Financial Glossary

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Financial terminology
1
Jargon buster
Financial
glossary
Speaking the language of finance with confidence is
often a deal-breaker. If you need to brush up on your
financial terminology, take a look at our AtoZ guide.
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Active return
Return on an investment relative to a benchmark.
For example, if a portfolio has a benchmark return
of 5% but the actual return is 8%, then the active
return is 3% (actual return minus the benchmark return).
Active returns can be positive or negative depending
on whether the actual return outperforms the
benchmark or not.

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Arbitrage
Exploiting usually small differences in the price
of securities, currencies, commodities, or other
assets to make a profit. Arbitrage can only happen
in an inefficient market.

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The total market value of financial assets an investment
company manages on behalf of its clients.
Assets under
management (AUM)

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A graphical model for valuing options. It is one of two
major methods for pricing options. The other being
Black-Scholes.
Binomial tree

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The formula that made it possible to create prices
in the derivatives market. The formula is named after
its creators: Fischer Black and Myron Scholes.
Black-Scholes

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A certificate issued by a government, company
or other organisation promising to repay borrowed
money at a fixed rate of interest at a specified time.
Bond

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The value that a convertible bond would have if it was no
longer convertible. The bond value represents the market
value of the bond less the value of the conversion option.
Bond value

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Organisations that buy investment services. These
include private equity funds, mutual funds, life insurance
companies, unit trusts, hedge funds and pension funds.
Buy-side

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For investors, it refers to their stock of wealth, which can be put to work in
order to earn income.
For companies, it typically refers to sources of financing such as newly issued
shares.
For banks, it refers to their ability to absorb losses in their accounts. Banks
normally obtain capital either by issuing new shares, or by keeping hold of
profits instead of paying them out as dividends. If a bank writes off a loss on
one of its assets – for example, if it makes a loan that is not repaid – then the
bank must also write off a corresponding amount of its capital. If a bank runs
out of capital, then it is insolvent, meaning it does not have enough assets to
repay its debts.
Capital

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The part of a financial system concerned with raising
capital by dealing in shares, bonds and other long-term
investments.
Capital markets

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The composition of a company’s mixture of debt and
equity financing. A company’s debt-equity ratio is often
referred to as its gearing.
Capital structure

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A small company created from a larger one. A company
undertaking a carve-out is not selling a business unit
outright, and may instead sell an equity stake in that
business or spin the business off on its own while
retaining an equity stake itself.
Carve-outs

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A measure of a company’s financial performance based
on the cash flow a company produces with its invested
capital.
Cash return on
gross investment (CROGI)

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A bond that uses a variety of high-yield junk bonds as
collateral. These bonds are separated, or pooled, into
tranches with higher and lower levels of risk.
Collateralised bond
obligations (CBO)

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A tradable derivative. A number of loans or debt securities
payable by various companies are put into a pool, and
new securities are issued which pay out according to the
pool’s collective performance.
Collateralised debt
obligation (CDO)

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Convexity
A measure of the way that bond duration and prices
change when interest rates fluctuate as shown in the
curve of the price to yield relationship. The shape of the
typical curve is convex.

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How a company is managed, in terms of the institutional
systems and protocols meant to ensure accountability
and sound ethics. The concept encompasses a variety of
issues, including disclosure of information to shareholders
and board members, senior executive pay, potential
conflicts of interest among managers and directors,
supervisory structures, etc.
Corporate
governance

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Derivatives that investors use to protect against, or bet
on, an entity being unable to repay its debts. The credit
default swaps market is believed to have played a big
part in the 2008 financial crisis.
Credit default
swap (CDS)

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The risk that a borrower will default on any type of debt
by failing to make required payments.
Credit risk

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A financial market where participants can issue new
debt, known as the primary market, or buy and sell debt
securities, known as the secondary market. This is usually
in the form of bonds, but it may include notes, bills, and
so on.
Debt market

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A financial contract which provides a way of investing in a particular product
without having to own it directly. For example, a stock market futures contract
allows investors to make bets on the value of a stock market index such
as the FTSE 100 without having to buy or sell any shares. The value of a
derivative can depend on anything from the price of coffee to interest rates
or what the weather is like. Credit derivatives such as credit default swaps
depend on the ability of a borrower to repay its debts. Derivatives allow
investors and banks to hedge their risks, or to speculate on markets. Futures,
forwards, swaps and options are all types of derivatives.
Derivative

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A way of estimating the attractiveness of an investment.
DCF analysis uses future free cash flow projections and
discounts them (most often using the weighted average
cost of capital) to arrive at a present value, which is
used to evaluate the potential for investment. If the value
arrived at through DCF analysis is higher than the current
cost of the investment, the opportunity may be a good
one.
Discounted cash
flow (DCF)

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The process of selling subsidiary business interests or
investments. Not to be confused with disinvestment,
which is a reduction in a company’s capital goods.
Divestment

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An income payment by a company to its shareholders
usually linked to its profits.
Dividend

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Dual-listed company
A merger between two companies, in which they agree
to combine their operations and cash flows, and make
similar dividend payments to shareholders in both
companies, while retaining separate shareholder registries
and identities. In most cases, the two companies are
listed in different countries.

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The value of a business or investment after subtracting
any debts owed by it. The equity in a company is the
value of all its shares.
Equity

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Same as stock market. Not to be confused with the
physical place where shares are traded. That’s called a
stock exchange.
Equity market

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A condition where a company cannot meet, or has
difficulty paying off its financial obligations to its creditors.
The chance of financial distress increases when a firm
has high fixed costs, illiquid assets, or revenues that are
sensitive to economic downturns.
Financial distress

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The organisation responsible for regulating the financial
services industry in the UK.
Financial Services
Authority (FSA)

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Fixed income
Any type of investment, such as bonds and other debt
instruments, that produces regular or fixed returns.

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Foreign exchange.
Forex (FX)

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The qualitative and quantitative information that
contributes to the economic well-being and the
subsequent financial valuation of a company, security
or currency. Analysts and investors analyse these
fundamentals to develop an estimate as to whether the
underlying asset is considered a worthwhile investment.
For businesses, information such as revenue, earnings,
assets, liabilities and growth are considered some of the
fundamentals.
Fundamentals

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A futures contract is an agreement to buy or sell a
commodity at a predetermined date and price. It could
be used to hedge or to speculate on the price of the
commodity. Futures contracts are a type of derivative and
are traded on an exchange.
Futures

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Same as leverage. The extent to which a company’s
operations are funded by lenders versus shareholders. A
company with a high proportion of debt to equity is highly
geared and is more vulnerable to fluctuations in business
activity. It presents a higher risk for shareholders.
Gearing

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A private investment fund which uses a range of
sophisticated strategies to maximise returns including
leveraging and derivatives trading. Despite its name,
hedging is rarely used.
Hedge fund

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A strategy to minimise risk. It involves deliberately taking
on a new risk that offsets the existing one. For example,
an importer of a commodity may sell futures contracts to
offset losses if prices fall.
Hedging

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The first sale of stock by a company to the public. A
company can raise money by issuing either debt or
equity. If the company has never issued equity to the
public, it’s known as an IPO.
Initial public
offering (IPO)

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A financial instrument based on an underlying financial
security whose value is affected by changes in interest
rates. Interest-rate derivatives are hedges used by
institutional investors such as banks to combat the
changes in market interest rates.
Interest-rate
derivatives

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Need for intermediation occurs due to the imperfect
nature of markets and everyday situations where the
complete (‘perfect’) knowledge about providers and
seekers (and about what they seek) is not available to
everyone.
Intermediation

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Agreement between two or more companies to cooperate
on a particular project or a business that serves their
mutual interests. In most cases, the agreement involves
the parties taking a share in the capital of a joint venture
company, and sharing costs and earnings in proportion to
that share.
Joint venture

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The acquisition of another company using a significant
amount of borrowed money (bonds or loans) to meet the
cost of acquisition.
Leveraged buy-out

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Holding a security such as a stock, commodity or
currency, with the expectation that the price will rise.
Long
(or ‘long position’)

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The branch of economics concerned with large-scale
or general economic factors, such as interest rates and
national productivity.
Macroeconomics

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A transaction where a company’s management team
purchases the assets and operations of the business they
manage.
Management
buy-out (MBO)

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When two businesses join together, either by merging or
by one company taking over the other.
Mergers and
acquisitions(M&A)

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Modern portfolio theory is based on the simple idea that
diversification can produce the same total returns for
less risk. Combining many financial assets in a portfolio
is less risky than putting all your investment eggs in one
basket. Harry Markowitz was awarded a Nobel Prize in
Economics for developing this theory. However, when it
came to investing his own money, Markowitz didn’t use
MPT, but chose a simpler rule which allocates money
equally across a number of funds under consideration.
Modern portfolio
theory (MPT)

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An investment fund that gathers capital from a number
of investors to create a pool of money that is then re-
invested into stocks, bonds and other assets. Mutual
funds are known as unit trusts in the UK.
Mutual fund

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A value that helps people decide whether to go ahead
with an investment or project. It is the current value of the
investment plus the present value of future cash flows,
minus the initial cost of the investment plus the present
value of any future cost.
Net present value (NPV)

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A type of derivative that gives an investor the right to buy
(or to sell) something at an agreed price and at an agreed
time in the future. Options become much more valuable
when markets are volatile, as they can be an insurance
against price swings.
Options

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Greeks – the quantities representing the sensitivity of
the price of derivatives such as options to a change
in underlying parameters on which the value of an
instrumentor portfolio of financial instruments is
dependent.
Exotics – Exotics are derivatives that are complex or are
available in emerging economies.
Options: Greeks,
Exotics

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Deciding on the weights of securities so that they best
suit the goal of the portfolio, such as: ‘maximise return for
a given risk’.
Portfolio
optimisation

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A simple way of judging whether shares are cheap or
expensive. It is the ratio of the market price of a share to
the company’s earnings (profit) per share.
Price-earning ratio

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A firm that specialises in buying up troubled or
undervalued companies, taking them private with the aim
of running them better and later taking them public or
selling them at a profit.
Private equity firm

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In the UK, a way of creating public-private partnerships by
funding public infrastructure projects with private capital.
Private finance
initiative (PFI)

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A financial ratio that measures a company’s profitability
and the efficiency with which its capital is employed.
Return on capital
employed (ROCE)

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The profit on an investment in relation to the amount
invested.
Return on
investment (ROI)

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An accounting principle under generally accepted
recognition accounting principles (GAAP) that determines
the specific conditions under which income becomes
realised as revenue. Generally, revenue is recognised only
when a pecific critical event has occurred and the amount
of revenue is measurable.
Revenue

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The process of managing the risk you want to bear, and
minimising your exposure to the risk you do not want.
Some of the ways that companies manage risk include
hedging, diversification, buying insurance and, simply,
avoidance.
Risk management

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The part of the financial industry involved with the
creation, promotion, analysis and sale of securities. Sell-
side individuals and firms work to create and service
stock products that will be made available to the buy-side
of the financial industry.
Sell-side

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The sale of a borrowed security, commodity or currency
with the expectation that the asset will fall in value.
Strategic asset The practice of realigning a portfolio’s
asset composition in allocation order to accommodate
changes in market.
Shorting

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An exchange of securities between two parties. For
example, if a firm in one country has a lower fixed interest
rate and one in another country has a lower floating
interest rate, an interest rate swap could be mutually
beneficial.
Swap

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Determining the value of an asset or a company.
Valuation

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The strategy of selecting stocks that trade for less
than their intrinsic values. Value investors actively seek
stocks of companies that they believe the market has
undervalued.
Value investing

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Private equity to help new companies grow. An alternative
source of finance for entrepreneurs who might otherwise
have to rely on a bank loan.
Venture capital

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A graph of the relationship between the yields and
maturities of different bonds of similar quality, currency
denomination and risk (usually government bonds).
Yield curve

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Masters in Finance – MiF
Masters in Financial Analysis – MFA
Beyond the jargon:
finance programmes at LBS

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Executive Education Programmes
■■ Corporate Finance Portfolio:
■■ Accounting and Financial Analysis
■■ Valuation
■■ Financial Strategies for Value Creation
■■ Advanced Corporate Finance
■■ Financing the Entrepreneurial Business
■■ Financial Seminar for Senior Managers
■■ Investment Management Programmes:
■■ Equity Portfolio Management
■■ Fixed Income Markets and Bond Portfolio
Management
■■ Masterclass in Private Equity
■■ Mergers and Acquisitions
■■ Project and Infrastructure Finance
■■ Strategic Investment Management
Beyond the jargon:
finance programmes at LBS

Financial Glossary

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