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Definition of Frictions

Frictions Image 1


The "stickiness" in making transactions; the total hassle including time, effort, money, and tax
effects of gathering information and making a transaction such as buying a stock or borrowing money.

Related Terms:

Acquisition of stock

A merger or consolidation in which an acquirer purchases the acquiree's stock.

Adjustable rate preferred stock (ARPS)

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

After-tax profit margin

The ratio of net income to net sales.

After-tax real rate of return

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

Allocation base A measure of activity or volume such as labour

hours, machine hours or volume of production
used to apportion overheads to products and

American Stock Exchange (AMEX)

The second-largest stock exchange in the United States. It trades
mostly in small-to medium-sized companies.

Asymmetric information

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

Frictions Image 1

Asymmetric taxes

A situation wherein participants in a transaction have different net tax rates.


An option is at-the-money if the strike price of the option is equal to the market price of the
underlying security. For example, if xyz stock is trading at 54, then the xyz 54 option is at-the-money.

Auction rate preferred stock (ARPS)

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

Average tax rate

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

average tax rate

total taxes owed divided by total income.

Before-tax profit margin

The ratio of net income before taxes to net sales.

Best-efforts sale

A method of securities distribution/ underwriting in which the securities firm agrees to sell
as much of the offering as possible and return any unsold shares to the issuer. As opposed to a guaranteed or
fixed price sale, where the underwriter agrees to sell a specific number of shares (with the securities firm
holding any unsold shares in its own account if necessary).

Beta equation (Stocks)

The beta of a stock is determined as follows:
[(n) (sum of (xy)) ]-[(sum of x) (sum of y)]
[(n) (sum of (xx)) ]-[(sum of x) (sum of x)]
where: n = # of observations (24-60 months)
x = rate of return for the S&P 500 Index
y = rate of return for the stock


The theoretical amount per share that each stockholder would receive if a company’s assets were sold on the balance sheet’s date. Book value equals:
(stockholders’ equity) / (Common stock shares outstanding)

Frictions Image 2

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.

Break-even time

Related: Premium payback period.

Buying the index

Purchasing the stocks in the S&P 500 in the same proportion as the index to achieve the
same return.

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.

capital stock

Ownership shares issued by a business corporation. A business
corporation may issue more than one class of capital stock shares.
One class may give voting privileges in the election of the directors of the
corporation while the other class does not. One class (called preferred
stock) may entitle a certain amount of dividends per share before cash
dividends can be paid on the other class (usually called common stock).
stock shares may have a minimum value at which they have to be issued
(called the par value), or stock shares can be issued for any amount
(called no-par stock). stock shares may be traded on public markets such
as the New York stock Exchange or over the Nasdaq network. There are
about 10,000 stocks traded on public markets (although estimates vary
on this number). In this regard, I find it very interesting that there are
more than 8,000 mutual funds that invest in stocks.

Capital Stock

The total amount of plant, equipment, and other physical capital.

Cash flow after interest and taxes

Net income plus depreciation.

Cash flow time-line

Line depicting the operating activities and cash flows for a firm over a particular period.

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.

Common stock

These are securities that represent equity ownership in a company. Common shares let an
investor vote on such matters as the election of directors. They also give the holder a share in a company's
profits via dividend payments or the capital appreciation of the security.

Common stock

Shares of ownership sold to the public.

Frictions Image 3

Common Stock

A financial security that represents an ownership claim on the
assets and earnings of a company. This claim is valid after the
claims of the debt providers and preferred stockholders have been

common stock

Ownership shares in a publicly held corporation.

Common Stock

That part of the capital stock of a corporation that carries voting rights and represents
the last claim on assets and dividends.

Common stock equivalent

A convertible security that is traded like an equity issue because the optioned
common stock is trading high.

Common stock market

The market for trading equities, not including preferred stock.

Common stock/other equity

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

Common stock ratios

Ratios that are designed to measure the relative claims of stockholders to earnings
(cash flow per share), and equity (book value per share) of a firm.

Conflict between bondholders and stockholders

These two groups may have interests in a corporation that
conflict. Sources of conflict include dividends, distortion of investment, and underinvestment. Protective
covenants work to resolve these conflicts.

Consigned stocks

Inventories owned by a company, but located on the premises
of its agents or distributors.

Convertible exchangeable preferred stock

Convertible preferred stock that may be exchanged, at the
issuer's option, into convertible bonds that have the same conversion features as the convertible preferred

Convertible preferred stock

Preferred stock that can be converted into common stock at the option of the holder.

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 of Common Stock

The rate of return required by the investors in the common stock of
the company. A component of the cost of capital.

Cost of Preferred Stock

The rate of return required by the investors in the preferred stock of
a company. A component of the cost of capital.

Cumulative preferred stock

Preferred stock whose dividends accrue, should the issuer not make timely
dividend payments. Related: non-cumulative preferred stock.

Current Income Tax Expense

That portion of the total income tax provision that is based on
taxable income.

Current Tax Payment Act of 1943

A federal Act requiring employers to withhold income taxes from employee pay.

cycle time

the time between the placement of an order to
the time the goods arrive for usage or are produced by
the company; it is equal to value-added time plus nonvalue-
added time

decision making

the process of choosing among the alternative
solutions available to a course of action or a problem

Deferred Income Tax Expense

That portion of the total income tax provision that is the result
of current-period originations and reversals of temporary differences.

Deferred Tax Asset

Future tax benefit that results from (1) the origination of a temporary difference
that causes pretax book income to be less than taxable income or (2) a loss, credit, or other
carryforward. Future tax benefits are realized on the reversal of deductible temporary differences
or the offsetting of a loss carryforward against taxable income or a tax-credit carryforward against
the current tax provision.

Deferred Tax Liability

Future tax obligation that results from the origination of a temporary
difference that causes pretax book income to exceed taxable income.

Deferred taxes

A non-cash expense that provides a source of free cash flow. Amount allocated during the
period to cover tax liabilities that have not yet been paid.

Departmental stocks

The informal and frequently unauthorized retention of excess inventory on the shop floor, which is used as buffer safety stock.

Depreciation tax shield

The value of the tax write-off on depreciation of plant and equipment.

depreciation tax shield

Reduction in taxes attributable to the depreciation allowance.

Direct stock-purchase programs

The purchase by investors of securities directly from the issuer.

Dividend yield (Stocks)

Indicated yield represents annual dividends divided by current stock price.

Double-tax agreement

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

earnings before interest and income tax (EBIT)

A measure of profit that
equals sales revenue for the period minus cost-of-goods-sold expense
and all operating expenses—but before deducting interest and income
tax expenses. It is a measure of the operating profit of a business before
considering the cost of its debt capital and income tax.

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.

Earnings before interest and taxes (EBIT)

The operating profit before deducting interest and tax.

Earnings before interest, taxes, depreciation and amortization (EBITDA)

The operating profit before deducting interest, tax, depreciation and amortization.

Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)

An earningsbased measure that, for many, serves as a surrogate for cash flow. Actually consists of working
capital provided by operations before interest and taxes.

Earnings per share of common stock

How much profit a company made on each share of common stock this year.

EBDDT - Earnings before depreciation and deferred taxes

This measure is used principally by
firms in the real estate industry, with the exception of real estate investment trusts, which typically
do not pay taxes.

Effective Tax Rate

The total tax provision divided by pretax book income from continuing

Electronic Federal Tax Payment Systems (EFTPS)

An electronic funds transfer system used by businesses to remit taxes to the government.

Employee stock fund

A firm-sponsored program that enables employees to purchase shares of the firm's
common stock on a preferential basis.

Employee stock ownership plan (ESOP)

A company contributes to a trust fund that buys stock on behalf of

Employee Stock Ownership Plan (ESOP)

a profit-sharing compensation program in which investments are made in
the securities of the employer

Employee Stock Ownership Plan (ESOP)

A fund containing company stock and owned by employees, paid for by ongoing contributions by the employer.

employee time sheet

a source document that indicates, for each employee, what jobs were worked on during the day and for what amount of time

Equivalent taxable yield

The yield that must be offered on a taxable bond issue to give the same after-tax
yield as a tax-exempt issue.

Exchange of stock

Acquisition of another company by purchase of its stock in exchange for cash or shares.

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 Unemployment Tax Act (FUTA)

A federal Act requiring employers to pay a tax on the wages paid to their employees, which is then used to create a
pool of funds to be used for unemployment benefits.

Fiat Money

Fiat money is paper currency made legal tender by law or fiat. It is not backed by gold or silver and is not necessarily redeemable in coin. This practice has had widespread use for about the last 70 years. If governments produce too much of it, there is a loss of confidence. Even so, governments print it routinely when they need it. The value of fiat money is dependent upon the performance of the economy of the country which issued it. Canada's currency falls into this category.

Floor stocks

Low-cost, high-usage inventory items stored near the shop floor,
which the production staff can use at will without a requisition and which are
expensed at the time of receipt, rather than being accounted for through a formal
inventory database.

Foreign tax credit

Home country credit against domestic income tax for foreign taxes paid on foreign
derived earnings.

Forward buying

The purchase of items exceeding the quantity levels indicated
by current manufacturing requirements.

Future-Oriented Financial Information

information about prospective results of operations, financial position and/or changes in financial position, based on assumptions about future economic conditions and courses of action. Future-oriented financial information is presented as either a forecast or a projection.

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

Growth stock

Common stock of a company that has an opportunity to invest money and earn more than the
opportunity cost of capital.

Heavenly Parachute Stock Option

A nonqualified stock option that allows a deceased option holder’s estate up to three years in which to exercise his or her

High-Powered Money

See money base.

Highly leveraged transaction (HLT)

Bank loan to a highly leveraged firm.

Hot money

money that moves across country borders in response to interest rate differences and that moves
away when the interest rate differential disappears.

idle time

the amount of time spent in storing inventory or
waiting at a production operation for processing

Imputation tax system

Arrangement by which investors who receive a dividend also receive a tax credit for
corporate taxes that the firm has paid.


A put option that has a strike price higher than the underlying futures price, or a call option
with a strike price lower than the underlying futures price. For example, if the March COMEX silver futures
contract is trading at $6 an ounce, a March call with a strike price of $5.50 would be considered in-the-money
by $0.50 an ounce.
Related: put.

Incentive Stock Option

An option to purchase company stock that is not taxable
to the employee at the time it is granted nor at the time when the employee
eventually exercises the option to buy stock.

Income stock

Common stock with a high dividend yield and few profitable investment opportunities.


What the business paid to the IRS.

Income tax

A government tax on the income earned by an individual or corporation.

Income Tax Expense

See income tax provision.

Income Tax Provision

The expense deduction from pretax book income reported on the
income statement. It consists of both current income tax expense and deferred income tax
expense. The terms income tax expense and income tax provision are used interchangeably.

Indirect Taxes

taxes paid by consumers when they buy goods and services. A sales tax is an example.

Inflation Tax

The loss in purchasing power due to inflation eroding the real value of financial assets such as cash.


bits of knowledge or fact that have been carefully
chosen from a body of data and arranged in a meaningful way

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.







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