Financial concept

FINANCIAL CONCEPTS

AMORTIZATION

In business, amortization refers to spreading payments over multiple periods.The term is used for two separate processes: amortization of loans andamortization of intangible assets.

AMORTIZATION OF LOANSAMORTIZATION OF

INTANGIBLE ASSETS

In lending, amortization is thedistribution of payment into multiplecash flow installments, as determinedby an amortization schedule. Unlikeother repayment models, eachrepayment installment consists ofboth principal and interest.Amortization is chiefly usedin loanrepayments (a common examplebeing a mortgage loan) and in sinkingfunds. Payments are divided into equalamounts for the duration of the loan,making it the simplest repaymentmodel.

In accounting, amortization refers toexpensing the acquisition cost minusthe residual value of intangibleassets (often intellectual property

Suchas patents and trademarks or copyrights) in a systematic manner overtheir estimated useful economic livesso as to reflect their consumption,expiry, obsolescence or other declinein value as a result of use or thepassage of time.

ASK PRICE

• Ask price, also called offer price, offer, asking price, or simply ask, is the price a seller states she or he will accept for a good.

• The seller may qualify the stated asking priceas firm or negotiable. Firm means the seller is saying he or she won'tchange the price. Negotiable means the seller is inviting the potentialbuyer to attempt to convince the seller to lower the price

BASE EFFECT

• The Base effect[1] relates to inflation in the corresponding period ofthe previous year, if the inflation rate was too low in the corresponding periodof the previous year, even a smaller rise in the Price Index will arithmeticallygive a high rate of inflation now. On the other hand, if the price index had risenat a high rate in the corresponding period of the previous year and recordedhigh inflation rate, a similar absolute increase in the Price index now will showa lower inflation rate now.

• An illustration of the base effect would be like: Price Index 100 goes to 150,and then to 200. The initial increase of 50, gives the percentage increase as50% but the subsequent increase of 50 gives the percentage increase as33.33%. This happens arithmetically as the base on which the percentage iscalculated has increased from 100 to 150.

BID PRICE

• A bid price is the highest price that a buyer (i.e., bidder) is willing to pay for agood. It is usually referred to simply as the "bid.“

• In bid and ask, the bid price stands in contrast to the ask price or "offer", andthe difference between the two is called the bid/ask spread.

BUY DOWN

• A buydown is a mortgage financing technique where the buyer attempts toobtain a lower interest rate for at least the first few years of themortgage.[1] The seller of the property usually provides payments to themortgage lending institution, which, in turn, lowers the buyer's monthlyinterest rate and therefore monthly payment. This is typically done for a periodof about one to five years. In a seller's market the seller might raise thepurchase price to compensate for the costs of the buydown but in mostmarkets it would not be to their advantage to use a buydown as an enticementif they are going to offset the benefit by raising the price.[2] In most cases, thebuydown does not even involve the seller. It is an arrangement between thelender and the buyer.

BUYER’S CREDIT

• Buyer's credit is short term credit availed to an importer (buyer) fromoverseas lenders such as banks and other financial institution for goods theyare importing. The overseas banks usually lend the importer (buyer) based onthe letter of comfort (a bank guarantee) issued by the importer's bank. For thisservice the importer's bank or buyer's credit consultant charges a fee called anarrangement fee.

• Buyer's credit helps local importers gain access to cheaper foreign funds thatmay be closer to LIBOR rates as against local sources of funding which aremore costly.

• The duration of buyer's credit may vary from country to country, as per thelocal regulations. For example in India, buyer's credit can be availed for oneyear in case the import is for tradeable goods and for three years if the importis for capital goods. Every six months, the interest on buyer's credit may getreset.

CAPITALIZATION RATE

• Capitalization rate (or "cap rate") is the ratio between the net operating income produced by an asset and its capital cost (the original price paid to buy the asset) or alternatively its currentmarket value. The rate is calculated in a simple fashion as follows:

• For example, if a building is purchased for $1,000,000 sale price and it produces $100,000 in positive net operating income (the amount left over after fixed costs and variable costs is subtracted from gross lease income) during one year, then:

• $100,000 / $1,000,000 = 0.10 = 10%

• The asset's capitalization rate is ten percent; one-tenth of the building's cost is paid by the year's net proceeds.

CASH FLOW

Cash flow is the movement of money into or out of a business, project, or financialproduct. It is usually measured during a specified, limited period of time.Measurement of cash flow can be used for calculating other parameters that giveinformation on a company's value and situation. Cash flow can be used, forexample, for calculating parameters: it discloses cash movements over the period.

COLLATERAL (FINANCE)

In lending agreements, collateral is a borrower's pledge of specific property toa lender, to secure repayment of a loan.[1][2] The collateral serves as protection fora lender against a borrower'sdefault - that is, any borrower failing to paythe principal and interest under the terms of a loan obligation. If a borrower doesdefault on a loan (due to insolvency or other event), that borrower forfeits (givesup) the property pledged as collateral—and the lender then becomes the owner ofthe collateral. In a typical mortgage loan transaction, for instance, the realestate being acquired with the help of the loan serves as collateral. Should thebuyer fail to pay the loan under the mortgage loan agreement, the ownership ofthe real estate is transferred to the bank. The bank uses alegalprocess called foreclosure to obtain real estate from a borrower who defaults on amortgage loan obligation. A pawnbroker is an easy and common example of abusiness that may accept a wide range of items rather than just dealing with cash.

CONCEPT OF COLLATERAL

Collateral, especially within banking, traditionally refers to secured lending (alsoknown as asset-based lending). More recently, complex collateralizationarrangements are used to secure trade transactions (also known as capital marketcollateralization). The former often presents unilateral obligations secured in theform of property, surety, guarantee or other as collateral (originally denoted by theterm security), whereas the latter often presents bilateral obligations secured bymore liquid assets such as cash or securities, often known for margin. Anotherexample might be to ask for collateral in exchange for holding something of valueuntil

COMPARATIVE ADVANTAGE

• In economics, comparative advantage refers to the ability of a party to produce aparticular good or service at a lower marginal and opportunity costover another.Even if one country is more efficient in the production of all goods (absoluteadvantage in all goods) than the other, both countries will still gain by trading witheach other, as long as they have different relative efficiencies.[1][2][3]

• For example, if, using machinery, a worker in one country can produce both shoesand shirts at 6 per hour, and a worker in a country with less machinery can produceeither 2 shoes or 4 shirts in an hour, each country can gain from trade because theirinternal trade-offs between shoes and shirts are different. The less-efficient countryhas a comparative advantage in shirts, so it finds it more efficient to produce shirtsand trade them to the more-efficient country for shoes. Without trade,its opportunity cost per shoe was 2 shirts; by trading, its cost per shoe can reduce toas low as 1 shirt depending on how much trade occurs (since the more-efficientcountry has a 1:1 trade-off). The more-efficient country has a comparativeadvantage in shoes, so it can gain in efficiency by moving some workers from shirt-production to shoe-production and trading some shoes for shirts. Without trade, itscost to make a shirt was 1 shoe; by trading, its cost per shirt can go as low as 1/2shoe depending on how much trade occurs.

COMPOUND INTEREST

• Compound interest arises when interest is added to the principal of a deposit or loan, so that, from that moment on, the interest that has been added also earns interest. This addition of interest to the principal is called compounding. A bank account, for example, may have its interest compounded every year: in this case, an account with $1000 initial principal and 20% interest per year would have a balance of $1200 at the end of the first year, $1440 at the end of the second year, and so on.

• In order to define an interest rate fully, and enable one to compare it with other interest rates, the interest rate and the compounding frequency must be disclosed. Since most people prefer to think of rates as a yearly percentage, many governments require financial institutions to disclose the equivalent yearly compounded interest rate on deposits or advances. For instance, the yearly rate for a loan with 1% interest per month is approximately 12.68% per annum (1.0112 − 1). This equivalent yearly rate may be referred to as annual percentage rate (APR), annual equivalent rate (AER), effective interest rate, effective annual rate, and by other terms. When a fee is charged up front to obtain a loan, APR usually counts that cost as well as the compound interest in converting to the equivalent rate. These government requirements assist consumers in comparing the actual costs of borrowing more easily.

CONTANGO

• Contango is a situation where the futures price (or forward price) of acommodity is higher than the expected spot price.(Black2009)[1](investopedia)[2] In a contango situation hedgers (commodityproducers and commodity users) or arbitrageurs/speculators (non-commercial investors),(EU & 2008 6)[3] are "willing to pay more for acommodity at some point in the future than the actual expected price of thecommodity. This may be due to people's desire to pay a premium to have thecommodity in the future rather than paying the costs of storage and carry costsof buying the commodity today."(investopedia)

• The opposite market condition to contango is known asnormal backwardation.(investopedia) "A market is "in backwardation" whenthe futures price is below the expected future spot price for a particularcommodity. This is favorable for investors who have long positions since theywant the futures price to rise."(investopedia)[2]

DEFLATION

• In economics, deflation is a decrease in the general price level of goods and services.[1] Deflation occurs when the inflation rate falls below 0% (a negative inflation rate). This should not be confused with disinflation, a slow-down in the inflation rate (i.e., when inflation declines to lower levels).[2]Inflation reduces the real value of money over time; conversely, deflation increases the real value of money – the currency of a national or regional economy. This allows one to buy more goods with the same amount of money over time.

• Economists generally believe that deflation is a problem in a modern economy because it increases the real value of debt, and may aggravate recessions and lead to a deflationary spiral.[3] Historically not all episodes of deflation correspond with periods of poor economic growth.[4] Deflation occurred in the U.S. during most of the 19th century (the most important exception was during the Civil War). This deflation was caused by technological progress that created significant economic growth.[5][6][7] This deflationary period of considerable economic progress preceded the establishment of the U.S. Federal Reserve System and its active management of monetary matters.

DELEVERAGING

• At the micro-economic level, deleveraging refers to the reduction of the leverage ratio, or the percentage of debt in the balance sheet of a single economic entity, such as a household or a firm. It is the opposite of leveraging, which is the practice of borrowing money to acquire assets and multiply gains and losses.

• At the macro-economic level, deleveraging of an economy refers to the simultaneous reduction of debt levels in multiple sectors, including private sectors and the government sector. It is usually measured as a decline of the total debt to GDP ratio in the national account. The deleveraging of an economy following a financial crisis has significant macro-economic consequences and is often associated with severe recessions.

DISCOUNTED CASH FLOW

• In finance, discounted cash flow (DCF) analysis is a method of valuing aproject, company, or asset using the concepts of the time value of money. Allfuture cash flows are estimated and discounted to give their presentvalues (PVs)—the sum of all future cash flows, both incoming and outgoing, isthe net present value (NPV), which is taken as the value or price of the cashflows in question. Present value may also be expressed as a number ofyears'purchase of the future undiscounted annual cash flows expected to arise.

• Using DCF analysis to compute the NPV takes as input cash flows and adiscount rate and gives as output a price; the opposite process—taking cashflows and a price and inferring a discount rate—is called the yield.

• Discounted cash flow analysis is widely used in investment finance, real estatedevelopment, corporate financial management and patent valuation.

DIVISION OF LABOUR

• The division of labour is the specialisation of cooperating individuals who perform specific tasks and roles. Historically, an increasingly complex division of labour is associated with the growth of total output and trade, the rise of capitalism, and of the complexity of industrialised processes. The concept and implementation of division of labour has been observed in ancient Sumerian(Mesopotamian) culture, where assignment of jobs in some cities coincided with an increase in trade and economic interdependence. In addition to trade and economic interdependence, division of labour generally increases both producer and individual worker productivity.

• In contrast to division of labour, division of work refers to the division of a large task, contract, or project into smaller tasks — each with a separate schedule within the overall project schedule.Division of labour, instead, refers to the allocation of tasks to individuals or organisations according to the skills and/or equipment those people or organisations possess. Often division of labourand division of work are both part of the economic activity within an industrial nation or organisation.

DOMESTIC LIABILITY DOLLARIZATION

Domestic liability dollarization (DLD) refers to the denomination of banking system deposits and lending in a currency other than that of the country in which they are held. DLD does not refer exclusively to denomination in US dollars, as DLD encompasses accounts denominated in internationally traded "hard" currencies such as the British pound sterling, the Swiss franc, the Japanese yen, and the Euro (and some of its predecessors, particularly the Deutschmark).

DOWN PAYMENT

Down payment (or downpayment) is a payment used in the context of the purchase of expensive items such as a car and a house, whereby the payment is the initial upfront portion of the total amount due and it is usually given in cash at the time of finalizing the transaction.[1] A loan or the amount in cash is then required to make the full payment.

DOWNSIDE RISK

• Downside risk is the financial risk associated with losses. That is, the risk of difference between the actual return and the expected return (when the actual return is less), or the uncertainty of that return.[1][2]

• Risk measures typically quantify the downside risk, whereas the standard deviation (an example of a deviation risk measure) measures both the upside and downside risk. Specifically, downside risk can be measured either with downside beta or by measuring lower semi-deviation.[3]:3 The statistic below-target semi deviation or simply target semi deviation (TSV) has become the industry standard.[4]

DOWNSIDE RISK V/S CAPM

It is important to distinguish between downside and upside risk because security distributions are non-normal and non-symmetrical.[9][10][11] This is in contrast to what the capital asset pricing model (CAPM) assumes: that security distributions are symmetrical, and thus that downside and upside betas for an asset are the same. Since investment returns tend to have non-normal distribution, however, there in fact tends to be a different probability for losses and for returns. The probability of losses is reflected in the downside risk of an investment, or the lower portion of the distribution of returns.[8] The CAPM, however, includes both halves of a distribution in its calculation of risk. That is why it is crucial to not simply rely upon the CAPM, but rather to distinguish between the downside risk, which is the risk of losses, and upside risk, or gain. Studies indicate that "around two-thirds of the time standard beta would under-estimate the downside risk."[3]:11