Learn about financial and economic terms
Over 50% of the firm is bought out and hence ownership changes hands. As a result, the acquirer is able to make decisions without the approval of it’s shareholders.
Ad Valorem Tax
An ownership tax based on the real value of an item, e.g. property tax.
A result of asymmetric information whereby sellers (or buyers) have greater knowledge than the buyers (or sellers) about the true quality and price of a good.
Total demand for all goods and services in an economy. The formula is given by: where C is consumer spending, I is investment, G is government spending, and (X-M) is the net exports.
Total supply of all goods and services in an economy for a given price. The Aggregate Supply (AS) curve is taken as fixed in short run models.
Also known as Pareto Efficiency, where all resources are allocated to their most efficient use and opportunity cost is minimised.
Used in the capital asset pricing model to describe an assets ability to beat the market or the benchmark, also known as abnormal or excess returns.
An accounting technique used in practice to lower the book value of loans or assets. Amortization can reduce the book value of loans through regular payments, and the value of intangible/fixed assets by spreading the cost across the assets lifetime.
The ability to profit from price discrepancies existing as a result of market inefficiencies.
Asset Backed Security (ABS)
A result of ‘information failure’ whereby one party possesses greater knowledge of an asset than the another party in a transaction.
A policy implemented by the government in order to restore public debt imbalances.
A method used to observe the performance of a portfolio in the past by using historical data.
A capital intervention by an individual, firm or government to prevent a company’s downfall/bankruptcy. The bailout typically comes with a stringent list of conditions the ailing company must meet.
Balance of Payments
BOP for short, given by the total number of exports minus the total number of imports in goods, services, capital and aid. The BOP is made up of the capital account, which includes central bank reserves and financial instruments, and the current account, which includes goods, services, investment and transfers (or economic output). In theory, the Current Account=Capital Account so BOP=0. A current account deficit means a country is a net importer and a current account surplus means a country is a net exporter.
An individual or firm is unable to repay their outstanding debt so files for the legal proceeding bankruptcy, whereby the assets are sold off and redistributed to their creditors.
Barriers To Entry
When the overall market or benchmark (e.g. FSTE100) declines over a sustained period.
Where ri is the return on individual asset, rm is the return on the overall market, and Cov is the covariance (how they move together) and Var is the variance (how actual returns vary from expected returns, σ squared)
A rare and unpredictable event which moves markets massively and has severe consequences. E.g. the 2008 recession.
A reliable, dependable, matured company with a market capitalisation in the billions. Name originates from blue chips in poker which have the highest value.
An individual or firm which charges fees for processing buy or sell orders.
When the overall market or benchmark (e.g. FSTE100) rises over a sustained period.
A call buyer pays a premium to a seller, giving the buyer the option to buy the asset at a strike (pre-determined) price before a specific time period. If the option is not exercised then the option buyer pays the premium to the seller. A call buyer (seller) makes profits when the underlying asset price rises (falls).
Capital Asset Pricing Model
A model used to describe the relationship between systematic risk and expected returns for an asset, given by the formula:
Where ε(ri) is the expected return on investment i, rf is equal to the risk free rate of interest (e.g. a government bond), ε(rm) is the expected return of the market, and βi is the volatility of investment i (see Beta).
The idea of a free market economy or laissez faire, whereby private individuals and businesses own capital goods. Adam Smith’s invisible hand drives market efficiency through the incentives mechanism; producers plough their resources into supplying the most profitable products (which have the highest demand). The trickle down effect distributes the producer gains throughout the economy. Margaret Thatcher was renowned for implementing capitalism in the 1980s through mass privatisation of state owned businesses (e.g. the mining industry), deregulation of markets, reducing trade union power, and improving labour market flexibility.
The net cash position of business transactions; net money coming in and going out. Signals to investors the ability of the business to make money and the liquidity available to pay off unforeseen costs. The Discounted Cash Flow (DCF) uses future cash flows to value a business.
An economy which doesn’t trade with other economies and is therefore self-sufficient (doesn’t exist in reality).
An ideology where production is owned communally so individuals contribute and earn the same. Private property is non-existent and communism advocates a classless society. The ideology originates from marxian economics and witnessed in planned economies (where the government allocates resources) such as China under Mao in 1958-62, and Russia under Lenin and then Stalin in 1922.
An economy which is able to produce a good/service at a cheaper cost to other economies. By moving resources out of other goods and services with a high opportunity cost and into the good/service with a comparative advantage, the economy can exploit this gain.
An asset’s earnings are reinvested in the asset to increase earnings (exponentially) over time. Compound interest rate is given by the formula:
Where FV is the future value, PV the present value, i the interest rate, and n is the time period.
Also known as a staple good, is bought for consumption by the average consumer. E.g. Coca-cola, cleaning products, and phone contracts.
Consumer Price Index
A weighted average of price changes for basket of consumer goods and services. These goods and services are associated with the cost of living and the index is used as an indicator of the level of inflation.
The difference between the price a consumer pays for a good and the price they are willing to pay.
The process whereby older, less efficient practices are replaced by innovative, more productive practices. E.g. the internet.
Credit Default Swap
Where a lender pays a premium (usually ongoing) for another investor to cover the risk of default until the maturity date. If the borrower defaults, the swaps seller pays the buyer the security’s value and the premium payments up to the maturity date.
A rating which quantifies the likelihood that the business defaults on their payment. Credit rating agencies such as S&P, Moody’s and Fitch, rank the borrowers from AAA to C and D where ratings below BB are considered junk bonds.
Cross Elasticity of Demand
Used to observe the relationship between the price and quantity demanded of two goods, given by this formula:
– If XED<0 then the goods are complements
– If XED>0 then the goods are substitutes
– The higher the number, the stronger the covariance
– Rare cases of Giffen and Veblen goods
Crowding Out Effect
Where too much government spending (e.g. increases interest rates) ‘crowds out’ or eliminates private sector spending. Whereas, crowding in is where increased government spending (e.g. negative output gap) increases demand and employment, raising private spending.
A digital or virtual currency based on blockchain technology or a decentralised network.
It is the exchange of interest (fixed or floating), and sometimes the principle amount, between two currencies. Companies with ties abroad often undertake currency swaps to achieve more favourable loans in the local currency.
A bloc of countries that impose the same import duties and operate under a free trade agreement.
A private platform where investors can trade without exposure to publicly revealing their intentions. For example, if it was publicly known RBS were selling 100,000 shares, the price they sell the shares at would fall.
An economic loss created by supply and demand disequilibrium or market inefficiency (misallocation of resources). E.g. price controls.
The amount a borrower owes a lender. Debt creates an opportunity for smaller companies to make large purchases in return for an interest rate.
A decline in the general price of goods and services. Commonly observed in a contractionary period when consumers delay spending and firms delay investment anticipating interest rate cuts. E.g. Japan and Eurozone. Also observed when aggregate supply increases.
The number of people aged 0-14 and over 65 divided by the number of people able to work, aged 14-65.
An accounting method which calculates the loss in value of a physical or tangible asset across its life expectancy.
When an intermediate or secondary good witnesses an increase in demand from an increase in the demand for the produced or final good. E.g. copper and nickel (used for battery production in electric vehicles) are in high demand with the take-off of electric vehicles.
Paid directly by the individual or business to the government. Typically progressive with higher income earners taxed more, e.g. income tax.
Diseconomies of Scale
When a firm becomes too big, they witness an increase in the cost per unit.
Internal factors such as:
– Hierarchical structure leads to a lack of communication and motivation.
– Overcrowding causes workers to get in each others way.
External factors such as:
– Increased taxation, increases costs.
– Loss of comparative advantage with other firms entering the market.
Earnings Before Interest, Taxes, Depreciation, and Amortization
EBITDA for short, a measure of profitability or an alternative to net income, excluding accounting practices and debt expenses. EBITDA/Enterprise Value (EV) is used to measure the return on investment and Debt/EBITDA measures the ability to pay off debt. However, EBITDA can be misleading as it removes the cost of capital investments or fixed costs.
Economies of Scale
As a firm increases in size, they benefit from a fall in the cost per unit.
Internal factors such as:
– Cheaper loans can be negotiated with banks because they require larger capital.
– Increased marketing budget- if 10% was allocated before, 10% now is much larger.
– Cheaper inputs because they can buy in bulk.
– Increased spending on technology
External factors such as:
– Subsidies and tax reductions, reduces costs.
Efficient Market Hypothesis
Where there is perfect information in the market which is reflected by the share price. Abnormal profits is impossible.
A Marxian ideology whereby all individuals receive equal treatment across religion, gender, economic status, and political beliefs.
When an individual values an object at a higher price than the market due to an emotional bias (e.g. ownership and loss aversion).
An economic theory stating that the percentage of disposable income spent on food decreases as disposable income increases, and the percentage of income spent on luxury goods increases.
EV for short, a more comprehensive measure of a companies value than just market capitalisation. Given by:
An exchange of future cash flows on a fixed-income product (e.g. benchmark interest rate, LIBOR) and an equity product (e.g. ETF/index).
Or the Expected Return, a sum of all the possible outcomes multiplied by the chance of that outcome occurring.
Expected Utility Hypothesis
An economic theory stating an individuals preference to risk (averse, neutral, or seeking) is determined by an individuals decision to take on a gamble (uncertain outcomes).
Normal business costs which are encountered in the day-to-day running of a business. E.g. rent, wages, raw materials etc.
Given by:where s is the starting value, i is the interest rate, and t is the time period.
Factors of Production
Inputs required for the output of goods/services; labour, land, entrepreneurship and capital.
A currency issued by a government which isn’t backed by a physical commodity such as gold or silver, the case for most modern currencies.
A market turnaround causing panic and a firesale of assets. Asset prices witness a massive decline in value as investors switch to holding cash. For example, the 1929 stock market crash, the 2001 dotcom bubble, and the 1997 Asian Currency Crisis.
First Mover Advantage
When a firm enters a new market and witnesses abnormal profit with a competitive advantage. They benefit from price setting, brand recognition and consumer loyalty. For example, eBay was the first online auction market.
An expansionary (contractionary) fiscal policy shifts the aggregate demand curve to the right (left) through increased (decreased) government spending and/or decreased (increased) taxation. The policy is based on the theory put forward by John Maynard Keynes.
A physical asset which requires a one off payment and the cost doesn’t rise with output. E.g. buildings and equipment.
Fixed Exchange Rate
When the currency is pegged against another currency or the value of gold. The central bank influences the demand and supply of the currency by buying and selling the currency respectively. For example, a government may want to artificially devalue their currency to promote exports.
Floating Exchange Rate
When the currency is left to market forces (supply and demand) or the “laissez faire” approach.
A voluntary transfer of money to another country, typically in a time of need.
Foreign Direct Investment
FDI for short, when an overseas investor decides to invest in a local business. E.g. Multinational Corporations (MNCs).
An over-the-counter contract made by two parties to buy/sell an asset at a specific price in the future (used as a hedging strategy).
Free Market Economy
The laissez faire approach where there is no intervention by governments, supply and demand incentivise the market.
When individuals consume or overconsume a good but don’t pay or underpay the burden of the cost in taxes.
Free Trade Agreement
The unemployment resulting the transition to jobs; including those out of education, leaving a job, and entering a job. Given by:
Where all available labour resources are in the most efficient practices and only voluntary unemployment exists.
A trading strategy exercised to great success by Warren Buffet, it is the use of economic and financial information to determine the intrinsic value of the security or currency.
Known as futures, is the same as a forward contract but trades on the exchange.
A theoretical, behavioural framework where an individual makes a choice and their strategy is observed. E.g. the prisoners dilemma.
The rate of change in delta from a 1 point move in the underlying asset’s price. A volatile option price means that the option is priced closer to the underlying asset, represented by a higher gamma.
A statistical measure of economic inequality. The coefficient is derived from the Lorenz Curve, perfect equality=0 and inequality=1.
The process of removing barriers to trade, capital, information and labour, removing deadweight loss from society.
Where the government only borrows to finance spending for future generations (i.e. invest) and taxation covers existing spending.
Gross Domestic Product
GDP for short, the total output of finished goods/services in the economy, where AD=AS. Typically, the growth trend for GDP is 2% pa.
A stock which is expected to achieve a high alpha and significantly beat the market, such as the S&P500.
An individual who guarantees to pay off a borrowers debts if they default.
The percentage difference between the market value of assets and the value used as collateral for a loan. Haircut can also means the spread.
When consumers have a positive experience with a certain good and then favour other goods from the same company. E.g. iPhone then Mac.
Head and Shoulders Pattern
A strategy implemented in finance to mitigate risk. The asset used to hedge has a negative correlation to offset any downside movement. E.g. Gold.
When the standard errors of a variable are not constant over time, breaking the assumption held for a linear regression (E.g. CAPM).
The movement of capital into a currency as investors try to capitalise on a higher (relative) rate of interest.
Human Development Index
HDI for short, a measure of a country’s social and economic development, comprised of years of schooling, expected years of schooling, life expectancy, and gross national income per capita.
A statistical method of testing an assumption randomly on a population parameter. The analyst accepts/rejects the null hypothesis.
Also known as systematic or specific risk, is the risk associated with the individual asset or industry.
The opposite to liquidity, when an asset is difficult to change back into cash without a loss in value. For example, a company which is struggling to meet their debt obligations is illiquid. Typically, it can be hard to find a buyer of an illiquid asset; to compensate for illiquidity, a liquidity premium is attached.
It is the opportunity cost which occurs from investing resources into a project and forgoing the ability to earn money off the resource elsewhere. For example, a new employee requires 5 hours training from their manager a day, the Implicit Cost = 5 (Manager’s Hours Lost) x Manager’s Hourly Pay.
A change in demand for a good depends on the change in their real income, either the price of a staple good changes or pay changes.
Income Elasticity of Demand
When there is a high concertation of income towards the end of the income distribution, reflected by a high gini coefficient.
Used in microeconomics, an Indifference Curve (IC) curve illustrates the combination of two goods, x and y, which give an individual the same utility. The curve is convex to the origin and curves don not intersect, the slope is given by: where MRS is the Marginal Rate of Substitution and MU is the marginal utility.
A tax which is passed onto the consumer by the supplier and then paid to the government. E.g. Sugar tax in the UK or VAT.
The transformation of an economy from producing primarily agricultural goods to manufacturing of goods. E.g. UK Industrial Revolution.
The quantity demanded of an inferior good has an inverse relationship with an individual’s income. E.g. canned goods and McDonalds.
A measure of the rate of change in the average price level of a basket of goods and services. Governments aim for an inflation rate of 2% per annum.
When an individual buys or sells a publicly traded share after obtaining non-public, asymmetric information.
A contract where an individual or business pays a premium to an insurer in return for financial cover against losses.
Intangible assets (not physical) which legally protects a companies activities from being stolen e.g. patents and trading secrets.
Where a decision by one firm affects another. They are not mutually exclusive.
International Monetary Fund
IMF for short, an international organisation promoting trade, economic growth, financial stability, and reducing poverty.
Inverted Head and Shoulders
Inverted Yield Curve
An economic theory constructed by Adam Smith which is a metaphor for hidden forces, the incentives mechanism, drive the free market.
When a currency depreciates, the BoP initially worsens because the price of foreign imports are more costly and domestic exports are cheaper. Then, the BoP improves as consumers increase demand for the cheaper domestic exports and reduce demand for the more expensive foreign imports. The BoP moves overtime like the letter J, a deficit initially and then a surplus as consumers switch to domestic exports.
A seasonal increase in stock prices because investors sell off in December for capital gains taxes, the buy in January using year-end cash bonuses. The S&P500 has risen in January 56 times in the last 91 years.
A product which generates two or more outputs. For example, cows milk and beef, if rise in D for beef, rise in S of cows, fall in P of milk.
A borrower with a high risk of default pays a higher premium to compensate. Note, a junk bond has a credit rating below BB.
A theory derived by John Maynard Keynes; a government can dampen cyclical effects with spending/taxation and interest rates.
An economy with supply and demand based on intellectual property, typically a country with core activities in the services sector.
On the macroeconomic level, the labour supply (those employed or actively seeking employment) and employer demand form an equilibrium wage.
At the microeconomic level, we observe the backward bending supply curve; wages increase as the hours worked increase, up to a point where they value an hour of leisure over the wage for an hour. The curve bends backwards because the individual has reached their target income. Employers at the microeconomic level, demand up to the point where value marginal product of labour (value of output from hiring an additional worker) equals the wage or marginal cost.
Measures the hourly output per unit of labour. Given by: Growth in productivity depends on the saving and investment in physical capital, technology and human capital.
A macroeconomic theory stating as the taxation rate increases, total revenue increases up to an optimal point. If the taxation rate increases beyond the optimal point, total revenue falls because there is less incentive to work or invest.
The French translation for “leave alone”, promotes a free market with no government intervention.
Law of Demand
A fundamental concept in economics; there is an inverse relationship between the price and quantity demanded because there is a diminishing marginal utility from receiving an extra good. Hence, the demand curve is downwards sloping.
Law of Diminishing Returns
Each additional increase in a factor of production results in a smaller additional increase in output if other factors of production are held fixed. E.g. overcrowding in manufacturing.
Law of One Price
The theory that the arbitrage opportunity eliminates differences in the price of the same economic good in different markets.
Law of Supply
A fundamental law which states that as prices rise, supply rises because profit motivated producers plough resources into supplying that good. Hence the supply curve is upwards sloping.
The short-term interest rate which credible, highly rated banks lend to each other, typically less than a year.
The growth in sales revenues generated from similar/same activities as previous periods. I.e. excludes the effects of expansion.
The upper price that takes an investor out of the trade. It is the profit that the investor is aiming for when they enter the trade.
The legal structure where if a company fails, then the investor only loses the amount invested. I.e. further private assets are not seized.
Line Of Best Fit
A line through a scatter plot of data points which minimises the residual sum of squares, describing the relationship of two variables.
The ability to buy or sell an investment in the market at price reflecting it’s intrinsic value; or ease of converting the investment to cash.
When the demand for cash rises but there is a lack of available cash across financial institutions, causing defaults and bankruptcies.
An income inequality curve showing the cumulative income distribution on the y-axis and the population percentile on the x-axis.
A good which isn’t a necessity but highly-desired, and witnesses an increase in the quantity demand as incomes increase e.g. Rolex and Ferrari.
Where the investor pays only a percentage of assets underlying value and borrows the rest from the brokerage firm.
MR for short, it is the change in total revenue (TR) from the sale of one additional unit (Q). Given by the formula: The marginal revenue curve is a linear downwards sloping curve with a gradient twice as steep as the demand curve.
The extra utility that an individual receives from consuming one additional unit of a good/service.
The total market value of a firm, equal to the no. of outstanding shares x price per share. Used to compare the size of firms.
More friendly than an acquisition, when two generally competing companies of similar value, e.g. market share and size, decide it would be beneficial for both parties to join together and form one company.
Studying individuals and firms rather than the whole economy, investigating their decisions and choices to maximise their utility.
A government-imposed, national wage which is the lowest wage per hour any employer can legally pay. It is an artificial wage floor; it can create involuntary unemployment if above the market clearing wage (D and S equilibrium).
An industry with many competitors and low barriers to entry but goods are similar not homogenous (degree of price making).
An individual or firm which holds the entire market share for a good/service, giving them market making power (set any price).
A situation in markets where there is just one buyer, giving them bargaining power. Typically, monopsonies are found where there is just one hirer, allowing them to set wages.
When a party has incentives to take risks or shirk because they do not suffer the consequences. E.g. government projects and 2008 banks.
A debt instrument where the real estate or property is used as collateral and the borrower pays back the mortgage through set instalments with either a fixed or floating interest rate.
Mortgage Backed Security
Moving Average Convergence Divergence
It is the proportional increase in income from an increase in spending. Given by:
Where events are independent, i.e. one does not have an effect on the other.
A theory derived from John Nash where every participant has optimised their outcome given other participants expected outcome.
Where a government seizes control of a business, typically for a discounted price, to correct market failure (e.g. monopolies) or to prevent takeover from foreign ownership.
Natural Unemployment Rate
NUR for short, the natural rate of unemployment which exists due to the labour force structure and market rigidities.
A good with a negative third party impact when consumed (produced). The marginal social benefit (cost) is lower (higher) than the marginal private benefit (cost), therefore the good is overconsumed (overproduced) in a free market. E.g. cigarettes and alcohol, corrected by high taxes.
Negative Interest Rate
Uncertainty is so high that an individual or investor is willing to incur a charge to hold their money in the banks. Typically, negative interest rates are observed during a period of deflation and governments try to incentivise banks to lend money freely.
Net Asset Value
NAV for short, is the net value of the entity. Given by:
A liquidity measure, the position of the company if they were asked to pay off all their debts immediately. Given by:
Neutrality of Money
Non-Accelerating Inflation Rate of Unemployment
A measure of new payrolls added by private and government organisations in the US i.e. excludes hiring in agriculture.
NPO for short, a business which is exempt from taxes because they have a social impact and a positive externality. E.g. hospitals, universities, charities and churches.
A natural substance which is irreplaceable or finite given the speed at which it is consumed. E.g. oil, gas and coal.
A bell shaped curve showing a symmetric, probability distribution around the mean. The curve shows the probability that the mean moves by a certain number of standard deviations (σ), for a normal distribution 2σ=95%. The null hypothesis is typically tested at the 5% significance level in hypothesis testing; if the mean lies outside of 2σ and -2σ, reject the null hypothesis in favour of the alternative hypothesis.
A good or service which witnesses an increase in quantity demanded due to an increase in consumer income and vice versa.
Where value judgements, opinions, and statements are used in economics. E.g. public policy, global development goals etc.
Occupational Labour Mobility
The ease of switching careers in the labour market. If labour mobility is high, productivity and growth rises with allocative efficiency.
Okun investigated the negative relationship between the unemployment rate and Gross National Product (a similar indicator to GDP but GNP takes into account income receipts from abroad), finding a 1% fall causes a 3% rise respectively. However, this finding only applies to the US and when the unemployment rate is between 3% and 7.5%.
A market structure similar to that of a monopoly, however, there are two or more firms which are interdependent. The firms collude explicitly (formally make a deal) or tacitly (firms know undercutting is the dominant strategy but it just leads to a retaliation so agree unofficially not to undercut which is the best response), achieving abnormal returns like a monopoly. E.g. OPEC.
Similar structure to an oligopoly but in this market there are only a few buyers for a good or service. E.g. U.S. fast-food industry buying meat.
On Balance Volume
Activities referring to a company’s core functions; the provision of a good/service. E.g. production, distribution, sales and marketing.
It is the economic cost forgone on the next best alternative when an agent invests an economic resource.
Optimal Currency Area
OCA for short, a geographic region or bloc of countries where a single currency provides a higher economic benefit. E.g. the euro.
Organisation of the Petroleum Exporting Countries
OPEC for short, a cartel including 14 of the world’s major oil-exporting countries. The oil output of each country is set to limit the supply and achieve a monopoly price. However, the market has been flooded by the US and fracking which has reduced OPEC’s market share.
Where a company switches away from producing a good/service and sources the good/service from a cheaper producer.
A market structure where a buyers and sellers of assets interact directly (electronically) without a broker or central exchange.
Where too many variables are included a model capturing some of the residual variation.
The ongoing costs in a business which excludes direct costs, costs associated with the production of the good/service. E.g. rent and insurance.
When a portfolio or fund holds a higher percent of a certain asset compared to the index or benchmark.
Paradox of Savings
A legal document granting ownership or property right to an inventor.
When all buyers and sellers have instantaneous, perfect knowledge of the market price, utility and cost.
A strategy employed by producers, ensuring their good/service expires before a certain date. Consumers will then replace the good/service increasing future demand. E.g. light bulbs and apple iPhone batteries.
Or command economy is where a government decides what goods/services are produced, and how they are distributed.
The use of data or facts to draw conclusions and predictions. Positive economics can actually be tested, unlike normative economics.
Individual’s whose income level is so low that they are unable to meet their basic necessities.
Where those in poverty are unable to escape poverty due to the economic system. E.g. poor education/health or no capital markets access.
When a firm ‘illegally’ (difficult to prosecute) lowers the price to drive out other competitors and increase their market share.
Firms can maximise their profits by selling the same product to consumers for a different price. There are three degrees of discrimination; first-degree is charging the maximum price the consumer is willing to pay (e.g. market stalls), second-degree is offering discounts for buying in bulk, and third-degree is charging a different price to different groups of consumers (e.g. discounted train tickets for under 16’s and +65’s).
The formula is given by: The P/E ratio is used by investors to estimate the relative value of a firm. Both forward and trailing P/E’s are used by investors. Typically, shares have an average P/E of roughly 20-30.
Price Elasticity of Demand
PED for short, given by:
– The good is inelastic if PED<1
– The good is elastic if PED>/=1
– Perfectly inelastic=0 and elastic=ꝏ
Occurs when there is a conflict of interest between the individual owning the asset (agent) and the individual controlling the asset (principal). E.g. shareholders care about constant, stable returns and a CEO cares about high bonuses (not risk as no consequences, moral hazard).
A well known example of game theory whereby two un-convicted prisoners are separated (no communication). The investigators present four deals:
– The best response is (Deny, Deny)
– There are multiple nash equilibria: given 2 denies, 1 denies and given 2 confesses, 1 confesses.
– The consequences of denying and the other prisoner confessing is too great-> (Confess, Confess) is the dominant strategy
Private Limited Company
opposite to nationalisation, it is the process of taking a government-owned company/operation/property private. Note, corporate privatisation is taking a publicly-owned company private.
The difference between the price a producer receives for supplying a good and the price they are willing to supply a good at.
Production Possibility Frontier
PPF for short, a concave curve showing the combination of output for two goods with a fixed input/resource.
A tax which increases in percentage as income increases, typically the case in most countries with income tax.
A tax where each individual pays the same percentage of income.
Firms or banks that directly invest their own money into assets, rather than investing clients funds and receiving a commission.
Or loss aversion theory, assumes that losses are valued differently to gains. If there are two equal choices, an individual will chose the option in terms of potential gains rather than the option in terms of potential losses.
A good which exhibits non rivalrous (not limited in supply) and non-excludable (available to everyone) characteristics. E.g. Sewers and parks. Note these characteristics do lead to the free-rider problem.
Public Limited Company
Plc for short, a limited liability company which has publicly listed shares on the stock market.
Purchasing Managers’ Index
PMI for short, an economic indicator which surveys private firms on factors like production, new orders, employment, supplier deliveries, and inventories. These are given a weight to the index which is calculated by:where P1 is the % reporting an improvement, P2 is the % reporting no change, and P3 is the % reporting a decline.
The amount of goods/services that one unit of currency can buy at a specific time.
The option buyer pays a premium to a seller, giving the buyer the option to sell an asset at a strike (pre-determined) price before a specific time period. If the option is not exercised then the option buyer pays the premium to the seller. A put buyer (seller) makes profits when the underlying asset price falls (rises).
The use of subjective judgement not based on numbers like quantitative analysis. E.g. employee’s happiness and firm’s values.
The use of mathematical and statistical data which is justifiable. E.g. financials and macroeconomic indicators.
Quantity Theory of Money
A theory derived by Irving Fisher which states that there is a proportional relationship between the money supply and the average price level or inflation. Given by this formula:where M is the money supply, V is the velocity of money (fixed), P is inflation, and T is the volume of transactions (fixed).
A government imposed limit on the number or total monetary value of goods which can be imported or exported, typically to protect domestic firms.
Random Walk Theory
The idea that past stock prices aren’t a gauge for future prices because stocks are independent and have the same distribution. I.e. stocks prices walk a random, unpredictable path.
Rational Expectation Theory
A variable which is adjusted for inflation, giving a more precise figure.
A tax which decreases in percentage as income increases. E.g. ad valorem tax is uniform but lower income earners pay more relatively.
When a regulator becomes invested in the firm and their interests rather than the interests of the public.
Relative Strength Index
A resource for which there is infinite supply because it is naturally replace. E.g. wind, solar, tidal and geothermal.
Repo for short, typically overnight, borrowing rate for US investor. I.e. an investor sells a US treasury in return for capital and then buys the US treasury back the next day.
Research and Development
When a firm re-invests profits to produce new, innovative goods and services.
Residual Sum of Squares
A statistical technique measuring the variance which is not explained by a regression model (residuals). Given by the formula:where yt is the observed value and y^ is the predicted value of y given x (the regression).
Where a rising asset price experiences downward pressure because there are a higher number of sellers shorting the asset at that price.
Retail Price Index
A theory developed by David Ricardo stating that higher government spending financed by debt will fail because consumers will save for higher expected taxes in the future rather than spend.
An intraday trading strategy where investors use candlestick charts and the MACD indicator to look for minor price changes in a stock.
Security Market Line
SML for short (used in the CAPM model), plots the market return and risk (the Beta). It is used to determine whether an individual asset is overvalued/undervalued depending if the asset is below/above the SML line.
Serial Serial Correlation
When a trader sells an asset (typically borrowed paying a fee/premium) in anticipation of a fall in price (with plans to buy it back later).
When a normal distribution or bell-curve is asymmetric, skewed positively/negatively to the right/left.
The difference between the expected price of a trade and the actual execution price. Slippage occurs during times of high spread due to high volatility and high orders, and also when there is low volume so a lack of demand for the asset.
Combining the benefits of passive management and the benefits of active management, such as value investing and portfolio diversification.
It is the capital attributed to institutional investors who have asymmetric or greater information. E.g. central banks and hedge funds.
The difference between two prices, rates or yield. Typically, the spread is the gap between the bid and the ask price of an asset.
A statistical measurement of the dispersion of a dataset from its mean. It is the square root of the variance.
Standard of Living
The level of wealth, comfort, and material well being of an average person in a given population, typically measure by GDP or GNP per Capita.
Forecasting the probability of various outcomes under different scenarios using random variables. E.g. Monte Carlo simulation.
Persistent unemployment which remains in the economy due to structural factors such as technology, geography, labour immobility and government policy.
A benefit given to an entity, typically by the government, in the form of a grant or a cut in taxes. Usually, subsidies are used to correct market failures such as undersupplied goods with a positive externality.
Where a falling asset price experiences upwards pressure because there are a higher number of buyers longing the asset at that price.
A short-term (a few days to weeks) technical strategy which uses trends, patterns, and buy/sell signals from the MACD.
It is the risk to the entire market which is difficult to diversify against. E.g. 2008 financial crisis which caused a mass sell off in all shares.
A less friendly acquisition, whereby the target doesn’t agree with the deal but the acquirer forces the deal by buying a large enough stake.
An econometric method of analysing how an asset or variable changes over time.
Too Big to Fail
These firms play a fundamental role in the economy. If the firm is failing, a government must intervene because the spillover effect would be disastrous on the economy. The government performs a cost-benefit analysis; weighing the cost of bailout against the economic cost of failure.
Tragedy Of the Commons
An economic problem where every individual has an incentive to consume a resource at the expense of other individuals. The resource must be scarce, rivalrous, and non-excludable. E.g. overfishing. Solutions include imposing private property rights and government regulation, e.g. a fishing quota.
Trickle Down Effect
A pro-capitalist theory stating that tax breaks and benefits for the richest individuals and businesses in society trickle down to the rest of society. The argument for this theory is that everyone benefits from growth which is most likely to come from the richest in society.
Uncovered Interest Rate Parity
UIP for short, theory which states that changes in the interest rate will equal changes in the relative foreign exchange. Given by the formula: where F0 is the forward rate, S0 is the spot rate, iA is the interest rate in country A, and iB is the interest rate in country B. UIP is taken as an assumption in some macroeconomic models.
When an investor writes an option without holding that position in the underlying asset.
Where not enough variables are included a model creating a bias.
When a portfolio or fund holds a lower percent of a certain asset compared to the index or benchmark.
The share of the labour force not employed but actively seeking work:
A horizontal probability distribution where every outcome has the same probability of being chosen. E.g. a six sided dice or a coin.
Unilateral Trade Agreements
A change in trade restrictions which applies to every country they trade with.
Benefits decrease incrementally as the hours worked increases, unlike the lump-sum benefits system. Universal credit incentivises individuals to increase their hours worked, overcoming the poverty trap. Universal credit began rolling out in 2016 and has faced much criticism with many individuals witnessing a sharp fall in benefits payments.
The legal structure where if a company fails, then the investors assume all the business debts, leading to the seizure of private assets.
Risk only observed in a specific type of industry or company and, unlike systematic risk, it can be diversified against.
Where all assets are given equal weight, therefore, a fall/rise in one stock will not have a significant impact on the whole index.
A theory which promotes actions which increase happiness or pleasure and rejects actions causing unhappiness or harm.
Central to microeconomic theory, it is the total satisfaction received by an individual from consuming a good or service.
VAT for short (an example of an indirect tax), it is a uniform consumption or sales tax which is placed on a good whenever value is added.
A cost which increases as output increases, typically inputs to make the good/service such as raw materials, packaging etc.
A statistical measurement of how far a variable deviates from the mean. Calculated by:where N is the number of observations, xi is the observed value of the item, and x ̅ is the mean value of the observations.
A rare case which defies the law of demand, as demand increases as price increases because the good has a status symbol. E.g. bugatti veyron.
The number of shares bought and sold for an asset in a specific period of time.
A legal contract signed by either party which forfeits the ability to hold another party liable. E.g. signing an injury/death waiver before a skydive.
Investors create a list of assets to monitor their movement or trade at a certain price.
A behavioural theory stating that as the value of individual’s assets increase (e.g. housing or portfolio), an individual’s spending increases.
When the trends of the highs and lows begin to converge, it is typically a flag to investors that there will be a price reversal.
Where all assets are given a different weight depending on price (e.g. Dow Jones) or market capitalisation (e.g. S&P500). Therefore, a fall/rise in one stock has a significant impact on the whole index.
An international organisation which provides research, advice and finance to help developing countries.
World Trade Organisation
WTO for short, an international organisation which monitors trade between nations and advocates free trade/globalization.
A firm actually operates above their predicted average cost curve in practice, due to a lack of competitive pressure.
Plots the yield (interest rate or coupon rate) on the y-axis and maturity on the x-axis. Typically, we observe upward sloping yield curves because higher maturity bonds have a greater risk of default, so investors are compensated with a higher yield. Flat and inverted yield curves signal concerns over future economic growth and interest rate cuts.
Zero-Bound Interest Rate
A macroeconomic theory stating that interest rates below 0% will not stimulate economic growth, a theory which has been upended recently.