Finance is an industry that is notorious for is jargon. I’ve had lots of request from my readers to create a post that gives definition for all these complicated words I use on the blog. I will update this post periodically with more words as requests from my readers come.
Adjustable-Rate Mortgage (ARM): A mortgage whose interest rate is adjusted periodically based on some underlying interest. In the states, this is typically the 3-month LIBOR.
Amortization: The procedure through which an individual pays off debt through time via regular scheduled payments. Car loans and mortgages are two examples of amortizing loans.
Amortizing Loan: A loan that is paid off through the process of amortization.
Amortization Schedule: A schedule that details each of the periodic payments on an amortizing loan (for example, a mortgage) along with how much of each payment is going to each of both principle and interest.
APR: Stands for Annual Percentage Rate, and it’s exactly what it sounds like – the annual interest rate on a loan. For some reason this is really common terminology when discussing car loans in particular. You will often see advertisements for financing at car dealerships that show “0% APR”.
Asset Allocation: A breakdown of how much of your net worth is in each asset class, typically expressed in percentages. Asset allocation can be high level (i.e. 30% bonds, 30% stocks, 30% real estate, 10% cash) or it can be much more granular (i.e.5% financial bonds, 5% energy bonds…)
Assets Under Management (AUM): The aggregates market value of all financial assets held in an investment fund. This includes cash and cash equivalents.
Bankruptcy: Bankruptcy is a legal process designed to help an unfortunate debtor gain relief from their obligations while also giving fair treatment to the lender.
Bear Market: A market in which there are more sellers than buyers, which causes the price of assets to fall. Alternatively you could say there is more supply than demand.
Bond: A bond is a contract between an issuing entity (typically a government or a corporation) and a lender/investor where the lender gives the issuer a predetermined amount of money (called the principal) for a fixed term and in return receives interest payments (also called coupon payments) until the maturity of the bond. At maturity, the lender receives the principal along with a final coupon payment. I’ve written a post dedicated to bonds called Bonds for the Beginner.
Bull Market: A market in which there are more buyers than sellers, which causes the price of assets to rise. Alternatively you could say there is more demand than supply, causes buyers to outbid one another.
Capital Gains: Income earned as a result of selling something for more than you purchased it for. For example, buying a house for $200,000 and selling it for $250,000 two years later means that you’ve incurred a $50,000 capital gain. Capital gains are subjected to more favorable tax treatment than normal income.
Capital Losses: The action of selling a security for less than you purchased it for. A capital loss is the direct opposite of a capital gain.
Credit Report: A detailed report of an individual’s borrowing history. The credit report is used to create a credit score.
Credit Score: A numerical score used to assess the creditworthiness of an individual or entity. For individuals, credit scores are described using numbers, and for corporations or governments, credit scores are described using letters (with AAA being the highest).
Credit Utilization: The amount of outstanding credit that is currently being used by an individual. Credit utilization is one of the factors that effects your credit score – understandably, lenders don’t like to lend more money to someone who is constantly close to their borrowing limits.
Derivative: A contract between two parties whose value is based on some underlying financial instrument. Examples of derivatives include stock options and oil futures.
Dilution: The process of the reduction in partial ownership of each share of company stock due to the company issuing more stock. For example if a company has 100 shares outstanding, each share represents a 1% ownership in the company. If the company issues an additional 50 shares to rasie capital, then the partial ownership of each share is reduced to 0.67%.
Diversification: The process of investing in a way that reduces exposure to any single asset or asset class to reduce overall risk.
Dividend: The payment of a company’s earnings directly through the shareholders. Dividends are decided by the company’s board of directors and are typically issued in either cash or additional stock.
Dollar-Cost Averaging: The technique of investing a fixed amount of money on a regular basis, regardless of the price of the underlying investment. More shares are bought at low prices and less shares are bought at high prices.
Earnings: The amount of profit earned by a company over a specified time period, typically a fiscal quarter (three months).
Executive Compensation: The pay awarded to the executives (particularly C-suite) of a company. This is highly controversial because of it’s contribution to the income inequality in the world, and often debated by shareholders.
Expense Ratio: See Management Expense Ratio.
Index: An indicator of something. Typically in finance we are talking about a stock market index, which is an indicator of the value of the stock market (or a subset of it). Examples of stock market indices include the American S&P 500 Index or the Canadian S&P/TSX Composite Index.
Index Fund: A type of investment fund that is designed to trade the components of some underlying index, known as the benchmark. Index funds are favorable because they have much lower fees than funds that seek to outperform the index.
Inflation: The gradual rise in the price of goods over time. Alternatively, inflation is the gradual reduction in purchasing power over time.
Liquidity: The degree to which an asset can be quickly bought or sold without affecting it’s price.
Management Expense Ratio: The percentage of a fund’s Assets Under Management (AUM) that is paid in fees on an annualized basis. Calculated by dividing the funds expenses by the fund’s total AUM.
Margin Account: A brokerage account in which investors are permitted to borrow money to buy securities.
Monetary Authority: The entity which controls the money supply in a given currency, typically with the goal of manipulating either inflation or market interest rates. In Canada, the monetary authority is the Bank of Canada. In the US, the monetary authority is the Federal Reserve.
Monetary Policy: The techniques used by a monetary authority (such as the Bank of Canada or the Federal Reserve) to control the supply of money in a given currency, typically with the goal of manipulating either inflation or market interest rates.
Mutual Fund: An investment vehicle that allows many investors to pool their money to be invested in diversified holdings and managed by professionals.
Net Worth: A measure of someone’s individual wealth that is calculate by adding up all assets and subtracting all liabilities.
Price-to-Earnings Ratio: A popular method for valuing companies. The PE Ratio is calculated by dividing per-share stock price by per-share earnings. A high PE Ratio may indicate an overvalued company, and a low PE Ratio may indicate a company that is trading below fair value.
Prime Rate: The lowest rate of interest that money may be lent to a company commercially.
Profit Margin: The amount (in %) by which the revenue of a company exceeds the cost of doing business.
Rebalancing: The process of buying and selling securities periodically to reset your portfolio to it’s intended asset allocation.
Return on Equity (ROE): A measure of company profitability that is calculated by dividing the total profit generated by a company by the total amount of shareholder’s equity.
S&P 500 Index: An American stock market index based on the 500 largest companies listed on the New York Stock Exchange (NYSE) or the NASDAQ Stock Exchange.
Share: A single unit of company stock.
Shareholder: An individual who owns a company’s stock.
Stock: Representation of a partial ownership in the issuing corporation. Stocks derive their value because the stock’s owner has a claim on both the corporation’s assets and future earnings. A single stock is often called a share, and the owner of stock is called a shareholder.
Stock Options: A contract that gives the purchaser the right (but not the obligation) to buy or sell a specificied amount of stock for a specified price (the strike price) on or before a specified date (the maturity date).
Tax: A compulsory contribution to government revenue, typically expressed as a percentage of an individual’s income.
Tax-Deferred: Income where tax is not paid now, but paid later. A typical form of tax-deffered income is contributions to RRSPs.
Tax-Free Savings Account (TFSA): A special type of account where any investment gains made inside the account are non-taxable. TFSAs can hold stocks, bonds, mutual funds, ETFs, GICs, and any other type of eligible investment.
Tax Loss Harvesting: Offsetting capital gains with capital losses to reduce the money you pay to capital gains tax.