Definition of Capitalism

Capitalism

An economic system in which the marketplace, through the pricing mechanism, determines the allocation and distribution of scarce goods and services, with a minimum of government involvement.

economic components model

Abrams’ model for calculating DLOM based on the interaction of discounts from four economic components.
This model consists of four components: the measure of the economic impact of the delay-to-sale, monopsony power to buyers, and incremental transactions costs to both buyers and sellers.

Accelerated cost recovery system (ACRS)

Schedule of depreciation rates allowed for tax purposes.

Administrative pricing rules

IRS rules used to allocate income on export sales to a foreign sales corporation.

Agency pass-throughs

Mortgage pass-through securities whose principal and interest payments are
guaranteed by government agencies, such as the government National Mortgage Association ("Ginnie Mae"), Federal Home Loan Mortgage Corporation ("Freddie Mac") and Federal National Mortgage Association ("Fannie Mae").

Arbitrage Pricing Theory (APT)

An alternative model to the capital asset pricing model developed by
Stephen Ross and based purely on arbitrage arguments.

Arbitrage-free option-pricing models

Yield curve option-pricing models.

Asset allocation decision

The decision regarding how an institution's funds should be distributed among the
major classes of assets in which it may invest.

Asset pricing model

A model for determining the required rate of return on an asset.

Asset pricing model

A model, such as the Capital Asset pricing Model (CAPM), that determines the required
rate of return on a particular asset.

Binomial option pricing model

An option pricing model in which the underlying asset can take on only two
possible, discrete values in the next time period for each value that it can take on in the preceding time period.

Black-Scholes option-pricing model

A model for pricing call options based on arbitrage arguments that uses
the stock price, the exercise price, the risk-free interest rate, the time to expiration, and the standard deviation
of the stock return.

Capital allocation

decision allocation of invested funds between risk-free assets versus the risky portfolio.

Capital asset pricing model (CAPM)

An economic theory that describes the relationship between risk and
expected return, and serves as a model for the pricing of risky securities. The CAPM asserts that the only risk
that is priced by rational investors is systematic risk, because that risk cannot be eliminated by diversification.
The CAPM says that the expected return of a security or a portfolio is equal to the rate on a risk-free security
plus a risk premium.

Clearing House Automated Payments System (CHAPS)

A computerized clearing system for sterling funds
that began operations in 1984. It includes 14 member banks, nearly 450 participating banks, and is one of the
clearing companies within the structure of the Association for Payment Clearing services (APACS).

Clearing House Interbank Payments System (CHIPS)

An international wire transfer system for high-value
payments operated by a group of major banks.

Concentration services

Movement of cash from different lockbox locations into a single concentration
account from which disbursements and investments are made.

Conventional pass-throughs

Also called private-label pass-throughs, any mortgage pass-through security not
guaranteed by government agencies. Compare agency pass-throughs.

Cumulative probability distribution

A function that shows the probability that the random variable will
attain a value less than or equal to each value that the random variable can take on.

Distributions

Payments from fund or corporate cash flow. May include dividends from earnings, capital
gains from sale of portfolio holdings and return of capital. Fund distributions can be made by check or by
investing in additional shares. Funds are required to distribute capital gains (if any) to shareholders at least
once per year. Some Corporations offer Dividend Reinvestment Plans (DRP).

Dupont system of financial control

Highlights the fact that return on assets (ROA) can be expressed in terms
of the profit margin and asset turnover.

Dynamic asset allocation

An asset allocation strategy in which the asset mix is mechanistically shifted in
response to -changing market conditions, as in a portfolio insurance strategy, for example.

Economic assumptions

economic environment in which the firm expects to reside over the life of the
financial plan.

Economic defeasance

See: in-substance defeasance.

Economic dependence

Exists when the costs and/or revenues of one project depend on those of another.

Economic earnings

The real flow of cash that a firm could pay out forever in the absence of any change in
the firm's productive capacity.

Economic exposure

The extent to which the value of the firm will change because of an exchange rate change.

Economic income

Cash flow plus change in present value.

Economic order quantity (EOQ)

The order quantity that minimizes total inventory costs.

Economic rents

Profits in excess of the competitive level.

Economic risk

In project financing, the risk that the project's output will not be salable at a price that will
cover the project's operating and maintenance costs and its debt service requirements.

Economic surplus

For any entity, the difference between the market value of all its assets and the market
value of its liabilities.

Economic union

An agreement between two or more countries that allows the free movement of capital,
labor, all goods and services, and involves the harmonization and unification of social, fiscal, and monetary
policies.

European Monetary System (EMS)

An exchange arrangement formed in 1979 that involves the currencies
of European Union member countries.

Exchange Rate Mechanism (ERM)

The methodology by which members of the EMS maintain their
currency exchange rates within an agreed upon range with respect to other member countries.

Federal Reserve System

The central bank of the U.S., established in 1913, and governed by the Federal
Reserve Board located in Washington, D.C. The system includes 12 Federal Reserve Banks and is authorized
to regulate monetary policy in the U.S. as well as to supervise Federal Reserve member banks, bank holding
companies, international operations of U.S.banks, and U.S.operations of foreign banks.

Flow-through basis

An account for the investment credit to show all income statement benefits of the credit
in the year of acquisition, rather than spreading them over the life of the asset acquired.

Flow-through method

The practice of reporting to shareholders using straight-line depreciation and
accelerated depreciation for tax purposes and "flowing through" the lower income taxes actually paid to the
financial statement prepared for shareholders.

Frequency distribution

The organization of data to show how often certain values or ranges of values occur.

Fully modified pass-throughs

Agency pass-throughs that guarantee the timely payment of both interest and
principal. Related: modified pass-throughs
Functional currency As defined by FASB No. 52, an affiliate's functional currency is the currency of the
primary economic environment in which the affiliate generates and expends cash.

Garmen-Kohlhagen option pricing model

A widely used model for pricing foreign currency options.

Government bond

See: government securities.

Government National Mortgage Association (Ginnie Mae)

A wholly owned U.S. government corporation
within the Department of Housing & Urban Development. Ginnie Mae guarantees the timely payment of
principal and interest on securities issued by approved servicers that are collateralized by FHA-issued, VAguaranteed,
or Farmers Home Administration (FmHA)-guaranteed mortgages.

Government sponsored enterprises

Privately owned, publicly chartered entities, such as the Student Loan
Marketing Association, created by Congress to reduce the cost of capital for certain borrowing sectors of the
economy including farmers, homeowners, and students.

Government securities

Negotiable U.S. Treasury securities.

Imputation tax system

Arrangement by which investors who receive a dividend also receive a tax credit for
corporate taxes that the firm has paid.

Information services

Organizations that furnish investment and other types of information, such as
information that helps a firm monitor its cash position.

Just-in-time inventory systems

systems that schedule materials/inventory to arrive exactly as they are
needed in the production process.

Leading economic indicators

economic series that tend to rise or fall in advance of the rest of the economy.

Lognormal distribution

A distribution where the logarithm of the variable follows a normal distribution.
Lognormal distributions are used to describe returns calculated over periods of a year or more.

Marketplace price efficiency

The degree to which the prices of assets reflect the available marketplace
information. marketplace price efficiency is sometimes estimated as the difficulty faced by active
management of earning a greater return than passive management would, after adjusting for the risk
associated with a strategy and the transactions costs associated with implementing a strategy.

Minimum price fluctuation

Smallest increment of price movement possible in trading a given contract. Also
called point or tick. The zero-beta portfolio with the least risk.

Minimum purchases

For mutual funds, the amount required to open a new account (minimum Initial
Purchase) or to deposit into an existing account (minimum Additional Purchase). These minimums may be
lowered for buyers participating in an automatic purchase plan

Minimum-variance frontier

Graph of the lowest possible portfolio variance that is attainable for a given
portfolio expected return.

Minimum-variance portfolio

The portfolio of risky assets with lowest variance.
Minority interest An outside ownership interest in a subsidiary that is consolidated with the parent for
financial reporting purposes.

Modified pass-throughs

Agency pass-throughs that guarantee (1) timely interest payments and (2) principal
payments as collected, but no later than a specified time after they are due. Related: fully modified passthroughs

Mortgage pass-through security

Also called a passthrough, a security created when one or more mortgage
holders form a collection (pool) of mortgages sells shares or participation certificates in the pool. The cash
flow from the collateral pool is "passed through" to the security holder as monthly payments of principal,
interest, and prepayments. This is the predominant type of MBS traded in the secondary market.

Multirule system

A technical trading strategy that combines mechanical rules, such as the CRISMA
(cumulative volume, relative strength, moving average) Trading system of Pruitt and White.

Non-financial services

Include such things as freight, insurance, passenger services, and travel.

Nonsystematic risk

Nonmarket or firm-specific risk factors that can be eliminated by diversification. Also
called unique risk or diversifiable risk. systematic risk refers to risk factors common to the entire economy.

Normal probability distribution

A probability distribution for a continuous random variable that is forms a
symmetrical bell-shaped curve around the mean.

Pass-through rate

The net interest rate passed through to investors after deducting servicing, management,
and guarantee fees from the gross mortgage coupon.

Pass-through securities

A pool of fixed-income securities backed by a package of assets (i.e. mortgages)
where the holder receives the principal and interest payments. Related: mortgage pass-through security

Pass-through coupon rate

The interest rate paid on a securitized pool of assets, which is less than the rate
paid on the underlying loans by an amount equal to the servicing and guaranteeing fees.

Payable through drafts

A method of making payment that is used to maintain control over payments made
on behalf of the firm by personnel in noncentral locations. The payer's bank delivers the payable through draft
to the payer, which must approve it and return it to the bank before payment can be received.

Policy asset allocation

A long-term asset allocation method, in which the investor seeks to assess an
appropriate long-term "normal" asset mix that represents an ideal blend of controlled risk and enhanced
return.

Price-specie-flow mechanism

Adjustment mechanism under the classical gold standard whereby
disturbances in the price level in one country would be wholly or partly offset by a countervailing flow of
specie (gold coins) that would act to equalize prices across countries and automatically bring international
payments back in balance.

Pricing efficiency

Also called external efficiency, a market characteristic where prices at all times fully
reflect all available information that is relevant to the valuation of securities.

Private-label pass-throughs

Related: Conventional pass-throughs.

Probability distribution

Also called a probability function, a function that describes all the values that the random variable can
take and the probability associated with each.

Progressive tax system

A tax system wherein the average tax rate increases for some increases in income but
never decreases with an increase in income.

Regulatory pricing risk

Risk that arises when regulators restrict the premium rates that insurance companies
can charge.

Short-term investment services

services that assist firms in making short-term investments.

Skewed distribution

Probability distribution in which an unequal number of observations lie below and
above the mean.

Split-rate tax system

A tax system that taxes retained earnings at a higher rate than earnings that are
distributed as dividends.

Standardized normal distribution

A normal distribution with a mean of 0 and a standard deviation of 1.

Systematic

Common to all businesses.

Systematic risk

Also called undiversifiable risk or market risk, the minimum level of risk that can be
obtained for a portfolio by means of diversification across a large number of randomly chosen assets. Related:
unsystematic risk.

Systematic risk principle

Only the systematic portion of risk matters in large, well-diversified portfolios.
The, expected returns must be related only to systematic risks.

Tactical Asset Allocation (TAA)

An asset allocation strategy that allows active departures from the normal
asset mix based upon rigorous objective measures of value. Often called active management. It involves
forecasting asset returns, volatilities and correlations. The forecasted variables may be functions of
fundamental variables, economic variables or even technical variables.

Throughput agreement

An agreement to put a specified amount of product per period through a particular
facility. For example, an agreement to ship a specified amount of crude oil per period through a particular
pipeline.

Two-state option pricing model

An option pricing model in which the underlying asset can take on only two
possible (discrete) values in the next time period for each value it can take on in the preceding time period.
Also called the binomial option pricing model.

Two-tier tax system

A method of taxation in which the income going to shareholders is taxed twice.

Underpricing

Issue of securities below their market value.

Unsystematic risk

Also called the diversifiable risk or residual risk. The risk that is unique to a company
such as a strike, the outcome of unfavorable litigation, or a natural catastrophe that can be eliminated through diversification.
Related: systematic risk

Yield curve option-pricing models

Models that can incorporate different volatility assumptions along the
yield curve, such as the Black-Derman-Toy model. Also called arbitrage-free option-pricing models.

Cost of goods sold

The cost of merchandise that a company sold this year. For manufacturing companies, the cost of raw
materials, components, labor and other things that went into producing an item.

MACRS (Modified Accelerated Cost Recovery System)

A depreciation method created by the IRS under the Tax Reform Act of 1986. Companies must use it to depreciate all plant and equipment assets installed after December 31, 1986 (for tax purposes).

Accounting system

A set of accounts that summarize the transactions of a business that have been recorded on source documents.

Allocation base A measure of activity or volume such as labour

hours, machine hours or volume of production
used to apportion overheads to products and
services.

Cost of goods sold

See cost of sales.

Cost-plus pricing

A method of pricing in which a mark-up is added to the total product/service cost.

Economic Value Added (EVA)

Operating profit, adjusted to remove distortions caused by certain accounting rules, less a charge
to cover the cost of capital invested in the business.

Overhead allocation

The process of spreading production overhead equitably over the volume of production of goods or services.

Planning, programming and budgeting system (PPBS)

A method of budgeting in which budgets are allocated to projects or programmes rather than to responsibility centres.

Target rate of return pricing

A method of pricing that estimates the desired return on investment to be achieved from the
fixed and working capital investment and includes that return in the price of a product/service.

Throughput contribution

Sales revenue less the cost of materials.

Cost of goods sold

The cost of the items that were sold during the current period.

Periodic inventory system

An inventory system in which the balance in the Inventory account is adjusted for the units sold only at the end of the period.

Perpetual inventory system

An inventory system in which the balance in the Inventory account is adjusted for the units sold each time a sale is made.

Capital Asset Pricing Model (CAPM)

A model for estimating equilibrium rates of return and values of
assets in financial markets; uses beta as a measure of asset risk
relative to market risk

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