Financial Terms Accounting rate of return (ARR)

# Definition of Accounting rate of return (ARR)

## Accounting rate of return (ARR)

A method of investment appraisal that measures
the profit generated as a percentage of the
investment â€“ see return on investment.

## accounting rate of return (ARR)

the rate of earnings obtained on the average capital investment over the life of a capital project; computed as average annual profits divided by average investment; not based on cash flow

# Related Terms:

## CARs (cumulative abnormal returns)

a measure used in academic finance articles to measure the excess returns an investor would have received over a particular time period if he or she were invested in a particular stock.
This is typically used in control and takeover studies, where stockholders are paid a premium for being taken over. Starting some time period before the takeover (often five days before the first announced bid, but sometimes a longer period), the researchers calculate the actual daily stock returns for the target firm and subtract out the expected market returns (usually calculated using the firmâ€™s beta and applying it to overall market movements during the time period under observation).
The excess actual return over the capital asset pricing model-determined expected return market is called an â€˜â€˜abnormal return.â€™â€™ The cumulation of the daily abnormal returns over the time period under observation is the CAR. The term CAR(-5, 0) means the CAR calculated from five days before the
announcement to the day of announcement. The CAR(-1, 0) is a control premium, although Mergerstat generally uses the stock price five days before announcement rather than one day before announcement as the denominator in its control premium calculation. However, the CAR for any period other than (-1, 0) is not mathematically equivalent to a control premium.

## discount rate

the rate of return on investment that would be required by a prudent investor to invest in an asset with a specific level risk. Also, a rate of return used to convert a monetary sum, payable or receivable in the future, into present value.

## Abnormal returns

Part of the return that is not due to systematic influences (market wide influences). In
other words, abnormal returns are above those predicted by the market movement alone. Related: excess
returns.

## Accelerated cost recovery system (ACRS)

Schedule of depreciation rates allowed for tax purposes.

## Accelerated depreciation

Any depreciation method that produces larger deductions for depreciation in the
early years of a project's life. Accelerated cost recovery system (ACRS), which is a depreciation schedule
allowed for tax purposes, is one such example.

## Accounting exposure

The change in the value of a firm's foreign currency denominated accounts due to a
change in exchange rates.

## Accounting earnings

Earnings of a firm as reported on its income statement.

## Accounting insolvency

Total liabilities exceed total assets. A firm with a negative net worth is insolvent on
the books.

## Accounting liquidity

The ease and quickness with which assets can be converted to cash.

## Active portfolio strategy

A strategy that uses available information and forecasting techniques to seek a
better performance than a portfolio that is simply diversified broadly. Related: passive portfolio strategy

## Adjustable rate preferred stock (ARPS)

Publicly traded issues that may be collateralized by mortgages and MBSs.

## After-tax real rate of return

Money after-tax rate of return minus the inflation rate.

## All equity rate

The discount rate that reflects only the business risks of a project and abstracts from the
effects of financing.

## Amortizing interest rate swap

Swap in which the principal or national amount rises (falls) as interest rates
rise (decline).

## Annual percentage rate (APR)

The periodic rate times the number of periods in a year. For example, a 5%
quarterly return has an APR of 20%.

## Annualized holding period return

The annual rate of return that when compounded t times, would have
given the same t-period holding return as actually occurred from period 1 to period t.

## Annuity in arrears

An annuity with a first payment on full period hence, rather than immediately.

## Arithmetic average (mean) rate of return

Arithmetic mean return.

## Arithmetic mean return

An average of the subperiod returns, calculated by summing the subperiod returns
and dividing by he number of subperiods.

## Auction rate preferred stock (ARPS)

Floating rate preferred stock, the dividend on which is adjusted every
seven weeks through a Dutch auction.

## Average accounting return

The average project earnings after taxes and depreciation divided by the average
book value of the investment during its life.

## Average rate of return (ARR)

The ratio of the average cash inflow to the amount invested.

## Average tax rate

Taxes as a fraction of income; total taxes divided by total taxable income.

## Barbell strategy

A strategy in which the maturities of the securities included in the portfolio are concentrated
at two extremes.

## BARRA's performance analysis (PERFAN)

A method developed by BarrA, a consulting firm in
Berkeley, Calif. It is commonly used by institutional investors applying performance attribution analysis to
evaluate their money managers' performances.

## Barrier options

Contracts with trigger points that, when crossed, automatically generate buying or selling of
other options. These are very exotic options.

## Base interest rate

Related: Benchmark interest rate.

Key strategies a firm intends to pursue in carrying out its business plan.

## Benchmark interest rate

Also called the base interest rate, it is the minimum interest rate investors will
demand for investing in a non-Treasury security. It is also tied to the yield to maturity offered on a
comparable-maturity Treasury security that was most recently issued ("on-the-run").

## Break-even payment rate

The prepayment rate of a MBS coupon that will produce the same CFY as that of
a predetermined benchmark MBS coupon. Used to identify for coupons higher than the benchmark coupon
the prepayment rate that will produce the same CFY as that of the benchmark coupon; and for coupons lower
than the benchmark coupon the lowest prepayment rate that will do so.

## Break-even tax rate

The tax rate at which a party to a prospective transaction is indifferent between entering
into and not entering into the transaction.

## Broker loan rate

Related: Call money rate.

## Bullet strategy

A strategy in which a portfolio is constructed so that the maturities of its securities are highly
concentrated at one point on the yield curve.

A passive investment strategy with no active buying and selling of stocks from the
time the portfolio is created until the end of the investment horizon.

## Call money rate

Also called the broker loan rate , the interest rate that banks charge brokers to finance
margin loans to investors. The broker charges the investor the call money rate plus a service charge.

## Carry

Related:net financing cost.

## Carring costs

Costs that increase with increases in the level of investment in current assets.

Book value.

## Cash and carry

Purchase of a security and simultaneous sale of a future, with the balance being financed
with a loan or repo.

## Combination strategy

A strategy in which a put and with the same strike price and expiration are either both
bought or both sold. Related: Straddle

## Conglomerate

A firm engaged in two or more unrelated businesses.

## Conglomerate merger

A merger involving two or more firms that are in unrelated businesses.

## Corporate acquisition

The acquisition of one firm by anther firm.

## Corporate bonds

Debt obligations issued by corporations.

## Corporate charter

A legal document creating a corporation.

## Corporate finance

One of the three areas of the discipline of finance. It deals with the operation of the firm
(both the investment decision and the financing decision) from that firm's point of view.

## Corporate financial management

The application of financial principals within a corporation to create and
maintain value through decision making and proper resource management.

## Corporate financial planning

Financial planning conducted by a firm that encompasses preparation of both
long- and short-term financial plans.

## Corporate processing float

The time that elapses between receipt of payment from a customer and the
depositing of the customer's check in the firm's bank account; the time required to process customer
payments.

## Corporate tax view

The argument that double (corporate and individual) taxation of equity returns makes
debt a cheaper financing method.

## Corporate taxable equivalent

rate of return required on a par bond to produce the same after-tax yield to
maturity that the premium or discount bond quoted would.

## Cost company arrangement

arrangement whereby the shareholders of a project receive output free of
charge but agree to pay all operating and financing charges of the project.

## Cost of carry

Related: Net financing cost

## Coupon rate

In bonds, notes or other fixed income securities, the stated percentage rate of interest, usually
paid twice a year.

## Covered call writing strategy

A strategy that involves writing a call option on securities that the investor
owns in his or her portfolio. See covered or hedge option strategies.

## Covered or hedge option strategies

Strategies that involve a position in an option as well as a position in the
underlying stock, designed so that one position will help offset any unfavorable price movement in the other,
including covered call writing and protective put buying. Related: naked strategies

## Crediting rate

The interest rate offered on an investment type insurance policy.

## Cross rates

The exchange rate between two currencies expressed as the ratio of two foreign exchange rates
that are both expressed in terms of a third currency.

## Crossover rate

The return at which two alternative projects have the same net present value.

## Cumulative abnormal return (CAR)

Sum of the differences between the expected return on a stock and the
actual return that comes from the release of news to the market.

## Current rate method

Under this currency translation method, all foreign currency balance-sheet and income
statement items are translated at the current exchange rate.

## Dedication strategy

Refers to multi-period cash flow matching.

## Detachable warrant

A warrant entitles the holder to buy a given number of shares of stock at a stipulated
price. A detachable warrant is one that may be sold separately from the package it may have originally been
issued with (usually a bond).

## Discount rate

The interest rate that the Federal Reserve charges a bank to borrow funds when a bank is
temporarily short of funds. Collateral is necessary to borrow, and such borrowing is quite limited because the
Fed views it as a privilege to be used to meet short-term liquidity needs, and not a device to increase earnings.

## Dividend rate

The fixed or floating rate paid on preferred stock based on par value.

## Dollar return

The return realized on a portfolio for any evaluation period, including (1) the change in market
value of the portfolio and (2) any distributions made from the portfolio during that period.

## Dollar-weighted rate of return

Also called the internal rate of return, the interest rate that will make the
present value of the cash flows from all the subperiods in the evaluation period plus the terminal market value
of the portfolio equal to the initial market value of the portfolio.

## Effective annual interest rate

An annual measure of the time value of money that fully reflects the effects of
compounding.

## Effective rate

A measure of the time value of money that fully reflects the effects of compounding.

## Equilibrium rate of interest

The interest rate that clears the market. Also called the market-clearing interest
rate.

## Ex post return

Related: Holding period return

## Exante return

The expected return of a portfolio based on the expected returns of its component assets and
their weights.

## Excess return on the market portfolio

The difference between the return on the market portfolio and the
riskless rate.

## Excess returns

Also called abnormal returns, returns in excess of those required by some asset pricing model.

## Exchange rate

The price of one country's currency expressed in another country's currency.

## Exchange Rate Mechanism (ERM)

The methodology by which members of the EMS maintain their
currency exchange rates within an agreed upon range with respect to other member countries.

## Exchange rate risk

Also called currency risk, the risk of an investment's value changing because of currency
exchange rates.

## Expected future return

The return that is expected to be earned on an asset in the future. Also called the
expected return.

## Expected return

The return expected on a risky asset based on a probability distribution for the possible rates
of return. Expected return equals some risk free rate (generally the prevailing U.S. Treasury note or bond rate)
plus a risk premium (the difference between the historic market return, based upon a well diversified index
such as the S&P500 and historic U.S. Treasury bond) multiplied by the assets beta.

## Expected return on investment

The return one can expect to earn on an investment. See: capital asset
pricing model.

## Expected return-beta relationship

Implication of the CAPM that security risk premiums will be
proportional to beta.

## Federal funds rate

This is the interest rate that banks with excess reserves at a Federal Reserve district bank
charge other banks that need overnight loans. The Fed Funds rate, as it is called, often points to the direction
of U.S. interest rates.

## Fixed-exchange rate

A country's decision to tie the value of its currency to another country's currency, gold
(or another commodity), or a basket of currencies.

## Fixed-rate loan

A loan on which the rate paid by the borrower is fixed for the life of the loan.

## Fixed-rate payer

In an interest rate swap the counterparty who pays a fixed rate, usually in exchange for a
floating-rate payment.

## Floating exchange rate

A country's decision to allow its currency value to freely change. The currency is not
constrained by central bank intervention and does not have to maintain its relationship with another currency
in a narrow band. The currency value is determined by trading in the foreign exchange market.

## Floating-rate contract

A guaranteed investment contract where the credit rating is tied to some variable
("floating") interest rate benchmark, such as a specific-maturity Treasury yield.

## Floating-rate note (FRN)

Note whose interest payment varies with short-term interest rates.

## Floating-rate payer

In an interest rate swap, the counterparty who pays a rate based on a reference rate,
usually in exchange for a fixed-rate payment

## Floating-rate preferred

Preferred stock paying dividends that vary with short-term interest rates.

## Forward exchange rate

Exchange rate fixed today for exchanging currency at some future date.

## Forward interest rate

Interest rate fixed today on a loan to be made at some future date.

## Forward rate

A projection of future interest rates calculated from either the spot rates or the yield curve.

## Forward rate agreement (FRA)

Agreement to borrow or lend at a specified future date at an interest rate
that is fixed today.

## Generally Accepted Accounting Principals (GAAP)

A technical accounting term that encompasses the
conventions, rules, and procedures necessary to define accepted accounting practice at a particular time.

## Geometric mean return

Also called the time weighted rate of return, a measure of the compounded rate of
growth of the initial portfolio market value during the evaluation period, assuming that all cash distributions
are reinvested in the portfolio. It is computed by taking the geometric average of the portfolio subperiod
returns.

## Growth rates

Compound annual growth rate for the number of full fiscal years shown. If there is a negative
or zero value for the first or last year, the growth is NM (not meaningful).

## Harmless warrant

Warrant that allows the user to purchase a bond only by surrendering an existing bond
with similar terms.