Definition of Due Diligence

Due Diligence

The process of systematically evaluating information, to identify risks and issues relating to a proposed transaction.(i.e. verify that information is what it is proposed to be).

Comprehensive due diligence investigation

The investigation of a firm's business in conjunction with a
securities offering to determine whether the firm's business and financial situation and its prospects are
adequately disclosed in the prospectus for the offering.

Letter of Intent

A document signifying genuine interest in reaching a final agreement, conditional upon the results of more detailed due diligence and negotiations.

Annuity due

An annuity with n payments, wherein the first payment is made at time t = 0 and the last
payment is made at time t = n - 1.

Due bill

An instrument evidencing the obligation of a seller to deliver securities sold to the buyer.
Occasionally used in the bill market.

Annuity Due

Annuity where the payments are to be made at the beginning of
each period

annuity due

a series of equal cash flows being received or paid at the beginning of a period

annuity due

Level stream of cash flows starting immediately.

Letter of credit (L/C)

A form of guarantee of payment issued by a bank used to guarantee the payment of
interest and repayment of principal on bond issues.

Letter stock

Privately placed common stock, so-called because the SEC requires a letter from the purchaser
stating that the stock is not intended for resale.

Letter of comment

A communication to the firm from the SEC that suggests changes to its registration
statement.

Shareholders' letter

A section of an annual report where one can find jargon-free discussions by
management of successful and failed strategies which provides guidance for the probing of the rest of the
report.

Accumulated Other Comprehensive Income

Cumulative gains or losses reported in shareholders'
equity that arise from changes in the fair value of available-for-sale securities, from the
effects of changes in foreign-currency exchange rates on consolidated foreign-currency financial
statements, certain gains and losses on financial derivatives, and from adjustments for underfunded
pension plans.

Side Letter

A separate agreement that is used to clarify or modify the terms of a sales agreement.
Side letters become a problem for revenue recognition when they undermine a sales agreement
by effectively negating some or all of an agreement's underlying terms and are maintained
outside of normal reporting channels.

Letters of Credit

A letter of credit is a guarantee of payment by a bank (issuing institution)to a third party for a specific amount of money, if certain conditions are met.

fractional interest discount

the combined discounts for lack of control and marketability. g the constant growth rate in cash flows or net income used in the ADF, Gordon model, or present value factor.

Accrued interest

The accumulated coupon interest earned but not yet paid to the seller of a bond by the
buyer (unless the bond is in default).

Affirmative covenant

A bond covenant that specifies certain actions the firm must take.

Amortizing interest rate swap

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

Annuity due

An annuity with n payments, wherein the first payment is made at time t = 0 and the last
payment is made at time t = n - 1.

Asymmetric information

information that is known to some people but not to other people.

Base interest rate

Related: Benchmark interest rate.

Basic business strategies

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

Bellwether issues

Related:Benchmark issues.

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").

Benchmark issues

Also called on-the-run or current coupon issues or bellwether issues. In the secondary
market, it's the most recently auctioned Treasury issues for each maturity.

Best-interests-of-creditors test

The requirement that a claim holder voting against a plan of reorganization
must receive at least as much as he would have if the debtor were liquidated.

Bond agreement

A contract for privately placed debt.

Book-entry securities

The Treasury and federal agencies are moving to a book-entry system in which securities are not represented by engraved pieces of paper but are maintained in computerized records at the
Fed in the names of member banks, which in turn keep records of the securities they own as well as those they
are holding for customers. In the case of other securities where a book-entry has developed, engraved
securities do exist somewhere in quite a few cases. These securities do not move from holder to holder but are
usually kept in a central clearinghouse or by another agent.

Bretton Woods Agreement

An agreement signed by the original United Nations members in 1944 that
established the International Monetary Fund (IMF) and the post-World War II international monetary system
of fixed exchange rates.

Business cycle

Repetitive cycles of economic expansion and recession.

Business failure

A business that has terminated with a loss to creditors.

Business risk

The risk that the cash flow of an issuer will be impaired because of adverse economic
conditions, making it difficult for the issuer to meet its operating expenses.

Capitalized interest

interest that is not immediately expensed, but rather is considered as an asset and is then
amortized through the income statement over time.

Cash deficiency agreement

An agreement to invest cash in a project to the extent required to cover any cash
deficiency the project may experience.

Cash flow after interest and taxes

Net income plus depreciation.

Cash transaction

A transaction where exchange is immediate, as contrasted to a forward contract, which
calls for future delivery of an asset at an agreed-upon price.

Changes in Financial Position

Sources of funds internally provided from operations that alter a company's
cash flow position: depreciation, deferred taxes, other sources, and capital expenditures.

Competitive offering

An offering of securities through competitive bidding.

Compound interest

interest paid on previously earned interest as well as on the principal.

Concession agreement

An understanding between a company and the host government that specifies the
rules under which the company can operate locally.

Conditional sales contracts

Similar to equipment trust certificates except that the lender is either the
equipment manufacturer or a bank or finance company to whom the manufacturer has sold the conditional
sales contract.

Confirmation

he written statement that follows any "trade" in the securities markets. Confirmation is issued
immediately after a trade is executed. It spells out settlement date, terms, commission, etc.

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.

Country financial risk

The ability of the national economy to generate enough foreign exchange to meet
payments of interest and principal on its foreign debt.

Coupon

The periodic interest payment made to the bondholders during the life of the bond.

Coupon equivalent yield

True interest cost expressed on the basis of a 365-day year.

Coupon payments

A bond's interest payments.

Coupon rate

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

Covered interest arbitrage

A portfolio manager invests dollars in an instrument denominated in a foreign
currency and hedges his resulting foreign exchange risk by selling the proceeds of the investment forward for
dollars.

Current coupon

A bond selling at or close to par, that is, a bond with a coupon close to the yields currently
offered on new bonds of a similar maturity and credit risk.

Current-coupon issues

Related: Benchmark issues

Debt securities

IOUs created through loan-type transactions - commercial paper, bank CDs, bills, bonds, and
other instruments.

Diffusion process

A conception of the way a stock's price changes that assumes that the price takes on all
intermediate values. dirty price. Related: full price

Discount securities

Non-interest-bearing money market instruments that are issued at a discount and
redeemed at maturity for full face value, e.g. U.S. Treasury bills.

Documented discount notes

Commercial paper backed by normal bank lines plus a letter of credit from a
bank stating that it will pay off the paper at maturity if the borrower does not. Such paper is also referred to as
LOC (letter of credit) paper.

Double-tax agreement

agreement between two countries that taxes paid abroad can be offset against
domestic taxes levied on foreign dividends.

Dual syndicate equity offering

An international equity placement where the offering is split into two
tranches - domestic and foreign - and each tranche is handled by a separate lead manager.

Dual-currency issues

Eurobonds that pay coupon interest in one currency but pay the principal in a different
currency.

Due bill

An instrument evidencing the obligation of a seller to deliver securities sold to the buyer.
Occasionally used in the bill market.

Dupont system of financial control

Highlights the fact that return on assets (ROA) can be expressed in terms
of the profit margin and asset turnover.

Earnings before interest and taxes (EBIT)

A financial measure defined as revenues less cost of goods sold
and selling, general, and administrative expenses. In other words, operating and non-operating profit before
the deduction of interest and income taxes.

Effective annual interest rate

An annual 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.

Equity contribution agreement

An agreement to contribute equity to a project under certain specified
conditions.

Euroequity issues

securities sold in the Euromarket. That is, securities initially sold to investors
simultaneously in several national markets by an international syndicate. Euromarket.
Related: external market

Exempt securities

Instruments exempt from the registration requirements of the securities Act of 1933 or the
margin requirements of the SEC Act of 1934. Such securities include government bonds, agencies, munis,
commercial paper, and private placements.

Expected value of perfect information

The expected value if the future uncertain outcomes could be known
minus the expected value with no additional information.

Federal agency securities

securities issued by corporations and agencies created by the U.S. government,
such as the Federal Home Loan Bank Board and Ginnie Mae.

Financial analysts

Also called securities analysts and investment analysts, professionals who analyze
financial statements, interview corporate executives, and attend trade shows, in order to write reports
recommending either purchasing, selling, or holding various stocks.

Financial assets

Claims on real assets.

Financial control

The management of a firm's costs and expenses in order to control them in relation to
budgeted amounts.

Financial distress

Events preceding and including bankruptcy, such as violation of loan contracts.

Financial distress costs

Legal and administrative costs of liquidation or reorganization. Also includes
implied costs associated with impaired ability to do business (indirect costs).

Financial engineering

Combining or dividing existing instruments to create new financial products.

Financial future

A contract entered into now that provides for the delivery of a specified asset in exchange
for the selling price at some specified future date.

Financial intermediaries

Institutions that provide the market function of matching borrowers and lenders or
traders.

Financial lease

Long-term, non-cancelable lease.

Financial leverage

Use of debt to increase the expected return on equity. financial leverage is measured by
the ratio of debt to debt plus equity.

Financial leverage clientele

A group of investors who have a preference for investing in firms that adhere to
a particular financial leverage policy.

Financial leverage ratios

Related: capitalization ratios.

Financial market

An organized institutional structure or mechanism for creating and exchanging financial assets.

Financial objectives

Objectives of a financial nature that the firm will strive to accomplish during the period
covered by its financial plan.

Financial plan

A financial blueprint for the financial future of a firm.

Financial planning

The process of evaluating the investing and financing options available to a firm. It
includes attempting to make optimal decisions, projecting the consequences of these decisions for the firm in
the form of a financial plan, and then comparing future performance against that plan.

Financial press

That portion of the media devoted to reporting financial news.

Financial ratio

The result of dividing one financial statement item by another. Ratios help analysts interpret
financial statements by focussing on specific relationships.

Financial risk

The risk that the cash flow of an issuer will not be adequate to meet its financial obligations.
Also referred to as the additional risk that a firm's stockholder bears when the firm utilizes debt and equity.

Firm

Refers to an order to buy or sell that can be executed without confirmation for some fixed period. Also,
a synonym for company.

Firm commitment underwriting

An undewriting in which an investment banking firm commits to buy the
entire issue and assumes all financial responsibility for any unsold shares.

Firm's net value of debt

Total firm value minus total firm debt.

Firm-specific risk

See:diversifiable risk or unsystematic risk.

Fiscal agency agreement

An alternative to a bond trust deed. Unlike the trustee, the fiscal agent acts as an
agent of the borrower.

Forward interest rate

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

Forward rate agreement (FRA)

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

Full coupon bond

A bond with a coupon equal to the going market rate, thereby, the bond is selling at par.

Going-private transactions

Publicly owned stock in a firm is replaced with complete equity ownership by a
private group. The shares are delisted from stock exchanges and can no longer be purchased in the open
markets.

Government securities

Negotiable U.S. Treasury securities.

Gross interest

interest earned before taxes are deducted.

High-coupon bond refunding

Refunding of a high-coupon bond with a new, lower coupon bond.

Highly leveraged transaction (HLT)

Bank loan to a highly leveraged firm.

Information asymmetry

A situation involving information that is known to some, but not all, participants.

Information Coefficient (IC)

The correlation between predicted and actual stock returns, sometimes used to
measure the value of a financial analyst. An IC of 1.0 indicates a perfect linear relationship between predicted
and actual returns, while an IC of 0.0 indicates no linear relationship.

Information costs

transaction costs that include the assessment of the investment merits of a financial asset.
Related: search costs.

Information services

Organizations that furnish investment and other types of information, such as
information that helps a firm monitor its cash position.

Information-content effect

The rise in the stock price following the dividend signal.

Informational efficiency

The speed and accuracy with which prices reflect new information.

Informationless trades

Trades that are the result of either a reallocation of wealth or an implementation of an
investment strategy that only utilizes existing information.

Information-motivated trades

Trades in which an investor believes he or she possesses pertinent
information not currently reflected in the stock's price.

Initial public offering (IPO)

A company's first sale of stock to the public. securities offered in an IPO are
often, but not always, those of young, small companies seeking outside equity capital and a public market for
their stock. Investors purchasing stock in IPOs generally must be prepared to accept very large risks for the
possibility of large gains. IPO's by investment companies (closed-end funds) usually contain underwriting
fees which represent a load to buyers.

Insider information

Relevant information about a company that has not yet been made public. It is illegal for
holders of this information to make trades based on it, however received.

Intercompany transaction

transaction carried out between two units of the same corporation.

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