Financial Terms
Lag response of prepayments

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Definition of Lag response of prepayments

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Lag response of prepayments

There is typically a lag of about three months between the time the weighted
average coupon of an MBS pool has crossed the threshold for refinancing and an acceleration in prepayment
speed is observed.

Related Terms:


Payment of a financial obligation later than is expected or required, as in lead and lag. Also, the number
of periods that an independent variable in a regression model is "held back" in order to predict the dependent


Payments made in excess of scheduled mortgage principal repayments.

net cost of normal spoilage

the cost of spoiled work less the estimated disposal value of that work

normal spoilage

spoilage that has been planned or foreseen; is a product cost

Spoilage, abnormal

Spoilage arising from the production process that exceeds the normal
or expected rate of spoilage. Since it is not a recurring or expected cost of ongoing
production, it is expensed to the current period.

Spoilage, normal

The amount of spoilage that naturally arises as part of a production
process, no matter how efficient that process may be.

Direct-Response Advertising

Advertising designed to elicit sales to customers who can be
shown to have responded specifically to the advertising in the past. Such costs can be capitalized
when persuasive historical evidence permits formulation of a reliable estimate of the future revenue
that can be obtained from incremental advertising expenditures.

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economic components model

Abrams’ model for calculating DLOM based on the interaction of discounts from four economic components.
This model consists of four components: the measure of the economic impact of the delay-to-sale, monopsony power to buyers, and incremental transactions costs to both buyers and sellers.

Gordon model

present value of a perpetuity with growth.
The end-ofyear Gordon model formula is: 1/(r - g)
and the midyear formula is: SQRT(1 + r)/(r - g).

log size model

Abrams’ model to calculate discount rates as a function of the logarithm of the value of the firm.

QMDM (quantitative marketability discount model)

model for calculating DLOM for minority interests r the discount rate

Accumulated Benefit Obligation (ABO)

An approximate measure of the liability of a plan in the event of a
termination at the date the calculation is performed. Related: projected benefit obligation.

Alternative mortgage instruments

Variations of mortgage instruments such as adjustable-rate and variablerate
mortgages, graduated-Payment mortgages, reverse-annuity mortgages, and several seldom-used

Arbitrage-free option-pricing models

Yield curve option-pricing models.

Arithmetic average (mean) rate of return

Arithmetic mean return.

Asset-backed security

A security that is collateralized by loans, leases, receivables, or installment contracts
on personal property, not real estate.

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Asset pricing model

A model for determining the required rate of return on an asset.

Asset pricing model

A model, such as the Capital Asset Pricing model (CAPM), that determines the required
rate of return on a particular asset.


An arithmetic mean of selected stocks intended to represent the behavior of the market or some
component of it. One good example is the widely quoted Dow Jones Industrial average, which adds the
current prices of the 30 DJIA's stocks, and divides the results by a predetermined number, the divisor.

Average accounting return

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

Average age of accounts receivable

The weighted-average age of all of the firm's outstanding invoices.

Average collection period, or days' receivables

The ratio of accounts receivables to sales, or the total
amount of credit extended per dollar of daily sales (average AR/sales * 365).

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.

Average life

Also referred to as the weighted-average life (WAL). The average number of years that each
dollar of unpaid principal due on the mortgage remains outstanding. average life is computed as the weighted average time to the receipt of all future cash flows, using as the weights the dollar amounts of the principal

Average maturity

The average time to maturity of securities held by a mutual fund. Changes in interest rates
have greater impact on funds with longer average life.

Average (across-day) measures

An estimation of price that uses the average or representative price of a
large number of trades.

Average rate of return (ARR)

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

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Average tax rate

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

Back fee

The fee paid on the extension date if the buyer wishes to continue the option.

Back office

Brokerage house clerical operations that support, but do not include, the trading of stocks and
other securities. Includes all written confirmation and settlement of trades, record keeping and regulatory
back-end loan fund
A mutual fund that charges investors a fee to sell (redeem) shares, often ranging from
4% to 6%. Some back-end load funds impose a full commission if the shares are redeemed within a
designated time, such as one year. The commission decreases the longer the investor holds the shares. The
formal name for the back-end load is the contingent deferred sales charge, or CDSC.

Back-to-back financing

An intercompany loan channeled through a bank.

Back-to-back loan

A loan in which two companies in separate countries borrow each other's currency for a
specific time period and repay the other's currency at an agreed upon maturity.


1) When bond yields and prices fall, the market is said to back-up.
2) When an investor swaps out of one security into another of shorter current maturity he is said to back up.


A market condition in which futures prices are lower in the distant delivery months than in
the nearest delivery month. This situation may occur in when the costs of storing the product until eventual
delivery are effectively subtracted from the price today. The opposite of contango.

Balance of payments

A statistical compilation formulated by a sovereign nation of all economic transactions
between residents of that nation and residents of all other nations during a stipulated period of time, usually a
calendar year.

Bargain-purchase-price option

Gives the lessee the option to purchase the asset at a price below fair market
value when the lease expires.

Binomial option pricing model

An option pricing model in which the underlying asset can take on only two
possible, discrete values in the next time period for each value that it can take on in the preceding time period.

Black-Scholes option-pricing model

A model for pricing call options based on arbitrage arguments that uses
the stock price, the exercise price, the risk-free interest rate, the time to expiration, and the standard deviation
of the stock return.

Break-even lease payment

The lease Payment at which a party to a prospective lease is indifferent between
entering and not entering into the lease arrangement.

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 time

Related: Premium payback period.

Buy limit order

A conditional trading order that indicates a security may be purchased only at the designated
price or lower.
Related: Sell limit order.


Another term for a repo.

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.

Cash flow time-line

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

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.

Clearing House Automated Payments System (CHAPS)

A computerized clearing system for sterling funds
that began operations in 1984. It includes 14 member banks, nearly 450 participating banks, and is one of the
clearing companies within the structure of the Association for Payment Clearing Services (APACS).

Clearing House Interbank Payments System (CHIPS)

An international wire transfer system for high-value
Payments operated by a group of major banks.

Closed-end mortgage

mortgage against which no additional debt may be issued.

Closing purchase

A transaction in which the purchaser's intention is to reduce or eliminate a short position in
a stock, or in a given series of options.


Assets than can be repossessed if a borrower defaults.

Collateral trust bonds

A bond in which the issuer (often a holding company) grants investors a lien on
stocks, notes, bonds, or other financial asset as security. Compare mortgage bond.

Collateralized mortgage obligation (CMO)

A security backed by a pool of pass-throughs , structured so that
There are several classes of bondholders with varying maturities, called tranches. The principal Payments from
the underlying pool of pass-through securities are used to retire the bonds on a priority basis as specified in
the prospectus.
Related: mortgage pass-through security

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.

Constant-growth model

Also called the Gordon-Shapiro model, an application of the dividend discount
model which assumes (1) a fixed growth rate for future dividends and (2) a single discount rate.

Continuous random variable

A random value that can take any fractional value within specified ranges, as
contrasted with a discrete variable.

Conventional mortgage

A loan based on the credit of the borrower and on the collateral for the mortgage.

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.

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.


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.

Cross-border risk

Refers to the volatility of returns on international investments caused by events associated
with a particular country as opposed to events associated solely with a particular economic or financial agent.

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

Date of payment

Date dividend checks are mailed.

Day order

An order to buy or sell stock that automatically expires if it can't be executed on the day it is entered.

Delivery versus payment

A transaction in which the buyer's Payment for securities is due at the time of
delivery (usually to a bank acting as agent for the buyer) upon receipt of the securities. The Payment may be
made by bank wire, check, or direct credit to an account.


Acceptance of a capital budgeting project contingent on the acceptance of another project.

Deterministic models

Liability-matching models that assume that the liability Payments and the asset cash
flows are known with certainty. Related: Compare stochastic models

Direct stock-purchase programs

The purchase by investors of securities directly from the issuer.

Discounted dividend model (DDM)

A formula to estimate the intrinsic value of a firm by figuring the
present value of all expected future dividends.

Discounted payback period rule

An investment decision rule in which the cash flows are discounted at an
interest rate and the payback rule is applied on these discounted cash flows.

Discrete random variable

A random variable that can take only a certain specified set of discrete possible
values - for example, the positive integers 1, 2, 3, . . .

Dividend clawback

With respect to a project financing, an arrangement under which the sponsors of a project
agree to contribute as equity any prior dividends received from the project to the extent necessary to cover
any cash deficiencies.

Dividend discount model (DDM)

A model for valuing the common stock of a company, based on the
present value of the expected cash flows.

Dividend growth model

A model wherein dividends are assumed to be at a constant rate in perpetuity.

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.

Dow Jones industrial average

This is the best known U.S.index of stocks. It contains 30 stocks that trade on
the New York Stock Exchange. The Dow, as it is called, is a barometer of how shares of the largest
U.S.companies are performing. There are thousands of investment indexes around the world for stocks,
bonds, currencies and commodities.

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.

Economic order quantity (EOQ)

The order quantity that minimizes total inventory costs.

Endogenous variable

A value determined within the context of a model.

Excess reserves

Any excess of actual reserves above required reserves.

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.

Exogenous variable

A variable whose value is determined outside the model in which it is used. Also called
a parameter.

Expected future cash flows

Projected future cash flows associated with an asset of decision.

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.

Expected value

The weighted average of a probability distribution.

Expected value of perfect information

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

Extrapolative statistical models

models that apply a formula to historical data and project results for a
future period. Such models include the simple linear trend model, the simple exponential model, and the
simple autoregressive model.

Factor model

A way of decomposing the factors that influence a security's rate of return into common and
firm-specific influences.

FHA prepayment experience

The percentage of loans in a pool of mortgages outstanding at the origination
anniversary, based on annual statistical historic survival rates for FHA-insured mortgages.

Fill or kill order

A trading order that is canceled unless executed within a designated time period.
Related: open order.

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







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