FINANCIAL TERMINOLOGY: FINANCIAL TERMS TO KNOW Part -I

 FINANCIAL TERMINOLOGY: FINANCIAL TERMS TO KNOW

Part -I

Fund-based Services: Financial services firms that cater the short-term and long-term needs of funds of corporate sector and others are in the fund-based services Examples of fund-based services are commercial banking, term-lending, bill discounting, factoring and forfaiting, venture capital, underwriting, leasing and hire purchase, etc. 

Fee-based Services: Financial services firms that enable the corporate sector and others to raise capital from the market and manage or transfer their risk to other participants of the market are in fee-based services. They provide these services against a fee. Example of fee-based services are merchant banking, broking service,credit rating, mutual funds, portfolio management services, etc.

Moral Hazard: Moral hazard is the tendency of an insured to take greater risk because she/he is insured.

Adverse Selection: Adverse selection is the tendency of insuring the low quality asset and not insuring high quality assets.

Credit Risk: The chances of the borrower defaulting the interest and/or principal. Financial services firms offering fund-based services are exposed to credit risk.

Due-diligence Risk: The chances of regulatory action when the financial services firm failed to properly check the compliance of various regulatory requirements by the issuer of capital and adequacy of the disclosure of information to the public at the time of public/rights issue. The lead manager has to be very cautious before issuing the due-diligence certificate.

Asset-Liability Gap Risk: When firms offering fund based services raise capital through different instruments having different maturity and interest terms and lend or invest in different forms, there is bound to be a mismatch in terms of future interest liability structure and maturity. The gap between the assets-liabilities on these accounts and the chances of firms failing to meet their obligation in the future is asset-liability gap risk.

Interest Rate Risk: Risk arising out of changes in the market interest rate. It affects the financial services firms which have issued securities as well as others which have invested in securities. Changes in interest rates also affect other segments of the financial markets.

Duration: It is a statistical measure that determines the sensitiveness of the security's market price when there is a change in the market interest rate. The variables that determine the duration are coupon rate, current market price and YTM and time to maturity.

Market Risk: The risk that affects all the securities in the market and thus cannot be eliminated through diversification. The changes in the macro-economic factors are the major source of market risk. This is also known as systematic risk.

Unsystematic Risk: The risk that are specific to a firm and its securities is unsystematic risk and could be reduced to a negligible level through diversification. 

Currency Risk: The risk that arises out of changes in currency values. Financial services firms that hold foreign currency assets or liabilities are affected by this risk.

RSA: Rate-sensitive assets (RSA) are those financial instruments whose value changes when there is a change in the market interest rates.

RSL: Rate-sensitive liabilities (RSL) are those liabilities which cause change in the future cash flows from the firm when there is a change in the market interest rates.

Credit Rating: It is an unfettered publication of opinion on credit and market risk associated with an instrument or the firm that raises capital from the market by the credit rating service companies.

Interest Rate Derivatives: A variety of financial instruments that enable the buyer to hedge interest rate risk. Most popular interest rate derivative products are interest rate futures, interest-rate options and interest rate swap.

Index Futures: A standardised forward instrument that allows the participants to buy and sell the underlying index.

Options: An instrument that gives a right to buy or sell a financial instrument at predetermined terms in the future. Options are available on a variety of financial assets.

Currency Swaps: An agreement between two parties to exchange principal and interest liability of different currencies.

Portfolio Insurance: Fund managers of mutual funds can insure the portfolio against market decline by using index futures or index options.

Dynamic Hedging: It is the process through which hedging is done in stages. This will allow the fund managers to have larger hedge when the market is declining and smaller hedge when the market is moving upward.

Structural Regulation determines the type of activities that different forms of institutions are permitted to engage in.

Prudential Regulation covers the internal management of financial service providers in relation to capital adequacy, liquidity and solvency.

Investors' Protection Regulation determine the nature and level of disclosure to be made by the financial service providers to the investors.

Banking Regulations consisting of Banking Regulation Act, 1949 and Directions from the Reserve Bank of India, govern the activities of the banking companies. NBFC Regulations are those directions given by the RBI to regulate different forms of Non-banking financial companies.

Insurance Regulatory Authority (interim) was set up in 1996 based on the recommendations of the Malhotra Committee primarily to regulate, promote and ensure orderly growth of the insurance business in a free market economy.

SEBI is a statutory body that regulates the securities markets and their participants with a main objective of protecting the interest of investors.

SEBI Regulations are set of regulations and guidelines issued by the SEBI on various investment institutions and market intermediaries.

Self Regulations are those framed by various industry associations that govern its members' activities, code of conduct and settlement of disputes between them.

Amortizing debt instruments provide for periodic payments that include both interest and principal.

Capital Market Instruments are debt instruments with maturities of more than a year

Coupon Rate is the rate of interest payable, which is stated on an annual basis .

Continuous Market means orders put on the trading system are matched by the system directly without any manual intervention.

Debt Instrument is a promissory note that evidences a debtor/creditor relationship

Floating Rate Bonds are short to medium term interest bearing instruments issued by financial intermediaries and corporates, in which the coupon rate changes to reflect market conditions.

Dated and State Government Securities are issued by RBI on behalf of Government of India and various state governments for a period of 2 years or more.

Issuer is the borrower who issues marketable debt instruments.

Marketable Debt Instruments are transacted in an exchange and are considered as securities. 

Money Market Instruments are debt instruments having maturities of less than one year.

Negotiated Market refers to deals that have been negotiated outside the exchange and are reported on the trading system for approval by the exchange.

Non-repo Trade outright purchase and sale of securities.

Repo Trades are repurchase agreements wherein a trader sells securities to a customer while simultaneously agreeing to repurchase them at a future date. 

Subsidiary General Ledger is a facility provided by the RBI for maintaining the records of the beneficial owners of Government securities in demand form.

Term to Maturity (or term) is the length of time until the debt instrument matures.

Treasury Bills (T-bills) are short-term obligations issued by RBI on behalf of Government of India at a discount.

Zero Coupon Bonds or zeros require no payment of interest or principal until such time as the instrument matures.

Demat: Investor securities like shares, debentures, etc. are converted into electronic data and stored in computers by a depository. 

Depository: Functions like a securities bank, where the dematerialized physical securities are traded and held in custody. 

Depository Account: An account which the investor opens with a DP wherein all the details of the investor's transactions are recorded in demat form.

Dematerialisation (Demat): Is a process where by physical existence of security certificates is made extinct and converted into electronic holdings. 

Rematerialisation: Converting the shares from electronic to physical or paper form.

Escrow Account: Brokers account with the clearing house bank for primary market issues and the amount collected by the broker from his clients as margin money shall be deposited in this account.

Merchant Banker: Any person who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing in securities as manager, consultant, advisor or rendering corporate advisory services in relation to such issue management.

Private Placement: Direct sale of securities by a company to investors. 

Public Issue: A method of raising funds from the public.

Rights Issue: Issues of new shares in which existing shareholders are given preemptive rights to subscribe to new issues of shares. 

Safety net scheme: The merchant bankers provide a buy-back facility to the individual investor in case the price of the share goes below the issue price after listing.

AMC: An agency which evolve policies for investments and disinvestment of the corpus of schemes of a mutual fund.

Closed End Scheme: A scheme which terminates after a specific period.

Corpus: Total funds with a scheme at any time. 

Custodian: An agency for the handling and safekeeping of funds, cash and securities. 

Fund: In India fund refers to a mutual fund whereas in U.S.A. fund refers to one scheme. One fund may launch many schemes in India.

Funds Manager: An individual or a group of individuals who make sale and purchase of securities for the schemes of a mutual fund. 

Load: It is the charge levied on those who purchase units of a scheme after the initial

issue of the scheme. It can be back-end load or front-end load. 

Mutual funds: An agency collecting savings. investing them to get better returns and share returns with contributors.

NAV: It is the intrinsic value (not face value) of a unit of a scheme.

Offer Document: It is a document issued giving required details of a mutual scheme.

Open End Scheme: A scheme which has no specific time frame for its operation.

Portfolio: A group of securities held together.

Credit cards 

Franchisee: The organization which takes franchise to operate the credit cards business from the franchisers like VISA and Mastercard. Franchiser: The organization which allows the franchiser to use their credit card operating system for a payment.

Issuer Bank: The bank which issues credit cards to the users and pays the bills when they are presented for a commission, and recovers the amount with interest.

Merchant Establishment: A business establishment which has agreed to accept the payment through credit cards.

Plastic Money: Another name for credit cards. As these cards are made of plastic, these are known as plastic cards or plastic money.

Factoring: is a financial service covering the financing and collection of accounts receivables in domestic as well as international trade.

Factor: acts as agent in realizing credit sales from buyer and passes on the realized sum to seller after deducting his commission. 

Forfaiting: denotes the purchase of trade bills or promissory notes by a bank or a financial institution without recourse to the seller.

Amortization: Amortization is a method of spreading an intangible asset's cost over the course of its useful life. Intangible assets are non-physical assets that are essential to a company, such as a trademark, patent, copyright, or franchise agreement.

Assets: Assets are items you own that can provide future benefit to your business, such as cash, inventory, real estate, office equipment, or accounts receivable, which are payments due to a company by its customers. 

• Current Assets: Which can be converted to cash within a year.

• Fixed Assets: Which can’t immediately be turned into cash, but are tangible items that a company owns and uses to generate long-term income

Asset Allocation: Asset allocation refers to how you choose to spread your money across different investment types, also known as asset classes. 

• Bonds: Bonds represent a form of borrowing. When you buy a bond, typically from the government or a corporation, you’re essentially lending them money. You receive periodic interest payments and get back the loaned amount at the time of the bond’s maturity—or the defined term at which the bond can be redeemed.

• Stocks: A stock is a share of ownership in a public or private company. When you buy stock in a company, you become a shareholder and can receive dividends—the company’s profits—if and when they are distributed.

• Cash and Cash Equivalents: This refers to any asset in the form of cash, or which can be converted to cash easily in the event it's necessary.

4. Balance Sheet: A balance sheet is an important financial statement that communicates an organization’s worth, or “book value.” The balance sheet includes a tally of the organization’s assets, liabilities, and shareholders’ equity for a given reporting period.

• The Balance Sheet Equation: Balance sheets are arranged according to the following equation: Assets = Liabilities + Owners’ Equity

 Capital Gain: A capital gain is an increase in the value of an asset or investment above the price you initially paid for it. If you sell the asset for less than the original purchase price, that would be considered a capital loss.

Capital Market: This is a market where buyers and sellers engage in the trade of financial assets, including stocks and bonds. Capital markets feature several participants, including:

• Companies: Firms that sell stocks and bonds to investors

• Institutional investors: Investors who purchase stocks and bonds on behalf of a large capital base

• Mutual funds: A mutual fund is an institutional investor that manages the investments of thousands of individuals

• Hedge funds: A hedge fund is another type of institutional investor, which controls risk through hedging—a process of buying one stock and then shorting a similar stock to make money from the difference in their relative performance

Cash Flow: Cash flow refers to the net balance of cash moving in and out of a business at a specific point in time. Cash flow is commonly broken into three categories, including:

• Operating Cash Flow: The net cash generated from normal business operations

• Investing Cash Flow: The net cash generated from investing activities, such as securities investments and the purchase or sale of assets

• Financing Cash Flow: The net cash generated financing a business, including debt payments, shareholders’ equity, and dividend payments

Cash Flow Statement: A cash flow statement is a financial statement prepared to provide a detailed analysis of what happened to a company’s cash during a given period of time. This document shows how the business generated and spent its cash by including an overview of cash flows from operating, investing, and financing activities during the reporting period.

Compound Interest: This refers to “interest on interest.” Rather, when you’re investing or saving, compound interest is earned on the amount you deposited, plus any interest you’ve accumulated over time. While it can grow your savings, it can also increase your debt; compound interest is charged on the initial amount you were loaned, as well as the expenses added to your outstanding balance over time.

 Depreciation: Depreciation represents the decrease in an asset’s value. It’s a term commonly used in accounting and shows how much of an asset’s value a business has used over a period of time.

EBITDA: An acronym standing for Earnings Before Interest, Taxes, Depreciation, and Amortization, EBITDA is a commonly used measure of a company’s ability to generate cash flow. To get EBITDA, you would add net profit, interest, taxes, depreciation, and amortization together.

Equity: Equity, often called shareholders’ equity or owners’ equity on a balance sheet, represents the amount of money that belongs to the owners of a business after all assets and liabilities have been accounted for. Using the accounting equation, shareholder’s equity can be found by subtracting total liabilities from total assets.

 Income Statement: An income statement is a financial statement that summarizes a business’s income and expenses during a given period of time. An income statement is also sometimes referred to as a profit and loss (P&L) statement.

Liabilities: The opposite of assets, liabilities are what you owe other parties, such as bank debt, wages, and money due to suppliers, also known as accounts payable. There are different types of liabilities, including:

• Current Liabilities: Also known as short-term liabilities, these are what’s due in the next year

• Long-Term Liabilities: These are financial obligations not due over a year that can be paid off over a longer period of time

 Liquidity: Liquidity describes how quickly your assets can be converted into cash. Because of that, cash is the most liquid asset. The least liquid assets are items like real estate or land, because they can take weeks or months to sell.

 Net Worth: You can calculate net worth by subtracting what you own, your assets, with what you owe, your liabilities. The remaining number can help you determine the overall state of your financial health.

 Profit Margin: Profit margin is a measure of profitability that’s calculated by dividing the net income by revenue or the net profit by sales. Companies often analyze two types of profit margins:

Gross Profit Margin: Which typically applies to a specific product or line item rather than an entire business

Net Profit Margin: Which typically represents the profitability of an entire company

Return on Investment (ROI): Return on Investment is a simple calculation used to determine the expected return of a project or activity in comparison to the cost of the investment, typically shown as a percentage. This measure is often used to evaluate whether a project will be worthwhile for a business to pursue. ROI is calculated using the following equation: ROI = [(Income - Cost) / Cost] * 100

Valuation: Valuation is the process of determining the current worth of an asset, company, or liability. There are a variety of ways you can value a business, but regularly repeating the process is helpful, because you’re then ready if ever faced with an opportunity to merge or sell your company, or are trying to seek funding from outside investors.

Working Capital: Also known as net working capital, this is the difference between a company’s current assets and current liabilities. Working capital—the money available for daily operations—can help determine an organization’s operational efficiency and short-term financial health.