Glossary

A probability based on logical analysis rather than on observation or personal judgment.

Under financial accounting, the earnings before tax (in company’s income statement) Compare: Taxable income

Liability account that records amounts a company owes to its vendors for goods and services that were purchased from them.

Amounts owed to a company by customers for goods or services sold on credit.  See also: Credit terms

Revenue is recorded when the firm earns it regardless of whether cash is paid. When a firm provides goods or services before it receives cash payment, revenue is recorded in the income statement. Accounts receivable increases. When a firm receives cash before it provides the goods or service to the customer, the excess cash is recorded as unearned revenue (liability). ...

Interest earned but not yet paid. When a bond sale is transacted in between coupon payment dates, the buyer has to pay the seller the flat price (dealer price) plus the accrued interest. Full price = Flat price + Accrued interest Accrued interest = Coupon x Proportion Proportion = Number of days since last coupon payment / Number of days ...

Expenses that have been recognised in the income statement but have not yet been paid as of the balance sheet date.

An investment strategy characterised by monitoring and attempting to capitalize on market conditions to optimize the risk and return relationship of short-term investments. Active strategies can include intentional matching (matching strategy) or mismatching (mismatching strategy) the timing of cash outflows with investment maturities.  A laddering strategy is an active strategy that falls somewhere between a matching and a passive strategy. ...

Measure how efficiently a company utilises its assets, such as the collection of receivables, and management of inventory. Such ratios include: Total asset turnover, Fixed asset turnover, Working capital turnover, Payables turnover, Receivables turnover, Inventory turnover, Number of days of payables, DSO, DOH

A day count convention where the actual number of days are used to determine the accrued interest for the period. Usually used for government bonds. Compare: 30/360 convention

Probability that at lease one event will occur. P(A or B) or P(A⋃B) P(A or B) = P(A) +P(B) – P(AB) See also: Multiplication rule

LEVEL II Adjusted R-squared is a modified version of the R-squared measure of how well the regression model fits the data in a simple linear regression study. It takes into account the number of independent variables in the model and adjusts the R-squared value accordingly. R-squared represents the percentage of the variance in the dependent variable that is explained by ...

A bond issued by an entity that is issued by entities created by national governments for specific purposes such as financing small businesses or providing mortgage financing. (e.g. Fannie Mae bonds) Because a quasi-government entity typically does not have direct taxing authority, bonds are repaid from the cash flows generated by the entity or from the project the bond issue ...

Agency costs refer to the costs associated with the conflicts of interest between a firm’s management and shareholders. Risks are borne by the company’s shareholders, while the management’s compensation is often tied to company performance, which may lead to excessive risk taking by the managers. Because shareholders are aware of this conflict, they will take steps to minimise these costs, ...

US securities backed by residential mortgage loans and guaranteed by a federal agency (e.g. Ginnie Mae) or guaranteed by either of the two Government-Sponsored Enterprises (Fannie Mae, Freddie Mac). Compare: Non-agency RMBS See also: Mortgage pass-through security, Prepayment risk

Under the converged revenue recognition standards, agents can only recognise commission as revenue, not the sale price.

The aggregate demand tells us from the consumers’ point of view, the relationship between the price level and the amount of output demanded at those prices.   Compare: Aggregate supply

The aggregate supply is the amount of output that all the domestic producers are willing to provide at various prices.  We must distinguish between the very short, short, and long-run aggregate supply curves. The main reason for the differences is due to the assumption regarding how input prices like wages, material costs and rent respond to changes in production levels. ...

Banker’s acceptances are often quoted as “all inclusive”, such that the interest is subtracted upfront from the amount borrowed.

HA, the hypothesis accepted when the null hypothesis H0 is rejected.

Trading venues that function like exchanges but do not exercise regulatory authority over their subscribers. Many ATS are known as dark pools because they do not display the orders that their clients send to them. Large investment managers especially like these systems because market prices often move to their disadvantage when other traders know about their large orders.

American depository receipts are denominated in U.S. dollars and trade in the United States. The underlying security on which the ADR is based is the American depository share, which trades in the firm’s home market. There are 4 kinds of ADRs which we summarise in this table.  Level 1 ADRs trade in the over-the-counter market and are not listed on ...

Type of option contract that can be exercised at any time up to the option’s expiration date.

The process of allocating the cost of long-term intangible assets (e.g. franchising agreement, copyright) having a finite useful life to accounting periods. Amortisation methods: Straight-line method, Double declining balance method, Units-of-production method See also: Depreciation (for tangible assets)

Bonds with a payment schedule that includes both payments of interest and repayments of principal for each period. Can be fully amortising, or partially amortising.

An information-processing bias in which decisions are made based on expectations of a prior number and overweighting its importance, making adjustments in relation to that number as new information arrives.  This is closely related to conservatism bias, which is the downplaying of new information to persist in the current belief. 

Companies are generally required to hold an annual general meeting within a certain period following the end of their fiscal year. At the AGM, the management provides shareholders with the audited financial statements for the year, addresses the company’s performance and significant actions over the period, and answers shareholder questions. Typically, anyone who owns the company’s shares is permitted to ...

A finite set of level sequential cash flows. Types: Ordinary Annuity, Annuity Due, Perpetuities

An annuity where the cash flows are paid at the beginning of each period.

The ANOVA (Analysis of Variance) table is a statistical tool used to determine if the regression model is significantly better than just predicting the mean of the dependent variable in a simple linear regression study. It is created by organizing the results of various calculations into a table with the following columns: Source of variation, Sum of Squares, Degrees of ...

A type of real estate performance index based on periodic estimates of property values by experts.  Even though the appraisals are done by experts, they are still subjective.

Using the approximate method to estimate the curvature of the price-yield relation of a bond. Approximate convexity = (V–+ V+  – 2V0) / (V0x ΔYTM2) See also: Convexity adjustment

Modified duration of a bond that is calculated using the approximate method by calculating the change in prices for a small change in yield-to-maturity in both directions (V– ,V+) ApproxModDur = (V– – V+) / (2 x V0 x ΔYTM) See also: Convexity adjustment

A risk-free operation that earns an expected positive net return but requires no net investment of money. Arbitrage opportunities do not last as arbitrageurs that take advantage of the situation will eventually bring prices to parity such that the expected return goes to zero. Arbitrage is the basis of pricing derivatives.

The sum of the observations divided by the number of observations.

Measure of funds flowing into advancing and declining stocks. Applied to a broad market like the New York Stock Exchange.   An index greater than 1 indicates that majority of the volume is in declining stock.  As such, large spikes in the index will coincide with days where there is a huge decline in the stock market.

A type of continuation pattern which represents a pause in an uptrend, to be continued when the resistance level is breached.

The price at which a dealer or trader is willing to sell an asset. See also: Bid price, Bid–ask spread

The process of determining how investment funds should be distributed among asset classes. This process begins with an analysis of the risk and return characteristics of various asset classes.  Common asset classes identified are cash, fixed-income securities, publicly traded stocks, private equity, real estate, as well as commodities. You can take the top-down analysis approach, which is to examine the ...

A type of bond issued by a legal entity called a special purpose vehicle on a collection of assets. May also refer to securities backed by receivables and loans other than mortgages. Examples: Agency MBS, Non-agency MBS, Auto Loans ABS, Credit Card Receivables ABS

Costs of asymmetric information refer to costs resulting from the fact that managers typically have more information about a company’s prospects and future performance than shareholders or creditors. Firms with complex products or little transparency in financial statements tend to have higher costs of asymmetric information, which results in higher required returns on debt and equity capital. Because shareholders and ...

An opinion by an independent accountant on whether the financial statements were prepared in accordance with accepted accounting principles.

A country that does not trade with other countries. Closed economy.

LEVEL II An autoregressive (AR) model is a time series model that regresses the dependent variable against one or more lagged values of itself. We use the past values of a variable to predict the current and future values of the variable. If the AR model only regresses on itself with a lag of one period, we call this a ...

An information-processing bias in which people put undue emphasis on information that is readily available, easy to recall, or based narrowly on personal experience or knowledge. In financial markets, availability bias is evident in the way participants choose their investments. Investors are familiar with broad classifications of stocks and bonds, so their investment universe may simply be a mix of ...

Financial assets (e.g. stocks and bonds, derivatives) that are not expected to be held to maturity or traded in the near term. They are recorded in the balance sheet at fair value through other comprehensive income (FVOCI). Compare: Held-to-maturity securities, Trading securities

An inventory accounting method that averages the total cost of available inventory items over the total units available for sale. Compare: Specific identification method, FIFO method, LIFO method