The layman’s glossary on financial crisis
The current financial crisis has thrown terminology from the business pages onto the front page of newspapers, with jargon now abounding everywhere from the watercooler to the back of a taxi.
Here is a guide to many of the business terms currently cropping up regularly, as well as some of the more exotic words coined to describe some of the social effects of the credit crunch.
The best credit rating that can be given to a corporation’s bonds, effectively indicating that the risk of default is negligible.
A rescue mechanism for UK companies in severe trouble. It allows them to continue as a going concern, under supervision, effectively to try to trade out of difficulty.
A firm in administration cannot be wound up without permission from a court.
Things that have earning power or some other value to their owner.
Fixed assets (also known as long-term assets) are things that have a useful life of more than one year, for example buildings and machinery; there are also intangible fixed assets, like the good reputation of a company or brand.
Current assets are the things that can easily be turned into cash and are expected to be sold or used up in the near future.
In a bear market, prices are falling and investors, anticipating losses, tend to sell. This can create a self-sustaining downward spiral.
A debt security – or more simply an IOU. The bond states when a loan must be repaid and what interest the borrower (issuer) must pay to the holder. Banks and investors buy and trade bonds.
A bull market is one in which prices are generally rising and investor confidence is high.
The wealth – cash or other assets – used to fuel the creation of more wealth. Within companies, often characterised as working capital or fixed capital.
Used of the stock markets, the point when a flurry of panic selling induces a bottoming out of prices.
Carry trade (currency)
Typically, the borrowing of currency with a low interest rate, converting it into currency with a high interest rate and then lending it. One common carry trade currency is the yen, as traders seek to benefit from Japan’s low interest rates. The element of risk is in the fluctuations in the currency market.
The term for bankruptcy protection in the US. It postpones a company’s obligations to its creditors, giving it time to reorganise its debts or sell parts of the business, for example.
Collateralised debt obligations (CDOs)
A collateralised debt obligation is a financial structure that groups individual loans, bonds or assets in a portfolio, which can then be traded.
In theory, CDOs attract a stronger credit rating than individual assets due to the risk being more diversified.
But as the performance of some assets has fallen, the value of many CDOs have also been reduced.
Unsecured, short-term loans issued by companies. The funds are typically used for working capital, rather than fixed assets such as a new building.
Commodities are products that, in their basic form, are all the same so it makes little difference from whom you buy them.
That means that they have a market price. You would be unlikely to pay more for iron ore from a particular mine, for example.
A short-term drop in stock market prices. The term comes from the notion that, when this happens, overpriced stocks are returning back to their “correct” values.
The situation created when banks hugely reduced their lending to each other because they were uncertain about how much money they had.
This in turn resulted in more expensive loans and mortgages for ordinary people.
Credit default swap
A swap designed to transfer credit risk, in effect a form of financial insurance. The buyer of the swap makes periodic payments to the seller in return for protection in the event of a default on a loan. Currency peg A commitment by a government to maintain its currency at a fixed value in relation to another currency.
Typically this is done by the government buying its own currency to force the value up, or selling its own currency to lower the value. One example of a peg was the fixing of the exchange rate of the Chinese yuan against the dollar.
Dead cat bounce
A phrase long used on trading floors to describe a short-lived recovery of share prices in a falling stock market.
The downward price movement of goods and services.
Derivatives are a way of investing in a particular product or security without having to own it. The value can depend on anything from the price of coffee to interest rates or what the weather is like.
Derivatives can be used as insurance to limit the risk of a particular investment.
Credit derivatives are based on the risk of borrowers defaulting on their loans, such as mortgages.
A payment by a company to its shareholders, usually linked to its profits.
In a business, equity is how much all of the shares put together are worth.
In a house, your equity is the amount your house is worth minus the amount of mortgage debt that is outstanding on it.
Fundamentals determine a company, currency or security’s value. A company’s fundamentals include its assets, debt, revenue, earnings and growth.
A futures contract is an agreement to buy or sell a commodity at a predetermined date and price. It could be used to hedge or to speculate on the price of the commodity.
Gross domestic product. A measure of economic activity in a country, namely of all the services and goods produced in a year. There are three main ways of calculating GDP – through output, through income and through expenditure.
A private investment fund with a large, unregulated pool of capital and very experienced investors.
Hedge funds use a range of sophisticated strategies to maximise returns – including hedging, leveraging and derivatives trading.
Making an investment to reduce the risk of price fluctuations to the value of an asset.
For example, if you owned a stock and then sold a futures contract agreeing to sell your stock on a particular date at a set price. A fall in price would not harm you – but nor would you benefit from any rise.
The upward price movement of goods and services.
Investment banks provide financial services for governments, companies or extremely rich individuals. They differ from commercial banks where you have your savings or your mortgage.
The economics of John Maynard Keynes. In modern political parlance, the belief that the state can directly stimulate demand in a stagnating economy. For instance, by borrowing money to spend on public works projects like roads, schools and hospitals.
Leveraging, or gearing, means using debt to supplement investment.
The more you borrow on top of the funds (or equity) you already have, the more highly leveraged you are.
Leveraging can maximise both gains and losses.
Deleveraging means reducing the amount you are borrowing.
London Inter Bank Offered Rate. The rate at which banks lend money to each other.
Confines an investor’s loss in a business to the amount of capital they invested. If a person invests £100,000 in a company and it goes under, they will lose only their investment and not more.
The liquidity of something is how easy it is to convert it into cash. Your current account, for example, is more liquid than your house.
If you needed to sell your house quickly to pay bills you would have drop the price substantially to get a sale.
Loans to deposit ratio
For financial institutions, the sum of their loans divided by the sum of their deposits.
Currently important because using other sources to fund lending is getting more expensive.
Recording the value of an asset on a daily basis according to current market prices.
So for a futures contract, what it would be worth if realised today rather than at the specified future date.
Global markets dealing in borrowing and lending on a short-term basis.
Monolines were set up in the 1970s to insure against the risk that a bond will default. Companies and public institutions issue bonds to raise money. If they pay a fee to a monoline to insure their debt that in turn helps to raise the credit rating of the bond which in turn means the institutions can raise the money more cheaply.
These are securities made up of mortgage debt or a collection of mortgages. Banks repackage debt from a number of mortgages which can be traded. Selling mortgages off frees up funds to lend to more homeowners. See securities.
Naked short selling
A version of short selling, illegal or restricted in some jurisdictions, where the trader does not first establish that he is able to borrow the relevant asset.
The act of bringing an industry or assets like land and property under state control.
Refers to a situation in which the value of your house is below the amount of the mortgage that still has to be paid off.
A class of shares that usually do not offer voting rights, but do offer a superior type of dividend, paid ahead of dividends to ordinary shareholders. Preference shareholders often also have superior status in the event of a liquidation.
When a company issues a statement indicating that its profits will not be as high as it had expected. Also profits warning.
Bonds are rated according to their safety from an investment standpoint – based on the ability of the company or government that has issued it to repay.
Ratings range from AAA, the safest, down to D, a company that has already defaulted.
To inject fresh money into a firm, thus reducing the debts of a company.
For example, when a government intervenes to recapitalise a bank, it might give cash in exchange for some form of guarantee, such as a stake in the company. Taxpayers can then benefit if the bank recovers.
A period of negative economic growth.
In most parts of the world a recession is technically defined as two consecutive quarters of negative economic growth – when real output falls.
In the United States, a larger number of factors are taken into account, like job creation and manufacturing activity. However, this means that a US recession can usually only be defined when it is already over.
Money not paid out as dividend and held awaiting investment in the company.
When a public company issues new shares to raise cash. The company might do this for a number or reasons – because it is running short of cash, or because it wants to make an expensive investment. By putting more shares on the market, a company dilutes the value of its existing shares.
Security lending is when one broker or dealer lends a security to another for a fee. This is the process that allows short selling.
Turning something into a security. For example, taking the debt from a number of mortgages and combining them to make a financial product which can then be traded.
Banks who buy these securities receive income when the original home-buyers make their mortgage payments.
Essentially, a contract that can be assigned a value and traded. It could be a stock, bond or mortgage debt, for example.
A technique used by investors who think the price of an asset, such as shares, currencies or oil contracts, will fall. They borrow the asset from another investor and then sell it in the relevant market.
The aim is to buy back the asset at a lower price and return it to its owner, pocketing the difference. Also shorting.
A term popularised in World War II for flashily-dressed chancers involved in black market dealings. A fictional spiv is ladies’ man Private Joe Walker in Dad’s Army.
Newspaper headline writers use “spiv” as shorthand for traders who play for high stakes.
The dreaded combination of inflation and stagnation – an economy that is not growing while prices continue to rise.
These carry a higher risk to the lender (and therefore tend to be at higher interest rates) because they are offered to people who have had financial problems or who have low or unpredictable incomes.
An exchange of securities between two parties. For example, if a firm in one country has a lower fixed interest rate and one in another country has a lower floating interest rate, an interest rate swap could be mutually beneficial.
Tier 1 capital
A calculation of the strength of a bank in terms of its capital, defined by the Basel Accords, typically comprising ordinary shares, disclosed reserves, retained earnings and some preference shares.
Debts that are very unlikely to be recovered from borrowers. Most lenders expect that some customers cannot repay; toxic debt describes a whole package of loans where it is now unlikely that it will be repaid.
When used of a rights issue, the institution pledging to purchase a certain number of shares if not bought by the public.
To unwind a deal is to reverse it – to sell something that you have previously bought, or vice versa.
When administrators are called in to a bank, they must do the unwinding before creditors can get any money back.
A document entitling the bearer to receive shares, usually at a stated price.
Reducing the book value of an asset to reflect a fall in its market value. For example, the write-down of a company’s value after a big fall in share prices.