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Equity cap

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Definition of Equity cap

Equity Cap Image 1

Equity cap

An agreement in which one party, for an upfront premium, agrees to compensate the other at
specific time periods if a designated stock market benchmark is greater than a predetermined level.



Related Terms:

Capital surplus

Amounts of directly contributed equity capital in excess of the par value.


Equity collar

The simultaneous purchase of an equity floor and sale of an equity cap.


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.


cost of capital

Refers to the interest cost of debt capital used by a business
plus the amount of profit that the business should earn for its equity
sources of capital to justify the use of the equity capital during the
period. Interest is a contractual and definite amount for a period,
whereas the profit that a business should earn on the equity capital
employed during the period is not. A business should set a definite goal
of earning at least a certain minimum return on equity (ROE) and compare
its actual performance for the period against this goal. The costs of
debt and equity capital are combined into either a before-tax rate or an
after-tax rate for capital investment analysis.


financial leverage

The equity (ownership) capital of a business can serve
as the basis for securing debt capital (borrowing money). In this way, a
business increases the total capital available to invest in its assets and
can make more sales and more profit. The strategy is to earn operating
profit, or earnings before interest and income tax (EBIT), on the capital
supplied from debt that is more than the interest paid on the debt capital.
A financial leverage gain equals the EBIT earned on debt capital
minus the interest on the debt. A financial leverage gain augments earnings
on equity capital. A business must earn a rate of return on its assets
(ROA) that is greater than the interest rate on its debt to make a financial
leverage gain. If the spread between its ROA and interest rate is unfavorable,
a business suffers a financial leverage loss.



weighted-average cost of capital

Weighted means that the proportions of
debt capital and equity capital of a business are used to calculate its
average cost of capital. This key benchmark rate depends on the interest
rate(s) on its debt and the ROE goal established by a business. This is a
return-on-capital rate and can be applied either on a before-tax basis or
an after-tax basis. A business should earn at least its weighted-average
rate on the capital invested in its assets. The weighted-average cost-ofcapital
rate is used as the discount rate to calculate the present value
(PV) of specific investments.


Capital Structure

The mix of the various types of debt and equity capital maintained by a firm. The more debt capital a firm has in its capital structure, the more highly leveraged the firm is considered to be.


Equity Cap Image 2

All equity rate

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


Asset/equity ratio

The ratio of total assets to stockholder equity.


Average cost of capital

A firm's required payout to the bondholders and to the stockholders expressed as a
percentage of capital contributed to the firm. Average cost of capital is computed by dividing the total
required cost of capital by the total amount of contributed capital.


Bottom-up equity management style

A management style that de-emphasizes the significance of economic
and market cycles, focusing instead on the analysis of individual stocks.


Cap

An upper limit on the interest rate on a floating-rate note.


Capital

Money invested in a firm.


Capital account

Net result of public and private international investment and lending activities.


Capital allocation

decision Allocation of invested funds between risk-free assets versus the risky portfolio.


Capital asset pricing model (CAPM)

An economic theory that describes the relationship between risk and
expected return, and serves as a model for the pricing of risky securities. The capM asserts that the only risk
that is priced by rational investors is systematic risk, because that risk cannot be eliminated by diversification.
The capM says that the expected return of a security or a portfolio is equal to the rate on a risk-free security
plus a risk premium.


Equity Cap Image 3

Capital budget

A firm's set of planned capital expenditures.


Capital budgeting

The process of choosing the firm's long-term capital assets.



Capital expenditures

Amount used during a particular period to acquire or improve long-term assets such as
property, plant or equipment.


Capital flight

The transfer of capital abroad in response to fears of political risk.


Capital gain

When a stock is sold for a profit, it's the difference between the net sales price of securities and
their net cost, or original basis. If a stock is sold below cost, the difference is a capital loss.


Capital gains yield

The price change portion of a stock's return.


Capital lease

A lease obligation that has to be capitalized on the balance sheet.


Capital loss

The difference between the net cost of a security and the net sale price, if that security is sold at a loss.


Capital market

The market for trading long-term debt instruments (those that mature in more than one year).


Capital market efficiency

Reflects the relative amount of wealth wasted in making transactions. An efficient
capital market allows the transfer of assets with little wealth loss. See: efficient market hypothesis.


Capital market imperfections view

The view that issuing debt is generally valuable but that the firm's
optimal choice of capital structure is a dynamic process that involves the other views of capital structure (net
corporate/personal tax, agency cost, bankruptcy cost, and pecking order), which result from considerations of
asymmetric information, asymmetric taxes, and transaction costs.


Capital market line (CML)

The line defined by every combination of the risk-free asset and the market portfolio.



Capital rationing

Placing one or more limits on the amount of new investment undertaken by a firm, either
by using a higher cost of capital, or by setting a maximum on parts of, and/or the entirety of, the capital
budget.


Capital structure

The makeup of the liabilities and stockholders' equity side of the balance sheet, especially
the ratio of debt to equity and the mixture of short and long maturities.


Capitalization

The debt and/or equity mix that fund a firm's assets.


Capitalization method

A method of constructing a replicating portfolio in which the manager purchases a
number of the largest-capitalized names in the index stock in proportion to their capitalization.


Capitalization ratios

Also called financial leverage ratios, these ratios compare debt to total capitalization
and thus reflect the extent to which a corporation is trading on its equity. capitalization ratios can be
interpreted only in the context of the stability of industry and company earnings and cash flow.


Capitalization table

A table showing the capitalization of a firm, which typically includes the amount of
capital obtained from each source - long-term debt and common equity - and the respective capitalization
ratios.


Capitalized

Recorded in asset accounts and then depreciated or amortized, as is appropriate for expenditures
for items with useful lives greater than one year.


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.


Common stock/other equity

Value of outstanding common shares at par, plus accumulated retained
earnings. Also called shareholders' equity.


Complete capital market

A market in which there is a distinct marketable security for each and every
possible outcome.


Cost of capital

The required return for a capital budgeting project.


Cost of limited partner capital

The discount rate that equates the after-tax inflows with outflows for capital
raised from limited partners.


Debt/equity ratio

Indicator of financial leverage. Compares assets provided by creditors to assets provided
by shareholders. Determined by dividing long-term debt by common stockholder equity.


Debt capacity

Ability to borrow. The amount a firm can borrow up to the point where the firm value no
longer increases.


Dedicated capital

Total par value (number of shares issued, multiplied by the par value of each share). Also
called dedicated value.


Deferred equity

A common term for convertible bonds because of their equity component and the
expectation that the bond will ultimately be converted into shares of common stock.


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.


Efficient capital market

A market in which new information is very quickly reflected accurately in share
prices.


Equity

Represents ownership interest in a firm. Also the residual dollar value of a futures trading account,
assuming its liquidation at the going market price.


Equity claim

Also called a residual claim, a claim to a share of earnings after debt obligation have been
satisfied.


Equity contribution agreement

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


Equity floor

An agreement in which one party agrees to pay the other at specific time periods if a specific
stock market benchmark is less than a predetermined level.


Equity kicker

Used to refer to warrants because they are usually issued attached to privately placed bonds.


Equity market

Related:Stock market


Equity multiplier

Total assets divided by total common stockholders' equity; the amount of total assets per
dollar of stockholders' equity.


Equity options

Securities that give the holder the right to buy or sell a specified number of shares of stock, at
a specified price for a certain (limited) time period. Typically one option equals 100 shares of stock.


Equity swap

A swap in which the cash flows that are exchanged are based on the total return on some stock
market index and an interest rate (either a fixed rate or a floating rate). Related: interest rate swap.


Equity-linked policies

Related: Variable life


Equityholders

Those holding shares of the firm's equity.


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


Foreign equity market

That portion of the domestic equity market that represents issues floated by foreign companies.


GEMs (growing-equity mortgages)

Mortgages in which annual increases in monthly payments are used to
reduce outstanding principal and to shorten the term of the loan.


Hard capital rationing

capital rationing that under no circumstances can be violated.


Human capital

The unique capabilities and expertise of individuals.


Interest rate cap

Also called an interest rate ceiling, an interest rate agreement in which payments are made
when the reference rate exceeds the strike rate.


Investor's equity

The balance of a margin account. Related: buying on margin, initial margin requirement.


Issued share capital

Total amount of shares that are in issue. Related: outstanding shares.


Legal capital

Value at which a company's shares are recorded in its books.


Leveraged equity

Stock in a firm that relies on financial leverage. Holders of leveraged equity face the
benefits and costs of using debt.


Long-term debt/capitalization

Indicator of financial leverage. Shows long-term debt as a proportion of the
capital available. Determined by dividing long-term debt by the sum of long-term debt, preferred stock and
common stockholder equity.


Long-term debt to equity ratio

A capitalization ratio comparing long-term debt to shareholders' equity.


Market capitalization

The total dollar value of all outstanding shares. Computed as shares times current
market price. It is a measure of corporate size.


Market capitalization rate

Expected return on a security. The market-consensus estimate of the appropriate
discount rate for a firm's cash flows.


Multifactor CAPM

A version of the capital asset pricing model derived by Merton that includes extramarket
sources of risk referred to as factor.


Net working capital

Current assets minus current liabilities. Often simply referred to as working capital.


Nondiversifiability of human capital

The difficulty of diversifying one's human capital (the unique
capabilities and expertise of individuals) and employment effort.


Opportunity cost of capital

Expected return that is foregone by investing in a project rather than in
comparable financial securities.


Other capital

In the balance of payments, other capital is a residual category that groups all the capital
transactions that have not been included in direct investment, portfolio investment, and reserves categories. It
is divided into long-term capital and short-term capital and, because of its residual status, can differ from
country to country. Generally speaking, other long-term capital includes most non-negotiable instruments of a
year or more like bank loans and mortgages. Other short-term capital includes financial assets of less than a
year such as currency, deposits, and bills.


Outstanding share capital

Issued share capital less the par value of shares that are held in the company's treasury.


Pecking-order view (of capital structure)

The argument that external financing transaction costs, especially
those associated with the problem of adverse selection, create a dynamic environment in which firms have a
preference, or pecking-order of preferred sources of financing, when all else is equal. Internally generated
funds are the most preferred, new debt is next, debt-equity hybrids are next, and new equity is the least
preferred source.


Perfect capital market

A market in which there are never any arbitrage opportunities.


Perfect market view (of capital structure)

Analysis of a firm's capital structure decision, which shows the
irrelevance of capital structure in a perfect capital market.


Personal tax view (of capital structure)

The argument that the difference in personal tax rates between
income from debt and income from equity eliminates the disadvantage from the double taxation (corporate
and personal) of income from equity.


Pie model of capital structure

A model of the debt/equity ratio of the firms, graphically depicted in slices of
a pie that represent the value of the firm in the capital markets.


Planned capital expenditure program

capital expenditure program as outlined in the corporate financial plan.


Preferred equity redemption stock (PERC)

Preferred stock that converts automatically into equity at a
stated date. A limit is placed on the value of the shares the investor receives.


Pro forma capital structure analysis

A method of analyzing the impact of alternative capital structure
choices on a firm's credit statistics and reported financial results, especially to determine whether the firm will
be able to use projected tax shield benefits fully.


Real capital

Wealth that can be represented in financial terms, such as savings account balances, financial
securities, and real estate.


Return on equity (ROE)

Indicator of profitability. Determined by dividing net income for the past 12
months by common stockholder equity (adjusted for stock splits). Result is shown as a percentage. Investors
use ROE as a measure of how a company is using its money. ROE may be decomposed into return on assets
(ROA) multiplied by financial leverage (total assets/total equity).


Shareholders' equity

This is a company's total assets minus total liabilities. A company's net worth is the
same thing.


"Soft" Capital Rationing

capital rationing that under certain circumstances can be violated or even viewed
as made up of targets rather than absolute constraints.


Static theory of capital structure

Theory that the firm's capital structure is determined by a trade-off of the
value of tax shields against the costs of bankruptcy.


Stockholder equity

Balance sheet item that includes the book value of ownership in the corporation. It
includes capital stock, paid in surplus, and retained earnings.


Stockholder's equity

The residual claims that stockholders have against a firm's assets, calculated by
subtracting total liabilities from total assets.


Stratified equity indexing

A method of constructing a replicating portfolio in which the stocks in the index
are classified into stratum, and each stratum is represented in the portfolio.


Top-down equity management style

A management style that begins with an assessment of the overall
economic environment and makes a general asset allocation decision regarding various sectors of the financial
markets and various industries. The bottom-up manager, in contrast, selects the specific securities within the
favored sectors.


Total debt to equity ratio

A capitalization ratio comparing current liabilities plus long-term debt to
shareholders' equity.


Venture capital

An investment in a start-up business that is perceived to have excellent growth prospects but
does not have access to capital markets. Type of financing sought by early-stage companies seeking to grow rapidly.


Weighted average cost of capital

Expected return on a portfolio of all the firm's securities. Used as a hurdle
rate for capital investment.


Working capital

Defined as the difference in current assets and current liabilities (excluding short-term
debt). Current assets may or may not include cash and cash equivalents, depending on the company.


Working capital management

The management of current assets and current liabilities to maximize shortterm liquidity.



 

 

 

 

 

 

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