SESSION 19 – GLOSSARY
1901 Accounting Rate of Return (ARR) – the average annual operating profit generated by a project Agency Costs – the reduction in shareholders’ returns below the maximum possible level due to company managers following personal objectives not in the best interests of shareholders
Alpha – a measure of abnormal return from a security i.e. where the forecast return is higher or lower than expected by CAPM
Asymmetry of information – the fact that potential investors know less about a company than its managers and may therefore over-estimate the risk of providing finance. This can be a particular problem for SME’s
Basis risk – the risk that interest rates on assets and liabilities are referenced to a different benchmark
Beta factors – a measure of the sensitivity of a security’s returns to systematic risk Bird in the Hand theory – suggest that shareholders may prefer the certainty of a cash
dividend today rather than reinvestment of profits to create an uncertain capital gain in the future
Bonus issue – issue of new shares to existing shareholders, without any subscription of new funds. Also referred to as a scrip issue
Business Risk – the volatility of operating profits, caused by the volatility of revenues and the level of operational gearing
CAPM – Capital Asset Pricing Model. A model that relates the systematic risk of an investment to the required return
Cap – an agreement that fixes a maximum rate of interest
Capital Rationing – where insufficient finance is available to undertake all available positive NPV projects
Cash conversion cycle – time period between paying suppliers and receiving cash from customers. Also known as the cash operating cycle or working capital cycle
Certificate of deposit – a tradable security issued by banks to investors who deposit a fixed amount for a fixed period
Clientele Theory – suggest that a company’s historical dividend pattern may have attracted particular investors. Changing the pattern in future may cause this “clientele” to sell their holdings and lead to a fall in share price
Collar – an agreement that keeps either a borrowing or lending rate between specified upper and lower limits
Convertible debt – debt that can, at the option of the investor, be either redeemed or converted into ordinary shares
SESSION 19 – GLOSSARY
1902
Corporate governance – controls and procedures implemented to reduce agency costs to an acceptable level
Corporate Social Responsibility (CSR) – a model which suggests that company managers should take into account the objectives of a wide range of stakeholders and not just the shareholders
Dividend Valuation Model – states that the value of a share is the present value of future expected dividends, discounted at the investors’ required return
Economic risk – the risk that long-term changes in exchange rates affects a company’s profitability
Efficient Markets Hypothesis (EHM) – a theory which asks what information is reflected in share prices
Environmental Management Accounting (EMA) – attempts to measure the full environmental impact of a company’s operations e.g. the cost of inefficient energy usage due to poor insulation of buildings
Financial gearing – the proportion of debt in the capital structure
Financial risk – the increased volatility of returns to ordinary shareholders due to interest on debt being a fixed committed cost
Financial distress risk – the risk of bankruptcy caused by dangerously high levels of financial gearing
Floor – an agreement that fixes a minimum rate of interest
Floor value – the value of convertible debt assuming that it will be redeemed rather than converted
Forward contract – a legally binding contract between a company and a bank to buy or sell a fixed amount of foreign currency at a fixed exchange rate on a fixed date in the future
Forward Rate Agreements – contracts which allow companies in advance to fix future borrowing or lending rates, based on a notional principal over a given period.
Futures contract – a traded forward contract
Gap exposure – the risk that interest rates on assets and liabilities are reset at different intervals
Gordon’s growth model – states that the forecast growth rate of a company’s dividend = proportion of profits retained × return on equity
Gross Redemption Yield – see Yield to Maturity
IRR – Internal Rate of Return; the discount rate where NPV equals zero
SESSION 19 – GLOSSARY
1903 Operational gearing – the proportion of fixed operating costs to variable operating costs Payback – the period of time required for the operating cash flows from a project to equal the cost of investment
Pecking Order theory – a theory which suggests that company managers have a preference for using internal finance i.e. retained earnings, rather than external finance. A key cause may be asymmetry of information
Pre-emptive rights – the right of existing shareholders to be offered new shares before they can be offered to new investors. Also known as pre-emption rights
Rights Issue – an offer of new shares to existing shareholders who hold pre-emptive rights Scrip dividend – issue of new shares to existing shareholders in lieu of a cash dividend Scrip Issue – see bonus issue
Securities – financial instruments that can be traded e.g. shares, bonds and derivatives. SME’s – Small and Medium-sized Enterprises. No official definition exists but generally these are unlisted companies
Special dividend – a substantial dividend payment that is not expected to be repeated in the near future
Stakeholders – groups of people who have some type of interest in an organization. Shareholders are the key stakeholder but other groups include employees, customers, suppliers and, arguably, even society as a whole.
Systematic risk – the relative effect on the returns of an individual security of changes in the market as a whole. Also known as market risk. It cannot be removed by diversification but can be measured using beta factors
Tax Shield – interest on debt is a tax allowable expense for a company and leads to lower corporate tax payments
Term Structure of Interest Rates – the relationship between short and long term interest rates Total Shareholder Returns (TSR) – the total return to shareholders via dividend and capital gain, usually measured over a one year period
Transaction Risk – the risk that exchange rates change between the date of an import/export and the related payment/receipt of foreign currency
Translation risk – gains/losses caused by translating the financial statements of overseas subsidiaries into the reporting currency of the parent upon consolidation
SESSION 19 – GLOSSARY
1904
