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Financial glossary

Financial glossary

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Published by Siraj Siddiqui
a glossary of main financial terms
a glossary of main financial terms

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Published by: Siraj Siddiqui on Nov 10, 2009
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Acceptance
The drawee’s acknowledgement of the LIABILITY on a BILL OF EXCHANGE, in writingon the instrument itself. A bill may also bear the co-acceptance by a bank, which is a guarantee tohonour the instrument in the event of default by the drawee.
Accommodation Bill
A BILL OF EXCHANGE without any consideration, or quid pro quo. In thiscase, a person signs a bill and makes himself liable, without receiving any value in return, such as,an advantage or a benefit. The purpose of accepting such a bill is to accommodate the drawer whois temporarily in need of funds. The acceptance enhances the LIQUIDITY of the instrument, whichcan be discounted by the drawer with a bank.
Accrual Basis
A method of accounting that recognizes revenues and expenses as they accrue,even though cash would not have been received or paid during the accrual period.
ADR 
An acronym for American Depository Receipt. It is an instrument traded at U.S. exchangesrepresenting a fixed number of shares of a foreign company that is traded in the foreign country. Bytrading in ADRs, U.S. investors manage to avoid some of the problems of dealing in foreignsecurities markets. The ADR route enables companies to raise funds in the U.S. financial markets,provided they meet the stringent regulatory norms for disclosure and accounting. (See also GDR.)
Allotment
The acceptance of an application subscribing to the shares or other securities of acompany. Such allotment establishes the contractual relationship that underlies an investmentthrough public subscription.
Amortization
The reduction f an amount at regular intervals over a certain time period. This termis used to refer to the reduction of debt by regular payment of loan installments during the life of aloan. It is also used to described the accounting process of writing off an intangible ASSET.
Annual Report
A yearly publication that contains particulars relating to the operating data of acompany, and which is published and distributed by the company to its share-holders, as per therequirement of the Companies Act. The important contents are the profit and loss statement andthe BALANCE SHEET. These statements show a company’s performance in terms of sales andearnings during a financial year, and also its year-end financial position in terms of ASSETS andLIABILITIES. It also contains the directors’ report, a notice to the shareholders about the proposedbusiness agenda of the annual general meeting and the auditor’s report.
Arbitrage
The simultaneous purchase and sale transactions in a security or acommodity, undertaken in different markets to profit from price differences. Forexample, an arbitrageur may find that the share of The Tata Iron and Steel Company (TISCO) istrading at a lower price, at the Vadodara Stock Exchange compared to the exchange at Bombay.Hence, he may simultaneously purchase TISCO stock in Vadodara at, say Rs.250, and sell inBombay at a higher price, say Rs.256, making a profit of Rs.6 per share less expenses.
Asset Management Company
(AMC) A company set up for floating and managing schemes of aMUTUAL FUND. An AMC earns fees by acting as the PORTFOLIO manager of a fund. The AMC isappointed by the Board of Trustees, which oversees its activities. Thus, a mutual fund is generallyestablished as a trust by a SPONSOR, which could be a registered company, bank or FINANCIALINSTITUTION. Also, a custodian and a registrar are appointed to ensure safe keeping of the fund’ssecurities and to deal with investors’ applications, correspondence, etc.
At-the-Money
The term relates to trading in listed OPTIONS. An option is said to be trading “at-the-money” when the STRIKING PRICE and the market price of the underlying share are equal.(See OPTIONS as well as Appendix II).
Badla System
An Indian term for a trading system with a mechanism for deferring either paymentfor shares purchased or delivery of shares sold. The system, discontinued by the Securities andExchange Board of India (SEBI), from March 1994, was applicable to A group or ‘Specified’ shares.For carrying forward a purchase transaction from one settlement period to the next, the buyernormally paid the seller a charge termed badla or ‘Contango’. This consideration would be fixed inthe badla session. When buyers could not take delivery, badla financiers would step in and help outthe buyers. In the reverse but abnormal situation, when the market was in an oversold position anda buyer demanded delivery but the seller could not respond even by borrowing shares, the buyerwould be paid a ‘Backwardation charge’, also known as undha badla. However the buyer could insist
 
on delivery, instead of accepting deferment charges, leading to an auction of the shares in question.The contango or backwardation charge depended on various factors including the extent of outstanding position, short sales, floating stocks, and the prevailing interest rate. The criticismagainst the badla system has essentially been on two counts: equity and transparency. The systemwas slanted in favour of short sellers who could, in a normal market situation, earn interest evenwithout owning the shares sold (it has been argued though, that such short selling helps to checkspeculative and frenzied buying). Also, it was suspected that the contango and backwardationcharges reportedly decided at the badla sessions were often untrue. Besides, it appears that thelimit of 90 days within which the carryovers were to be settled, was often exceeded.Some features of the new system of CARRY FORWARD (CF), introduced at the Bombay StockExchange in January 1996, are :1. Sale or purchase of transactions may be carried forward up to 75 days. 2. Brokers are to classifythe transactions, as to whether for delivery or CF, and report daily. 3. Badla sessions will be screen-based. 4. Strict monitoring of brokers’ positions with the imposition of various margins: daily, mark-to-market and CF.A more liberal Modified Carry Forward System based on the recommendations of the J. S. Varmacommittee was introduced in 1997. Salient features of the new system include an increase in theoverall carry forward limit per broker, reduction in daily margin and removal of the limit onfinanciers.
Balance of Payments
A statement that contains details of all the economic transactions of acountry with the rest of the world, for a given time period, usually one year. The statement has twoparts: the Current Account and the Capital Account.The ‘Current Account’ gives a record of a country’s: (a) Trade Balance which shows the difference of exports and imports of physical goods such as machinery, textiles, chemicals and tea, (b) ‘Invisibles’ that comprise services (rendered and received) such as transportation and insurance andcertain other flows, notably private transfers by individuals. When imports of goods exceed exports,it is referred to as a ‘Trade Deficit’. However, the overall current account position depends on boththe trade balance and the performance of ‘Invisibles’.The ‘Capital Account’ contains details of the inward and outward flows of capital and internationalgrants and loans. Examples of such flows are external assistance, foreign (direct andPORTFOLIO) investments, subscription to Global Depository Receipts orEUROCONVERTIBLE BONDS and deposits of non-residents. Inflows on the capital account arehelpful in financing a current account DEFICIT. Any gap that remains is covered by drawing onexchange or gold reserves, or by credit from the International Monetary Fund. Depending on thenature of imports, a deficit on the current account indicates an excess of investment over domesticsaving in an economy. So long as this deficit is kept in check (evaluated as a percentage of theCROSS DOMESTIC PRODUCT), the DEBT SERVICE RATIO would remain within manageable limits.A challenge posed to India some years ago was the upward pressure on the Rupee’s exchange ratein the wake of large capital account inflows. So, to maintain the competitiveness of India’s exports,the Reserve Bank of India (RBI) resorted to purchases of foreign exchange. However, this has alsocaused money supply to increase, and the RBI has had to ‘sterilize’ such monetization by raising theCASH RESERVE RATIO or by engaging in OPEN MARKET OPERATIONS.
Balance Sheet
A statement of the financial position of an enterprise, as on a certain date, and in acertain format showing the type and amounts of the various ASSETS owned, LIABILITIES owed, andshareholder’s funds.
Bank Guarantee
The financial guarantees and performance guarantees issued by banks on behalf of their clients. A financial guarantee assures repayment of money. (e.g. an advance received on anelectrification contract), in the event of non-completion of the contract by the client. A performanceguarantee provides an assurance of compensation in the event of inadequate or delayedperformance on a contract. A deferred payment guarantee promises payment of installments due toa supplier of machinery or equipment.
 
Bank Rate
The rate of interest charged by the Reserve Bank of India (RBI) on financialaccommodation extended to banks and FINANCIAL INSTITUTIONS. The support is provided in theform of a bills rediscounting facility and advances or REFINANCE against specified ASSETS (e.g.TREASURY BILLS and DATED SECURITIES) or PROMISSORY NOTES.The intent behind changing the Bank Rate at certain junctures is to raise or lower the cost of fundsthat banks obtain from the RBI. This, in turn, would alter the structure of banks’ interest rates andthereby serve to curb or encourage the use of credit. However, the Bank Rate is a relatively passiveinstrument of credit control. In the wake of the East Asian currency crisis, the RBI used the BankRate in conjunction with the CASH RESERVE RATIO and other measures to stabilize the exchangerate of the Rupee.In recent times, it has been RBI’s endeavor to make the Bank Rae and effective signaling device aswell as a reference rate. However, since frequent changes in the Bank Rate may be undesirable, theshort-term REPOS interest rate seems to be a useful supplement in influencing the flow and cost of funds in the short term.
Bear
A person who expects share prices in general to decline and who is likely to indulge in SHORTSALES.
Bear Market
A long period of declining security prices. Widespread expectations of a fall incorporate profits or a slowdown in general economic activity can bring about a bear market.
Beta
(b) A measure of the volatility of a stock in relation to the market. More specifically, it is theindex of SYSTEMATIC RISK, indicating the sensitivity of return on a security or a PORTFOLIO toreturn from the market. It is the slope of the regression line, known as the CHARACTERISTIC LINE,which shows the relationship of an ASSET with the market. For measuring market returns, a proxysuch as a broad-based index is used. Thus, if b exceeds 1, the security is more volatile than themarket, and is termed an ‘Aggressive Security’. For example, a beta of 1.3 implies that a security’sreturn will increase by 13 percent when the return from the market goes up by 10 percent. An assetwhose beta is less than 1 is termed a ‘defensive security’. Based on this, an aggressive growthstrategy would be to invest in high beta stocks when the market is poised for an upswing; similarly,a switchover to low beta stocks is recommended when a downswing is imminent.
Bills of Exchange
A credit instrument that originates from the creditor (drawer) on which theDEBTOR (drawee) acknowledges his LIABILITY; after such acceptance, the drawer may get the billdiscounted, so as to realize the proceeds immediately. As an illustration, consider the following :Hindustan Rasayan, a supplier of chemicals, draws a 90- day bill of Rs.6,20,000 on Indian ParmaCorporation (drawee) directing the drawee to make payment at the end of 90 days to or to theorder of Pyramid Finance Limited (payee).After the drawee accepts the bill, it is discounted with Pyramid Finance at a DISCOUNT RATE of 20percent per annum. Hindustan Rasayan thus receives6,20,000 x (1 – (90/365 x 20/100)) = Rs.5,89,425The effective interest rate works out to 21 percent :6,20,000 5,89,425 365-------------------------------5,89,425 90
Blue Chip
A share of a company that is financially very sound, with an impressive track record of earnings and DIVIDENDS, and which is highly regarded for its competent management, qualityproducts and/or services. Examples in India are Hindustan Lever, Gujarat Ambuja Cements, andReckitt & Colman among others.
Bond
A long-term debt instrument on which the issuer pays interest periodically, known as ‘Coupon’. Bonds are secured by COLLATERAL in the form of immovable property. While generally,bonds have a definite MATURITY, ‘Perpetual Bonds’ are securities without any maturity. In the U.S.,the term DEBENTURES refers to long-term debt instruments which are not secured by specific

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