Financial Jargon Explained

Here is where we give you a simple guide to the meanings of some of the terms used in today’s capital markets.

Accumulation Units

These appear in unit trusts where income is re-invested by purchasing more units in the fund

ADR

American Depository Receipt, this is a receipt issued by a US bank that holds the underlying shares. ADRs are used by non-US investors to trade on Wall Street

AIM

The Alternative Investment Market is a vehicle for listing smaller companies where the listing requirements are less stringent than a full listing

Amortisation

An annual charge taken through the profit and loss account that allows for the gradual write down in the value of an asset, over the expected life of the asset

A policy issued by an Insurance company on retirement that guarantees a fixed rate of income for the remainder of your life

Arbitrage

Professional activity aimed at exploiting differences in price between two markets, i.e. London and Johannesburg for Gold shares

Bear Market

A Bear market is a market where the underlying trend is downwards

Beta

A measure of share price volatility, and hence risk. Share prices with a high Beta tend to be more volatile than shares with a low Beta

Bid-Offer Spread

This is the difference between the bid price (the price at which the holder can sell the shares) and the offer price The price at which the purchaser can buy the shares)

Bid price

This is the price at which an investor sells an underlying asset

Bonds

The other main asset class is Bonds, either Government Bonds (Gilts) or Corporate Bonds issued by our leading companies.

Bonus Issue

An issue of extra shares to existing holders free of charge. The market capitalisation is unchanged, however as the price falls to reflect the extra shares

Bull Market

A Bull market is a market where the underlying trend is upwards. These trends can stay in place for several years

Capital Employed

The total value of all the assets being used by the business to make money. This is calculated as total assets less total liabilities

Cash Flow

Cash flow is the lifeblood of any business. Free cash flow is calculated after deductions of interest payments and tax

Corporate Bonds

Issues by companies, not governments but can go bust. To compensate for this higher risk a higher return is available in the form of a higher yield. Bonds are graded as to their safety. G7 Government Bonds are all AAA, as are some “Supra Nationals” such as the World Bank and European Investment Bank. Next in line are AA Bonds, usually issued by large companies, and so on. The Bonds are graded by Rating Agencies such as Moody’s or Standard and Poors, and the ratings can change up and own during the life of the Bond. Many Institutions are prevented from owing bonds below the AA rating. A further problem with Corporate Bonds is marketability. Whilst a healthy two-way market exists in the mainstream Government Bonds, this is not always the case for Corporate Bonds, which can be difficult to buy or sell during the life of the bond. Tax treatment is also less favourable than for Gilts, although this is equalized via the higher yield. Corporate Bonds therefore carry greater risk but offer greater return than Government Bonds

Convertible Bonds

These are a “half way house” between a Bond and an Equity, but in reality are much closer to a bond. Like bonds they carry a fixed coupon and a maturity date. The difference is that they can be converted into shares of the underlying company at a pre-determined formula, usually once a year. This conversion (at the option of the holder) usually involves a loss of income (the shares yield less than the bonds) and a capital loss (the convertible bond usually trades at a price premium to the equity due to the higher income).

CREST

This is an electronic system used to settle trades executed in the market

Dividend

A distribution from a company to a shareholder usually in cash, although shares and other assets can also be distributed.

Dividend Yield

This is the amount of income per every £100 invested (as a percentage) and as such is comparable to the rate of interest offered by a Building Society deposit account. As price rises, yield falls and vice versa

Earnings Yield

The Earnings yield is different from the dividend yield. The dividend yield is the amount a shareholder receives as his/her annual income, expressed as a percentage. The Earnings yield is the company profits relative to the share price; i.e. it is the inverse of the P/E ratio

Equities – Ordinary Shares

These are the most popular for private investors and represent the area of greatest potential reward. However the golden rule of all investment is that reward goes hand in hand with risk – the greater the potential reward, the greater the risk.

GDR

Global Depositary Receipt, similar to an ADR but used for international stocks traded in London as well

Gilts

Conventional Gilts carry a fixed coupon and a known price at redemption (usually par, i.e. £100).

Gross Redemption Yield

This is roughly the return available on a bond taking into account the current income plus any capital gain or loss to redemption (in reality it is a very complex discounted cash flow measure)

Index linked Bonds (Gilts)

These are Bonds issued mainly by the Government that do not pay a fixed coupon. Instead the “Start up coupon” is increased in line with inflation over the life of the bond. Also the proceeds on redemption are calculated to deliver full index linking over the life of the Bond.

Insider Dealing

This is where shares are bought or sold at the same time as you have privileged information that is price sensitive. It is illegal, but prosecutions are quite rare

Investment Club

This is a group of private investors that meet to discuss and implement investment strategy on a pooled basis

Market Cap

Market Capitalization is the total value of the entire company, i.e. the sum required to purchase all the outstanding shares

N.A.V. (Net Asset Value)

Net Asset value is calculated by stock market analysts to indicate the asset backing of a particular share. For example, an oil exploration company’s N.A.V is calculated by working out the total value of all it’s oil wells and dividing by the number of shares in issue. However this calculation requires certain assumptions to be made. For example, how much could the assets fetch in a “fire sale”? Alternatively a company may own some prime real estate that is in the books at considerably below market value

Offer price

This is the price at which an investor purchases an underlying asset

P/E Ratio

This is the price of a share relative to the earnings of the company. It is used for comparative purposes. A low P/E is considered “cheap” whilst a high P/E is considered “expensive”. However a low P/E can also be considered “unwanted” whereas a high P/E can indicate “investor demand”. As with much to do with the stock market, beauty is in the eye of the beholder. An easy way to understand P/E ratio is that if you purchase a company (i.e. all the shares) on a P/E of 8, it will take you 8 years to recoup your purchase cost

Preference Shares

Although these are called shares they are in reality a fixed income investment (unless they are a convertible preference). They pay a fixed dividend every year and the holder receives no benefit from any upside in the ordinary shares. Also in the winding up of an insolvent company, the preference shareholders rank below the bondholders in any pay out but above the ordinary shareholders. As a result preference shares offer some of the highest yields around. As with all Corporate Bonds marketability can be a problem. One advantage for a corporation considering purchasing preference shares is that the dividend is franked income, that is that it has already suffered corporation tax at source. This means that preference dividends (as with ordinary dividends) are effectively free of tax to a corporate holder

Return on Capital Employed

A the name suggests, this is the return on capital employed and is defined as the profit before interest and tax divided by total assets less current liabilities

Rights Issue

This is an offer for existing shareholders to subscribe for extra share usually at a discount

SETS

The Stock Exchange Electronic Trading Service (SETS) is the formal name for the electronic trading system introduced by the London Stock Exchange in 1997

Stag

A short term speculator who subscribes for new issues with the intention of a quick sale and profit

Stamp Duty

A tax payable on share and property purchases in the UK

XD

This is the date that determines the ownership of the dividend (usually a semi-annual affair). The owner of the shares on ex/dividend day is the legal owner of the dividend

Yield Curve

A graph showing the shape of Bond yields of differing maturities

Yield Gap

Difference between the yield on government bonds and the yield on equities