Finance Terms Flashcards
Asset
Def: something which holds value over time. An asset is something with economic value, which the holder of the assets will provide some future benefit and produce positive cash flow
Financial Assets
Def: a tangible liquid asset which derives value due to a contractual claim of some underlying physical asset. Financial assets don’t necessarily have physical worth. Since they don’t have value until converted to cash, the value can fluctuate.
Real Assets
Def: physical or tangible assets which have value because of their unique properties, land, commodities, buildings, machines are examples
Security
Def: a document which represents a claim to revenue earned by a real underlying asset; whether stock, bonds, or bank loans, securities are essentially one party (the investor) loaning money to a borrower (organization, government)
Capital Goods
Def: a type of real asset that is involved in producing finished goods (factories, land, machines)
Capital Gains Taxes
Def: taxes which are paid on shares of stock sold in a given tax year. If shares are sold within 1 ur. Of purchasing them, the tax rate you pay on them depends on you income tax rate. If you wait for more than a year you will end up paying much less.
Income Statement
Def: presents information on how much a company makes in revenue and how much it pays in expenses
Net income
Def: the money left over after expenses, depreciation, etc. This vale is an accounting concept which is not equivalent to cash on hand
Statement of cash flows
Def: shows investors how much cash is coming into a company and how much is going out
Depreciation/Amortization
Def: the accounting for wear and tear on real assets the company holds
Current Ratio
Def: current assets / current liabilities (current means payable or due within 12 months)
Quick Ratio
Def: cash + securities + accts. receivable / total current liabilities
Operating Margin
Def: EBIT / total sales; this tells us how many cents of each dollar of revenue is profit
ROA
Def: net income / total assets; this measures how much money you would earn as an investor who purchased an equivalent ratio of stocks to bonds that the firm holds; this is determined by the leverage ratio. For a firm that as a LR of 6.67 you would need to hold $5.67 of bonds for every $1 dollar of shares. Keep in mind that these are accounting measures and and include non-cash accounting concepts such as amortization.
The ROA is supposed to give one an idea of how well management is able to utilize their asset base to create income. Note: not all industries have the same average ROA. Capital-intensive business tend to have low ROA’s.
Method of Comparables
Def: a method of measuring the value of different securities based on some common value driver (some characteristic they both share which should affect both securities in the same way).
P/E ratio
Def: a ratio that allows investors to compare the value of stocks relative to their peers; those with higher P/E’s are “popular,” meaning that investors believe these stocks have good long term prospects; thus, justifying the higher price above earnings per share
Fundamental Models
Def: based on principles that any investment price is dependent on cash it will pay you; cash paid now is worth more than cash in paid in the future
Beta(symbol)
Def: a measure of riskiness of a stock; a beta of 1 is equivalent to the overall market risk (the performance of the stock should generally follow the moves of the market)
Leverage
Def: the funds which are borrowed in order to invest; much more dangerous to invest with borrowed money (if value of asset goes down you owe money not only on what your funds, but you also must make up the principle of the loan)
Covered Call
Def: an investing strategy where the holder of a stock writes call options on those stocks. They can make money off the sale cost of the option contracts on top of any capital gains that accrue if the option is not exercised
Technical Analysis
Def: using past stock price movements to divine a trend which would allow the analyst to predict were the stock price will go in the future; practitioners of this school are called “Chartists”
“Breadth” of the market
Def: a tool of the chartist that compares the number of companies that are gaining as opposed to loosing; expressed as a ratio
Risk
Def: the possibility that the actual return on an investment is than expected
Margin of Safety
Def: the investing concept of ensuring safety of principle by paying less than what a company is currently worth, this reduces risk of buying a stock that is already overpriced and is riding on the hopes of exceptional gains too far into the future to allow reliable forecasting
Net Working Capital
Def: Assets minus patents, plant and equipment and other non-liquid assets minus all debt obligations. Dividing this by share count give some idea of how much a company is worth based on owners’ claim to assets
Risk Premium on Equity Investment
Def: the extra return expected from stocks above what can be expected from a “safe asset,” such as t-bills, in order for an investor to consider purchasing them
Black Swan
Def: an incredibly unlikely event; the idea which serves as a warning; that although it is highly improbable, it can still occur
Equity
Def: the value of shares listed by a company; the monetary value of a company beyond any amount owed to creditors; interest of the owner of common stock
Safe Harbor
Def: legal provision that reduces or eliminates liability as long as certain conditions are met; the standard comments regarding potential risks or inaccuracy of figures given prior to quarterly conference or in financial statements
Investor
Def: one who seeks capital appreciation and dividend income from an asset after conducting thorough and reasoned analysis of the assets underlying value. Investor seek to find value in an asset by purchasing it when its market price is significantly below the intrinsic value.
Speculator
Def: one who attempts to “play”, or “time” the market. Speculators do not conduct due diligence efforts to ascertain the underlying value from any accepted value driver. Rather, they attempt to gauge the highs and lows of stock market activity to determine when to buy or sell. This process is inherently risky because success is dependent on the whims of the herd that drive prices up and down, often seemingly for no sound reason.
Free Cash Flow
Def: operating cash flow - capital expenditures
Working Capital
Def: short-term assets - short-term liabilities; it is a measure of a company’s short-term financial health, and ability to meet obligations. Also measures a companies efficiency in collecting payment for goods/services rendered.
Working capital ratio: STA / STL should be around 1.2-2. Anything higher than two indicates that not all cash is being invested. Anything lower than 1 indicates potential liquidity problems.
Heuristic
Def: of air based on experimentation; trial and error method
Heuristics are the “preset” mental modes of thought that lead to behavioral biases
Self-attribution Bias
Def: when one attributes successes to skill and failures to bad luck
Hindsight Bias
Def: when one believes that they correctly predicted an event before it happened, even though it was really just a “guy” feeling
Neglecting the Base Case
Def: a bias where one believes A is caused by B due to stereotyping of A to the general group B, even though it is more likely some other thing C
Availability Bias
Def: when one weighs evidence more heavily simply because such stories or evidence are more visible in the media
Anchoring or Adjustment Bias
Def: when one relies to heavily on one piece of information
Retained Earnings
Def: part of shareholders’ equity on balance sheet; adds net earnings or subtracts net loss from past retained earnings; represents the amount of net income earned less dividends paid, this money can be reinvested in the business or pay debt
Investor
Def: one who ensures (tot he extent possible) safety of principle and adequate return through thorough analysis
An investor is one who would be fine not knowing the daily price of the investment he holds, because he knows the true intrinsic value it is worth, and is willing to wait for this to be reflected in the price
An investor is not concerned with being right temporarily
Gramm-Leach-Bliley Act Act of 1999;
Financial Services Modernization Act
Def: removed market barriers to banking, securities, and insurance companies, allowing consolidation
Glass-Steagall Act 1933
Def: separates commercial banking from investment banking
