Ch# Term Definition1 finance The knowledge, science, techniques, and art of managing money.

(p. 2) 1 financial markets Provide a forum where savers of funds and users of funds can

transact business. (p. 4)1 financial institutions Intermediaries that allow for the efficient transfer of the savings of

individuals, governments, and business for financial securities. (p. 4)

1 financial services The part of finance concerned with design and delivery of advice and financial products to individuals, business, and government. (p. 5)

1 corporate finance Concerns the duties of the financial manager in the business firm. (p. 5)

1 financial manager Actively manages the financial affairs of any type of business, whether financial or nonfinancial, private or public, large or small, profit-seeking or not-for-profit. (p. 5)

1 publicly traded company A company whose common shares are listed and trade on a recognized stock exchange. (p. 7)

1 sole proprietorship A business owned by one person and operated for his or her own benefit. (p. 7)

1 unlimited liability The condition of a sole proprietorship (or general partnership) allowing the owner’s total wealth to be taken to repay creditors. (p. 7)

1 partnership A business owned by two or more people and operated for profit. (p. 8)

1 partnership agreement The written contract used to formally establish a business partnership. (p. 9)

1 limited partnership A partnership with one or more general partners with unlimited liability and one or more limited partners with limited liability. (p. 9)

1 corporation A business entity created by law (often called a "legal entity”). (p. 9)

1 shareholders The owners of a corporation, whose ownership or "equity” is evidenced by <I>common shares</I>. (p. 9)

1 common shares The purest and most basic form of corporate ownership. (p. 9)

1 dividends Periodic distributions of earnings to the shareholders of a firm. (p. 9)

1 board of directors Group elected by the firm’s shareholders and having ultimate authority to guide corporate affairs and set corporate strategy. (p. 9)

1 president or chief executive officer (CEO)

Corporate official responsible for managing the firm’s day-to-day operations and carrying out the policies established by the board of directors. (p. 10)

1 income trust Created through the conversion of a regular corporation to a trust structure, where the business becomes a different type of legal entity; the benefit is a significant reduction in taxes. (p. 11)

1 S&P/TSX Composite Index The measure of how the Canadian stock market has done over a stated time period, which might be a day, a week, a month, a year, or a number of years. (p. 12 )

1 treasurer The officer responsible for the firm’s financial activities such as financial planning and fund raising, making capital expenditure decisions, and managing cash, credit, the pension fund, and foreign exchange. (p. 14)

1 controller The officer responsible for the firm’s accounting activities, such as corporate accounting, tax management, financial accounting, and

cost accounting. (p. 14)1 foreign exchange manager The manager responsible for monitoring and managing the firm’s

exposure to loss from currency fluctuations. (p. 15)

1 marginal analysis Economic principle that states that financial decisions should be made and actions taken only when the added benefits exceed the added costs. (p. 15)

1 accrual basis Recognizes sales revenue at the time of sale and the expenses incurred to generate the sales. (p. 16)

1 cash basis Recognizes revenues and expenses only with respect to actual inflows and outflows of cash. (p. 16)

1 capital structure The mix of short- and long-term financing and the mix of debt and equity financing used by a company. (p. 18)

1 earnings per share (EPS) The amount earned during the accounting period on each outstanding common share, calculated by dividing the period’s total earnings available for the firm’s common shareholders by the number of common shares outstanding. (p. 20)

1 risk The chance that actual outcomes may differ from those expected. (p. 21)

1 economic value added (EVA)

EVA, a way to measure the value of a company, is the difference between a company’s net operating profit after tax and the total cost of invested capital. (p. 22)

1 stakeholders Groups such as employees, customers, suppliers, creditors, owners, communities, and others who have a direct economic link to the firm. (p. 24)

1 ethics Standards of conduct or moral judgment. (p. 26)

1 agency problem The likelihood that managers may place personal goals ahead of corporate goals. (p. 29)

1 corporate governance The set of actions and procedures common shareholders use to ensure they receive a reasonable return on their investment in the company. (p. 30)

1 agency costs The reduction in shareholders’ wealth due to the agency problem. (p. 30)

1 incentive plans Management compensation plans that tend to tie management compensation to share price; most popular incentive plan involves the grant of <I>stock option</I>s. (p. 32)

1 stock options An incentive allowing managers to purchase common shares at the market price set at the time of the grant. (p. 32)

1 performance plans Plans that compensate managers on the basis of proven performance measured by EPS, growth in EPS, and other ratios of return. <I>Performance shares</I> and/or cash <I>bonuses</I> are used as compensation under these plans. (p. 32)

1 performance shares Common shares granted to management for meeting stated performance goals. (p. 32)

1 cash bonuses Cash paid to management for achieving certain performance goals. (p. 33)

1 hostile takeover The acquisition of the firm (the <I>target</I>) by another firm or group (the <I>acquirer</I>) that is not supported by management. (p. 34)

1 financial forecasting The process used to estimate a company’s requirement for financing for a future time period. (p. 36)

1 money market The market where debt securities that will mature within one year are traded. (p. 37)

1 capital market The market that trades long-term debt securities and common and

preferred equity securities. (p. 37) 1 primary market The market where financial securities are initially issued and where

the issuer receives the proceeds from the sale of the financial security. (p. 37)

1 secondary market The market that allows the owner of a previously created financial security to sell this security or to buy more of this or other securities, or allows a buyer to express an interest in acquiring a financial security. (p. 37)

1 stock exchange An actual, physical secondary market that allows investors to buy and sell preferred and common shares. (p. 37)

1 risk&#151return tradeoff The return expected depends on the amount of risk taken. (p. 37)

1 risk-averse The attitude toward risk in which a higher return would be expected if risk increased. (p. 37)

1 required rate of return The minimum return required given the risk of an investment; the greater the risk of loss, the greater the required return. (p. 37)

1 interest The return paid on debt financing. (p. 38)1 interest rate The cost of money. The greater the risk of the debt security, the

higher the interest rate. (p. 38)1 cost of capital The overall cost to a company of a mix of debt and common equity

financing. (p. 38)1 capital budgeting The process of analyzing the investment in assets with an expected

life greater than one year. (p. 38)2 Canadian Institute of

Chartered Accountants (CICA)

Sets accounting, auditing, and assurance standards for business, not-for-profit organizations, and government, and represents the CA profession in Canada. (p. 46)

2 generally accepted accounting principles (GAAP)

The accounting practices, procedures, and standards used to maintain financial records, reports, and statements. (p. 46)

2 Accounting Standards Board (AcSB)

The accounting profession’s rule-setting body, part of the CICA, that authorizes the generally accepted accounting principles (GAAP) used in Canada. (p. 46)

2 amortization The systematic expensing of a portion of the cost of a fixed asset against sales. (p. 47)

2 balance sheet Summary statement of the firm’s financial position at a given point in time. (p. 49)

2 current assets Short-term assets, expected to be converted into cash within 1 year or less. (p. 49)

2 current liabilities Short-term liabilities, expected to be paid within 1 year or less. (p. 49)

2 intangible assets Assets that cannot be seen or touched, but are valuable to a company. (p. 51)

2 goodwill The amount paid for a business in excess of the value of the assets acquired. (p. 51)

2 stated value The actual value of preferred shares when originally sold to investors. (p. 52)

2 common equity The total investment made by the company’s owners consisting of the value of common shares plus retained earnings. (p. 52)

2 common shares The total proceeds received from the sale of common shares since the company was formed. (p. 52)

2 retained earnings The running total of all earnings, net of dividends, that have been retained and reinvested in the firm since its inception. (p. 52)

2 book value The total value of common equity at the date of the balance sheet. (p. 52)

2 statement of retained earnings

Details the change in retained earnings from the beginning to the end of the fiscal year. (p. 53)

2 statement of cash flows (SCF)

Provides a summary of the firm’s operating, investment, and financing cash flows and reconciles them with changes in its cash and marketable securities during the period of concern. (p. 54)

2 operating flows Cash flows directly related to production and sale of the firm’s products and services. (p. 54)

2 investment flows Cash flows associated with purchase and sale of both fixed assets and business interests. (p. 55)

2 financing flows Cash flows that result from debt and equity financing transactions; include issue and repayment of debt, cash inflow from the sale of stock, and cash outflows to pay cash dividends or repurchase stock. (p. 55)

2 active business income Income derived from normal business activities of a corporation; the difference between sales and expenses. (p. 66)

2 passive income Income from a specified investment business or from a personal services business that is taxed at higher corporate tax rates. (p. 66)

2 intercorporate dividends Dividends received by a corporation from investments in preferred and common shares held in other corporations. (p. 66)

2 capital gains The positive difference between the selling price of a capital asset and the asset’s original cost plus the costs incurred to sell the asset. (p. 67)

2 capital assets A fixed asset that is amortized, land, or financial assets (common shares, preferred shares, and fixed income securities like bonds) held by a corporation. (p. 67)

2 taxable capital gain The portion of the capital gain that is taxable; currently the taxable portion is 50 percent. (p. 67)

2 net capital gains The difference between capital gains and losses for a tax year; 50 percent of this amount is taxable. (p. 67)

2 CCA rates Rates set by the Canada Revenue Agency (CRA) that are used to calculate the CCA on an asset class; the rates range from 4 to 100 percent. (p. 72)

2 undepreciated capital cost (UCC)

The undepreciated value of an asset or asset class that is the basis for the amount of CCA that is claimed; also referred to as the <I>book value</I> of an asset. (p. 72)

2 investment tax credit (ITC) An incentive for businesses in various regions of the country to purchase certain types of fixed assets or undertake certain types of research and development activities; results in a reduction in federal taxes payable. (p. 77)

2 Canadian-controlled private corporation (CCPC)

A small, private business majority-owned by Canadian residents. (p. 79)

2 general rate reduction The deduction that most corporations are allowed from the net federal tax rate of 28 percent. (p. 79)

2 small business deduction A 16. 5 percent reduction in the net federal tax rate that the federal

government allows CCPCs. (p. 81) 2 annual report The report that corporations must provide to common shareholders

that summarizes and documents the firm’s financial activities during the past year. (p. 82)

2 letter to shareholders Typically, the first element of the annual report following a summary of the company’s financial performance for the year, and the direct communication from senior management to the firm’s owners. (p. 82)

2 Management’s Discussion and Analysis (MD&A)

MD&A is a supplemental report that allows the reader to look at the company through the eyes of management by providing a current and historical analysis of the business of the company. (p. 84)

3 ratio analysis Involves the methods of calculating and interpreting financial ratios to assess the firm’s performance. (p. 111)

3 liquidity A firm’s ability to satisfy its short-term obligations <I>as they come due</I>. (p. 116)

3 net working capital A measure of liquidity calculated by subtracting current liabilities from current assets. (p. 116)

3 current ratio A measure of liquidity calculated by dividing the firm’s current assets by its current liabilities. (p. 116)

3 quick (acid-test) ratio A measure of liquidity calculated by dividing the firm’s current assets minus inventory by current liabilities. (p. 117)

3 activity ratios Measure the company’s effectiveness at managing accounts receivable, inventory, accounts payable, fixed assets, and total assets. (p. 118)

3 inventory turnover The average number of times a company turns over (sells) their complete stock of inventory in a year. (p. 119)

3 average age of inventory Measures the effectiveness of the company’s management of inventory; it is the average length of time inventory is held by the company. (p. 120)

3 average collection period The average amount of time needed to collect accounts receivable. (p. 121)

3 average payment period The average amount of time needed to pay accounts payable. (p. 122)

3 fixed asset turnover Indicates the efficiency with which the firm uses its net fixed assets to generate sales. (p. 123)

3 total asset turnover Indicates the efficiency with which the firm uses its assets to generate sales. (p. 123)

3 capitalization ratios Show how a firm has financed the investment in assets. There are three alternatives: debt, preferred equity, and common equity. (p. 125)

3 coverage ratios Measure the firm’s ability to service the sources of financing. (p. 125)

3 debt ratio Measures the proportion of total assets financed by the firm’s creditors. (p. 125)

3 preferred equity ratio Measures the proportion of total assets financed by preferred shareholders. (p. 126)

3 common equity ratio Measures the proportion of total assets financed by common shareholders. (p. 126)

3 costly debt ratio Measures the proportion of total assets financed by costly forms of debt financing. (p. 126)

3 debt/equity ratio Measures the proportion of long-term debt to common equity. (p. 127)

3 times interest earned ratio Sometimes called the <I>interest coverage ratio</I>, it measures the firm’s ability to make contractual interest payments. (p. 127)

3 fixed-charge coverage ratio Measures the firm’s ability to meet all fixed-payment obligations. (p. 128)

3 common-size income statement

An income statement in which each item is expressed as a percentage of sales. (p. 130)

3 gross margin Measures the percentage of each sales dollar remaining after the firm has paid the direct costs of the products sold (COGS). (p. 130)

3 operating margin Measures the percent of each sales dollar remaining after all expenses associated with producing and selling the product and operating the company are deducted. (p. 130)

3 profit margin Measures the percentage of each sales dollar remaining after all expenses, including financing expenses and taxes, have been deducted. (p. 130)

3 return on total assets (ROA)

Measures the firm’s overall effectiveness in generating profits with its available assets; also called the <I>return on investment (ROI) </I>. (p. 130)

3 return on equity (ROE) Measures the return earned on the owners’ investment in the firm. (p. 132)

3 price/earnings (P/E) ratio Measures the amount investors are willing to pay for each dollar of the firm’s earnings; the higher the P/E ratio, the greater the investor confidence. (p. 133)

3 DuPont model A method used to analyze the key measure of profitability from a shareholder’s perspective: return on equity (ROE). (p. 134)

3 leverage The advantage gained by using a lever. (p. 137)

3 financial leverage The use of debt financing to acquire assets. (p. 137) 3 cross-sectional ratio

analysisComparison of one company’s ratios to another company’s or group of companies’ ratios calculated for the same time period; industry average ratios are often used. (p. 141)

3 benchmarking A type of <I>cross-sectional analysis</I> in which the firm’s ratio values are compared to those of a key competitor or group of competitors, primarily to identify areas for improvement. (p. 142)

3 time-series analysis Evaluation of the firm’s financial performance over time using financial ratio analysis. (p. 144)

4 pro forma statements Projected, or forecasted, financial statements: the income statement and the balance sheet. (p. 176)

4 financial planning process Planning that begins with long-term (strategic) financial plans that in turn guide the formulation of short-term (operating) plans and budgets. (p. 176)

4 long-term (strategic) financial plans

Planned financial actions and the anticipated financial impact of those actions over periods ranging from 2 to 10 years. (p. 176)

4 short-term (operating) financial plans

Planned short-term financial actions and the anticipated impact of those actions. (p. 177)

4 cash budget (cash forecast) A statement of the firm’s planned inflows and outflows of cash that is used to estimate its short-term cash requirements. (p. 178)

4 sales forecast The prediction of the firm’s sales over a given period, based on external and internal data, and used as the key input to the financial planning process. (p. 178)

4 external forecast A sales forecast based on the relationships observed between the firm’s sales and certain key external economic indicators. (p. 179)

4 internal forecast A sales forecast based on a buildup, or consensus, of forecasts through the firm’s own sales channels. (p. 179)

4 cash receipts All of a firm’s inflows of cash in a given financial period. (p. 180)

4 cash disbursements All outlays of cash by the firm during a given financial period. (p. 181)

4 net cash flow The mathematical difference between the firm’s cash receipts and its cash disbursements in each period. (p. 183)

4 ending cash The sum of the firm’s beginning cash and its net cash flow for the period. (p. 183)

4 required total financing Amount of funds needed by the firm if the ending cash for the period is less than the desired minimum cash balance; typically represented by a line of credit. (p. 183)

4 excess cash balance The (excess) amount available for investment by the firm if the period’s ending cash is greater than the desired minimum cash balance; assumed to be invested in marketable securities. (p. 183)

4 percent-of-sales method A method of developing the pro forma income statement that assumes all expenses remain the same percent of sales in the forecast year as they were in the most recent fiscal year. (p. 192)

4 dividend payout ratio The percent of NIAT (or earnings available to common shareholders) that is paid out to common shareholders as dividends during the year. (p. 192)

4 spontaneous sources of financing

The increases in accounts payable and accruals that will occur as inventory and other direct costs of production increase with sales, an internal source of financing for the company. (p. 193)

4 total financing required The change in total assets from the latest fiscal year to the forecast year. (p. 194 )

4 statement of external financing required

The forecasted statement that shows the difference between total financing required and the two internal sources of financing, providing the amount of external financing required. (p. 195)

4 capital intensity ratio The dollar amount of assets needed for each $1 increase in sales; the larger the number, the more capital-intensive the company, and therefore the higher the amount of financing required. (p. 198 )

4 judgmental approach A method for developing the pro forma balance sheet in which the values of certain balance sheet accounts are estimated, and others are calculated, based on a ratio analysis. (p. 203)

5 institutional investors Financial intermediaries such as mutual funds, pension funds, and life insurance companies. (p. 236)

5 mutual funds Investment companies that receive cash from individuals for investment in both money and capital market securities. (p. 236)

5 pension funds Investment entities established by employers to provide a pension to employees during retirement. (p. 237)

5 life insurance companies Invest premiums from life insurance policyholders to ensure sufficient funds are available to pay out the stated value of the life insurance policy upon the death of the policyholder. (p. 237)

5 Bank of Canada The central bank in Canada whose main function is to manage monetary policy. (p. 237)

5 Bank Rate The interest rate the Bank of Canada charges on one-day loans to financial institutions (chartered banks and investment dealers) as the lender of last resort. (p. 244)

5 overnight rate The average interest rate the Bank of Canada wants financial institutions to use when they lend each other money for one day, or “overnight." (p. 244)

5 operating band A band, one-half of a percentage point wide, with the overnight rate at the centre and the bank rate at the top. (p. 244)

5 short-dated bonds Long-term government bonds that are approaching maturity. (p. 245)

5 commercial paper Short-term, unsecured promissory notes issued by corporations;

sometimes referred to as <I>corporate paper</I>. (p. 245) 5 finance company paper Short-term secured promissory notes issued by sales finance

companies. (p. 245) 5 bankers’ acceptances Created when a chartered bank adds its guarantee of payment to the

promissory note of a corporate borrower. (p. 246)5 day loans Made by chartered banks to investment dealers who are major

holders of treasury bills. (p. 246) 5 Eurocurrency market The market for short-term bank deposits denominated in U. S. (p.

246)5 London Interbank Offered

Rate (LIBOR) The base interest rate on all Eurocurrency loans. (p. 247)

5 term loan A borrowing arrangement, usually with a bank, for a certain amount at a stated interest rate for a specific time period. (p. 248 )

5 bond A long-term debt security that has a specific asset or assets pledged as collateral. (p. 249)

5 debenture An unsecured long-term debt security that is backed by the general earnings potential of the corporation. (p. 249)

5 long-term debt A contractual liability between the two parties, the borrower (issuer) and the lender (saver). (p. 249)

5 coupon rate The interest rate on a long-term debt issue which is set at the time of the issue and is constant for the full term of the issue. (p. 250)

5 financial engineering Designing new financial securities or processes due to changing market conditions and investor preferences. (p. 250)

5 trust indenture (trust deed) The legal document that details the contractual relationship between the borrower and lender. (p. 252)

5 trustee A third party who acts on behalf of the purchasers of the debt securities. (p. 252)

5 restrictive covenants Contractual clauses that place operating and financial constraints on the borrower. (p. 252)

5 subordination A stipulation that subsequent creditors agree to wait until all claims of the <I>senior debt</I> are satisfied. (p. 253)

5 sinking-fund requirement A provision providing for the gradual retirement of long-term debt prior to the original term of the issue. (p. 253)

5 call price (bond) The stated price at which bonds may be repurchased prior to maturity by using the call feature. (p. 254)

5 call premium The amount by which the call price exceeds the bond’s par value. (p. 254)

5 floor rate The yield on federal government debt for any maturity. (p. 257)

5 risk premium The additional coupon investors will require based on the risk of the issuer and of the debt issue. (p. 257)

5 Eurobond Long-term debt issued by an international borrower in a currency other than that of the country in which it is sold. (p. 259)

5 foreign bond Long-term debt issued in a country’s financial market, in that country’s currency, by a foreign borrower. (p. 260)

5 limited liability A feature of common equity meaning that investors cannot lose more than they have invested in the firm. (p. 261)

5 privately owned (company) All common shares of a firm are owned by a single individual. (p. 261)

5 closely owned (company) All common shares of a firm are owned by a small group of investors (such as a family). (p. 261)

5 publicly owned (company) Common shares of a firm are owned by a broad group of unrelated individual or institutional investors. (p. 261)

5 preemptive rights Allow common shareholders to maintain their proportionate ownership in the corporation when new shares are issued. (p. 261)

5 dilution of ownership rights Occurs when a new share issue results in each present shareholder having a claim on a smaller part of the firm’s earnings than previously. (p. 261)

5 non-voting common shares Common shares that carry no right to vote on issues affecting the company. (p. 265)

5 subordinate voting common shares

Common shares that carry a right to vote on issues affecting the company but the vote is inferior to the votes of other shares. (p. 265)

5 voting (or superior voting) shares

Common shares that carry superior voting privileges to other common shares. (p. 265)

5 dual-class share structure A company that has both non-voting (or subordinate) and voting (or superior voting) shares outstanding. (p. 265)

5 coattail provision In the event of a takeover offer for the company, this provision allows the holders of the non-voting or restricted-voting shares the right to convert their shares into an equal number of the superior voting shares. (p. 266)

5 proxy statement A statement giving the votes of a shareholder to another party. (p. 267)

5 proxy battle The attempt by a non-management group to gain control of the management of a firm by soliciting a sufficient number of proxy votes. (p. 267)

5 international equity market A vibrant equity market that emerged in the past 20 years to allow corporations to sell blocks of shares in several different countries simultaneously. (p. 267)

5 American Depository Receipts (ADRs)

Claims issued by U. S. banks that represent ownership of a foreign company’s common shares held by the bank in the foreign market. (p. 269)

5 preferred equity The third major source of long-term financing for corporations that broadens the firm’s capital structure, raising financing without giving up ownership or incurring obligations. (p. 269)

5 stated value The value of the preferred share on the issue date. (p. 269)

5 cumulative feature Missed dividend payments on preferred shares accumulate, meaning that dividends in arrears must be paid with the current dividend prior to the payment of dividends to common shareholders. (p. 270)

5 call price (preferred) The repurchase price for a preferred share issue; generally the stated value plus a call premium. (p. 271)

5 retractable preferreds A type of preferred share whose holder has the right to force the issuer to repurchase the preferred share at the stated value. (p. 272)

5 floating rate preferreds A type of preferred share whose quarterly dividend paid is based on interest rates in the market and will float with these rates. (p. 272)

5 convertible preferreds A type of preferred share whose holders have the option of converting them into a predetermined number of common shares on a specific date. (p. 272)

5 Dutch Auction preferred shares

Preferred shares similar to money market securities with no stated maturity; the dividend rate is reset on a regular basis through a

Dutch auction process. (p. 272) 5 securities exchanges The secondary marketplace that allows for the subsequent trading

of financial securities created in the primary market. (p. 273) 5 efficient market A market that allocates funds to their most productive uses due to

competition among wealth-maximizing investors; it determines and publicizes prices that are believed to be close to their true value. (p. 273)

5 over-the-counter exchange An intangible market for the purchase and sale of securities not listed on organized exchanges. (p. 275)

5 Nasdaq The National Association of Securities Dealers Automated Quotation System, the best-known OTC market in the world, which rivals the New York Stock Exchange in trading volumes. (p. 275)

5 board lot A trade of 100 shares, the usual multiple for most share transactions. (p. 276)

5 odd lots Share transactions that are not for a multiple of 100 shares. (p. 276)

5 price/earnings (P/E) ratio Measures the amount investors are willing to pay for each dollar of the firm’s earnings. (p. 277)

5 underwriting The means by which new financial securities are created in the primary market, the basic financial market transaction. (p. 282)

5 investment banker A term for investment dealers when performing the underwriting function. (p. 282)

5 private placements The sale of the security directly to a group of investors or an institutional investor; these securities will not trade on financial markets after issue. (p. 282)

5 public offerings The sale of securities that will be traded on secondary financial markets. (p. 282)

5 initial public offering (IPO) Referred to as <I>going public</I>, the process of offering common shares of a privately owned company to the general public for the first time. (p. 282)

5 new issue An issue of long-term debt, preferred shares, or common shares where the funds raised flow to the company. (p. 282)

5 seasoned offering A new issue of common shares; the shares sold add to the existing pool of common shares. (p. 282)

5 secondary offering The sale to the public of a large block of common shares held by the founding owners or a controlling company. (p. 282)

5 preliminary prospectus The document that provides all information investors require to make a decision regarding the investment merits of the security issue. (p. 283)

5 red herring Another term for the preliminary prospectus, so called due to the statement on the first page printed in red ink stating that the securities have not been approved for sale. (p. 283)

5 due diligence The process completed by the underwriter to ensure there is no misrepresentation and that the prospectus contains full and true disclosure. (p. 283)

5 underwriting syndicate The group of investment dealers who buy the security issue from the company and then resell it to investors (savers). (p. 284)

5 banking group Includes the lead underwriter and, in most larger deals, a number of other large investment dealers. (p. 284)

5 selling group Smaller, regional investment dealers who do not assume any of the risks of underwriting, but only attempt to sell a certain portion of the issue. (p. 284)

5 firm agreement An underwriting agreement where the syndicate agrees to buy all of the securities at the stated price, guaranteeing the organization receives the amount of money. (p. 284)

5 best efforts agreement An underwriting agreement where the syndicate agrees to <I>try</I> to sell the issue, but the sale is not guaranteed. (p. 284)

5 escape clauses

Provisions in the underwriting agreement that allow the syndicate to not buy the issue from the organization if specific conditions exist. (p. 284)

5 road show Presentations, by the company and lead underwriter, regarding the issue made to financial analysts and institutional investors across Canada. (p. 285)

5 green sheet A document prepared by the underwriter that summarizes key information in the prospectus. (p. 285)

5 blue skying An investment industry term referring to the approval of the final prospectus by provincial securities commissions. (p. 285)

5 prompt offering prospectus (POP) system

A filing process for firms meeting certain requirements that allows companies to raise financing within five days of filing. (p. 286 )

5 short-form prospectus The document filed for the POP system that omits much of the information that is in a “regular” prospectus. (p. 286)

5 bought deal The lead underwriter(s) purchases the total amount of a new security issue from the issuing company with the intention of quickly selling the issue to investors. (p. 289)

6 time line A horizontal line on which time zero appears at the leftmost end and future periods are marked from left to right; can be used to depict investment cash flows. (p. 304)

6 compound interest Interest earned on a given deposit that has become part of the principal at the end of a specified period. (p. 308)

6 principal The amount of money on which interest is paid. (p. 308)

6 future value The value of a present amount at a future date found by applying <I>compound interest</I> over a specified period of time. (p. 308)

6 future value interest factor The multiplier used to calculate at a specified interest rate the future value of a present amount as of a given time. (p. 310)

6 semiannual compounding Compounding of interest over two periods within the year. (p. 313) 6 quarterly compounding Compounding of interest over four periods within the year. (p. 313)

6 continuous compounding Compounding of interest an infinite number of times per year at intervals of microseconds. (p. 316)

6 nominal (stated) annual rate

Contractual annual rate of interest charged by a lender or promised by a borrower. (p. 317)

6 effective (true) annual rate (EAR)

The annual rate of interest actually paid or earned. (p. 317)

6 annual percentage rate (APR)

The <I>nominal annual rate</I> of interest, found by multiplying the periodic rate by the number of periods in 1 year. (p. 318)

6 annuity A stream of equal annual cash flows. These cash flows can be <I>inflows</I> of returns earned on investments or <I>outflows</I> of funds invested to earn future returns. (p. 319)

6 ordinary annuity An annuity for which the cash flow occurs at the <I>end</I> of each period. (p. 319)

6 annuity due An annuity for which the cash flow occurs at the <I>beginning</I> of each period. (p. 319)

6 future value interest factor for an annuity (<I>FVIFa</I>)

The multiplier used to calculate the future value of an <I>ordinary annuity</I> at a specified interest rate over a given period of time. (p. 321)

6 present value The current dollar value of a future amount; the amount of money that would have to be invested today at a given rate of return over a specified period to equal the future amount. (p. 326)

6 discounting cash flows The process of finding present values; the inverse of compounding interest. (p. 326)

6 present value interest factor The multiplier used to calculate at a specified discount rate the present value of an amount to be received in a future period. (p. 327)

6 mixed stream A stream of cash flows of different amounts at various future points in time. (p. 330)

6 perpetuity An annuity with an infinite life, providing an identical cash flow every year. (p. 337)

6 present value interest factor for an annuity

The multiplier used to calculate the present value of an annuity at a specified discount rate over a given period of time. (p. 333)

6 interest-only loans Loans that only require the periodic payment of interest and the separate repayment of principal at some future date or dates. (p. 340)

6 installment loan A loan where each payment made is an equal amount, and consists of some interest and some principal; as payments are made, the amount of interest paid falls, while the amount of principal paid increases. (p. 340)

6 loan amortization schedule A table that allocates each loan payment to interest and principal, so that over the amortization period of the loan, the principal outstanding is reduced to 0. (p. 340)

7 portfolio A collection, or group, of assets. (p. 367)

7 risk The chance of financial loss or, more formally, the variability of returns associated with a given asset. (p. 368)

7 return The total gain or loss experienced on an investment asset over a given period of time; calculated by dividing the asset’s change in price plus any cash distributions during the period by its price at the beginning of the period. (p. 369)

7 arithmetic mean The sum of the periodic returns divided by the total number of periods for which returns are available. (p. 370)

7 geometric mean The average compound rate of return earned on the investment in an asset per holding period. (p. 370)

7 risk-indifferent The attitude toward risk in which no change in return would be required for an increase in risk. (p. 372)

7 risk-averse The attitude toward risk in which an increased return would be required for an increase in risk. (p. 373)

7 risk-seeking The attitude toward risk in which a decreased return would be accepted for an increase in risk. (p. 373)

7 sensitivity analysis An approach for assessing risk that uses a number of possible return estimates to obtain a sense of the variability among outcomes. (p. 373)

7 range A measure of an asset’s risk, which is found by subtracting the pessimistic (worst) outcome from the optimistic (best) outcome. (p. 374)

7 probability The <I>chance</I> that a given outcome will occur. (p. 375) 7 probability distribution A model that relates probabilities to the associated outcomes. (p.

375) 7 bar chart The simplest type of probability distribution; shows only a limited

number of outcomes and associated probabilities for a given event.

(p. 375) 7 continuous probability

distribution A probability distribution showing all the possible outcomes and associated probabilities for a given event. (p. 375)

7 standard deviation (s<I>k</I>)

The most common statistical indicator of an asset’s risk; it measures the dispersion around the expected value. (p. 376)

7 expected return ˆ<I>kj</I> The most likely return on asset <I>j</I> over a stated period. (p. 376)

7 normal probability distribution

A symmetrical probability distribution whose shape resembles a "'bell-shaped” curve. (p. 377)

7 coefficient of variation (<I>CV</I>)

A measure of relative dispersion that is useful in comparing the risk of assets with differing expected returns. (p. 381)

7 risk premium The extra return required to invest in a risky asset rather than a risk-free asset (t-bills). (p. 387)

7 efficient portfolio A portfolio that maximizes return for a given level of risk or minimizes risk for a given level of return. (p. 392)

7 correlation A statistical measure of the relationship, if any, between series of numbers representing data of any kind. (p. 393)

7 positively correlated Descriptive of two series that move in the same direction. (p. 393) 7 negatively correlated Descriptive of two series that move in opposite directions. (p. 393) 7 correlation coefficient A measure of the degree of correlation between two series. (p. 393) 7 perfectly positively

correlated Describes two positively correlatedseries that have a correlation coefficientof +1. (p. 393)

7 perfectly negatively correlated

Describes two negatively correlated series that have a correlation coefficient of 21. (p. 393)

7 uncorrelated Two series of data that lack any relationship; this is represented by a correlation coefficient of 0. (p. 394)

7 political risk Risk that arises from the possibility that a host government might take actions harmful to foreign investors or that political turmoil in a country might endanger investments made in that country by foreign nationals. (p. 401)

7 capital asset pricing model (CAPM)

The basic theory that links together risk and return for all assets. (p. 402)

7 total risk The combination of a security’s nondiversifiable and diversifiable risk. (p. 402)

7 diversifiable risk The portion of an asset’s risk that is attributable to firm-specific, random causes; can be eliminated through diversification. (p. 402)

7 nondiversifiable risk The relevant portion of an asset’s risk attributable to market factors that affect all firms; cannot be eliminated through diversification. (p. 402)

7 beta coefficient (b) A measure of nondiversifiable risk. An index of the degree of movement of an asset’s return in response to a change in the market return. (p. 403)

7 market return The return on the market portfolio of all traded securities. (p. 403) 7 security market line (SML) The depiction of the capital asset pricing model (CAPM) as a graph

that reflects the required return in the marketplace for each level of nondiversifiable risk (beta). (p. 408)

7 efficient market An assumed “perfect” market in which there are many small investors, each having the same information and expectations with respect to securities; there are no restrictions on investment, no taxes, and no transaction costs; and all investors are rational, view securities similarly, and are risk-averse, preferring higher returns and lower risk. (p. 413)

8 interest rate The compensation paid by the borrower of funds to the lender; from the borrower’s point of view, the cost of borrowing funds. (p. 436)

8 required return The cost of funds obtained by selling equity; it is based on the return investors require given the risk of the investment. (p. 436)

8 real rate of interest The rate that creates an equilibrium between the supply of savings and the demand for investment funds in a perfect world, without inflation, where funds suppliers and demanders have no liquidity preference and all outcomes are certain. (p. 437)

8 nominal rate of interest The actual rate of interest charged by the supplier of funds and paid by the demander. (p. 437)

8 risk-free rate of interest, <I>R</I>_F

The required return on a risk-free asset, typically a 3-month government of Canada t-bill. (p. 438)

8 term structure of interest rates (TSIR)

The relationship between the yield (rate of return) and the time to maturity for debt securities with similar default risk. (p. 440)

8 yield to maturity Annual rate of interest earned on a security purchased on a given day and held to maturity. (p. 440)

8 yield curve A graph of the <I>term structure of interest rates</I> that depicts the relationship between the <I>yield to maturity</I> of a security (<I>y</I> axis) and the time to maturity (<I>x</I> axis); it shows the pattern of interest rates on securities of equal quality and different maturity. (p. 440)

8 normal (upward-sloping) yield curve

An upward-sloping yield curve that indicates generally cheaper short-term borrowing costs than long-term borrowing costs. (p. 440)

8 inverted (downward-sloping) yield curve

A downward-sloping yield curve that indicates generally cheaper long-term borrowing costs than short-term borrowing costs. (p. 440)

8 flat yield curve A yield curve that reflects relatively similar borrowing costs for both short- and longer-term loans. (p. 440)

8 expectations hypothesis Theory suggesting that the yield curve reflects investor expectations about future interest rates; an increasing inflation expectation results in an upward-sloping yield curve and a decreasing inflation expectation results in a downward-sloping yield curve. (p. 442)

8 liquidity preference theory Theory suggesting that for any given issuer, long-term yields tend to be higher than short-term yields due to the lower liquidity and higher responsiveness to general interest rate movements of longer-term securities; causes the yield curve to be upward-sloping. (p. 443)

8 market segmentation theory Theory suggesting that the market for loans is segmented on the basis of maturity and that the supply of and demand for loans within each segment determine prevailing yields; the slope of the yield curve is determined by the general relationship between the prevailing rates in each segment. (p. 443)

8 floor rate The yield on the debt securities, of any maturity, for the least risky issuer in the country&#151the government of Canada. (p. 444)

8 risk&#151return tradeoff The expectation that for accepting greater risk, investors must be compensated with greater returns. (p. 446)

8 valuation The process that links risk and return to determine the value of an asset. (p. 447)

8 interest-rate risk The chance that interest rates will change and thereby change the required return and bond value. (p. 457)

8 yield to maturity (YTM) The rate of return investors earn if they buy a bond at a specific price and hold it until maturity. Assumes that issuer makes all scheduled interest and principal payments as promised. (p. 459)

8 expected return, ˆ<I>ki</I>

The yearly return an investor expects to receive based on an analysis of the fundamentals of the asset and its ability to generate cash flows in the future. The expected return on a common share. (p. 463)

8 efficient market hypothesis (EMH)

Theory describing the behaviour of an assumed “perfect” market, which states (1) securities are typically in equilibrium, (2) security prices fully reflect all public information available and react swiftly to new information, and (3) because stocks are fairly priced, investors need not waste time looking for mispriced securities. (p. 464)

8 dividend valuation model (DVM)

The value of common shares is dependent on the present value of the dividends received over an infinite time horizon. (p. 465)

8 zero-growth model An approach to dividend valuation that assumes a constant, nongrowing dividend stream. (p. 466)

8 constant-growth model A widely cited dividend valuation approach that assumes that dividends will grow at a constant rate that is less than the required return. (p. 466)

8 Gordon model A common name for the <I>constant-growth model</I> that is widely cited in dividend valuation. (p. 467)

8 variable-growth model A dividend valuation approach that allows for a change in the dividend growth rate. (p. 468)

8 book value per share The amount per common share that would be received if all of the firm’s assets were <I>sold for their exact book (accounting) value</I> and the proceeds remaining after paying all liabilities (and preferred shares) were divided among the common shareholders. (p. 472)

8 liquidation value per share The <I>actual amount</I> per common share that would be received if all of the firm’s assets were <I>sold for their market value</I>, liabilities (and preferred shares) were paid, and any remaining money were divided among the common shareholders. (p. 473)

8 price/earnings multiple approach

A technique to estimate the firm’s share value; calculated by multiplying the firm’s expected earnings per share (EPS) by an appropriate P/E ratio. (p. 473)

8 interest equivalent factor A tax-related adjustment that must be made that allows the before-tax dividend yield on equity securities to be compared to the before-tax yield on debt securities. (p. 479)

9 cost of capital The rate of return that a firm must earn on its investment projects to increase the market value of its common shares. (p. 502)

9 business risk The risk to the firm of being unable to cover operating costs. (p. 502)

9 financial risk The risk to the firm of being unable to cover required financial obligations (interest, lease payments, preferred share dividends and principal repayments). (p. 502)

9 marginal cost of financing The cost of financing today, based on company-specific and financial market data; it is based on an estimate of investors’ current required returns. (p. 504)

9 optimal capital structure (OCS)

The mix of debt and equity financing that results in the lowest possible cost of capital for a company. (p. 504)

9 cost of long-term debt, <I>k</I>_dt

The after-tax cost today of raising long-term funds through borrowing from either financial institutions or investors. (p. 509)

9 net proceeds Funds actually received from the sale of a security. (p. 510 ) 9 flotation costs The total costs of issuing and selling a security. (p. 510) 9 discounts Reductions in the price of the security that are required to sell this

security to investors. (p. 510) 9 cost of preferred equity,

<I>k_p</I> The relationship between the cost of the preferred equity and the amount of funds provided by the preferred share issue; found by dividing the annual dividend, <I>D_t</I>, by the net proceeds from the sale of the preferred share, <I>N_p</I>. (p. 514)

9 cost of common equity, <I>k_s</I>

The expected return investors require to hold the common shares of a company. (p. 515)

9 constant-growth dividend valuation (Gordon) model

Assumes that the value of a common share equals the present value of all future dividends (assumed to grow at a constant rate) that it is expected to provide over an infinite time horizon. (p. 515)

9 capital asset pricing model (CAPM)

Calculates investors’ required return on common equity based on the risk-free rate of return plus the asset risk premium. (p. 516)

9 cost of reinvested profits, <I>k_r</I>

Since reinvested profits are common shareholders’ money, these funds have a cost which is the cost of common equity, <I>k_s</I>. (p. 518)

9 cost of a new issue of common shares, <I>k_n</I>

The cost of common shares, net of discounts and associated flotation costs. (p. 518)

9 discounted Sold at a price below current market price, <I>P</I>₀. (p. 518)

9 weighted average cost of capital (WACC), <I>k_a</I>

Reflects the expected cost of funds for the upcoming year; found by weighting the cost of each specific type of capital by its proportion in the firm’s capital structure. (p. 521)

9 book value weights Weights that use accounting values to measure the proportion of each type of capital in the firm’s financial structure. (p. 523)

9 market value weights Weights that use market values to measure the proportion of each type of capital in the firm’s financial structure. (p. 523)

9 historic weights Either book or market value weights based on <I>actual</I> capital structure proportions. (p. 523)

9 target weights Either book or market value weights based on <I>optimal</I> capital structure proportions. (p. 524)

9 marginal cost of capital (MCC)

The firm’s average cost of capital associated with its <I>next dollar</I> of total new financing. (p. 525)

9 break point The level of new financing at which the cost of one of the financing components rises, there by causing an upward shift in the <I>marginal cost of capital (MCC)</I>. (p. 525)

9 marginal cost of capital (MCC) schedule

Graph that relates the firm’s weighted average cost of capital to the level of total new financing. (p. 527)

9 investment opportunities schedule (IOS)

A ranking of investment possibilities from best (highest return) to worst (lowest return). (p. 528)

10 breakeven analysis Indicates the level of operations necessary to cover all operating costs and the profitability associated with various levels of sales. (p. 552)

10 operating breakeven point The level of sales necessary to cover all operating costs; the point at which EBIT = $0. (p. 553)

10 operating leverage The use of <I>fixed operating costs</I> to magnify the effects of changes in sales on the firm’s earnings before interest and taxes. (p. 558)

10 degree of operating The numerical measure of the firm’s operating leverage. (p. 559)

leverage (DOL) 10 financial leverage The use of <I>fixed financial costs</I> to magnify the effects of

changes in earnings before interest and taxes on the firm’s earnings per share. (p. 562)

10 degree of financial leverage (DFL)

The numerical measure of the firm’s financial leverage. (p. 564)

10 total leverage The use of <I>fixed costs, both operating and financial</I>, to magnify the effect of changes in sales on the firm’s earnings per share. (p. 565)

10 degree of total leverage (DTL)

The numerical measure of the firm’s total leverage. (p. 566)

10 pecking order A hierarchy of financing beginning with reinvested profits followed by debt financing and finally external equity financing. (p. 580)

10 asymmetric information The situation in which managers of a firm have more information about operations and future prospects than do investors. (p. 581)

10 signal A financing action by management that is believed to reflect its view of the firm’s common share value; generally, debt financing is viewed as a <I>positive signal</I> that management believes that the shares are “undervalued,” and a new share issue is viewed as a <I>negative signal</I> that management believes that the shares are “overvalued." (p. 581)

10 optimal capital structure The capital structure at which the weighted average cost of capital is minimized, thereby maximizing the firm’s value. (p. 583)

10 EBIT&#151EPS approach An approach for selecting the capital structure that maximizes earnings per share over the expected range of earnings before interest and taxes. (p. 584 )

10 financial breakeven point The level of EBIT necessary just to cover all fixed financial costs; the level of EBIT for which EPS = $0. (p. 586)

11 reinvested profits Earnings not distributed as dividends; a form of <I>internal</I> financing. (p. 612)

11 dividend yield The percentage return an investor holding the common share today would receive based on the most recent quarterly dividend; the indicated yearly dividend divided by the share price. (p. 614)

11 date of record (dividends) Set by the firm’s directors, the date on which all persons whose names are recorded as shareholders receive a declared dividend at a specified future time. (p. 615)

11 ex dividend Period beginning two <I>business days</I> prior to the date of record during which a stock is sold without the right to receive the current dividend. (p. 615)

11 payment date The actual date on which the firm makes the dividend payment to the holders of record. (p. 615)

11 dividend reinvestment plans (DRIPs)

Plans that enable shareholders to use dividends received on the firm’s shares to acquire additional full or fractional shares at no transaction (brokerage) cost. (p. 616)

11 residual theory of dividends

A theory that the dividend paid by a firm should be the amount left over after all acceptable investment opportunities have been undertaken. (p. 617)

11 dividend irrelevance theory A theory put forth by Miller and Modigliani that, in a perfect world, the value of a firm is unaffected by the distribution of dividends and is determined solely by the earning power and risk of its assets. (p. 620)

11 informational content The information provided by the dividends of a firm with respect to future earnings, which causes owners to bid the price of the firm’s shares up or down. (p. 620)

11 clientele effect The argument that a firm attracts shareholders whose preferences with respect to the payment and stability of dividends correspond to the payment pattern and stability of the firm itself. (p. 620)

11 dividend relevance theory The theory that there is a direct relationship between a firm’s dividend policy and its market value. (p. 621)

11 bird-in-the-hand argument The belief, in support of <I>dividend relevance theory</I>, that current dividend payments (“a bird in the hand”) reduce investor uncertainty and result in a higher value for the firm’s shares. (p. 621)

11 dividend policy The plan to be followed when making the dividend decision. (p. 622)

11 capital impairment rule Prevents the payment of dividends from the value of common shares on the balance sheet. (p. 622)

11 insolvency rule A company cannot pay dividends while insolvent or if the payment of dividends makes the company insolvent. (p. 622)

11 dividend payout ratio Indicates the percentage of each dollar earned that is distributed to the owners in the form of cash; calculated by dividing the firm’s cash dividend per share by its earnings per share. (p. 625)

11 constant-payout-ratio dividend policy

A dividend policy based on the payment of a certain percentage of earnings to owners in each dividend period. (p. 626)

11 regular dividend policy A dividend policy based on the payment of a fixed-dollar dividend in each period. (p. 626)

11 target dividend-payout ratio A policy under which the firm attempts to pay out a certain percentage of earnings as a stated dollar dividend, which it adjusts toward a target payout as proven earnings increases occur. (p. 627)

11 low-regular-and-extra dividend policy

A dividend policy based on paying a low regular dividend, supplemented by an additional dividend when earnings are higher than normal. (p. 628)

11 extra dividend An additional dividend optionally paid by the firm if earnings are higher than normal in a given period. (p. 628)

11 stock dividend The payment to existing owners of a dividend in the form of common shares. (p. 628)

11 stock split A method commonly used to lower the market price of a firm’s common shares by increasing the number of shares belonging to each shareholder. (p. 630)

11 share consolidation (reverse stock split)

A method used to raise the market price of a firm’s stock by exchanging a certain number of outstanding shares for one new share of stock. (p. 631)

11 share repurchase Company purchase of its own common shares from investors in the stock market; the company then retires the shares. (p. 631)

11 open-market share repurchases

Company purchases of its own shares on a stock exchange at the market price once approval from the stock exchange is received; termed a <I>normal course issuer bid</I> in Canada. (p. 633)

11 fixed-price tender bid An offer by a company to purchase a certain percentage of its own shares at a stated price that is well above the current market price within a specified time period; termed a <I>substantial issuer bid</I>. (p. 633)

11 Dutch-auction bid A variation of the fixed-price tender bid where the company specifies the number of shares it wishes to repurchase and a range of prices at which it will purchase the shares. (p. 633)

12 capital budgeting The process of evaluating and selecting long-term investment projects that achieve the goal of owner wealth maximization. (p. 649)

12 capital expenditure An outlay of funds by the firm that is expected to produce benefits

over a period of time <I>greater than</I> one year. (p. 650) 12 operating expenditure An outlay of funds by the firm resulting in benefits received within

one year. (p. 650) 12 capital budgeting process Consists of five distinct but interrelated steps beginning with

proposal generation, followed by review and analysis, decision making, implementation, and follow-up. (p. 651)

12 independent projects Projects whose cash flows are unrelated or independent of one another; the acceptance of one does not eliminate the others from further consideration. (p. 652)

12 mutually exclusive projects Projects that compete with one another, so that the acceptance of one eliminates the others from further consideration. (p. 653)

12 replacement projects Projects that involve replacing an existing asset with a new asset. (p. 653)

12 unlimited funds The financial situation in which a firm is able to accept all independent projects that provide an acceptable return. (p. 653)

12 capital rationing The financial situation in which a firm has only a fixed number of dollars to allocate among competing capital expenditures. (p. 653)

12 accept/reject approach The evaluation of capital expenditure proposals to determine whether they meet the firm’s minimum acceptance criterion. (p. 653)

12 ranking approach The ranking of capital expenditure projects on the basis of some predetermined measure, such as the rate of return. (p. 654)

12 cash flow pattern An initial outflow followed by a series of inflows. (p. 654) 12 incremental cash flows The additional cash flows&#151outflows or

inflows&#151expected to result from a proposed capital expenditure. (p. 655)

12 incremental cost The relevant cash outflow required now, at time zero, for a capital budgeting project. (p. 655)

12 operating cash inflows The incremental after-tax cash inflows resulting from use of a project during its life. (p. 655)

12 terminal cash flow The after-tax non-operating cash flow occurring in the final year of a project, usually attributable to liquidation of the project. (p. 656)

12 sophisticated approaches to capital budgeting

Capital budgeting techniques that integrate time value procedures, risk and return considerations, and valuation concepts to select capital expenditures that are consistent with the firm’s goal of maximizing owners’ wealth. (p. 656)

12 net present value (NPV) The difference between the value of the project to the company and the project’s incremental cost. (p. 657)

12 sunk costs Cash outlays that have already been made (i.e., past outlays) and therefore have no effect on the cash flows relevant to a current decision. (p. 661 )

12 opportunity costs Cash flows that could be realized from an alternative use of an owned asset. (p. 661)

12 incremental cost The relevant cash outflows incurred if a capital budgeting project is implemented. (p. 662)

12 installation cost Costs incurred to place equipment or machinery into operation. (p. 662)

12 incremental cost of a new asset

The total of all costs incurred to get an asset to the point of being able to produce cash inflows for the company, less the proceeds from the sale of the asset being replaced. (p. 662)

12 change in net working capital

The difference between the change in current assets and current liabilities associated with an investment project. (p. 663)

12 operating income The principal reason a company considers investing in a fixed asset; operating income may increase because sales increase, costs decrease, or both occur. (p. 665)

12 capital cost allowance (CCA)

The tax version of amortization, a non-cash expense that increases cash flow. (p. 667)

12 CCA rates Rates set by the Canada Revenue Agency (CRA) that are used to calculate the CCA on an asset class; the rates range from 4 to 100 percent. (p. 667)

12 undepreciated capital cost (UCC)

The undepreciated value of an asset or asset class that is the basis for the amount of CCA that is claimed; also referred to as the tax value of an asset. (p. 667)

12 tax shields The tax savings the firm will experience from being able to claim the CCA on the asset. (p. 668)

12 investment tax credit (ITC) An incentive for businesses in various regions of the country to purchase certain types of fixed assets or undertake certain types of research and development activities; results in a reduction in federal taxes payable. (p. 669)

12 cash grants Direct cash payments by any level of government to the company. (p. 672)

12 interest rate buydowns Government payments of interest on a loan on behalf of a company. (p. 672)

12 wage and rent subsidies Payment made by the government to the company’s employees or landlord to reduce the effective cost of proceeding with a project. (p. 672)

12 tax breaks Reductions in the property taxes or reductions in income taxes the company would have to pay on the profits generated on an operation. (p. 672)

12 salvage value The amount received when a project is terminated and an asset is sold. (p. 673)

12 net working capital recovered

With the termination of a project, the sales associated with the project cease, and the company will recover the originally invested net working capital. (p. 673)

12 payback period The length of time in years it takes for a project’s yearly incremental after-tax cash inflows to recover the incremental cost of the project. (p. 683)

12 fish-and-bait test A description for the payback period; it concentrates on recovering the bait (the incremental cost), paying no attention to the size of the fish (the present value of all cash inflows). (p. 685)

12 internal rate of return (IRR) The discount rate that equates the present value of the cash inflows with the incremental cost of a capital budgeting project; the discount rate that makes the NPV of a project equal to 0. (p. 686)

12 NPV profile A table and/or graph that shows the NPV for a project at various discount rates. (p. 687)

12 conflicting rankings Conflicts in the ranking of projects using the NPV and IRR techniques resulting from differences in the magnitude and timing of cash inflows. (p. 690)

12 cross-over rate The discount rate where NPV profiles intersect, meaning the NPVs of the two projects are equal, and where the ranking decision for the projects changes. (p. 691)

13 risk The chance that the inputs into the analysis of an investment project will prove to be wrong. (p. 728)

13 GIGO (garbage in, garbage out)

If cash inflows are overestimated and/or the cost of capital underestimated, then decisions that prove to be very costly for the firm and the shareholders can result; poor forecasts can result in poor capital budgeting decisions. (p. 728)

13 forecasting risk The possibility that the estimated cash flows are wrong (either too high or low) and, as a result, a wrong decision is made. (p. 731)

13 breakeven cash inflow The minimum level of after-tax cash inflow necessary for a project

to be acceptable; that is, NPV is greater than or equal to $0. (p. 732)

13 sensitivity analysis A behavioural approach that uses a number of possible values for a given variable to assess its impact on a firm’s return. (p. 732)

13 scenario analysis A behavioural approach that evaluates the impact on return of simultaneous changes in a number of variables. (p. 733)

13 simulation A statistically based behavioural approach that applies predetermined probability distributions and random numbers to estimate risky outcomes. (p. 734)

13 exchange rate risk The danger that an unexpected change in the exchange rate between the dollar and the currency in which a project’s cash flows are denominated can reduce the market value of that project’s cash flow. (p. 735)

13 transfer prices Prices that subsidiaries charge each other for the goods and services traded between them. (p. 736)

13 certainty equivalents (CEs) Risk-adjustment factors that represent the percent of estimated cash inflow that investors would be satisfied to receive <I>for certain</I> rather than the cash inflows that are possible for each year. (p. 737)

13 risk-free rate, <I>R_F</I>

The rate of return that one would earn on a virtually riskless investment such as a short-term Government of Canada treasury bill. (p. 737)

13 risk-adjusted discount rate (RADR)

The rate of return that must be earned on a given project to compensate for the risk of the project. (p. 738)

13 annualized net present value (ANPV) approach

An approach to evaluating unequal-lived projects that converts the net present value of unequal-lived, mutually exclusive projects into an equivalent annual amount (in NPV terms). (p. 751)

13 real options Opportunities that are embedded in capital projects that enable managers to alter their cash flows and risk in a way that affects project acceptability (NPV). Also called <I>strategic options</I>. (p. 752)

13 internal rate of return approach

An approach to capital rationing that involves graphing project IRRs in descending order against the total dollar investment, to determine the group of acceptable projects. (p. 755)

13 investment opportunities schedule (IOS)

The graph that plots project IRRs in descending order against total dollar investment. (p. 755)

13 profitability index The project’s NPV divided by its incremental cost; used to determine the group of projects with the highest overall present value. (p. 755)

14 short-term financial management or working capital management

Management of current assets and current liabilities. (p. 775)

14 net working capital The difference between the firm’s current assets and its current liabilities; can be positive or negative. (p. 776)

14 profitability The relationship between revenues and costs generated by using the firm’s assets&#151both current and fixed&#151in productive activities. (p. 776)

14 risk (of technical insolvency)

The probability that a firm will be unable to pay its bills as they come due. (p. 776)

14 technically insolvent Describes a firm that is unable to pay its bills as they come due. (p. 776)

14 operating cycle (OC) The time from the beginning of the production process to the collection of cash from the sale of the finished product. (p. 779)

14 cash conversion cycle (CCC)

The amount of time a firm’s resources are tied up; calculated by subtracting the average payment period from the operating cycle.

(p. 779) 14 permanent financing Financing required to fund a permanent amount of current assets on

the balance sheet. (p. 780) 14 seasonal financing Financing required for the seasonal amount of current assets on the

balance sheet. (p. 782) 14 refinancing risk The risk that the firm may not be able to obtain all of the financing

needed once short-term debt matures. (p. 783) 14 aggressive financing

strategy Use only current liabilities to finance the investment in the current assets; it reduces costs, but increases the three forms of risk. (p. 783)

14 conservative financing strategy

Use of long-term financing (long-term debt or equity) to finance the investment in current assets. (p. 783)

14 matching strategy Use short-term debt to finance the seasonal current assets and long-term sources to finance the permanent current assets. (p. 783)

14 ABC inventory system Inventory management technique that divides inventory into three groups&#151A, B, and C&#151in descending order of importance and level of monitoring, on the basis of the dollar investment in each. (p. 787)

14 two-bin method Unsophisticated inventory-monitoring technique that is typically applied to C group items and involves reordering inventory when one of two bins is empty. (p. 787)

14 economic order quantity (EOQ) model

Inventory management technique for determining an item’s optimal order size, which is the size that minimizes the total of its order costs and carrying costs. (p. 788)

14 order costs The fixed costs of placing, receiving, and handling an inventory order. (p. 788)

14 carrying costs The variable costs per unit of holding an item in inventory for a specific period of time. (p. 788)

14 total cost of inventory The sum of order costs and carrying costs of inventory. (p. 788)

14 reorder point The point at which to reorder inventory, expressed as days of lead time times daily usage. (p. 789)

14 safety stock Extra inventory that is held to prevent stockouts of important items. (p. 789)

14 just-in-time (JIT) system Inventory management technique that minimizes inventory investment by having materials arrive at exactly the time they are needed for production. (p. 790)

14 materials requirement planning (MRP) system

Inventory management technique that applies EOQ concepts and a computer to compare production needs to available inventory balances and determine when orders should be placed for various items on a product’s bill of materials. (p. 790)

14 credit standards The firm’s minimum requirements for extending credit to a customer. (p. 791)

14 four C’s of credit The four key dimensions—character, capacity, capital, and conditions&#151used by credit analysts to provide a framework for in-depth credit analysis. (p. 791)

14 credit scoring A credit selection method commonly used with high-volume/small-dollar credit requests; relies on a credit score determined by applying statistically derived weights to a credit applicant’s scores on key financial and credit characteristics. (p. 794)

14 credit terms The terms of sale for customers who have been extended credit by the firm. (p. 795)

14 cash discount A percentage deduction from the purchase price; available to credit customers that pay their accounts within a specified time. (p. 795)

14 cash discount period The number of days after the beginning of the credit period during which the cash discount is available. (p. 796)

14 credit period The number of days after the beginning of the credit period until full payment of the account is due. (p. 796)

14 credit monitoring The ongoing review of a firm’s accounts receivable to determine whether customers are paying according to the stated credit terms. (p. 799)

14 aging of accounts receivable

A credit-monitoring technique that uses a schedule indicating the percentages of the total accounts receivable balance that have been outstanding for specified periods of time. (p. 801)

14 float Funds that have been sent by the payer but are not yet usable funds to the payee. (p. 803)

14 mail float The time delay between when payment is placed in the mail and when it is received. (p. 804)

14 processing float The time between receipt of a payment and its deposit into the firm’s account. (p. 804)

14 clearing float The time between deposit of a payment and when spendable funds become available to the firm. (p. 804)

14 lockbox system A collection procedure in which customers mail payments to a post office box that is emptied regularly by the firm’s bank, which processes the payments and deposits them in the firm’s account. This system speeds up collection time by reducing processing time as well as mail and clearing time. (p. 804)

14 controlled disbursing The strategic use of mailing points and bank accounts to lengthen mail float and clearing float, respectively. (p. 804)

14 cash concentration The process used by the firm to bring lockbox and other deposits together into one bank, often called the <I>concentration bank</I>. (p. 805)

14 depository transfer cheque (DTC)

An unsigned cheque drawn on one of a firm’s bank accounts and deposited in another. (p. 805)

14 ACH (automated clearinghouse) transfer

Preauthorized electronic withdrawal from the payer’s account and deposit into the payee’s account via a settlement among banks by the automated clearinghouse, or ACH. (p. 805)

14 wire transfer An electronic communication that, via bookkeeping entries, removes funds from the payer’s bank and deposits them in the payee’s bank. (p. 805)

14 zero-balance account (ZBA)

A disbursement account that always has an end-of-day balance of zero because the firm deposits money to cover cheques drawn on

the account only as they are presented for payment each day. (p. 806)

15 spontaneous liabilities Financing that arises from the normal course of business; the two major short-term sources of such liabilities are accounts payable and accruals. (p. 820)

15 unsecured short-term financing

Short-term financing obtained without pledging specific assets as collateral. (p. 821)

15 accounts payable management

Management by the firm of the time that elapses between its purchase of raw materials and its mailing payment to the supplier. (p. 822)

15 cost of giving up a cash discount

The rate of interest implied by delaying payment of an account payable for an additional number of days. (p. 823)

15 stretching accounts payable Paying bills as late as possible without damaging the firm’s credit rating. (p. 826)

15 accruals Liabilities for services received for which payment has yet to be made and for which an invoice has not been received. (p. 826)

15 short-term, self-liquidating loan

An unsecured short-term loan in which the use to which the borrowed money is put provides the mechanism through which the loan is repaid. (p. 827)

15 prime rate of interest (prime rate)

The lowest rate of interest charged by leading banks on business loans to their most secure business borrowers. (p. 827)

15 fixed rate loan A loan with a rate of interest that is determined at a set increment above the prime rate at which it remains fixed until maturity. (p. 828)

15 floating rate loan A loan with a rate of interest initially set at a stated premium above the prime rate and allowed to “float,” or vary, as the prime rate varies until maturity. (p. 828)

15 discount loans Loans on which interest is paid in advance by being deducted from the amount borrowed. (p. 828)

15 single-payment note A short-term, one-time loan made to a borrower who needs funds for a specific purpose for a short period. (p. 829)

15 line of credit An agreement between a commercial bank and a business specifying the amount of unsecured short-term borrowing the bank will make available to the firm over a given period of time. (p. 830)

15 operating-change restrictions

Contractual restrictions that a bank may impose on a firm’s financial condition or operations as part of a line-of-credit agreement. (p. 830)

15 compensating balance A required chequing account balance equal to a certain percentage of the amount borrowed from a bank under a line-of-credit or revolving credit agreement. (p. 831)

15 annual cleanup The requirement that for a certain number of days during the year borrowers under a line of credit carry a zero loan balance (i.e., owe the bank nothing). (p. 831)

15 revolving credit agreement A line of credit guaranteed to a borrower by a commercial bank regardless of the scarcity of money. (p. 832)

15 commitment fee The fee that is normally charged on a <I>revolving credit agreement</I>; it often applies to the average unused balance of the borrower’s credit line. (p. 832)

15 corporate paper A form of financing consisting of short-term, unsecured promissory notes issued by firms with a high credit standing. (p. 832)

15 letter of credit A letter written by a company’s bank to the company’s foreign supplier, stating that the bank guarantees payment of an invoiced amount if all the underlying agreements are met. (p. 834)

15 secured short-term Short-term financing (loans) that has specific assets pledged as

financing collateral. (p. 836)

15 security agreement The agreement between the borrower and the lender that specifies the collateral held against a secured loan. (p. 836)

15 percentage advance The percentage of the book value of the collateral that constitutes the principal of a secured loan. (p. 837)

15 pledge of accounts receivable

The use of a firm’s accounts receivable as security, or collateral, to obtain a short-term loan. (p. 838)

15 lien A publicly disclosed legal claim on collateral. (p. 838) 15 non-notification basis The basis on which a borrower, having pledged an account

receivable, continues to collect the account payments without notifying the account customer. (p. 838)

15 notification basis The basis on which an account customer whose account has been pledged (or factored) is notified to remit payment directly to the lender (or factor). (p. 838)

15 factoring accounts receivable

The outright sale of accounts receivable at a discount to a factor or other financial institution. (p. 838)

15 factor A financial institution that specializes in purchasing accounts receivable from businesses. (p. 838)

15 non-recourse basis The basis on which accounts receivable are sold to a factor with the understanding that the factor accepts all credit risks on the purchased accounts. (p. 839)

15 floating inventory lien A secured short-term loan against inventory under which the lender’s claim is on the borrower’s inventory in general. (p. 841)

15 trust receipt inventory loan A secured short-term loan against inventory under which the lender advances 80 to 100 percent of the cost of the borrower’s relatively expensive inventory items in exchange for the borrower’s promise to repay the lender, with accrued interest, immediately after the sale of each item of collateral. (p. 841)

15 warehouse receipt loan A secured short-term loan against inventory under which the lender receives control of the pledged inventory collateral, which is stored by a designated warehousing company on the lender’s behalf. (p. 841)

16 leasing The process by which a firm can obtain the use of fixed assets for which it must make a series of contractual, periodic, tax-deductible payments. (p. 854)

16 lessee Has physical control of and uses the assets under a lease contract; makes the lease payments. (p. 854)

16 lessor The owner of an asset being leased; receives the lease payments. (p. 854)

16 conditional sales agreement A way to finance the purchase of an asset with the debt financing provided to the purchaser by the asset vendor. (p. 856)

16 operating lease A cancellable contractual arrangement in which the lessor allows the lessee use of an asset in return for stated periodic payments; generally, the term of the lease is less than the life of the asset, and the total payments over the term of the lease are less than the lessor’s initial cost of the leased asset. (p. 856)

16 cancellable An option on an operating lease that allows the lessee to stop making lease payments and return the asset to the lessor. (p. 857)

16 financial (or capital) lease A non-cancellable contractual arrangement for major fixed assets requiring the lessee to make periodic payments to the lessor;

generally, the term of the lease is the life of the asset, and the total payments over the term of the lease are greater than the lessor’s initial cost of the leased asset. (p. 857)

16 direct lease A lease under which a lessor purchases assets that are then leased to a given lessee. (p. 858)

16 sale-leaseback arrangement A lease where a lessee sells assets they already own to the lessor and, at the same time, commits to leasing them back. (p. 858)

16 leveraged lease A lease under which the lessor acts as an equity participant, supplying only about 20 percent of the cost of the asset, while a lender supplies the balance. (p. 859)

16 maintenance clauses Provisions normally included in a lease that require one of the parties to maintain the assets and to make insurance and tax payments. (p. 859)

16 renewal option Grants the lessee the right to re-lease the asset at the expiration of the lease contract. (p. 859)

16 purchase option Allows the lessee to purchase the leased asset at maturity for a pre-specified price, generally the asset’s fair market value. (p. 859)

16 off-balance-sheet financing Financing that does not have to be shown on the balance sheet, but only reported in the notes to the financial statements. (p. 861)

16 capitalized lease As required by Canadian accounting regulations, a financial (capital) lease that has the present value of the payments included as an asset and as an offsetting liability on the firm’s balance sheet. (p. 861)

16 lease-or-purchase question The question facing firms looking to acquire new fixed assets: whether to lease the assets or to purchase them using borrowed funds. (p. 863)

17 hybrid security A form of debt or equity financing that possesses characteristics of <I>both</I> debt and equity financing. (p. 901)

17 derivative security A security that is neither debt nor equity but derives its value from an underlying asset that is often another security; called <I>derivative</I> for short. (p. 901)

17 conversion feature An option that is included as part of a long-term debt or a preferred share issue that allows its holder to change the security into a stated number of common shares. (p. 903)

17 convertible bond A bond that can be changed into a specified number of common shares. (p. 903)

17 straight bond A bond that is nonconvertible, having no conversion feature. (p. 903)

17 convertible preferred shares Preferred shares that can be changed into a specified number of common shares. (p. 903)

17 straight preferred shares Preferred shares that have no conversion feature. (p. 903)

17 conversion ratio The ratio at which a convertible security can be exchanged for common shares. (p. 903)

17 conversion price The per-share price that is effectively paid for common shares as the result of conversion of a convertible security. (p. 903)

17 conversion (or share) value The value of a convertible security measured in terms of the market price of the common shares into which it can be converted. (p. 904)

17 contingent securities Convertibles, warrants, and stock options. Their presence affects the reporting of a firm’s earnings per share (EPS). (p. 905)

17 basic EPS Earnings per share (EPS) calculated without regard to any contingent securities. (p. 905)

17 diluted EPS Earnings per share (EPS) calculated under the assumption that all contingent securities that would have dilutive effects are converted into common shares. (p. 905)

17 overhanging issue A convertible security that cannot be forced into conversion by using the call feature. (p. 906)

17 straight bond value The price at which a convertible bond would sell in the market without the conversion feature. (p. 907)

17 market premium The amount by which the market value exceeds the straight or conversion value of a convertible security. (p. 908)

17 warrant An instrument that gives its holder the right to purchase a certain number of common shares at a specified price within a certain period of time. (p. 909)

17 exercise price The price at which holders of warrants can purchase a specified number of common shares. (p. 910)

17 implied price of a warrant The price effectively paid for each warrant attached to a bond. (p. 911)

17 warrant premium The difference between the actual market value and theoretical value of a warrant. (p. 912)

17 intrinsic value The positive difference between the current market price of a firm’s common shares and the exercise price of the warrant. (p. 912)

17 option An instrument that provides its holder with an opportunity to purchase or sell a specified asset at a stated price on or before a set <I>expiration date</I>. (p. 915)

17 call option A security that provides the holder the right to purchase the common shares of a specific company, on or before a specified future date, at a stated price. (p. 915)

17 put option A security that provides the holder the right to sell the common shares of a specific company, on or before a specified future date, at a stated price. (p. 915)

17 option writer Creates an option contract for sale to option buyers. (p. 915)

17 strike (exercise) price The stated price at which the holder of the option can exercise the option. (p. 915)

17 option premium The price paid by the buyer of an option contract, and the amount received by the seller; it is quoted on a per-share basis. (p. 916)

17 expiration date The last day on which the option can be exercised; this is the third Friday of the month of the option contract. (p. 916)

17 American option An option contract that may be exercised at any time up to the expiration date. (p. 916)

17 European option An option contract that may be exercised only on the expiration date. (p. 916)

17 Long-Term Equity AnticiPation Security (LEAPS)

A long-term call or put option, on either common shares or stock market indexes, with expiration dates that are at least 1 year and up to 2.5 to 3 years in the future. (p. 917)

17 zero-sum trade Profit made by purchasers of options comes at the expense of sellers; profit made by sellers of options comes at the expense of purchasers. (p. 918)

17 in the money (call) When the current price of a company’s common shares (<I>P</I>) is greater than the call option’s strike price (<I>S</I>). (p. 920)

17 intrinsic value (option) The minimum amount an option is worth; this value can never be less than zero. (p. 920)

17 at the money When the current price of a company’s common shares (<I>P</I>) is equal to the call option’s strike price (<I>S</I>). (p. 920)

17 out of the money (call) When the current price of a company’s common shares (<I>P</I>) is less than the call option’s strike price (S). (p. 920)

17 out of the money (put) When the current price of a company’s common shares (<I>P</I>) is greater than the put option’s strike price (<I>S</I>). (p. 920)

17 in the money (put) When the current price of a company’s common shares (P) is less than the put option’s strike price (<I>S</I>). (p. 920)

17 time value of an option (TV)

The difference between the premium (<I>V</I>) and the intrinsic value (<I>IV</I>) of an option; all options have some time value up to their point of expiration. (p. 920)

17 Canadian Derivatives Clearing Corporation (CDCC)

The agency that regulates the trading of options in Canada. (p. 923)

17 open interest The number of open option contracts at a given time; it indicates the number of open positions that exist for a particular option contract or for all option contracts for a company. (p. 925)

17 future options Options that trade on currencies, interest rates, and commodities like lumber, corn, cotton, rice, sugar, or gold, or on the level of interest rates in Canada or another country, that are used by companies who wish to protect a position in one of these areas. (p. 931)

17 managerial stock options Options created by the company and granted to senior managers as part of their compensation package; they are often used by publicly traded companies as a way of dealing with the agency issue. (p. 932)

17 counterparties The companies that participate in a swap. (p. 934) 17 notional amount The dollar amount of the loan that is subject to a swap. (p. 935) 17 vanilla swap Allows for the simple exchange of fixed for floating interest rate

payments; used as a way to hedge or offset risk that exists on their balance sheets, or to benefit from a comparative borrowing advantage. (p. 935)

17 swap dealer The financial institution, usually a bank, that acts as an intermediary on behalf of the companies engaged in the swap. (p. 936)

17 comparative advantage A situation that exists when the differences in borrowing rates in the fixed and floating rate debt markets for two companies are not equal; the reason a swap opportunity exists. (p. 938)

17 currency swap Occurs when counterparties exchange fixed or floating interest rate payments in one currency for fixed or floating interest rate payments in another currency; in addition, the notional amount of a currency swap is exchanged. (p. 938)

18 corporate restructuring The activities involving expansion or contraction of a firm’s operations or changes in its asset or financial (ownership) structure. (p. 959)

18 bidding company (bidder) The acquiring company; the company making an offer to acquire all or part of another company. (p. 960)

18 target company The acquired company; the company that is the subject of the bidding company’s interest. (p. 960)

18 merger A bidding company acquires and completely absorbs the target company; the bidder maintains its name and identity after the merger. (p. 961)

18 consolidation Two firms are combined but neither maintain their name, identity, or existence; a completely new company is created. (p. 961)

18 tender offer (merger) A public offer by the bidder to acquire all of the common shares of

the target company at a stated price. (p. 961) 18 acquisition of assets The bidder acquires all or some of the assets of the target, with the

purchased assets moving to the bidder while the target retains its liabilities and other contingent claims or unsettled lawsuits. (p. 961)

18 holding company A corporation that has voting control of one or more other corporations. (p. 961)

18 subsidiaries The companies controlled by a holding company. (p. 961) 18 M&A activity The practitioner term used in the financial press for mergers and

acquisitions; it refers to all types of mergers, acquisitions, and consolidations. (p. 962)

18 friendly merger A merger transaction endorsed by the target firm’s management and board, approved by its shareholders, and easily consummated. (p. 962)

18 hostile takeover A merger transaction not supported by the target firm’s management and board, forcing the bidding company to try to gain control of the firm by buying common shares on the stock market. (p. 962)

18 strategic merger A merger transaction undertaken to achieve economies of scale. (p. 962)

18 financial merger A merger transaction undertaken with the goal of restructuring the target company to improve its cash flow and unlock its hidden value. (p. 963)

18 tax loss carryforward In a merger, the tax loss of one of the firms that can be applied against the future income of the merged firm over the shorter of either seven years or until the total tax loss has been fully recovered. (p. 964)

18 horizontal merger A merger of two firms in the <I>same line of business</I>. (p. 966)

18 vertical merger A merger in which a firm acquires a <I>supplier or a customer</I>. (p. 966)

18 congeneric merger A merger in which one firm acquires another firm that is <I>in the same general industry</I> but neither in the same line of business nor a supplier or customer. (p. 966)

18 conglomerate merger A merger combining firms in <I>unrelated businesses</I>. (p. 966)

18 leveraged buyout (LBO) An acquisition technique involving the use of a large amount of debt to purchase a firm; an example of a </I>financial merger</I>. (p. 967)

18 synergy The extra value created by merging two firms, B and T; the amount by which the value of T to B (<I>V</I>T^B) exceeds the amount that B pays for T (<I>P</I>_T). (p. 969)

18 common share exchange An acquisition method in which the bidding firm exchanges its common shares for the common shares of the target company according to a predetermined ratio. (p. 973)

18 ratio of exchange The amount paid per share of the target company divided by the market price per share of the bidding firm. (p. 974)

18 ratio of exchange in market price

Indicates the market price per share of the acquiring firm paid for each dollar of market price per share of the target firm. (p. 978)

18 pooling method The balance sheets of the two firms are added together (pooled) with the merged firm’s balance sheet being a combination of the bidding and target company’s balance sheets. (p. 979)

18 purchase method The bidding firm determines the fair market value of the target firm’s assets and these values are reflected in the merged company’s balance sheet. (p. 979)

18 net fair market value The market value of the assets acquired, less the amount of the acquired firm’s debt. (p. 979)

18 goodwill The difference between the amount the bidder paid for the target and the estimated net fair market value of the assets acquired; it must be greater than zero. (p. 980)

18 investment bankers Financial intermediaries hired by bidding companies in mergers to find suitable target companies and assist in negotiations. (p. 982)

18 takeover defences Strategies for fighting hostile takeovers. (p. 984) 18 white knight A takeover defence in which the target firm finds a bidder more to

its liking than the initial hostile bidder and prompts the two to compete to take over the firm. (p. 984)

18 poison pill A takeover defence in which a firm issues securities that give their holders certain rights that become effective when a takeover is attempted; these rights make the target firm less desirable to a hostile bidder. (p. 984)

18 greenmail A takeover defence under which a target firm repurchases through private negotiation a large block of its common shares at a premium from one or more shareholders to end a hostile takeover attempt by those shareholders. (p. 984)

18 leveraged recapitalization A takeover defence in which the target firm pays a large debt-financed cash dividend, increasing the firm’s financial leverage and deterring the takeover attempt. (p. 984)

18 golden parachutes Provisions in the employment contracts of key executives that provide them with sizeable compensation if the firm is taken over; deters hostile takeovers to the extent that the cash outflows required are large enough to make the takeover unattractive. (p. 984)

18 shark repellents Antitakeover amendments to a corporate charter that constrain the firm’s ability to transfer managerial control of the firm as a result of a merger. (p. 984)

18 pyramiding An arrangement among holding companies wherein one holding company controls other holding companies, thereby causing an even greater magnification of earnings and losses. (p. 985)

18 technical insolvency Business failure that occurs when a firm is unable to pay its liabilities as they come due. (p. 989)

18 asset insolvency A type of failure that occurs when the company’s liabilities exceed the market value of the company’s assets, meaning the company cannot satisfy the claims of creditors. (p. 989)

18 bankruptcy A legal state resulting in proceedings that can result in the reorganization of a company, or its liquidation. (p. 989)

18 voluntary settlement An arrangement between a technically insolvent or bankrupt firm and its creditors enabling it to bypass many of the costs involved in legal bankruptcy proceedings. (p. 990)

18 <I>Companies’ Creditors Arrangement Act</I> (CCAA)

Allows a company in financial difficulty to resist its creditors and to negotiate with them in an attempt to avoid bankruptcy and carry on its business as a going concern. (p. 991)

18 Plan of Arrangement A creditor- and court-approved plan that allows the debtor company to survive, provides repayment to both the secured and unsecured creditors who have extended credit to the business, and may include payments to both preferred and common shareholders. (p. 992)

18 secured creditors Creditors who have specific assets pledged as collateral for the loan and in the liquidation of the failed firm receive proceeds from the

sale of those assets. (p. 992) 18 unsecured creditors Creditors who have a general claim against all of the firm’s assets

other than those specifically pledged as collateral. (p. 992) 18 <I>Bankruptcy and

Insolvency Act</I> A more recent and regulated solution to insolvency that clearly specifies the procedures and time line that must be followed by the debtor and creditors in a reorganization. (p. 992)

18 proposal A suggested agreement between the company and the company’s creditors regarding repayment of the company’s debts. (p. 993)

19 multinational companies (MNCs)

Firms that have international assets and operations in foreign markets and draw part of their total revenue and profits from such markets. (p. 1008)

19 North American Free Trade Agreement (NAFTA)

The treaty establishing free trade and open markets among Canada, Mexico, and the United States. (p. 1011)

19 European Union (EU) A significant economic force currently made up of 25 nations that permit free trade within the union. (p. 1011)

19 European Open Market The transformation of the European Union into a single market at year-end 1992. (p. 1012)

19 Euro A single currency adopted on January 1, 1999, by 12 of the 15 EU nations, who switched to a single set of Euro bills and coins on January 1, 2002. (p. 1012)

19 monetary union The official melding of the national currencies of the EU nations into one currency, the <I>Euro</I>, on January 1, 2002. (p. 1012)

19 Mercosur Group A major South American trading bloc that includes countries that account for more than half of total Latin American GDP. (p. 1012)

19 Free Trade Area of the Americas

A trading bloc that would extend the NAFTA and the Mercosur Group to create a free trade zone from the Arctic to Cape Horn. (p. 1012)

19 General Agreement on Tariffs and Trade (GATT)

A treaty that has governed world trade throughout most of the postwar era; it extends free trading rules to broad areas of economic activity and is policed by the <I>World Trade Organization (WTO</I>). (p. 1013)

19 World Trade Organization (WTO)

International body that polices world trading practices and mediates disputes between member countries. (p. 1013)

19 foreign subsidiary An incorporated business established by an MNC that is completely separate from the parent. (p. 1013)

19 branch A business run by an MNC that is operated directly within a foreign country without incorporating; it is not separate from the parent, but part of the same entity. (p. 1013)

19 foreign affiliate A foreign corporation in which the MNC owns at least 10 percent of the common shares. (p. 1013)

19 joint venture A partnership under which the participants have contractually agreed to contribute specified amounts of money and expertise in exchange for stated proportions of ownership and profit. (p. 1013)

19 double taxation A situation wherein the same income is taxed in two separate countries; to reduce double taxation, many countries have negotiated tax treaties that override domestic law. (p. 1015)

19 Euromarket The international financial market that provides for borrowing and lending currencies outside their country of origin. (p. 1017)

19 offshore centres Certain cities or states (including London, Singapore, Bahrain, Nassau, Hong Kong, and Luxembourg) that have achieved prominence as major centres for Euromarket business. (p. 1017)

19 Section 1650 The CICA regulation requiring Canadian companies to convert the financial statements of foreign subsidiaries into Canadian dollars

for inclusion in the parent company’s consolidated financial statements. (p. 1019)

19 integrated foreign subsidiary

An operation that is financially or operationally <I>interdependent</I> with the parent company. (p. 1019)

19 temporal method The foreign exchange translation method takes all transactions engaged in by the foreign subsidiary and converts them into Canadian dollars using the exchange rate in effect on the date of the original transaction. (p. 1019)

19 self-sustaining foreign subsidiary

An operation that is financially and operationally <I>independent</I> of the parent company. (p. 1019)

19 current rate method All financial transactions are measured in the currency of the foreign operations and consolidation occurs by converting all balance sheet accounts at the exchange rate in effect at the close of the fiscal year and all income statement accounts at the average exchange rate for the fiscal year. (p. 1020)

19 exchange rate risk The risk caused by varying exchange rates between two currencies. (p. 1020)

19 foreign exchange rate The value of two currencies with respect to each other. (p. 1020) 19 floating relationship The fluctuating relationship of the values of two currencies with

respect to each other. (p. 1021)

19 fixed (or semifixed) relationship

The constant (or relatively constant) relationship of a currency to one of the major currencies, a combination (basket) of major currencies, or some type of international foreign exchange standard. (p. 1021)

19 spot exchange rate The rate of exchange between two currencies on any given day. (p. 1021)

19 forward exchange rate The rate of exchange between two currencies at some specified future date. (p. 1021)

19 accounting exposure The risk resulting from the effects of changes in foreign exchange rates on the translated value of a firm’s financial statement accounts denominated in a given foreign currency. (p. 1025)

19 economic exposure The risk resulting from the effects of changes in foreign exchange rates on the firm’s value. (p. 1025)

19 political risk The potential discontinuity or seizure of an MNC’s operations in a host country due to the host’s implementation of specific rules and regulations. (p. 1025)

19 macro political risk The subjection of all foreign firms to political risk (takeover) by a host country because of political change, revolution, or the adoption of new policies. (p. 1025)

19 micro political risk The subjection of an individual firm, a specific industry, or companies from a particular foreign country to political risk (takeover) by a host country. (p. 1025)

19 national entry control systems

Comprehensive rules, regulations, and incentives introduced by host governments to regulate inflows of <I>foreign direct investments</I> from MNCs and at the same time extract more benefits from their presence. (p. 1027)

19 foreign direct investment (FDI)

The transfer by a multinational firm of capital, managerial, and technical assets from its home country to a host country. (p. 1028)

19 international bond A bond that is initially sold outside the country of the borrower and often distributed in several countries. (p. 1031)

19 foreign bond An <I>international bond</I> that is sold primarily in the country of the currency of the issue. (p. 1031)

19 Eurobond An <I>international bond</I> that is sold primarily in countries other than the country of the currency in which the issue is denominated. (p. 1031)

19 Euroequity market The capital market around the world that deals in international equity issues; London has become <I>the</I> centre of Euroequity activity. (p. 1032)

19 Eurocurrency markets The portion of the Euromarket that provides short-term, foreign-currency financing to subsidiaries of MNCs. (p. 1034)

19 nominal interest rate In the international context, the stated interest rate charged on financing when only the MNC parent’s currency is involved. (p. 1034)

19 effective interest rate In the international context, the rate equal to the nominal rate plus (or minus) any forecast appreciation (or depreciation) of a foreign currency relative to the currency of the MNC parent. (p. 1034)

19 hedging strategies Techniques used to offset or protect against risk; in the international context, these include borrowing or lending in different currencies, undertaking contracts in the forward, futures, and/or options markets, and also swapping assets/liabilities with other parties. (p. 1035)