Definition of Federal Insurance Contributions Act of 1935 (FICA)

Federal Insurance Contributions Act of 1935 (FICA)

A federal act authorizing the government to collect Social Security and Medicare payroll taxes.

ADF (annuity discount factor)

the present value of a finite stream of cash flows for every beginning $1 of cash flow.

fractional interest discount

the combined discounts for lack of control and marketability. g the constant growth rate in cash flows or net income used in the ADF, Gordon model, or present value factor.

PPF (periodic perpetuity factor)

a generalization formula invented by Abrams that is the present value of regular but noncontiguous cash flows that have constant growth to perpetuity.

Act of state doctrine

This doctrine says that a nation is sovereign within its own borders and its domestic
actions may not be questioned in the courts of another nation.

Active

A market in which there is much trading.

Active portfolio strategy

A strategy that uses available information and forecasting techniques to seek a
better performance than a portfolio that is simply diversified broadly. Related: passive portfolio strategy

Actuals

The physical commodity underlying a futures contract. Cash commodity, physical.

Amortization factor

The pool factor implied by the scheduled amortization assuming no prepayemts.

Annuity factor

Present value of $1 paid for each of t periods.

Asset activity ratios

Ratios that measure how effectively the firm is managing its assets.

Bullet contract

A guaranteed investment contract purchased with a single (one-shot) premium. Related:
Window contract.

Cash settlement contracts

Futures contracts, such as stock index futures, that settle for cash, not involving
the delivery of the underlying.

Cash transaction

A transaction where exchange is immediate, as contrasted to a forward contract, which
calls for future delivery of an asset at an agreed-upon price.

Certificate of deposit (CD)

Also called a time deposit, this is a certificate issued by a bank or thrift that
indicates a specified sum of money has been deposited. A CD bears a maturity date and a specified interest
rate, and can be issued in any denomination. The duration can be up to five years.

Characteristic line

The market model applied to a single security. The slope of the line is a security's beta.

Coinsurance effect

Refers to the fact that the merger of two firms decreases the probability of default on
either firm's debt.

Collection fractions

The percentage of a given month's sales collected during the month of sale and each
month following the month of sale.

Conditional sales contracts

Similar to equipment trust certificates except that the lender is either the
equipment manufacturer or a bank or finance company to whom the manufacturer has sold the conditional
sales contract.

Contract

A term of reference describing a unit of trading for a financial or commodity future. Also, the actual
bilateral agreement between the buyer and seller of a transaction as defined by an exchange.

Contract month

The month in which futures contracts may be satisfied by making or accepting a delivery.
Also called value managers, those who assemble portfolios with relatively lower betas, lower price-book and
P/E ratios and higher dividend yields, seeing value where others do not.

Conversion factors

Rules set by the Chicago Board of Trade for determining the invoice price of each
acceptable deliverable Treasury issue against the Treasury Bond futures contract.

De facto

Existing in actual fact although not by official recognition.

Discount factor

Present value of $1 received at a stated future date.

Diversification

Dividing investment funds among a variety of securities with different risk, reward, and
correlation statistics so as to minimize unsystematic risk.

Efficient diversification

The organizing principle of modern portfolio theory, which maintains that any riskaverse
investor will search for the highest expected return for any level of portfolio risk.

Equipment trust certificates

Certificates issued by a trust that was formed to purchase an asset and lease it
to a lessee. When the last of the certificates has been repaid, title of ownership of the asset reverts to the
lessee.

Exact matching

A bond portfolio management strategy that involves finding the lowest cost portfolio
generating cash inflows exactly equal to cash outflows that are being financed by investment.

Factor

A financial institution that buys a firm's accounts receivables and collects the debt.

Factor analysis

A statistical procedure that seeks to explain a certain phenomenon, such as the return on a
common stock, in terms of the behavior of a set of predictive factors.

Factor model

A way of decomposing the factors that influence a security's rate of return into common and
firm-specific influences.

Factor portfolio

A well-diversified portfolio constructed to have a beta of 1.0 on one factor and a beta of
zero on any other factors.

Factoring

Sale of a firm's accounts receivable to a financial institution known as a factor.

Federal agency securities

Securities issued by corporations and agencies created by the U.S. government,
such as the federal Home Loan Bank Board and Ginnie Mae.

Federal credit agencies

Agencies of the federal government set up to supply credit to various classes of
institutions and individuals, e.g. S&Ls, small business firms, students, farmers, and exporters.

Federal Deposit Insurance Corporation (FDIC)

A federal institution that insures bank deposits.

Federal Financing Bank

A federal institution that lends to a wide array of federal credit agencies funds it
obtains by borrowing from the U.S. Treasury.

Federal funds

Non-interest bearing deposits held in reserve for depository institutions at their district federal
Reserve Bank. Also, excess reserves lent by banks to each other.

Federal funds market

The market where banks can borrow or lend reserves, allowing banks temporarily
short of their required reserves to borrow reserves from banks that have excess reserves.

Federal funds rate

This is the interest rate that banks with excess reserves at a federal Reserve district bank
charge other banks that need overnight loans. The Fed Funds rate, as it is called, often points to the direction
of U.S. interest rates.

Federal Home Loan Banks

The institutions that regulate and lend to savings and loan associations. The
federal Home Loan Banks play a role analogous to that played by the federal Reserve Banks vis-à-vis
member commercial banks.

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.

Federally related institutions

Arms of the federal government that are exempt from SEC registration and
whose securities are backed by the full faith and credit of the U.S. government (with the exception of the
Tennessee Valley Authority).

Floating-rate contract

A guaranteed investment contract where the credit rating is tied to some variable
("floating") interest rate benchmark, such as a specific-maturity Treasury yield.

Forward contract

A cash market transaction in which delivery of the commodity is deferred until after the
contract has been made. It is not standardized and is not traded on organized exchanges. Although the
delivery is made in the future, the price is determined at the initial trade date.

Forward forward contract

In Eurocurrencies, a contract under which a deposit of fixed maturity is agreed to
at a fixed price for future delivery.

Freddie Mac (Federal Home Loan Mortgage Corporation)

A Congressionally chartered corporation that
purchases residential mortgages in the secondary market from S&Ls, banks, and mortgage bankers and
securitizes these mortgages for sale into the capital markets.

Futures contract

Agreement to buy or sell a set number of shares of a specific stock in a designated future
month at a price agreed upon by the buyer and seller. The contracts themselves are often traded on the futures
market. A futures contract differs from an option because an option is the right to buy or sell, whereas a
futures contract is the promise to actually make a transaction. A future is part of a class of securities called
derivatives, so named because such securities derive their value from the worth of an underlying investment.

Futures contract multiple

A constant, set by an exchange, which when multiplied by the futures price gives
the dollar value of a stock index futures contract.

Glass-Steagall Act

A 1933 act in which Congress forbade commercial banks to own, underwrite, or deal in
corporate stock and corporate bonds.

GMCs (guaranteed mortgage certificates)

First issued by Freddie Mac in 1975, GMCs, like PCs, represent
undivided interest in specified conventional whole loans and participations previously purchased by Freddie Mac.

Going-private transactions

Publicly owned stock in a firm is replaced with complete equity ownership by a
private group. The shares are delisted from stock exchanges and can no longer be purchased in the open
markets.

Guaranteed insurance contract

A contract promising a stated nominal interest rate over some specific time
period, usually several years.

Guaranteed investment contract (GIC)

A pure investment product in which a life company agrees, for a
single premium, to pay the principal amount of a predetermined annual crediting (interest) rate over the life of
the investment, all of which is paid at the maturity date.

Hell-or-high-water contract

A contract that obligates a purchaser of a project's output to make cash
payments to the project in all events, even if no product is offered for sale.

Highly leveraged transaction (HLT)

Bank loan to a highly leveraged firm.

Insurance principle

The law of averages. The average outcome for many independent trials of an experiment
will approach the expected value of the experiment.

Intercompany transaction

Transaction carried out between two units of the same corporation.

International diversification

The attempt to reduce risk by investing in the more than one nation. By
diversifying across nations whose economic cycles are not perfectly correlated, investors can typically reduce
the variability of their returns.

Liquidity diversification

Investing in a variety of maturities to reduce the price risk to which holding long
bonds exposes the investor.

Magic of diversification

The effective reduction of risk (variance) of a portfolio, achieved without reduction
to expected returns through the combination of assets with low or negative correlations (covariances).
Related: Markowitz diversification

Manufactured housing securities (MHSs)

Loans on manufactured homes - that is, factory-built or
prefabricated housing, including mobile homes.

Market impact costs

Also called price impact costs, the result of a bid/ask spread and a dealer's price concession.

Markowitz diversification

A strategy that seeks to combine assets a portfolio with returns that are less than
perfectly positively correlated, in an effort to lower portfolio risk (variance) without sacrificing return.
Related: naive diversification

Maturity factoring

Factoring arrangement that provides collection and insurance of accounts receivable.

Most distant futures contract

When several futures contracts are considered, the contract settling last.
Related: nearby futures contract

Multifactor CAPM

A version of the capital asset pricing model derived by Merton that includes extramarket
sources of risk referred to as factor.

Naive diversification

A strategy whereby an investor simply invests in a number of different assets and
hopes that the variance of the expected return on the portfolio is lowered.
Related: Markowitz diversification.

Nearby futures contract

When several futures contracts are considered, the contract with the closest
settlement date is called the nearby futures contract. The next futures contract is the one that settles just after
the nearby futures contract. The contract farthest away in time from settlement is called the most distant
futures contract.

Negotiated certificate of deposit

A large-denomination CD, generally $1MM or more, that can be sold but
cannot be cashed in before maturity.

Net benefit to leverage factor

A linear approximation of a factor, T*, that enables one to operationalize the
total impact of leverage on firm value in the capital market imperfections view of capital structure.

Next futures contract

The contract settling immediately after the nearby futures contract.

Nexus (of contracts)

A set or collection of something.

Notification date

The day the option is either exercised or expires.

Old-line factoring

Factoring arrangement that provides collection, insurance, and finance for accounts receivable.

One-factor APT

A special case of the arbitrage pricing theory that is derived from the one-factor model by
using diversification and arbitrage. It shows the expected return on any risky asset is a linear function of a
single factor.

Open contracts

Contracts which have been bought or sold without the transaction having been completed by
subsequent sale or purchase, or by making or taking actual delivery of the financial instrument or physical
commodity.

Optimal contract

The contract that balances the three types of agency costs (contracting, monitoring, and
misbehavior) against one another to minimize the total cost.

Options contract

A contract that, in exchange for the option price, gives the option buyer the right, but not
the obligation, to buy (or sell) a financial asset at the exercise price from (or to) the option seller within a
specified time period, or on a specified date (expiration date).

Options contract multiple

A constant, set at $100, which when multiplied by the cash index value gives the
dollar value of the stock index underlying an option. That is, dollar value of the underlying stock index = cash
index value x $100 (the options contract multiple).

Overreaction hypothesis

The supposition that investors overreact to unanticipated news, resulting in
exaggerated movement in stock prices followed by corrections.

Pool factor

The outstanding principal balance divided by the original principal balance with the result
expressed as a decimal. Pool factors are published monthly by the Bond Buyer newspaper for Ginnie Mae,
Fannie Mae, and Freddie Mac(federal Home Loan Mortgage Corporation) MBSs.

Portfolio insurance

A strategy using a leveraged portfolio in the underlying stock to create a synthetic put
option. The strategy's goal is to ensure that the value of the portfolio does not fall below a certain level.

Present value factor

Factor used to calculate an estimate of the present value of an amount to be received in
a future period.

Price impact costs

Related: market impact costs

Principal of diversification

Highly diversified portfolios will have negligible unsystematic risk. In other
words, unsystematic risks disappear in portfolios, and only systematic risks survive.

Project loan certificate (PLC)

A primary program of Ginnie Mae for securitizing FHA-insured and coinsured
multifamily, hospital, and nursing home loans.

Reaction

A decline in prices following an advance. Opposite of rally.

Receivables balance fractions

The percentage of a month's sales that remain uncollected (and part of
accounts receivable) at the end of succeeding months.

Reported factor

The pool factor as reported by the bond buyer for a given amortization period.

Round-trip transactions costs

Costs of completing a transaction, including commissions, market impact
costs, and taxes.

Security characteristic line

A plot of the excess return on a security over the risk-free rate as a function of
the excess return on the market.

Set of contracts perspective

View of corporation as a set of contracting relationships, among individuals
who have conflicting objectives, such as shareholders or managers. The corporation is a legal contrivance that
serves as the nexus for the contracting relationships.

Short-run operating activities

Events and decisions concerning the short-term finance of a firm, such as
how much inventory to order and whether to offer cash terms or credit terms to customers.

Single factor model

A model of security returns that acknowledges only one common factor.
See: factor model.

Strip mortgage participation certificate (strip PC)

Ownership interests in specified mortgages purchased
by Freddie Mac from a single seller in exchange for strip PCs representing interests in the same mortgages.
Stripped bond Bond that can be subdivided into a series of zero-coupon bonds.

Structured arbitrage transaction

A self-funding, self-hedged series of transactions that usually utilize
mortgage securities as the primary assets.

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.

Take-or-pay contract

A contract that obligates the purchaser to take any product that is offered to it (and pay
the cash purchase price) or pay a specified amount if it refuses to take the product.

Tax Reform Act of 1986

A 1986 law involving a major overhaul of the U.S. tax code.

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