Definition of Residual income (RI)

Residual income (RI)

The profit remaining after deducting from profit a notional cost of capital on the investment in a business or division of a business.

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.

Absolute priority

Rule in bankruptcy proceedings whereby senior creditors are required to be paid in full
before junior creditors receive any payment.

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.

Administrative pricing rules

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

All-or-none underwriting

An arrangement whereby a security issue is canceled if the underwriter is unable
to re-sell the entire issue.

American Depositary Receipts (ADRs)

Certificates issued by a U.S. depositary bank, representing foreign
shares held by the bank, usually by a branch or correspondent in the country of issue. One ADR may
represent a portion of a foreign share, one share or a bundle of shares of a foreign corporation. If the ADR's
are "sponsored," the corporation provides financial information and other assistance to the bank and may
subsidize the administration of the ADRs. "Unsponsored" ADRs do not receive such assistance. ADRs carry
the same currency, political and economic risks as the underlying foreign share; the prices of the two, adjusted for the SDR/ordinary ratio, are kept essentially identical by arbitrage. American depositary shares(ADSs) are
a similar form of certification.

American option

An option that may be exercised at any time up to and including the expiration date.
Related: European option

American shares

Securities certificates issued in the U.S. by a transfer agent acting on behalf of the foreign
issuer. The certificates represent claims to foreign equities.

American Stock Exchange (AMEX)

The second-largest stock exchange in the United States. It trades
mostly in small-to medium-sized companies.

American-style option

An option contract that can be exercised at any time between the date of purchase and
the expiration date. Most exchange-traded options are American style.

Annualized holding period return

The annual rate of return that when compounded t times, would have
given the same t-period holding return as actually occurred from period 1 to period t.

Appraisal rights

A right of shareholders in a merger to demand the payment of a fair price for their shares, as
determined independently.

Appropriation request

Formal request for funds for capital investment project.

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.

Arithmetic average (mean) rate of return

Arithmetic mean return.

Arithmetic mean return

An average of the subperiod returns, calculated by summing the subperiod returns
and dividing by he number of subperiods.

Arm's length price

The price at which a willing buyer and a willing unrelated seller would freely agree to
transact.

Ask price

A dealer's price to sell a security; also called the offer price.

Asset-backed security

A security that is collateralized by loans, leases, receivables, or installment contracts
on personal property, not real estate.

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.

Asymmetric information

Information that is known to some people but not to other people.

Asymmetric taxes

A situation wherein participants in a transaction have different net tax rates.

Attribute bias

The tendency of stocks preferred by the dividend discount model to share certain equity
attributes such as low price-earnings ratios, high dividend yield, high book-value ratio or membership in a
particular industry sector.

Authorized shares

Number of shares authorized for issuance by a firm's corporate charter.

Automated Clearing House (ACH)

A collection of 32 regional electronic interbank networks used to
process transactions electronically with a guaranteed one-day bank collection float.

Average collection period, or days' receivables

The ratio of accounts receivables to sales, or the total
amount of credit extended per dollar of daily sales (average AR/sales * 365).

Average maturity

The average time to maturity of securities held by a mutual fund. Changes in interest rates
have greater impact on funds with longer average life.

Balloon maturity

Any large principal payment due at maturity for a bond or loan with or without a a sinking
fund requirement.

Bankruptcy risk

The risk that a firm will be unable to meet its debt obligations. Also referred to as default or insolvency risk.

Bargain-purchase-price option

Gives the lessee the option to purchase the asset at a price below fair market
value when the lease expires.

Barrier options

Contracts with trigger points that, when crossed, automatically generate buying or selling of
other options. These are very exotic options.

Basis price

Price expressed in terms of yield to maturity or annual rate of return.

Basis risk

The uncertainty about the basis at the time a hedge may be lifted. Hedging substitutes basis risk for
price risk.

Biased expectations theories

Related: pure expectations theory.

Bid price

This is the quoted bid, or the highest price an investor is willing to pay to buy a security. Practically
speaking, this is the available price at which an investor can sell shares of stock. Related: Ask , offer.

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.

Book-entry securities

The Treasury and federal agencies are moving to a book-entry system in which securities are not represented by engraved pieces of paper but are maintained in computerized records at the
Fed in the names of member banks, which in turn keep records of the securities they own as well as those they
are holding for customers. In the case of other securities where a book-entry has developed, engraved
securities do exist somewhere in quite a few cases. These securities do not move from holder to holder but are
usually kept in a central clearinghouse or by another agent.

Bridge financing

Interim financing of one sort or another used to solidify a position until more permanent
financing is arranged.

British clearers

The large clearing banks that dominate deposit taking and short-term lending in the domestic
sterling market.

Bullish, bearish

Words used to describe investor attitudes. Bullish refers to an optimistic outlook while
bearish means a pessimistic outlook.

Business risk

The risk that the cash flow of an issuer will be impaired because of adverse economic
conditions, making it difficult for the issuer to meet its operating expenses.

Call price

The price, specified at issuance, at which the issuer of a bond may retire part of the bond at a
specified call date.

Call price

The price for which a bond can be repaid before maturity under a call provision.

Call risk

The combination of cash flow uncertainty and reinvestment risk introduced by a call provision.

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.

Carring costs

Costs that increase with increases in the level of investment in current assets.

Characteristic line

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

Clean price

Bond price excluding accrued interest.

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.

Clearing member

A member firm of a clearing house. Each clearing member must also be a member of the
exchange. Not all members of the exchange, however, are members of the clearing organization. All trades of
a non-clearing member must be registered with, and eventually settled through, a clearing member.

Clearing house / Clearinghouse

An adjunct to a futures exchange through which transactions executed its floor are settled by a
process of matching purchases and sales. A clearing organization is also charged with the proper conduct of
delivery procedures and the adequate financing of the entire operation.

Commercial risk

The risk that a foreign debtor will be unable to pay its debts because of business events,
such as bankruptcy.

Company-specific risk

Related: Unsystematic risk

Comparison universe

The collection of money managers of similar investment style used for assessing
relative performance of a portfolio manager.

Competitive offering

An offering of securities through competitive bidding.

Completion risk

The risk that a project will not be brought into operation successfully.

Compounding period

The length of the time period (for example, a quarter in the case of quarterly
compounding) that elapses before interest compounds.

Consumer Price Index (CPI)

The CPI, as it is called, measures the prices of consumer goods and services and is a
measure of the pace of U.S. inflation. The U.S.Department of Labor publishes the CPI very month.

Continuous random variable

A random value that can take any fractional value within specified ranges, as
contrasted with a discrete variable.

Contribution margin

The difference between variable revenue and variable cost.

Conversion parity price

Related:Market conversion price

Convertible price

The contractually specified price per share at which a convertible security can be
converted into shares of common stock.

Convertible security

A security that can be converted into common stock at the option of the security holder,
including convertible bonds and convertible preferred stock.

Counterparty risk

The risk that the other party to an agreement will default. In an options contract, the risk
to the option buyer that the option writer will not buy or sell the underlying as agreed.
Country economic risk Developments in a national economy that can affect the outcome of an international
financial transaction.

Country financial risk

The ability of the national economy to generate enough foreign exchange to meet
payments of interest and principal on its foreign debt.

Country risk General

Level of political and economic uncertainty in a country affecting the value of loans or
investments in that country.

Covariance

A statistical measure of the degree to which random variables move together.

Covered call writing strategy

A strategy that involves writing a call option on securities that the investor
owns in his or her portfolio. See covered or hedge option strategies.

Credit period

The length of time for which the customer is granted credit.

Credit risk

The risk that an issuer of debt securities or a borrower may default on his obligations, or that the
payment may not be made on a negotiable instrument. Related: Default risk

Credit scoring

A statistical technique wherein several financial characteristics are combined to form a single
score to represent a customer's creditworthiness.

Cross-border risk

Refers to the volatility of returns on international investments caused by events associated
with a particular country as opposed to events associated solely with a particular economic or financial agent.

Cum rights

With rights.

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.

Currency risk

Related: Exchange rate risk

Currency risk sharing

An agreement by the parties to a transaction to share the currency risk associated with
the transaction. The arrangement involves a customized hedge contract embedded in the underlying
transaction.

Current maturity

Current time to maturity on an outstanding debt instrument.
Current / noncurrent method
Under this currency translation method, all of a foreign subsidiary's current
assets and liabilities are translated into home currency at the current exchange rate while noncurrent assets
and liabilities are translated at the historical exchange rate, that is, the rate in effect at the time the asset was
acquired or the liability incurred.

Debt securities

IOUs created through loan-type transactions - commercial paper, bank CDs, bills, bonds, and
other instruments.

Debt service parity approach

An analysis wherein the alternatives under consideration will provide the firm
with the exact same schedule of after-tax debt payments (including both interest and principal).

Default risk

Also referred to as credit risk (as gauged by commercial rating companies), the risk that an
issuer of a bond may be unable to make timely principal and interest payments.

Defined contribution plan

A pension plan in which the sponsor is responsible only for making specified
contributions into the plan on behalf of qualifying participants. Related: defined benefit plan
Delayed issuance pool Refers to MBSs that at the time of issuance were collateralized by seasoned loans
originated prior to the MBS pool issue date.

Delivery price

The price fixed by the Clearing house at which deliveries on futures are in invoiced; also the
price at which the futures contract is settled when deliveries are made.

Derivative instruments

Contracts such as options and futures whose price is derived from the price of the
underlying financial asset.

Derivative markets

Markets for derivative instruments.

Derivative security

A financial security, such as an option, or future, whose value is derived in part from the
value and characteristics of another security, the underlying security.

Devaluation A decrease in the spot price of the currency

Dirty price

Bond price including accrued interest, i.e., the price paid by the bond buyer.

Discount period

The period during which a customer can deduct the discount from the net amount of the bill
when making payment.

Discount securities

Non-interest-bearing money market instruments that are issued at a discount and
redeemed at maturity for full face value, e.g. U.S. Treasury bills.

Discounted payback period rule

An investment decision rule in which the cash flows are discounted at an
interest rate and the payback rule is applied on these discounted cash flows.

Discrete random variable

A random variable that can take only a certain specified set of discrete possible
values - for example, the positive integers 1, 2, 3, . . .

Discriminant analysis

A statistical process that links the probability of default to a specified set of financial ratios.

Distributed

After a Treasury auction, there will be many new issues in dealer's hands. As those issues are
sold, it is said that they are distributed.

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).

Diversifiable risk

Related: unsystematic risk.

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