Common Financial Terms - Part III

r-squared

A measurement of how closely a portfolio's performance correlates with the performance of a benchmark index, such as the S&P 500, and thus a measurement of what portion of its performance can be explained by the performance of the overall market or index. Values for r-squared range from 0 to 1, where 0 indicates no correlation and 1 indicates perfect correlation.

back-to-back loans

An arrangement in which two companies in different countries borrow each other's currency for a given period of time, in order reduce foreign exchange risk for both of them. also called parallel loans.

Authorized shares

The maximum number of shares of stock that a company can issue. This number is specified initially in the company's charter, but it can be changed with shareholder approval. Generally a much greater number of shares are authorized than required, to give the company flexibility to issue more stock as needed. also called authorized stock or shares authorized.

Swap spread

The difference between the swap rate on a contract and the yield on a government bond of the same maturity. It is used to represent the risk associated with the investment, since changes in interest rates will ultimately affect return. Swap spreads are based on LIBOR rates, the creditworthiness of the swap's parties, and other economic factors that could influence the terms of the investment's interest rates.

Variable rate

Any interest rate or dividend that changes on a periodic basis. Variable rates are often used for convertibles, mortgages, and certain other kinds of loans. The change is usually tied to movement of an outside indicator, such as the prime interest rate. Movement above or below certain levels is often prevented by a predetermined floor and ceiling for a given rate. also called adjustable rate.

Payout

A taxable payment declared by a company's board of directors and given to its shareholders out of the company's current or retained earnings, usually quarterly. Payouts are usually given as cash (cash dividend), but they can also take the form of stock (stock dividend) or other property. Payouts provide an incentive to own stock in stable companies even if they are not experiencing much growth. Companies are not required to pay payouts. The companies that offer payouts are most often companies that have progressed beyond the growth phase, and no longer benefit sufficiently by reinvesting their profits, so they usually choose to pay them out to their shareholders. also called dividend.

Employee Stock Ownership Plan

ESOP. A trust established by a corporate which acts as a tax-qualified, defined-contribution retirement plan by making the corporation's employees partial owners. contributions are made by the sponsoring employer, and can grow tax-deferred, just as with an IRA or 401(k) plan. But unlike other retirement plans, the contributions must be invested in the company's stock. The benefits for the company include increased cash flow, tax savings, and increased productivity from highly motivated workers. The main benefit for the employees is the ability to share in the company's success. Due to the tax benefits, the administration of ESOPs is regulated, and numerous restrictions apply. also called stock purchase plan.

Preferred shares

Capital stock which provides a specific dividend that is paid before any dividends are paid to common stock holders, and which takes precedence over common stock in the event of a liquidation. Like common stock, preferred shares represent partial ownership in a company, although preferred stock shareholders do not enjoy any of the voting rights of common stockholders. Also unlike common stock, a preferred share pays a fixed dividend that does not fluctuate, although the company does not have to pay this dividend if it lacks the financial ability to do so. The main benefit to owning preferred share is that the investor has a greater claim on the company's assets than common stockholders. Preferred shareholders always receive their dividends first and, in the event the company goes bankrupt, preferred shareholders are paid off before common stockholders. In general, there are four different types of preferred stock: cumulative preferred, non-cumulative, participating, and convertible. also called preferred stock.

GDR

Global Depositary Receipt. A negotiable certificate held in the bank of one country representing a specific number of shares of a stock traded on an exchange of another country. American Depositary Receipts make it easier for individuals to invest in foreign companies, due to the widespread availability of price information, lower transaction costs, and timely dividend distributions. also called European Depositary Receipt.

Incentive stock option

ISO. A type of employee stock option which provides tax advantages for the employer that a non-qualified stock option does not, but which is subject to more stringent requirements. For ISOs, no income tax is due when the options are granted or when they're exercised. Instead, the tax is deferred until the holder sells the stock, at which time he/she is taxed for his/her entire gain. As long the sale is at least two years after the options were granted and at least one year after they were exercised, they'll be taxed at the lower, long-term capital gains rate; otherwise, the sale is considered a "disqualifying disposition", and they'll be taxed as if they were nonqualified options (the gain at exercise is taxed as ordinary income, and any subsequent appreciation is taxed as capital gains). ISOs may not be granted at a discount to the current stock price, and they are not transferable, except through a will. also called qualified stock option.




Financial Terms - Part I
Financial Terms - Part II
Financial Terms - Part IV
Financial Terms - Part V
Financial Terms - Part VI