accounts and deposited in another of the firm's bank accounts.
American Stock Exchange: A major stock exchange in the United States though not as large as the NYSE in terms of daily trading volume or the market capitalization of listed companies.
reverse LBO (or second IPO): A formerly public company that has previously gone private through a leveraged buyout and then goes public again. Also called a second IPO.
bearer bonds: Bonds that both shelter investment income from taxation and provide protection against exchange rate risk.
agency costs of (outside) equity: In an efficient market, informed investors only pay a price per share that fully reflects the perks an entrepreneur is expected to consume after the equity sale, so the entrepreneur bears the full costs of her or his actions.
Chapter 7: Section of the Bankruptcy Reform Act of 1978 that details the procedures to be followed when liquidating a failed firm.
interest rate swap: A swap contract in which two parties exchange payment obligations involving different interest payment schedules.
residual theory of dividends: States that observed dividend payments will simply be a residual, the cash left over after corporations have funded all their positive-NPV investments.
international common stock: Equity issues sold in more than one country by nonresident corporations.
fixed exchange rate: An exchange rate system in which the price of one currency is fixed relative to all other currencies by government authorities.
dividend yield: Annual dividend per share divided by stock price.
statutory merger: A target integration in which the acquirer can absorb the target's resources directly with no remaining trace of the target as a separate entity.
General Agreement on Tariffs and Trade (GATT): A trade treaty that extends free trade principles to broad areas of economic activity in many countries.
economies of scale: Relative operating costs are reduced for merged companies because of an increase in size that allows for the reduction or elimination of overlapping resources.
resource complementarities: A firm with a particular operating expertise merges with a firm with another operating strength to create a company that has expertise in multiple areas.
federal funds rate: The interest rate that U.S. banks charge each other for overnight loans.
real interest rate parity: An equilibrium relationship that predicts that the real interest rate will be the same in every country.
conversion ratio: The number of shares bondholders receive if they convert their bonds into shares.
business failure: The unfortunate circumstance of a firm's inability to stay in business.
top-down sales forecast: A sales forecast that relies heavily on macroeconomic and industry forecasts.
primary-market transactions: Sales of securities to investors by a corporation to raise capital for the firm.
floating-rate issues: Debt issues with an interest (coupon) rate that periodically changes.
economies of scope: Value-creating benefits of increased size for merged companies.
cash flow from operations: Cash inflows and outflows directly related to the production and sale of a firm's products or services. Calculated as net income plus depreciation and other noncash charges.
Capital Asset Pricing Model (CAPM): States that the expected return on a specific asset equals the risk-free rate plus a premium that depends on the asset's beta and the expected risk premium on the market portfolio.
average payment period: The average length of time it takes a firm to pay its suppliers. Calculated by dividing the firm's accounts payable balance by its average daily purchases.
annual percentage yield (APY): The annual rate of interest actually earned reflecting the impact of compounding frequency. The same as the effective annual rate.
contribution margin: The sale price per unit minus variable cost per unit.
required rate of return: The rate of return that investors require from an investment given the risk of the investment.
constant payout ratio dividend policy: Used by a firm to establish that a certain percentage of earnings is paid to owners in each dividend period.
stock split: Involves a company splitting the par value of its stock and issuing new shares to existing investors. For example, in a 2-for-1 split, the firm doubles the number of shares outstanding.
income bonds: An unsecured type of bond that pays interest only when the debtor company has positive earnings.
high-yield bonds: Bonds rated below investment grade (also known as junk bonds).
weighted average cost of capital (WACC): The after-tax weighted-average required return on all types of securities issued by a firm, in which the weights equal the percentage of each type of financing in a firm's overall financial structure.
discounted payback: The amount of time it takes for a project's discounted cash flows to recover the initial investment.
transactions exposure: The risk that movements in exchange rates will adversely affect the value of a particular transaction.
collective action problem: When individual stockholders expend time and resources monitoring managers, bearing the costs of monitoring management while the benefit of their activities accrues to all shareholders.
putable bonds: Bonds that investors can sell back to the issuer at a predetermined price under certain conditions.
lifetime low prices: The lowest settlement prices recorded for a contract since its inception.
hedging: Procedures used by firms to offset many of the more threatening market risks.
Gordon growth model: Values a share of stock under the assumption that dividends grow at a constant rate forever.
Treasury bills: Debt instruments issued by the federal government that mature in less than one year.
Samurai bonds: Yen-denominated bonds issued by non-Japanese corporations.
return on total assets (ROA): A measure of the overall effectiveness of management in generating returns to common stockholders with its available assets.
scenario analysis: A more complex form of sensitivity analysis that provides for calculating the decision variable, such as net present value, when a whole set of assumptions changes in a particular way.
cash receipts: All of a firm's cash inflows in a given period.
economic exposure: The risk that a change in prices will negatively impact the value of all cash flows of a firm.
forward rate: In a currency forward contract, the forward price.
debtor in possession (DIP): The firm filing a reorganization petition.
marking-to-market: Daily cash settlement of all futures contracts.
zero growth model: The simplest approach to stock valuation that assumes a constant dividend stream.
secured creditors: Creditors who have specific assets pledged as collateral and who receive the proceeds from the sale of those assets.
split-up: The division and sale of all of a company's subsidiaries, so that it ceases to exist (except possibly as a holding company with no assets).
principal: The amount of money on which interest is paid.
tax-loss carryforwards: Negative income (net losses) can be used to offset taxes due on future income.
insolvent: A firm is insolvent when (a) it is not paying its debts as they come due; (b) within the immediately preceding 120 days a custodian (a third party) was appointed or took possession of the debtor's property; or (c) the fair market value of its assets is less than the stated value of its liabilities.
compound interest: Interest earned both on the principal amount and on the interest earned in previous periods.
financial risk: Refers to how a firm chooses to distribute the business risk affecting a firm's cash lows between stockholders and bondholders.
fiduciary: Someone who invests and manages money on someone else's behalf.
capital budgeting function: Selecting the best projects in which to invest the resources of the firm, based on each project's perceived risk and expected return.
spin-off: A parent company creates a new company with its own shares to form a division or subsidiary, and existing shareholders receive a pro rata distribution of shares in the new company.
primary offering: An offering in which the shares offered for sale are newly issued shares, which increases the number of outstanding shares and raises new capital for the firm.
conservative strategy: When a company makes sure that it has enough long-term financing to cover its permanent investments in fixed and current assets as well as the additional seasonal investments in current assets that it makes during the various quarters each year.
interest differential: In an interest rate swap, only the differential is exchanged.
market portfolio: A portfolio that contains some of every asset in the economy.
agency costs of debt: Costs that must be weighed against the benefits of leverage in reducing the agency costs of outside equity.
quick (acid-test) ratio: A measure of a firm's liquidity that is similar to the current ratio except that it excludes inventory, which is usually the least-liquid current asset.
extra dividend / special dividend: The additional dividend that a firm pays if earnings are higher than normal in a given period.
league table: Ranks investment banks, based on the total value of securities they underwrote globally during a given year.
financial leverage: Using fixed-cost sources of financing, such as debt and preferred stock, to magnify both the risk and expected return on a firm's investments.
refund: To refinance a debt with new bonds at a lower interest rate.
underwrite: The investment banker purchases shares from a firm and resells them to investors.
LIBOR: The London Interbank Offered Rate. The rate that the most creditworthy international banks that deal in Eurodollars charge on interbank loans.
liquidity crisis: A firm is unable to pay its liabilities as they come due because assets cannot be converted into cash within a reasonable period of time.
employee stock ownership plan (ESOP): The transformation of a public corporation into a private company by the employees of the corporation itself.
growing perpetuity: An annuity promising to pay a growing amount at the end of each year forever.
economic failure: A firm fails to earn a return that is greater than its cost of capital.
carrying cost: The variable cost per unit of holding an item in inventory for a specified period of time. Used in calculating the EOQ.
free cash flow (FCF): The net amount of cash flow remaining after the firm has met all operating needs and paid for investments, both long-term (fixed) and short-term (current). Represents the cash amount that a firm could distribute to investors after meeting all its other obligations.
leasing: Acquiring use of an asset by renting rather than by purchasing the asset.
market capitalization: The value of the shares of a company's stock that are owned by the stockholders: the total number of shares issued multiplied by the current price per share.
debentures: Unsecured bonds backed only by the general faith and credit of the borrowing company.
coupon rate: The rate derived by dividing the bond's annual coupon payment by its par value.
maintenance clauses: Specifying who is to maintain the assets and make insurance and tax payments.
venture capitalists: Professional investors who specialize in high-risk/high-return investments in rapidly growing entrepreneurial businesses.
cash disbursements: All outlays of cash by a firm in a given period.
bond equivalent yield (BEY): The percentage return on zero-coupon bonds calculated as the difference between the par value and the purchase price.
additional paid-in capital: The difference between the price the company received when it sold stock in the primary market and the par value of the stock, multiplied by the number of shares sold. This represents the amount of money the firm received from selling stock, above and beyond the stock's par value.
basis risk: The possibility of unanticipated changes in the difference between the futures price and the spot price.
sustainable growth model: Derives an expression that determines how rapidly a firm can grow while maintaining a balance between its outflows (increases in assets) and inflows (increases in liabilities and equity) of cash.
payoff diagrams: A diagram that shows how the expiration date payoff from an option or a portfolio varies, as the underlying asset price changes.
controlled disbursement: A bank service that provides early notification of checks that will be presented against a company's account on a given day.
processing float: The time that elapses between the receipt of a payment by a firm and its deposit into the firm's account.
participation rights: Agreements giving the venture capitalists the right to participate, on equal terms, in any sale of portfolio-company stock to third parties that the company's managers might arrange for themselves.
president or chief executive officer (CEO): The top company manager with overall responsibility and authority for managing daily company affairs and carrying out policies established by the board.
zero-balance accounts (ZBAs): Disbursement accounts that always have an end-of-day balance of zero. The purpose is to eliminate nonearning cash balances in corporate checking accounts.
National Association of Securities Dealers Automated Quotation (Nasdaq) System: An electronic system that facilitates trading in OTC stocks.
ABC system: An inventory control system that segregates inventory into three groups—A, B, and C. The A items require the largest dollar investment and the most intensive control, the B items require the next largest investment and less intensive control, and the C items require the smallest investment and the least intensive control.
discount investment: An investment vehicle for which the investor pays less than face value at the time of purchase, and then receives the face value of the investment at its maturity date.
joint and several liability: A legal concept that makes each partner in a partnership legally liable for all the debts of the partnership.
investment banks: Financial institutions that assist firms in the process of issuing securities to investors. Investment banks also advise firms engaged in mergers and acquisitions, and they are active in the business of selling and trading securities in secondary markets.
plug figure: A line item on the pro forma balance sheet that represents an account that can be adjusted after all other projections are made, so that the balance sheet balances.
operating profit margin: A measure of profitability that represents the percentage of each sales dollar remaining after deducting all costs and expenses other than interest and taxes.
Gramm-Leach-Bliley Act: Act that allowed commercial banks, securities firms, and insurance companies to join together.
electronic bill presentment and payment (EBPP): A system in the business-to-consumer market under which consumers are sent bills in an electronic format and can then pay them via electronic means.
full disclosure: Requires issuers to reveal all relevant information concerning the company selling the securities and the securities themselves to potential investors.
hostile takeover: The acquisition of one firm by another through an open-market bid for a majority of the target's shares if the target firm's senior managers do no support (or, more likely, actively resist) the acquisition.
managed floating rate system: A hybrid currency system in which a government loosely fixes the value of the national currency.
book building: A process in which underwriters ask prospective investors to reveal information about their demand for the offering. Through conversations with investors, the underwriter tries to measure the demand curve for a given issue, and the investment bank sets the offer price after gathering all the information it can from investors.
purchasing card programs: Implemented by companies as a means of reducing the cost of low-dollar indirect purchases. Also called procurement card programs.
prime rate: The rate of interest charged by U.S. banks on loans to business borrowers with excellent credit records.
indirect quote: An exchange rate quoted in terms of foreign currency per unit of domestic currency.
discount: A bond sells at a discount when its market price is less than its part value.
put-call parity: A relationship that links the market prices of stock, risk-free bonds, call options, and put options.
operating lease: A contractual arrangement whereby the lessee agrees to make periodic payments to the lessor, often for five years or less, to obtain an asset's services. The lessee generally receives an option to cancel, and the asset has a useful life longer than the lease.
leveraged leases: The lessor acts as an equity participant, supplying only about 20 percent of the cost of the asset, and a lender supplies the balance.
forward premium: When one currency buys more of another on the forward market than it buys on the spot market.
risk-management function: Managing firms' exposures to all types of risk, both insurable and uninsurable, in order to maintain optimum risk-return trade-offs and thereby maximize shareholder value.
forward-spot parity: An equilibrium relationship that predicts that the current forward rate will be an unbiased predictor of the spot rate on a future date.
ex-dividend: A purchaser of a stock does not receive the current dividend.
dividend per share (DPS): The portion of the earnings per share paid to stockholders.
fundamental principle of financial leverage: States that substituting long-term debt for equity in a company's capital structure increases both the level of expected returns to shareholders—measured by earnings per share or ROE—and the risk (dispersion) of those expected returns.
bust-up: The takeover of a company that is subsequently split up.
goodwill: An intangible asset created if the restated values of the target in a merger lead to a situation in which its assets are less than its liabilities and equity.
financial leverage: Using debt to magnify both the risk and expected return on a firm's investments. Also, the result of the presence of debt when firms finance their operations with debt and equity, leading to a higher stock beta.
dual-class recapitalization: Organizational restructuring in which the parties wishing to concentrate control (usually management) buy all the shares of a newly issued Class B stock, which carries "super" voting rights (100 votes per share, for example).
expectations theory: In equilibrium, investors should expect to earn the same return whether they invest in long-term Treasury bonds or a series of short-term Treasury bonds.
Treasury Inflation-Protected Securities (TIPS): Notes and bonds issued by the federal government that make coupon payments that vary with the inflation rate.
sale-leaseback arrangement: One firm sells an asset to another for cash, then leases the asset from its new owner.
bottom-up sales forecast: A sales forecast that relies on the assessment by sales personnel of demand in the coming year on a customer-by-customer basis.
interest rate risk: The risk that changes in market interest rates will cause fluctuations in a bond's price. Also, the risk of suffering losses as a result of unanticipated changes in market interest rates.
par value (bonds): The face value of a bond, which the borrower repays at maturity.
collection policy: The procedures used by a company to collect overdue or delinquent accounts receivable. The approach used is often a function of the industry and the competitive environment.
in the money: A call (put) option is in the money when the stock price is greater (less) than the strike price.
financial deficit: More financial capital for investment and investor payments than is retained in profits by a corporation.
present value: The value today of a cash flow to be received at a specific date in the future, assuming an opportunity to earn interest at a specified rate.
current ratio: A measure of a firm's ability to meet its short-term obligations, defined as current assets divided by current liabilities.
cash position management: The collection, concentration, and disbursement of funds for the company.
acquisition: The purchase of additional resources by a business enterprise.
firm-commitment: An offering in which the investment bank underwrites the firm's securities and thereby guarantees that the firm will successfully complete its sale of securities.
bankruptcy costs: The direct and indirect costs of the bankruptcy process.
real return: Approximately, the difference between an investment's stated or nominal return and the inflation rate.
paid-in capital: The number of shares of common stock outstanding times the original selling price of the shares, net of the parvalue.
stock dividend: The payment to existing owners of a dividend in the form of stock.
variable growth model: Assumes that the growth rate dividend will vary during different periods of time, when calculating the value of a firm's stock.
collateral trust bonds: A bond secured by financial assets held by a trustee.
reverse stock split: Occurs when a firm replaces a certain number of outstanding shares with just one new share. This is done to increase the stock price.
Rule 144A offering: A special type of offer, first approved in April 1990, that allows issuing companies to waive some disclosure requirements by selling stock only to sophisticated institutional investors, who may then trade the shares among themselves.
agency costs: Costs that arise due to conflicts of interest between shareholders and managers.
electronic depository transfer (EDT): The term used in the cash management trade for an automated clearinghouse (ACH) debit transfer.
underwriting spread: The difference between the net price and the offer price.
takeover: Any transaction in which the control of one entity is taken over by another.
breakeven analysis: The study of what is required for a project's profits and losses to balance out.
fixed-for-floating currency swap: A combination of a currency swap and an interest rate swap.
diversification: The act of investing in many different assets rather than just a few.
net profit margin: A measure of profitability that represents the percentage of each sales dollar remaining after all costs and expenses, including interest, taxes, and preferred stock dividends, have been deducted.
DuPont system: An analysis that uses both income and balance sheet information to break the ROA and ROE ratios into component pieces.
cramdown procedure: Used when a reorganization plan fails to meet the standard for approval by all classes, but at least one class of creditors has voted for a reorganization plan; or when the firm is clearly insolvent and the existing equity has no value.
fungibility: The ability to close out a position by taking an offsetting position.
split-off: A parent company creates a new, independent company with its own shares, and ownership of the company is transferred to certain existing shareholders only, in exchange for their shares in the parent.
external financing function: Raising capital to support companies' operations and investment programs.
pro forma financial statements: A forecast of what a firm expects its income statement and balance sheet to look like a year or two ahead.
lead underwriter: The investment bank that takes the primary role in assisting a firm in a public offering of securities.
return on common equity (ROE): A measure that captures the return earned on the common stockholders' (owners') investment in a firm.
bear hug: The potential acquirer approaches the target with both a merger offer and the threat of a proxy fight and/or hostile tender offer to gain the remaining shares needed to obtain voting control of the target if the merger offer is refused.
transactions exposure: The risk that a change in prices will negatively affect the value of a specific transaction or series of transactions.
corporate finance: The activities involved in managing money in a business environment.
lien: A legal contract specifying under what conditions a lender can take title to an asset if a loan is not repaid, and prohibiting the borrowing firm from selling or disposing of the asset without the lender's consent.
fixed asset turnover: A measure of the efficiency with which a firm uses its fixed assets, calculated by dividing sales by the number of dollars of net fixed asset investment.
subordinated debentures: An unsecured bond that has a legal claim inferior to other outstanding bonds.
clearing float: The time between deposit of the check and presentation of the check back to the bank on which it is drawn.
London Interbank Offered Rate (LIBOR): The interest rate that banks in London charge each other for overnight loans. Widely used as a benchmark interest rate for short-term floating-rate debt.
registration statement: The principal disclosure document for all public security offerings.
stock option plans: Plans set up to provide stock options to newly-hired managers of portfolio companies in order to give them incentives to manage the company to create value.
proxy fight: A ploy used by outsiders to attempt to gain control of a firm by soliciting a sufficient number of votes to unseat existing directors.
recapitalization: Alteration of a company's capital structure to change the relative mix of debt and equity financing, leaving total capitalization unchanged.
American Depositary Receipts (ADRs): Dollar-denominated claims, issued by U.S. banks, that represent ownership of shares of a foreign company's stock held on deposit by the U.S. bank in the issuing firm's home country.
aggressive strategy: When a company relies heavily on short-term borrowing, not only to meet the seasonal peaks each year but also to finance a portion of the long-term growth in sales and assets.
date of record: The date on which the names of all persons who own shares in a company are recorded as stockholders and thus eligible to receive a dividend.
involuntary reorganization: A reorganization initiated by an outside party, usually a creditor.
principal: The amount of money on which interest is paid.
time value: The difference between an option's market price and its intrinsic value.
McFadden Act: Congressional act of 1927 that prohibited interstate banking.
efficient markets hypothesis (EMH): Asserts that financial asset prices fully reflect all available information (as formally presented by Eugene Fama in 1970).
voluntary reorganization: A strategy that sustains a firm so that the creditor can continue to receive business from it.
net payoff: The difference between the payoff received when the option expires and the premium paid to acquire the option.
net working capital: A measure of a firm's liquidity calculated by subtracting current liabilities from current assets.
interest rate risk: The risk that changes in market interest rates will cause fluctuations in a bond's price. Also, the risk of suffering losses as a result of unanticipated changes in market interest rates.
debt-to-equity ratio: A measure of the firm's financial leverage, calculated by divided long-term debt by stockholders' equity.
direct lease: A lessor acquires the assets that are leased to a given lessee.
Z score: The product of a quantitative model for forecasting bankruptcy that uses a blend of traditional financial ratios and a statistical technique known as multiple discriminant analysis. The Z score has been found to be about 90 percent accurate in forecasting bankruptcy one year in the future and about 80 percent accurate in forecasting it two years in the future.
pure conglomerate mergers: Unrelated diversification mergers that occur between companies in completely different lines of business.
consolidation: A merger in which both the acquirer and target disappear as separate corporations, combining to form an entirely new corporation with new common stock.
share repurchase program: A company announcing this kind of program states that it will buy some of its own shares over a period of time.
closing futures price: The price used to settle all contracts at the end of each day's trading.
creditor control: The creditor committee takes control of the firm and operates it until all claims have been settled.
assignment: An agreement of the creditors by which they pass the power to liquidate the firm's assets to an adjustment bureau, a trade association, or a third party.
indenture: A legal document stating the conditions under which a bond has been issued.
average collection period: The average amount of time that elapses from a sale on credit until the payment becomes usable funds for a firm. Calculated by dividing accounts receivable by average sales per day. Also called the average age of accounts receivable.
lockbox system: A technique for speeding up collections that is popular because it affects all three components of float. Instead of mailing payments to the company, customers mail payments to a post office box, which is emptied regularly by the firm's bank.
short-term financing: Accounts payable, commercial paper, and various types of short-term loans that are used by a firm to finance seasonal fluctuations in current asset investments and provide adequate liquidity to achieve its growth objectives and meet its obligations in a timely manner.
double taxation problem: Taxation of corporate income at both the company and the personal levels—the single greatest disadvantage of the corporate form.
preferred stock: A form of ownership that has preference over common stock with regard to income and assets.
bank account analysis statement: A regular report (usually monthly) provided to a bank's commercial customers that specifies all services provided, including items processed and any charges assessed.
accredited investors: Individuals or institutions that meet certain income and wealth requirements.
forward rate agreement (FRA): A forward contract in which the underlying asset is not an asset at all but an interest rate.
Treasury STRIP: A zero-coupon bond representing one coupon payment or the final principal payment made by an existing Treasury note or bond.
mortgage bonds: A type of secured bond, where the security is real estate.
operational synergy: Economies of scale, economies of scope, and resource complementarities.
derivative securities: Securities such as options, futures, forwards, and swaps that derive their value from some underlying asset.
junk bonds: Bonds rated below investment grade (also known as high yield bonds).
noncash expenses: Tax-deductible expenses for which there is no corresponding cash outflow. They include depreciation, amortization, and depletion.
sponsored ADR: An ADR for which the issuing (foreign) company absorbs the legal and financial costs of creating and trading the security.
matching strategy: When a company finances permanent assets (fixed assets plus the permanent component of current assets) with long-term funding sources and finances its temporary or seasonal asset requirements with short-term debt.
pure stock exchange merger: A merger in which stock is the only mode of payment.
mail float: The time delay between when payment is placed in the mail and when payment is received.
expected return: A forecast of the return that an asset will earn over some period of time.
primary security issues: Security offerings that raise capital for firms.
secondary offering: An offering whose purpose is to allow an existing shareholder to sell a large block of stock to new investors. This kind of offering raises no new capital for the firm.
earnings per share (EPS): Earnings available for common stockholders divided by the number of shares of common stock outstanding.
wealth tax: A tax levied on stock appreciation every period, regardless of whether the shares are sold or not.
shares authorized: The shares of a company's stock that shareholders and the board authorize the firm to sell to the public.
ratio analysis: Calculating and interpreting financial ratios to assess a firm's performance and status.
corporate charter: The legal document created at the corporation's inception to govern its operations.
road show: A tour of major cities taken by a firm and its bankers several weeks before a scheduled offering.
antitrust: Legislation intended to prevent mergers that are deemed to have anticompetitive effects on the business environment.
market extension merger: A combination of firms that produce the same product in different geographic markets.
Treasury bonds: Debt instruments issued by the federal government with maturities longer than 10 years.
liquidity preference theory: States that the slope of the yield curve is influenced not only by expected interest rate changes, but also by the liquidity premium that investors require on long-term bonds.
wire transfer: In the United States, the primary wire transfer system, known as Fedwire, is run by the Federal Reserve System and is available to all depository institutions.
tender-merger: A merger that occurs after an acquirer secures enough voting control of the target's shares through a tender offer to effect a merger.
activity ratios: A measure of the speed with which a firm converts various accounts into sales or cash.
dividend payout ratio: The percentage of current earnings available for common stockholders paid out as dividends. Calculated by dividing the firm's cash dividend per share by its earnings per share.
earnings available for common stockholders: Net income net of preferred stock dividends.
sensitivity analysis: A tool that allows exploration of the impact of individual assumptions on a decision variable, such as a project's net present value, by determining the effect of changing one variable while holding all others fixed.
conversion premium: The percentage increase in the underlying stock that must occur before it is profitable to exercise the option to convert a bond into shares.
call price: The price at which a bond issuer may call or repurchase an outstanding bond from investors.
effective: Status of an offering before any shares can actually be sold to public investors.
cash concentration: The process of bringing the lockbox and other deposits together into one bank, often called the concentration bank.
contribution margin: The sale price per unit (SP) minus variable cost per unit (VC).
accrual-based approach: Revenues are recorded at the point of sale and costs when they are incurred, not necessarily when a firm receives or pays out cash.
Proposition II: Asserts that the expected return on a levered firm's equity is a linear function of that firm's debt-to-equity ratio.
junk bonds: Bonds rated below investment grade (also known as high yield bonds).
share issue privatization (SIP): A government executing one of these will sell all or part of its ownership in a state-owned enterprise to private investors via a public share offering.
product extension mergers: Diversification mergers that combine companies with similar but not identical lines of business.
floating-rate bonds: Bonds that make coupon payments that vary through time. The coupon payments are usually tied to a benchmark market interest rate. Also called variable-rate bonds.
equipment trust certificates: A secured bond often used to finance transporation equipment.
decision tree: A visual representation of the sequential choices that managers face over time with regard to a particular investment.
capital investment: Investments in long-lived assets such as plant, equipment, and advertising.
free cash flow (FCF): The net amount of cash flow remaining after the firm has met all operating needs and paid for investments, both long-term (fixed) and short-term (current). Represents the cash amount that a firm could distribute to investors after meeting all its other obligations.
mixed offering: An offering in which some of the shares come from existing shareholders and some are new. Also, a merger financed with a combination of cash and securities.
retained earnings: The cumulative total of the earnings that a firm has reinvested since its inception.
semiannual compounding: Interest compounds twice a year.
law of one price: A theory that says that the identical good trading in different markets must sell at the same price.
equity kickers: Warrants attached to another security offering (usually a bond offering) that give investors more upside potential.
payback period: The amount of time it takes for a given project's cumulative net cash inflows to recoup the initial investment.
sinking fund: A provision in a bond indenture that requires the borrower to make regular payments to a third-party trustee for use in retiring the bond
constant nominal payment policy: Based on the payment of a fixed-dollar dividend in each period.
cash flow approach: Used by financial professionals to focus attention on current and prospective inflows and outflows of cash.
negative covenants: Restrictions a borrower must accept in order to secure a loan. What a company must not do.
financial engineering: The process of using the principles of financial economics to design and price financial instruments.
yield spread: The difference in yield to maturity between two bonds or two classes of bonds with similar maturities.
loan amortization schedule: Used to determine loan amortization payments and the allocation of each payment to interest and principal.
fixed-price offer: An offer in which the underwriters set the final offer price for a new issue weeks in advance.
tracking stocks: Equity claims based on (and designed to mirror, or track) the earnings of wholly owned subsidiaries of diversified firms.
long position: To own an option or another security.
agency cost/tax shield trade-off model of corporate leverage: This model expresses the value of a levered firm as the value of an unlevered firm, plus the present values of tax shields and the agency costs of outside equity, minus the present value of bankruptcy costs and the agency costs of debt.
forward integration: A merger in which the acquired company provides a later step in the production process.
at the money: An option is at the money when the stock price equals the strike price.
index fund: A passively managed fund that tries to mimic the performance of a market index such as the S&P 500.
cost of marginal investment in accounts receivable: The marginal investment in accounts receivable required to support a proposed change in credit policy multiplied by the required return on investment.
capital budgeting: The process of identifying which long-lived investment projects a firm should undertake.
margin account: The account into which the investor must deposit the initial margin.
payment pattern: The normal timing in which a firm's customers pay their accounts, expressed as the percentage of monthly sales collected in each month following the sale.
trustee: In bankruptcy, someone appointed by a judge to replace a firm's current management team and to oversee liquidation or reorganization.
exercise the option: Pay (receive) the strike price and buy (sell) the underlying asset.
strategic merger: Seeks to create a more efficient merged company than the two premerger companies operating independently.
stand-alone companies: Companies created for the sole purpose of constructing and operating a single project.
common stock: The most basic form of corporate ownership.
internal capital markets: Created when the high-cash-flow businesses of a conglomerate generate enough cash to fund the riskier business ventures internally.
brokers: Agents who facilitate secondary-market trading by bringing buyers and sellers together.
mortgage bonds: A bond secured by real estate or buildings.
net present value (NPV): The sum of the present value of all of a given project's cash flows, both inflows and outflows, discounted at a rate consistent with the project's risk. Also, a method for valuing capital investments
subordinated debenture: An unsecured type of bond.
all-in rate: The base rate and the spread.
collateral: The specific assets pledged to secure a loan.
assets-to-equity (A/E) ratio: A measure of the proportion of total assets financed by a firm's equity. Also called the equity multiplier.
balloon payment: A term loan agreement that requires periodic interest payments over the life of the loan followed by a large lump-sum payment at maturity.
antitakeover amendments: Adding defensive measures to corporate charters to avoid a hostile takeover.
Green Shoe option: An option to sell more shares than originally planned.
open interest: The number of contracts that are currently outstanding.
bulge bracket: Consists of firms that generally occupy the lead or co-lead manager's position in large, new security offerings, meaning that they take primary responsibility for the new offering (even though other banks participate as part of a syndicate), and as a result they earn higher fees.
capital loss: The decrease in the price of an asset that occurs over a period of time.
settlement price: The average price at which a contract sells at the end of a trading day.
net working capital: The difference between a firm's current assets and its current liabilities. Often used as a measure of liquidity.
yield to maturity: The discount rate that equates the present value of the bond's cash flows to its market price.
ratchet provisions: Contract terms that adjust downward the par value of the stock venture capitalists have purchased in a company in case the firm must sell new stock at a lower price than the VC originally paid. This preserves the venture capitalists' ownership stake in portfolio companies, at the expense of the company's managers.
market/book (M/B) ratio: A measure used to assess a firm's future performance by relating its market value per share to its book value per share.
economic order quantity (EOQ) model: A common tool used to estimate the optimal order quantity for big-ticket items of inventory. It considers operating and financial costs and determines the order quantity that minimizes overall inventory costs.
accounting rate of return: Calculation of a hurdle rate by dividing net income by the book value of assets, either on a year-by-year basis or by taking an average over the project's life.
mail-based collection system: Processing centers receive the mail payments, open the envelopes, separate the check from the remittance information, prepare the check for deposit, and send the remittance information to the accounts receivable department for application of payment.
operating assets: Cash, marketable securities, accounts receivable, and inventories that are necessary to support the day-to-day operations of a firm.
direct costs of bankruptcy: Out-of-pocket cash expenses directly related to bankruptcy filing and administration.
debt ratio: A measure of the proportion of total assets financed by a firm's creditors.
cash settlement: An agreement between two parties, in which one party pays the other party the cash value of its option position, rather than forcing it to exercise the option by buying or selling the underlying asset.
electronic invoice presentment and payment (EIPP): A system in business-to-business transactions under which business customers are sent bills in an electronic format and then can pay them via electronic means.
equity carve-out: Occurs when a parent company sells shares of a subsidiary corporation to the public through an initial public offering. The parent company may sell some of the subsidiary shares that it already owns, or the subsidiary may issue new shares.
currency forward contract: Exchange of one currency for another at a fixed date in the future.
foreign bond: A bond issued in a host country's financial market, in the host country's currency, by a nonresident corporation.
free cash flow theory of mergers: Michael Jensen (1986) hypothesizes that managers will use free cash flow to invest in mergers that have negative net present values in order to build corporate empires from which the managers will derive personal benefits, including greater compensation.
managerialism theory of mergers: Poorly monitored managers will pursue mergers to maximize their corporation's asset size because managerial compensation is usually based on firm size, regardless of whether or not these mergers create value for stockholders.
total return: A measure of the performance of an investment that captures both the income it paid and its capital gain or loss over a stated period of time.
due diligence: Examination of potential security issuers in which investment banks are legally required to search out and disclose all relevant information about an issuer before selling securities to the public.
euro: The currency used throughout the countries that make up the European Union.
callable: Bonds that the issuer can repurchase from investors at a predetermined price known as the call price.
agency bonds: Bonds issued by federal government agencies. Agency bonds are not explicitly backed by the full faith and credit of the U.S. government. Agencies issue bonds to promote the formation of credit in certain sectors of the economy such as real estate, education, and farming.
Herfindahl Index (HI): A measure popularized by Comment and Jarrell (1995) to demonstrate the relationship between corporate focus and shareholder wealth.
LIBOR: The London Interbank Offered Rate.
market risk premium: The additional return earned (or expected) on the market portfolio over and above the risk-free rate.
entrepreneurial finance: Study of the special challenges and problems involved with investment in and financing of entrepreneurial growth companies.
inventory turnover: A measure of how quickly a firm sells its goods.
warrants: Securities that grant rights similar to a call option, except that when a warrant is exercised, the firm must issue a new share, and it receives the strike price as a cash inflow.
Glass-Steagall Act: Congressional act of 1933 mandating the separation of investment and commercial banking.
interest rate floor: A put option on interest rates.
equipment trust certificates: A type of secured bond used to finance transportation equipment.
recapitalization: Alteration of a company's capital structure to reduce high fixed charges.
cross-default covenant: In which the borrower is often considered to be in default on all debts if it is in default on any debt.
Gordon growth model: The valuation model, named after Myron Gordon, that views cash flows as a growing perpetuity.
systematic risk: Risk that cannot be eliminated through diversification.
times interest earned ratio: A measure of the firm's ability to make contractual interest payments, calculated by dividing earnings before interest and taxes by interest expense.
liquidation: Winding up a firm's operations, selling off its assets, and distributing the proceeds to creditors.
greenmail: Targeted repurchase of shares, at an above-market price, by a company from a potential acquirer, paid to make the "raider" drop the threat of acquiring the company.
hedge ratio: A combination of stock and options that results in a risk-free payoff.
standard deviation: A measure of volatility equal to the square root of variance.
monetary union: An agreement between many European countries to integrate their monetary systems including using a single currency.
debentures: Unsecured bonds backed only by the general faith and credit of the borrowing company.
Proposition I: The famous "irrelevance proposition," which imagines that a company is operating in a world of frictionless capital markets, and in a world where there is uncertainty about corporate revenues and earnings.
angel capitalists: Wealthy individuals who make private equity investments on an ad hoc basis.
reorganization: The process in bankruptcy designed to allow businesses that are in temporary financial distress but are worth saving to continue operating while the claims of creditors are settled using a collective procedure.
residual claimants: Investors who have the right to receive cash flows only after all other claimants have been satisfied. Common stockholders are typically the residual claimants of corporations.
money market mutual funds: Professionally managed short-term investment portfolios used by many small companies and some large companies.
corporate governance function: Developing ownership and corporate governance structures for companies that ensure that managers behave ethically and make decisions that benefit shareholders.
beta: A standardized measure of the risk of an individual asset, one that captures only the systematic component of its volatility.
real option: The right, but not the obligation, to take a future action that changes an investment's value.
integrated accounts payable: Provides a company with outsourcing of its accounts payable or disbursement operations. The outsourcing may be as minor as contracting with a bank to issue checks and perform reconciliations or as major as outsourcing the entire payables function.
random walk: A description of the movement of the price of a financial asset over time. When prices follow a random walk, future and past prices are statistically unrelated, and the best forecast of the future price is simply the current price.
financial management function: Managing firms' internal cash flows and its mix of debt and equity financing, both to maximize the value of the debt and equity claims on firms' and to ensure that companies can pay off their obligations when they come due.
general creditors: Creditors who have no specific assets pledged as collateral, or the proceeds from the sale of whose pledged assets are inadequate to cover the debt.
cross-hedging: The underlying securities in a futures contract and the assets being hedged have different characteristics.
best efforts: The investment bank promises to give its best effort to sell the firm's securities at the agreed-upon price; but if there is insufficient demand for the issue, then the firm withdraws the issue from the market.
forward discount: When one currency buys less of another on the forward market than it buys on the spot market.
target dividend payout ratio: Under this policy, the firm attempts to pay out a certain percentage of earnings, but rather than let dividends fluctuate, it pays a stated dollar dividend and adjusts it toward the target payout slowly as proven earnings increases occur.
forward price: The price to which parties in a forward contract agree. The price dictates what the buyer will pay to the seller on a future date.
workout: A firm that becomes technically insolvent or bankrupt may make an arrangement with its creditors that enables it to bypass many of the costs involved in legal bankruptcy proceedings.
underwriting syndicate: Consists of many investment banks that collectively purchase the firm's shares and market them, thereby spreading the risk exposure across the syndicate.
asset substitution: An investment that will increase firm value but does not earn a return high enough to fully redeem the maturing bonds.
Treasury notes: Debt instruments issued by the federal government with maturities ranging from 1to 10 years.
time value of money: The financial concept that recognizes the fact that a dollar received today is more valuable than a dollar received in the future.
capital rationing: The situation where a firm has more positive NPV projects than its available budget can fund. It must choose a combination of those projects that maximizes shareholder wealth.
unsponsored ADR: An ADR in which the issuing firm is not involved with the issue at all and may even oppose it.
payment date: The actual date on which a firm mails the dividend payment to the holders of record.
renewal options: In an operating lease, the lessee often has the option to renew a lease at its expiration.
initial return: The gain when an allocation of shares from an investment banker is sold at the first opportunity because the offer price is consistently lower that what the market is willing to bear.
portfolio weights: The percentage invested in each of several securities in a portfolio. Portfolio weights must sum to 1.0 (or 100%).
institutional venture capital funds: Formal business entities with full-time professionals dedicated to seeking out and funding promising ventures.
private placements: Unregistered security offerings sold directly to accredited investors.
unsecured creditors: Creditors who have no specific assets pledged as collateral, or the proceeds from the sale of whose pledged assets are inadequate to cover the debt.
intrinsic value: For a call, intrinsic value equals S - X or zero, whichever is greater. For a put, it equals X - S or zero, whichever is greater.
opportunity costs: Lost cash flows on an alternative investment that the firm or individual decides not to make.
option premium: The market price of the option.
coupon: A fixed amount of interest that a bond promises to pay investors.
five C's of credit: A framework for performing in-depth credit analysis without providing a specific accept or reject decision.
financial intermediary: An institution that raises capital by issuing liabilities against itself, and then lends that capital to corporate and individual borrowers.
underlying asset: The asset from which an option or other derivative security derives its value.
Protective covenants: Provisions of the bond indenture that stipulate actions that the borrower must do (positive covenants) or actions that the borrower must not do (negative covenants).
operating cycle (OC): Measurement of the time that elapses from the firm's receipt of raw materials to begin production to its collection of cash from the sale of the finished product.
fallen angels: Bonds that received investment-grade ratings when first issued but later fell to junk status.
spin-off: A parent company creates a new company with its own shares to form a division or subsidiary, and existing shareholders receive a pro rata distribution of shares in the new company.
industry shock theory of takeovers: Explains much of the activity in the wave of mergers as a reaction to some external shock to the industry, such as a change in regulation or the introduction of a fundamentally new technology.
noncash charges: Expenses, such as depreciation, amortization, and depletion allowances, that appear on the income statement but do not involve an actual outlay of cash.
insolvency bankruptcy: A firm's liabilities exceed the fair market value of its assets.
Yankee bonds: Bonds sold by foreign corporations to U.S. investors.
default risk: The risk that the corporation issuing a bond may not make all scheduled payments.
Chapter 11: Section of the Bankruptcy Reform Act of 1978 that outlines the procedures for reorganizing a failed or failing firm, whether its petition is filed voluntarily or involuntarily.
unseasoned equity offering: An initial offering of shares by a company that does not currently have a public listing for trading its stock.
entrepreneurial growth companies (EGCs): Rapidly growing private companies that are usually technology-based and which offer both high returns and high risk to equity investors. These are the companies typically funded by venture capitalists.
S corporation: An ordinary corporation in which the stockholders have elected to allow shareholders to be taxed as partners while still retaining their limited-liability status as corporate stockholders.
terminal value: The value of a project at a given future date.
exchange rate: The price of one currency in terms of another currency.
annuity due: An annuity for which the payments occur at the beginning of each period.
low-regular-and-extra policy: Policy of a firm paying a low regular dividend supplemented by an additional cash dividend when earnings warrant it.
total cost: The sum of the order costs and the carrying costs that is minimized at the economic order quantity (EOQ) model.
prepackaged bankruptcy: Companies prepare a reorganization plan that is negotiated and voted on by creditors and stockholders before the company actually files for Chapter 11 bankruptcy.
equity claimants: Owners of a corporation's equity securities.
bond ratings: Grades assigned to bonds by specialized agencies that evaluate the capacity of bond issuers to repay their debts. Lower grades signify higher default risk.
shelf registration (Rule 415): A procedure that allows a qualifying company to file a "master registration statement," a single document summarizing planned financing over a two-year period.
competitively bid offer: The firm announces the terms of its intended equity sale, and investment banks bid for the business.
fixed-rate offerings: Issues that have a coupon interest rate that remains constant throughout the issue's life.
financing flows: Result from debt and equity financing transactions.
subsidiary merger: A merger in which the acquirer maintains the identity of the target as a separate subsidiary or division.
project finance (PF) loans: Loans usually arranged for infrastructure projects such as toll roads, bridges, and power plants.
certification: Assurance that the issuing company is in fact disclosing all material information.
target cash balance: A cash total that is set for checking accounts to avoid engaging in cash position management.
commercial paper: The primary corporate obligation in the short-term market. Typically structured as an unsecured promissory note with a maturity of less than 270 days and sold to other corporations and individual investors. Most issues are also backed by credit guarantees from a financial institution and are sold on a discount basis.
bond ratings: Grades assigned based on degree of risk.
voluntary settlement: A firm that becomes technically insolvent or bankrupt may make an arrangement with its creditors that enables it to bypass many of the costs involved in legal bankruptcy proceedings.
effective annual rate (EAR): The annual rate of interest actually paid or earned, reflecting the impact of compounding frequency. Also called the true annual return.
prime lending rate: The interest rate charged by banks on their most creditworthy borrowers.
mortgage-backed securities (MBS): Debt securities that pass through to investors the principal and interest payments that homeowners make on their mortgages.
net present value (NPV) profile: A plot of a project's NPV (on the y axis) against various discount rates (on the x axis). It is used to illustrate the relationship between the NPV and the IRR for the typical project.
stated annual rate: The contractual annual rate of interest charged by a lender or promised by a borrower.
cash application: The process through which a customer's payment is posted to its account and the outstanding invoices are cleared as paid.
business risk: Refers to the variability of a firm's cash flows, as measured by the variability of EBIT.
operating leverage: Measures the tendency of the volatility of operating cash flows to increase with fixed operating costs.
availability float: The time between deposit of a check and availability of the funds to a firm.
ordinary annuity: An annuity for which the payments occur at the end of each period.
staged financing: Method of investing venture capital in a portfolio company in stages, over time, with additional funding being provided each stage only if the company is achieving satisfactory results. Used by venture capitalists to minimize their risk exposure.
field-banking system: System characterized by many collection points, each of which may have a depository account at a local bank.
announcement date: The day a firm releases the dividend record and payment dates to the public.
equity capital: An ownership interest usually in the form of common or preferred stock.
covered interest arbitrage: A trading strategy designed to exploit deviations from interest rate parity to earn an arbitrage profit.
shares issued: The shares of a company's stock that have been issued or sold to the public.
agency cost/contracting model of dividends: A theoretical model that explains empirical regularities in dividend payment and share repurchase patterns, based on agency problems between managers and shareholders.
lessee: The user of the underlying asset who makes regular payments to the lessor.
horizontal merger: A combination of competitors within the same geographic market.
breakeven point (BEP): The level of sales or production that a firm must achieve in order to avoid losses by fully covering all costs. Calculated by dividing total fixed costs (FC) by the contribution margin.
automated clearinghouse (ACH) debit transfer: A preauthorized electronic withdrawal from the payer's account.
signaling model of dividends: Assumes that managers use dividends to convey positive information to poorly informed shareholders.
investment-grade bonds: Bonds rated Baa or higher by Moody's (BBB by S&P).
par value (stock): An arbitrary value assigned to common stock on a firm's balance sheet.
just-in-time (JIT) system: An inventory management technique used to make sure that materials arrive exactly when they are needed for production, rather than being stored on-site. To work effectively it requires close teamwork among vendors and purchasing and production personnel.
triangular arbitrage: A trading strategy in which traders buy a currency in a country where the value of that currency is too low and immediately sell the currency in another country where the currency value is too high.
oversubscribe: When the investment banker builds a book of orders for stock that is greater than the amount of stock the firm intends to sell.
tailing the hedge: Purchasing enough futures contracts to hedge risk exposure, but not so many as to cause overhedging.
qualified institutional buyers: Institutions with assets exceeding $100 million.
positive covenants: Requirements a borrower must meet to secure a loan. What a company must do.
equity multiplier: A measure of the proportion of total assets financed by a firm's equity. Also called the assets-to-equity (A/E) ratio.
Sarbanes-Oxley Act of 2002 (SOX): Act of Congress that established new corporate governance standards for U.S. public companies, and that established the Public Company Accounting Oversight Board (PCAOB).
initial margin: The minimum dollar amount required of an investor when taking a position in a futures contract.
positive pay: A bank service used to combat the most common types of check fraud. A company transmits a check-issued file, designating the check number and amount of each item, to the bank when the checks are issued. The bank matches the presented checks against this file and rejects any items that do not match.
total asset turnover: A measure of the efficiency with which a firm uses all its assets to generate sales; calculated by dividing the dollars of sales a firm generates by the dollars of asset investment.
corporate bonds: Bonds issued by corporations.
nominal return: The stated return offered by an investment unadjusted for the effects of inflation.
marginal tax rate: The tax rate applicable to a firm's next dollar of earnings. An income statement in which all entries are expressed as a percentage of sales.
direct quote: An exchange rate quoted in terms of units of domestic currency per unit of foreign currency.
swap contract: Agreement between two parties to exchange payment obligations on two underlying financial liabilities that are equal in principal amount but differ in payment patterns.
average collection period (ACP): The average length of time from a sale on credit until the payment becomes usable funds for a firm. Also known as days' sales outstanding (DSO).
working capital: Refers to what is more correctly known as net working capital.
loan amortization: A borrower makes equal periodic payments over time to fully repay a loan.
protective put: A portfolio containing a share of stock and a put option on that stock.
credit scoring: Applies statistically derived weights for key financial and credit characteristics to predict whether or not a credit applicant with specific scores for each characteristic will pay the requested credit in a timely fashion.
aging of accounts receivable: A schedule that indicates the portions of the total accounts receivable balance that have been outstanding for specified periods of time.
prospectus: The first part of a registration statement; it is distributed to all prospective investors.
redemption option: Option for venture capitalists to sell a company back to its entrepreneur or founders.
purchasing power parity: An equilibrium relationship that predicts that currency movements are tied to differences in inflation rates across countries.
manufacturing resource planning II (MRPII): Expands on MRP by using a complex computerized system to integrate data from many departments and generate a production plan for the firm along with management reports, forecasts, and financial statements.
call premium: The amount by which the call price exceeds the par value of a bond. Paid by corporations to call bonds after a protection period ends.
material requirements planning (MRP): A computerized system used to control the flow of resources, particularly inventory, within the production-sale process. Uses a master schedule to ensure that the materials, labor, and equipment needed for production are at the right places in the right amounts at the right times.
arbitrage: The process of buying something in one market at a low price and simultaneously selling it in another market at a higher price to generate an immediate, risk-free profit.
extension: An arrangement wherein a firm's creditors are promised payment in full, although not immediately.
effective borrowing rate (EBR): Generally determined as the total amount of interest and fees paid, divided by the average usable loan amount.
passively managed: An approach to running a mutual fund in which the fund manager makes no attempt to identify over valued or under valued stocks, but instead holds a diversified portfolio and attempts to minimize the costs of operating the fund.
out of the money: A call (put) option is out of the money when the stock price is less (greater) than the strike price.
managerial risk reduction theory: Implies that acquiring firms manager acquire other firms primarily to reduce the volatility of the combined firm's earnings, thus reducing the risk that they will be fired due to an unexpected decline in earnings.
collateral trust bonds: A type of bond secured by stock and/or bonds that are owned by the issuer.
discounting: Describes the process of calculating present values.
book value: The value of a firm's equity as recorded on the firm's balance sheet.
financial synergies: A merger results in less-volatile cash flows, lower default risk, and a lower cost of capital.
Jobs and Growth Tax Relief Reconciliation Act of 2003: Act of Congress that reduced the rate of personal taxation of dividend income, reducing the double taxation problem.
dividend: A periodic cash payment that firms make to investors who hold the firms' preferred or common stock.
term structure of interest rates: The relationship between yield to maturity and time to maturity among bonds having similar risk.
appreciate: A currency appreciates when it buys more of another currency than it did previously.
maintenance margin: Margin level required to maintain an open position.
foreign bond: A bond issued in a host country's financial market, in the host country's currency, by a nonresident corporation.
municipal bonds: Issued by U.S. state and local governments. Interest received on these bonds is exempt from federal income tax.
shareholders: Owners of common and preferred stock of a corporation.
percentage-of-sales method: Constructing pro forma statements by assuming that all items grow in proportion to sales.
venture capital: A professionally managed pool of money raised for the sole purpose of making actively managed direct equity investments in rapidly growing private companies.
vertical merger: Companies with current or potential buyer-seller relationships combine to create a more integrated company.
floating exchange rate: An exchange rate system in which a currency's value is allowed to fluctuate in response to market forces.
management buyout (MBO): The transformation of a public corporation into a private company by the current managers of the corporation.
securitization: The repackaging of loans and other traditional bank-based credit products into securities that can be sold to public investors.
credit monitoring: The ongoing review of a firm's accounts receivable to determine if customers are paying according to the stated credit terms.
treasury stock: Common shares that were issued and later reacquired by the firm through share repurchase programs and are therefore being held in reserve by the firm.
unanimous consent procedure (UCP): A reorganization plan instituted by consent of all creditors and equity classes.
technical insolvency: A firm is unable to pay its liabilities as they come due, although its assets are still greater than its liabilities.
financial (or capital) lease: A noncancelable contractual arrangement whereby the lessee agrees to make periodic payments to the lessor, typically for more than five years, to obtain an asset's services. Same as a capital lease.
variance: A measure of volatility equal to the sum of squared deviations from the mean divided by one less than the number of observations in the sample.
capital gain: The increase in the price of an asset that occurs over a period of time.
exercise price: The price at which an option holder can buy or sell the underlying asset.
price/earnings (P/E) ratio: A measure of a firm's long-term growth prospects that represents the amount investors are willing to pay for each dollar of a firm's earnings.
cash conversion cycle (CCC): The elapsed time between the points at which a firm pays for raw materials and at which it receives payment for finished goods.
secondary-market transactions: Trades between investors that generate no new cash flow for the firm.
future value: The value of an investment made today measured at a specific future date using compound interest.
proxy statements: A document mailed to shareholders that describes the matters to be decided by a shareholder vote in an upcoming annual meeting. Shareholders can sign their proxy statements and grant their voting rights to other parties.
relevant cash flows: All of the incremental, after-tax cash flows (initial outlay, operating cash flow, and terminal value) associated with a proposed investment.
managerial synergies: Efficiency gains from combining the management teams of merged companies.
conversion value: The market price of the stock, multiplied by the number of shares of stock that bondholders receive if they convert.
convertible bond: A bond that gives investors the option to redeem their bonds for shares of the issuer's stock rather than cash.
selling group: Consists of investment banks that may assist in selling shares but are not formal members of the underwriting syndicate.
convertible bond: A bond that gives investors the right to convert their bonds into shares.
initial public offering (IPO): Corporations offer shares for sale to the public for the first time; the first public sale of company stock to outside investors.
translation exposure or accounting exposure: The risk that exchange rate movements will adversely impact reported financial results on a firm's financial statements.
demand registration rights: Agreements giving the venture capitalists the right to demand that a portfolio company's managers arrange for a public offering of shares in the company, to be paid for by the company itself.
agency problems: The conflict between the goals of a firm's owners and its managers.
reverse LBO: A formerly public company that has previously gone private through a leveraged buyout and then goes public again. Also called a second IPO.
unsystematic risk: Risk that can be eliminated through diversification.
convertible bonds: Securities that allow bondholder to change each bond into a stated number of shares of common stock.
spot price: The price that the buyer pays the seller in a current, cash market transaction.
absolute priority rules (APR): Rules contained in Chapter 7 of the Bankruptcy Reform Act of 1978 that specify the procedure by which secured creditors are paid first, then unsecured creditors, then preferred shareholders, and finally common stockholders.
boards of directors: Elected by shareholders to be responsible for hiring and firing managers and setting overall corporate policies.
listed securities: Securities that trade on major stock exchanges.
strategic plan: A multiyear action plan for the major investments and competitive initiatives that a firm's senior managers believe will drive the future success of the enterprise.
opening futures price: Price on the first trade of the day.
treasury stock: Common shares that have been issued but are no longer outstanding because the firm repurchased them.
corporate venture capital funds: Subsidiaries or stand-alone firms established by nonfinancial corporations eager to gain access to emerging technologies by making early-stage investments in high-tech firms.
term loan: A loan made by a financial institution to a business, with an initial maturity of more than 1 year, generally 5 to 12 years.
Eurobond: A bond issued by an international borrower and sold to investors in countries with currencies other than that in which the bond is denominated.
financial venture capital funds: Subsidiaries of financial institutions, particularly commercial banks.

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