Glossary

Overusing the same data to search for patterns.

Chart pattern where the short-term moving average crosses below the long-term moving average. This is usually a sell signal. Compare: Golden cross

When a monopoly seeks to maximise profit by producing at the level where its MR equal MC, it increases its producer surplus, but at the expense of consumer surplus.   Not only is this unfair to consumers, there is a deadweight loss, which is a loss of economic efficiency.   This is created because the monopoly produce a quantity that ...

Dealers  buy and sell securities directly from the traders, and they maintain an inventory. Dealers provide liquidity in the market and profit primarily from the bid-ask spread.

Refers to secured bonds in the UK. Refers to unsecured bonds in the US.

Restrictions imposed by the lender on the borrower to protect the lenders position. Debt covenants can reduce default risk and thus reduce borrowing costs. The restrictions can be in the form of affirmative covenants or negative covenants.

A coverage ratio measured by financial risk and leverage. Debt coverage = CFO / Total debt

A coverage ratio measured by the firm’s ability to satisfy long-term debt with operating cash flow. Debt payment ratio = CFO / Cash paid for long-term debt repayment

Such ratios measure the amount of debt relative to the capital structure of the firm. They include: Debt-to-asset ratio, Debt-to-capital ratio, Debt-to-equity ratio, Financial leverage ratio

Debt-to-asset ratio = Total debt / Total assets

Debt-to-capital ratio = Total Debt / (Total Debt+Total Shareholders’ equity)

Debt-to-EBITDA = Total debt / EBITDA A type of leverage ratio which measures a firm’s total debt to its EBITDA. A higher ratio indicates higher leverage and higher credit risk. Debt-to-EBITDA ratio is more volatile for firms in cyclical industries or with high operating leverage because of their high variability of EBITDA.

A basic cash flow coverage ratio of the net operating income, compared to the required debt service cost. DSC = Net Operating Income / Debt service

Market/economic cycle based on the last digit in the year. It is theorised that years ending with ‘0’ have the worst performance, while the years ending with ‘5’ are the best.

The day that a company issues a statement declaring a specific dividend.  See also: Ex-dividend date, Holder-of-record date, Payment date

Probability that a borrower fails to pay interest or repay principal when due. See also: Credit risk

An extra return that compensates investors/lenders for the possibility that the borrower will fail to make a contractual payment.

A liquidity ratio that measures how long a company can continue to pay its expenses from its existing liquid assets, without receiving any additional cash inflow. Defensive interval ratio = (Cash + Marketable Securities + Receivables) / Average Daily Expenditures

Bond that pays no coupons for its initial years (predetermined) but then pays a higher coupon than it otherwise normally would for the remainder of its life.

Created due to temporary differences as a result of Carrying value < Tax base DTA = (Tax base – Carrying value) x Tax rate

Created due to temporary differences as a result of Carrying value > Tax base DTL = (Tax base – Carrying value) x Tax rate

The firm promises to make periodic payments to employees after retirement. The employee does not need to be concerned about the investment decisions as the employer assumes all the investment risk. In practise, most firms set up a trust to manage the pension assets.  The trust is responsible for generating the income and principal growth necessary to pay the pension ...

A retirement plan in which the firm contributes a sum each period to the employee’s retirement account. In any event, the firm makes no promise to the employee regarding the future payout to the employee.  The employee makes the investment decisions and takes responsibility for the decision, so all of the investment risk lies with the employee. Compare: Defined benefit ...

Deflation is the phenomenon where the inflation rate is persistently negative over a period of time.  Deflation is commonly associated with deep recessions, and is a scenario that central banks want to avoid at all cost as it is difficult to bring an economy out of deflation. This is because when most prices are decreasing, consumers delay purchases because they ...

DFL = % change in net income / % change in operating income (EBIT) DFL = EBIT / (EBIT – I) I: Interest expense A measure of financial risk. See also: Degree of Operating Leverage, Degree of Total Leverage

DOL = % change in operating income / % change in number of units sold DOL = Q(P-V) / [Q(P-V) – F] Q: quantity of units soldP: price per unitV: variable cost per unitF: fixed operating costs A measure of the operating risk of a company. This measure is the sensitivity of a firm’s EBIT to its sales, and is ...

DTL = DOL x DFL A measure of the sensitivity of a firm’s net income to its sales.

On the settlement date for a forward contract, the short is required to deliver the underlying asset to the long, and the long pays for it at the contract price. Compare: Cash-settled forward contract

Quantity demanded of a good/service as a function of its own-price, and possibly other variables. Q = cP + k c: Elasticity coefficient (ΔQ/ΔP)

When prices rise as a result of demand pressures, it is called demand-pull inflation.  The increased demand is usually a result of an increase in the money supply, or increased government spending.  When this happens, the aggregate demand curve shifts to the right.  At this new short-run equilibrium, both the output and price levels are higher.   With real GDP ...

In simple linear regression, the dependent variable is the variable being predicted by the regression model. It is also known as the “outcome” or “response” variable and is the variable being affected by the independent variable. The dependent variable is important in simple linear regression because it is used to evaluate the accuracy of the model. Compare: Independent variable

Banks take on customer deposits, pay interest on them, and provide transaction services such as checking accounts. They then make loans to various borrowers with the funds, who pay interest on their loans, which forms the cash flows for the bank to pay interest on the deposits. Payday lenders and factoring companies lend money to firms and individuals on the ...

Depository receipts (DR) represent ownership in a foreign firm, traded like ordinary shares in local market, in local market currencies. To create DRs, a bank deposits shares of a foreign firm, and then issues depository receipts representing ownership of a specific number of the foreign shares in the local market, which can be bought by local investors. The depository bank ...

The process of systematically allocating the cost of long-lived tangible assets to the periods during which the assets are expected to provide economic benefits. Under IFRS, components of an asset are required to be depreciated separately using the component depreciation method. Depreciation methods: Straight-line method, Double declining balance method, Units-of-production method See also: Amortisation (for intangible assets)

Eventually, long-lived assets may be removed from the balance sheet.  Derecognition occurs when assets are sold, abandoned, or exchanged. If sold Asset is removed from the balance sheet. The difference between the sale proceeds and the carrying value of the asset, is reported as a gain or loss in the income statement.  If abandoned Treatment is similar to a sale, ...

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

The study of how data can be summarised effectively. (vs Inferential statistics)

A type of private equity fund that makes minority equity investments in more mature companies that are seeking capital to expand or restructure operations, enter new markets, or finance major acquisitions.

The EPS that would result if all dilutive securities were converted into common shares.

Financial instruments that can potentially be converted into common stock. e.g. Convertible preferred shares, Convertible bonds, Stock options, Warrants

A type of finance lease where no gross profit is recognised by the lessor at the inception of the lease. Not allowed under IFRS. Compare: Sales-type lease

A format for the presentation of the cash flow statement which begins with cash inflows from customers and then deducts cash outflows for purchases, operating expenses, interest, and taxes. CFO = ∑ Cash Inflows – ∑ Cash Outflows Compare: Indirect method

Operations that the management has decided to dispose of, but either has not yet done so.  It could also have been disposed of in the current year after the operation had generated income or losses. To be accounted for as a discontinued operation, the business must be physically and operationally distinct from the rest of the firm. Any income or ...

If a bond is issued at a discount, the discount must be amortised over the term of the bond. This can be done using the Effective interest amortisation method or the Straight line amortisation method.

For a floating-rate note, the credit risk of the issuer relative to the credit risk of the reference rate instrument. The discount margin at issuance should be the same as the quoted margin, but as time goes by, the credit risk of the issuer would have changed, so the discount margin can change over the life of an FRN.

In capital budgeting, the number of years it takes for the cumulative discounted cash flows from a project to equal the original investment. See also: Payback period

Number of possible outcomes can be counted. Compare: Continuous random variable

Inflation rate that is decreasing over time, but still above zero. See also: Deflation

A type of private equity fund that buys the debt of mature companies in financial difficulty. Distressed debt investors often take an active role in the management and direction of the company or in the reorganisation of the company. The return on investment is a function of the ability of the investor to restructure the company back to profitability.

A measure of the benefit of diversification in a portfolio. The ratio of the standard deviation of an equally weighted portfolio to the standard deviation of a randomly selected security. (The denominator can be the average standard deviation of the securities in the portfolio). Diversification Ratio = Std dev of equal weighted portfolio / Std deviation of randomly selected security

A present value model that estimates the intrinsic value of an equity share based on the present value of its expected future dividends. The fundamental dividend discount model which is impractical because it requires us to estimate every dividend in the future. The Gordon Growth Model simplifies this process by assuming that dividends will grow in perpetuity at a single ...

A coverage ratio measured by the firm’s ability to make dividend payments from operating cash flow. Dividend payment ratio = CFO / Dividends paid

Measures the percentage of earnings that a company pays out as dividends to its shareholders. Dividend payout ratio = Common share dividends / Net Income available to common shares

An accelerated depreciation method that involves depreciating the asset at double the straight-line rate over its useful. Depreciation stops when net book value reaches residual value. This method is not used for amortisation. DDB Depreciation = 2/Useful life x (Cost – Accumulated Depreciation) Compare: Straight-line method

A reversal pattern that is formed when the price forms two peaks at roughly the same price level. Used to predict a change from an uptrend to a downtrend.

Bonds that make coupon payments in one currency and pay the par value at maturity in another currency.

LEVEL II In multiple linear regression, a dummy variable is a binary variable that is used to represent a categorical independent variable. These variables take on the value of 1 or 0, indicating the presence or absence of a particular category. For example, suppose we want to test whether stock returns were different in January than during the remaining months ...

The decomposition of ROE as the product of other financial ratios  to evaluate the drivers of ROE. ROE = Tax burden x Interest burden x EBIT margin x Total asset turnover x Financial leverage

Duration gap = Macaulay Duration – Investment Horizon

LEVEL II The Durbin-Watson (DW) test is a statistical test used to detect autocorrelation in the residuals of a linear regression model. The test statistic is a value between 0 and 4, with the null hypothesis being that there is no autocorrelation in the residuals. A value close to 2 indicates no autocorrelation, a value less than 2 indicates positive ...