SESSION 19 GLOSSARY

1901
Accounting Rate of Return (ARR) the average annual operating profit generated by a project
Agency Costs the reduction in shareholders returns below the maximum possible level due
to company managers following personal objectives not in the best interests of shareholders
Alpha a measure of abnormal return from a security i.e. where the forecast return is higher
or lower than expected by CAPM
Asymmetry of information the fact that potential investors know less about a company than
its managers and may therefore over-estimate the risk of providing finance. This can be a
particular problem for SMEs
Basis risk the risk that interest rates on assets and liabilities are referenced to a different
benchmark
Beta factors a measure of the sensitivity of a securitys returns to systematic risk
Bird in the Hand theory suggest that shareholders may prefer the certainty of a cash
dividend today rather than reinvestment of profits to create an uncertain capital gain in the
future
Bonus issue issue of new shares to existing shareholders, without any subscription of new
funds. Also referred to as a scrip issue
Business Risk the volatility of operating profits, caused by the volatility of revenues and the
level of operational gearing
CAPM Capital Asset Pricing Model. A model that relates the systematic risk of an
investment to the required return
Cap an agreement that fixes a maximum rate of interest
Capital Rationing where insufficient finance is available to undertake all available positive
NPV projects
Cash conversion cycle time period between paying suppliers and receiving cash from
customers. Also known as the cash operating cycle or working capital cycle
Certificate of deposit a tradable security issued by banks to investors who deposit a fixed
amount for a fixed period
Clientele Theory suggest that a companys historical dividend pattern may have attracted
particular investors. Changing the pattern in future may cause this clientele to sell their
holdings and lead to a fall in share price
Collar an agreement that keeps either a borrowing or lending rate between specified upper
and lower limits
Convertible debt debt that can, at the option of the investor, be either redeemed or converted
into ordinary shares
Conversion premium market value of convertible debt minus current conversion value
SESSION 19 GLOSSARY
1902
Corporate governance controls and procedures implemented to reduce agency costs to an
acceptable level
Corporate Social Responsibility (CSR) a model which suggests that company managers
should take into account the objectives of a wide range of stakeholders and not just the
shareholders
Dividend Valuation Model states that the value of a share is the present value of future
expected dividends, discounted at the investors required return
Economic risk the risk that long-term changes in exchange rates affects a companys
profitability
Efficient Markets Hypothesis (EHM) a theory which asks what information is reflected in
share prices
Environmental Management Accounting (EMA) attempts to measure the full environmental
impact of a companys operations e.g. the cost of inefficient energy usage due to poor
insulation of buildings
Financial gearing the proportion of debt in the capital structure
Financial risk the increased volatility of returns to ordinary shareholders due to interest on
debt being a fixed committed cost
Financial distress risk the risk of bankruptcy caused by dangerously high levels of financial
gearing
Floor an agreement that fixes a minimum rate of interest
Floor value the value of convertible debt assuming that it will be redeemed rather than
converted
Forward contract a legally binding contract between a company and a bank to buy or sell a
fixed amount of foreign currency at a fixed exchange rate on a fixed date in the future
Forward Rate Agreements contracts which allow companies in advance to fix future
borrowing or lending rates, based on a notional principal over a given period.
Futures contract a traded forward contract
Gap exposure the risk that interest rates on assets and liabilities are reset at different
intervals
Gordons growth model states that the forecast growth rate of a companys dividend =
proportion of profits retained return on equity
Gross Redemption Yield see Yield to Maturity
IRR Internal Rate of Return; the discount rate where NPV equals zero
NPV Net Present Value; the change in shareholders wealth due to an investment project
SESSION 19 GLOSSARY
1903
Operational gearing the proportion of fixed operating costs to variable operating costs
Payback the period of time required for the operating cash flows from a project to equal the
cost of investment
Pecking Order theory a theory which suggests that company managers have a preference for
using internal finance i.e. retained earnings, rather than external finance. A key cause may
be asymmetry of information
Pre-emptive rights the right of existing shareholders to be offered new shares before they
can be offered to new investors. Also known as pre-emption rights
Rights Issue an offer of new shares to existing shareholders who hold pre-emptive rights
Scrip dividend issue of new shares to existing shareholders in lieu of a cash dividend
Scrip Issue see bonus issue
Securities financial instruments that can be traded e.g. shares, bonds and derivatives.
SMEs Small and Medium-sized Enterprises. No official definition exists but generally
these are unlisted companies
Special dividend a substantial dividend payment that is not expected to be repeated in the
near future
Stakeholders groups of people who have some type of interest in an organization.
Shareholders are the key stakeholder but other groups include employees, customers,
suppliers and, arguably, even society as a whole.
Systematic risk the relative effect on the returns of an individual security of changes in the
market as a whole. Also known as market risk. It cannot be removed by diversification but
can be measured using beta factors
Tax Shield interest on debt is a tax allowable expense for a company and leads to lower
corporate tax payments
Term Structure of Interest Rates the relationship between short and long term interest rates
Total Shareholder Returns (TSR) the total return to shareholders via dividend and capital
gain, usually measured over a one year period
Transaction Risk the risk that exchange rates change between the date of an import/export
and the related payment/receipt of foreign currency
Translation risk gains/losses caused by translating the financial statements of overseas
subsidiaries into the reporting currency of the parent upon consolidation
Treasury Bills virtually risk-free short-dated debt securities issued by governments
Unsystematic risk the risk that is specific to a company and hence can be diversified away
by building a portfolio of investments
SESSION 19 GLOSSARY
1904
WACC Weighted Average Cost of Capital; the average cost of long-term finance
Warrants share options attached to debt to make the debt more attractive to investors
Yield to Maturity (YTM) the average annualized return on a debt security, taking into
account both income and capital gains