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Liquidity theory of the term structure

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Definition of Liquidity theory of the term structure

Liquidity Theory Of The Term Structure Image 1

Liquidity theory of the term structure

A biased expectations theory that asserts that the implied forward
rates will not be a pure estimate of the market's expectations of future interest rates because they embody a
liquidity premium.



Related Terms:

Expectations hypothesis theories

Theories of the term structure of interest rates which include the pure
expectations theory, the liquidity theory of the term structure, and the preferred habitat theory. These theories
hold that each forward rate equals the expected future interest rate for the relevant period. These three theories
differ, however, on whether other factors also affect forward rates, and how.
Expectations theory of forward exchange rates A theory of foreign exchange rates that holds that the
expected future spot foreign exchange rate t periods in the future equals the current t-period forward exchange
rate.


Accounting liquidity

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


Agency theory

The analysis of principal-agent relationships, wherein one person, an agent, acts on behalf of
anther person, a principal.


Arbitrage Pricing Theory (APT)

An alternative model to the capital asset pricing model developed by
Stephen Ross and based purely on arbitrage arguments.


Bubble theory

Security prices sometimes move wildly above their true values.



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.


Capital Structure

The combination of debt, preferred stock, and common stock used
by a company to provide capital for the purchase of its fixed
assets


Liquidity Theory Of The Term Structure Image 2

capital structure

Firm’s mix of long-term financing.


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.


capital structure, or capitalization

terms that refer to the combination of
capital sources that a business has tapped for investing in its assets—in
particular, the mix of its interest-bearing debt and its owners’ equity. In a
more sweeping sense, the terms also include appendages and other features
of the basic debt and equity instruments of a business. Such things
as stock options, stock warrants, and convertible features of preferred
stock and notes payable are included in the more inclusive sense of the
terms, as well as any debt-based and equity-based financial derivatives
issued by the business.


Coefficient of determination

A measure of the goodness of fit of the relationship between the dependent and
independent variables in a regression analysis; for instance, the percentage of variation in the return of an
asset explained by the market portfolio return.


coefficient of determination

a measure of dispersion that
indicates the “goodness of fit” of the actual observations
to the least squares regression line; indicates what proportion
of the total variation in y is explained by the regression model


cost structure

the relative composition of an organization’s
fixed and variable costs


Credit Terms

Conditions under which credit is extended by a lender to a borrower.


Deterministic models

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


Disintermediation

Withdrawal of funds from a financial institution in order to invest them directly.


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Euro-medium term note (Euro-MTN)

A non-underwritten Euronote issued directly to the market. Euro-
MTNs are offered continuously rather than all at once as a bond issue is. Most Euro-MTN maturities are
under five years.


expectations theory of exchange rates

theory that expected spot exchange rate equals the forward rate.



Financial intermediaries

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


financial intermediary

Firm that raises money from many small investors and provides financing to businesses or other
organizations by investing in their securities.


Financial Intermediary

Any institution, such as a bank, that takes deposits from savers and loans them to borrowers.


Financial Intermediation

The process whereby financial intermediaries channel funds from lender/savers to borrower/spenders.


Flexible Term

Optional periods of time which the conditions of a contract will be carried out.


Infrastructure

Basic facilities, such as transportation, communication, and legal systems, on which economic activity depends.


Intermarket sector

spread The spread between the interest rate offered in two sectors of the bond market for
issues of the same maturity.


Intermarket spread swaps

An exchange of one bond for another based on the manager's projection of a
realignment of spreads between sectors of the bond market.


Intermediary

An independent third party that may act as a mediator during negotiations.


Liquidity Theory Of The Term Structure Image 4

Intermediate Good

A good used in producing another good.



Intermediate-term

Typically 1-10 years.


Intermediation

Investment through a financial institution. Related: disintermediation.


Liquidity

A market is liquid when it has a high level of trading activity, allowing buying and selling with
minimum price disturbance. Also a market characterized by the ability to buy and sell with relative ease.


Liquidity

A measure of the ability of a business to pay its debts as they fall due – see also working capital.


Liquidity

A term that means nearness to cash; the closer an asset is to becoming cash or a liability is to using cash, the more liquid that asset or liability is.


Liquidity

The ease with which assets or securities can be sold for cash on
short notice at a fair price


liquidity

Ability of an asset to be converted to cash quickly at low cost.


Liquidity

Ease with which an asset can be sold on short notice at a fair price.


Liquidity

The degree to which an asset can be cheaply and quickly turned into money.


Liquidity Crisis

Situation in which a firm is unable to meet due bills; a period of "technical insolvency".


Liquidity diversification

Investing in a variety of maturities to reduce the price risk to which holding long
bonds exposes the investor.


Liquidity preference hypothesis

The argument that greater liquidity is valuable, all else equal. Also, the
theory that the forward rate exceeds expected future interest rates.


Liquidity premium

Forward rate minus expected future short-term interest rate.


Liquidity ratios

Ratios that measure a firm's ability to meet its short-term financial obligations on time.


Liquidity ratios

Ratios that measure a firm's ability to meet its short-term financial obligations on time.


Liquidity risk

The risk that arises from the difficulty of selling an asset. It can be thought of as the difference
between the "true value" of the asset and the likely price, less commissions.


Local expectations theory

A form of the pure expectations theory which suggests that the returns on bonds
of different maturities will be the same over a short-term investment horizon.


Long-term

In accounting information, one year or greater.


Long-term assets

Value of property, equipment and other capital assets minus the depreciation. This is an
entry in the bookkeeping records of a company, usually on a "cost" basis and thus does not necessarily reflect
the market value of the assets.


Long-term debt

An obligation having a maturity of more than one year from the date it was issued. Also
called funded debt.


Long-term debt

A debt for which payments will be required for a period of more than
one year into the future.


Long Term Debt

Liability due in a year or more.


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 ratio

The ratio of long-term debt to total capitalization.


Long-term debt to equity ratio

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


Long-term financial plan

Financial plan covering two or more years of future operations.


Long-term liabilities

Amount owed for leases, bond repayment and other items due after 1 year.


LONG-TERM LIABILITIES

Bills that are payable in more than one year, such as a mortgage or bonds.


Long-term liabilities

Amounts owing after more than one year.


Longer-Term Fixed Assets

Assets having a useful life greater than one year but the duration of the 'long term' will vary with the context in which the term is applied.


Market segmentation theory or preferred habitat theory

A biased expectations theory that asserts that the
shape of the yield curve is determined by the supply of and demand for securities within each maturity sector.


matrix structure

an organizational structure in which functional
departments and project teams exist simultaneously
so that the resulting lines of authority resemble a grid


Medium-term note

A corporate debt instrument that is continuously offered to investors over a period of
time by an agent of the issuer. Investors can select from the following maturity bands: 9 months to 1 year,
more than 1 year to 18 months, more than 18 months to 2 years, etc., up to 30 years.


Modern portfolio theory

Principles underlying the analysis and evaluation of rational portfolio choices
based on risk-return trade-offs and efficient diversification.


Normal backwardation theory

Holds that the futures price will be bid down to a level below the expected
spot price.


organizational structure

the manner in which authority and
responsibility for decision making is distributed in an entity


Other long term liabilities

Value of leases, future employee benefits, deferred taxes and other obligations
not requiring interest payments that must be paid over a period of more than 1 year.


pecking order theory

Firms prefer to issue debt rather than equity if internal finance is insufficient.


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 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.


predetermined overhead rate

an estimated constant charge per unit of activity used to assign overhead cost to production or services of the period; it is calculated by dividing total budgeted annual overhead at a selected level of volume or activity by that selected measure of volume or activity; it is also the standard overhead application rate


Preferred habitat theory

A biased expectations theory that believes the term structure reflects the
expectation of the future path of interest rates as well as risk premium. However, the theory rejects the
assertion that the risk premium must rise uniformly with maturity. Instead, to the extent that the demand for
and supply of funds does not match for a given maturity range, some participants will shift to maturities
showing the opposite imbalances. As long as such investors are compensated by an appropriate risk premium
whose magnitude will reflect the extent of aversion to either price or reinvestment risk.


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.


Pure expectations theory

A theory that asserts that the forward rates exclusively represent the expected
future rates. In other words, the entire term structure reflects the markets expectations of future short-term
rates. For example, an increasing sloping term structure implies increasing short-term interest rates. Related:
biased expectations theories


Quantity Theory of Money

theory that velocity is constant, and so a change in money supply will change nominal income by the same percentage. Formalized by the equation Mv = PQ.


random walk theory

Security prices change randomly, with no predictable trends or patterns.


Real Business Cycle Theory

Belief that business cycles arise from real shocks to the economy, such as technology advances and natural resource discoveries, and have little to do with monetary policy.


Repayment Terms

The length of time given a borrower by a lender to repay a debt and the frequency of principal payments which the borrower has to meet.


Restricted Liquidity

Inability of an individual/company to convert an asset into cash or cash equivalent without significant cost.


Short-term financial plan

A financial plan that covers the coming fiscal year.


Short-term investment services

Services that assist firms in making short-term investments.


Short-term solvency ratios

Ratios used to judge the adequacy of liquid assets for meeting short-term
obligations as they come due, including
1) the current ratio,
2) the acid-test ratio,
3) the inventory turnover ratio, and
4) the accounts receivable turnover ratio.


Short-term tax exempts

Short-term securities issued by states, municipalities, local housing agencies, and
urban renewal agencies.


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.


Structured arbitrage transaction

A self-funding, self-hedged series of transactions that usually utilize
mortgage securities as the primary assets.


Structured debt

Debt that has been customized for the buyer, often by incorporating unusual options.


Structured portfolio strategy

A strategy in which a portfolio is designed to achieve the performance of some
predetermined liabilities that must be paid out in the future.


Structured settlement

An agreement in settlement of a lawsuit involving specific payments made over a
period of time. Property and casualty insurance companies often buy life insurance products to pay the costs
of such settlements.


Structured Settlement

Historically, damages paid out during settlement of personal physical injury cases were distributed in the form of a lump-sum cash payment to the plaintiff. This windfall was intended to provide for a lifetime of medical and income needs. The claimant or his/her family was then forced into the position of becoming the manager of a large sum of money.
In an effort to create a more financially stable arrangement for the claimant, the structured Settlement was developed. A structured Settlement is an alternative to a lump sum cash payment in the resolution of personal physical injury, wrongful death, or workers’ compensation cases. The settlement usually consists of two components: an up-front cash payment to provide for immediate needs and a series of future periodic payments which are funded by the defendant’s purchase of one or more annuity policies. Those payors make payments directly to the claimant. In the unfortunate event of the claimant’s death, a guaranteed portion of the settlement may be directed to a beneficiary or his/her estate.
A structured Settlement is a guaranteed source of funds paid to the claimant or his/her family on a tax-free basis.


Term

See term to maturity.


Term

This is usually the duration of a loan.


term

The period of time during which a financial contract – such as a GIC or a loan – is in force.


Term

The time period during which a policy is in force, or the time it takes for a policy to reach maturity.


Term bonds

Often referred to as bullet-maturity bonds or simply bullet bonds, bonds whose principal is
payable at maturity. Related: serial bonds


Term Deposit

An interest-earning bank deposit that cannot be withdrawn without penalty until a specific time.


Term Fed Funds

Fed Funds sold for a period of time longer than overnight.


Term insurance

Provides a death benefit only, no build-up of cash value.


Term Life

A product that provides life coverage for a specified duration typically not beyond the age of 75.


Term life insurance

A contract that provides a death benefit but no cash build-up or investment component.
The premium remains constant only for a specified term of years, and the policy is usually renewable at the
end of each term.



 

 

 

 

 

 

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