FINANCIAL CONCEPTS

AMORTIZATION

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

AMORTIZATION OF LOANSAMORTIZATION OF

INTANGIBLE ASSETS

In lending, amortization is the distribution of payment into multiple cash flow installments, as determined by an amortization schedule. Unlike other repayment models, each repayment installment consists of both principal and interest. Amortization is chiefly used in loanrepayments (a common example being a mortgage loan) and in sinking funds. Payments are divided into equal amounts for the duration of the loan, making it the simplest repayment model. 

In accounting, amortization refers to expensing the acquisition cost minus the residual value of intangible assets (often intellectual property Such as patents and trademarks or copyrights) in a systematic manner over their estimated useful economic lives so as to reflect their consumption, expiry, obsolescence or other decline in value as a result of use or the passage of time.

ASK PRICE

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

• The seller may qualify the stated asking price as firm or negotiable. Firm means the seller is saying he or she won't change the price. Negotiable means the seller is inviting the potential buyer to attempt to convince the seller to lower the price

BASE EFFECT

• The Base effect[1] relates to inflation in the corresponding period of the previous year, if the inflation rate was too low in the corresponding period of the previous year, even a smaller rise in the Price Index will arithmetically give a high rate of inflation now. On the other hand, if the price index had risen at a high rate in the corresponding period of the previous year and recorded high inflation rate, a similar absolute increase in the Price index now will show a lower inflation rate now.

• An illustration of the base effect would be like: Price Index 100 goes to 150, and then to 200. The initial increase of 50, gives the percentage increase as 50% but the subsequent increase of 50 gives the percentage increase as 33.33%. This happens arithmetically as the base on which the percentage is calculated has increased from 100 to 150.

BID PRICE

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

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

BUY DOWN

• A buydown is a mortgage financing technique where the buyer attempts to obtain a lower interest rate for at least the first few years of the mortgage.[1]

 The seller of the property usually provides payments to the mortgage lending institution, which, in turn, lowers the buyer's monthly interest rate and therefore monthly payment. This is typically done for a period of about one to five years. In a seller's market the seller might raise the purchase price to compensate for the costs of the buydown but in most markets it would not be to their advantage to use a buydown as an enticement if they are going to offset the benefit by raising the price.[2] In most cases, the buydown does not even involve the seller. It is an arrangement between the lender and the buyer.

BUYER’S CREDIT

• Buyer's credit is short term credit availed to an importer (buyer) from overseas lenders such as banks and other financial institution for goods they are importing. The overseas banks usually lend the importer (buyer) based on the letter of comfort (a bank guarantee) issued by the importer's bank. For this service the importer's bank or buyer's credit consultant charges a fee called an arrangement fee.

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

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

CAPITALIZATION RATE

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

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

• $100,000 / $1,000,000 = 0.10 = 10%

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

CASH FLOW

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

COLLATERAL (FINANCE)

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

CONCEPT OF COLLATERAL

Collateral, especially within banking, traditionally refers to secured lending (also known as asset-based lending). More recently, complex collateralization arrangements are used to secure trade transactions (also known as capital market collateralization). The former often presents unilateral obligations secured in the form of property, surety, guarantee or other as collateral (originally denoted by the term security), whereas the latter often presents bilateral obligations secured by more liquid assets such as cash or securities, often known for margin. Another example might be to ask for collateral in exchange for holding something of value until

COMPARATIVE ADVANTAGE

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

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

COMPOUND INTEREST

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

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

CONTANGO

• Contango is a situation where the futures price (or forward price) of a commodity is higher than the expected spot price.(Black 2009)[1](investopedia)[2] In a contango situation hedgers (commodity producers and commodity users) or arbitrageurs/speculators (non-commercial investors),(EU & 2008 6)[3] are "willing to pay more for a commodity at some point in the future than the actual expected price of the commodity. This may be due to people's desire to pay a premium to have the commodity in the future rather than paying the costs of storage and carry costs of buying the commodity today."(investopedia)

• The opposite market condition to contango is known as normal backwardation.(investopedia) "A market is "in backwardation" when the futures price is below the expected future spot price for a particular commodity. This is favorable for investors who have long positions since they want the futures price to rise."(investopedia)[2]

DEFLATION

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

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

DELEVERAGING

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

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

DISCOUNTED CASH FLOW

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

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

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

DIVISION OF LABOUR

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

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

DOMESTIC LIABILITY DOLLARIZATION

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

DOWN PAYMENT

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

DOWNSIDE RISK

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

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

DOWNSIDE RISK V/S CAPM

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