Financial Terms
Monte-Carlo simulation

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Definition of Monte-Carlo simulation

Monte-Carlo Simulation Image 1

Monte-Carlo simulation

A mathematical modeling process. For a model that
has several parameters with statistical properties, pick a set of random values
for the parameters and run a simulation. Then pick another set of values, and
run it again. Run it many times (often 10,000 times) and build up a statistical
distribution of outcomes of the simulation. This distribution of outcomes is
then used to answer whatever question you are asking.

Monte Carlo simulation

An analytical technique for solving a problem by performing a large number of trail
runs, called simulations, and inferring a solution from the collective results of the trial runs. Method for
calculating the probability distribution of possible outcomes.

Related Terms:


The use of a mathematical model to imitate a situation many times in order to estimate the
likelihood of various possible outcomes. See: monte carlo simulation.

simulation analysis

Estimation of the probabilities of different possible outcomes, e.g., from an investment project.


Annual report required by the SEC each year. Provides a comprehensive overview of a company's state
of business. Must be filed within 90 days after fiscal year end. A 10Q report is filed quarterly.

Acceleration Clause

Clause causing repayment of a debt, if specified events occur or are not met.

acid test ratio (also called the quick ratio)

The sum of cash, accounts receivable, and short-term marketable
investments (if any) is divided by
total current liabilities to compute This ratio. Suppose that the short-term
creditors were to pounce on a business and not agree to roll over the
debts owed to them by the business. In This rather extreme scenario, the
acid test ratio reveals whether its cash and near-cash assets are enough
to pay its short-term current liabilities. This ratio is an extreme test that
is not likely to be imposed on a business unless it is in financial straits.
This ratio is quite relevant when a business is in a liquidation situation
or bankruptcy proceedings.

Acquisition of assets

A merger or consolidation in which an acquirer purchases the selling firm's assets.

Monte-Carlo Simulation Image 1

Agency problem

Conflicts of interest among stockholders, bondholders, and managers.

agency problems

Conflicts of interest between the firm’s owners and managers.

Aggregate Supply

Total quantity of goods and services supplied.

Aggregate Supply Curve

Combinations of price level and income for which the labor market is in equilibrium. The short-Run aggregate supply curve incorporates information and price/wage inflexibilities in the labor market, whereas the long-Run aggregate supply curve does not.

algebraic method

a process of service department cost allocation
that considers all interrelationships of the departments
and reflects these relationships in simultaneous

Allowance method

A Method of adjusting accounts receivable to the amount that is expected to be collected based on company experience.

Analytical Review

The process of attempting to infer the presence of potential problems
through the analysis of ratios and other relationships, often over time.

Arbitrage-free option-pricing models

Yield curve option-pricing models.


Any possession that has value in an exchange.

Monte-Carlo Simulation Image 2


A resource, recorded through a transaction, that is expected to yield a benefit to a


Something that is owned; a financial claim or a piece of property that is a store of value.


Probable future economic benefit that is obtained or controlled by an entity as a result of
a past transaction or event.


Anything owned by, or owed to, an individual or business which has commercial or exchange value (e.g., cash, property, etc.).


All things of value owned by an individual or organization.

Asset activity ratios

Ratios that measure how effectively the firm is managing its assets.

Asset allocation decision

The decision regarding how an institution's funds should be distributed among the
major classes of assets in which it may invest.

Asset-Backed Securities

Bond or note secured by assets of company.

Asset-backed security

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

Asset-based financing

Methods of financing in which lenders and equity investors look principally to the
cash flow from a particular asset or set of assets for a return on, and the return of, their financing.

Asset-Based Financing

Loans granted usually by a financial institution where the asset being financed constitutes the sole security given to the lender.

Asset classes

Categories of assets, such as stocks, bonds, real estate and foreign securities.

Asset Coverage

Extent to which a company's net assets cover a particular debt obligation, class of preferred stock, or equity position.

Asset-coverage test

A bond indenture restriction that permits additional borrowing on if the ratio of assets to
debt does not fall below a specified minimum.

Asset/equity ratio

The ratio of total assets to stockholder equity.

Asset for asset swap

Creditors exchange the debt of one defaulting borrower for the debt of another
defaulting borrower.

Asset/liability management

Also called surplus management, the task of managing funds of a financial
institution to accomplish the two goals of a financial institution:
1) to earn an adequate return on funds invested, and
2) to maintain a comfortable surplus of assets beyond liabilities.

asset mix

The weighting of assets in an investment portfolio among different asset classes (e.g. shares, bonds, property, cash, overseas investments.

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.

Asset-specific Risk

The amount of total risk that can be eliminated by diversification by
creating a portfolio. Also known as company-specific risk or
unsystematic risk.

Asset substitution

A firm's investing in assets that are riskier than those that the debtholders expected.

Asset substitution problem

Arises when the stockholders substitute riskier assets for the firm's existing
assets and expropriate value from the debtholders.

Asset swap

An interest rate swap used to alter the cash flow characteristics of an institution's assets so as to
provide a better match with its iabilities.

Asset turnover

The ratio of net sales to total assets.

asset turnover

a ratio measuring asset productivity and showing the number of sales dollars generated by each dollar of assets

asset turnover ratio

A broad-gauge ratio computed by dividing annual
sales revenue by total assets. It is a rough measure of the sales-generating
power of assets. The idea is that assets are used to make sales, and the
sales should lead to profit. The ultimate test is not sales revenue on
assets, but the profit earned on assets as measured by the return on
assets (ROA) ratio.


A firm's productive resources.


Anything of value that a company owns.


Things that the business owns.


Items owned by the company or expenses that have been paid for but have not been used up.

Assets requirements

A common element of a financial plan that describes projected capital spending and the
proposed uses of net working capital.

Automated Clearing House (ACH)

A collection of 32 regional electronic interbank networks used to
process transactions electronically with a guaranteed one-day bank collection float.

Automated Clearing House (ACH)

A banking clearinghouse that processes direct
deposit transfers.

Average-Cost Inventory Method

The inventory cost-flow assumption that assigns the average
cost of beginning inventory and inventory purchases during a period to cost of goods sold and
ending inventory.


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.

Bank for International Settlements (BIS)

An international bank headquartered in Basel, Switzerland, which
serves as a forum for monetary cooperation among several European central banks, the Bank of Japan, and the
U.S. Federal Reserve System. Founded in 1930 to handle the German payment of World War I reparations, it
now monitors and collects data on international banking activity and promulgates rules concerning
international bank regulation.


State of being unable to pay debts. Thus, the ownership of the firm's assets is transferred from
the stockholders to the bondholders.


The reorganization or liquidation of a firm that cannot pay its debts.

Bankruptcy cost view

The argument that expected indirect and direct bankruptcy costs offset the other
benefits from leverage so that the optimal amount of leverage is less than 100% debt finaning.

Bankruptcy risk

The risk that a firm will be unable to meet its debt obligations. Also referred to as default or insolvency risk.

Bankruptcy view

The argument that expected bankruptcy costs preclude firms from being financed entirely
with debt.

Bargain-purchase-price option

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

Base probability of loss

The probability of not achieving a portfolio expected return.

Batch picking

picking for several summarized orders at the same time, thereby
reducing the total number of required picks. The combined picks must still be
separated into their constituent orders, typically at some central location.

Benefit Ratio Method

The proportion of unemployment benefits paid to a company’s
former employees during the measurement period, divided by the total
payroll during the period. This calculation is used by states to determine the unemployment
contribution rate to charge employers.

Benefit Wage Ratio Method

The proportion of total taxable wages for laid off
employees during the measurement period divided by the total payroll during
the period. This calculation is used by states to determine the unemployment
contribution rate to charge employers.

Binomial model

A Method of pricing options or other equity derivatives in
which the probability over time of each possible price follows a binomial
distribution. The basic assumption is that prices can move to only two values
(one higher and one lower) over any short time period.

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 model

The first complete mathematical model for pricing
options, developed by Fischer Black and Myron Scholes. It examines market
price, strike price, volatility, time to expiration, and interest rates. It is limited
to only certain kinds of options.

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.

Block house

Brokerage firms that help to find potential buyers or sellers of large block trades.

Book runner

The managing underwriter for a new issue. The book Runner maintains the book of securities sold.

Bootstrapping, bootstrap method

An arithmetic Method for backing an
implied zero curve out of the par yield curve.

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.

build mission

a mission of increasing market share, even at
the expense of short-term profits and cash flow; typically
pursued by a business unit that has a small market share
in a high-growth industry; appropriate for products that
are in the early stages of the product life cycle

Builder buydown loan

A mortgage loan on newly developed property that the builder subsidizes during the
early years of the development. The builder uses cash to buy down the mortgage rate to a lower level than the
prevailing market loan rate for some period of time. The typical buydown is 3% of the interest-rate amount
for the first year, 2% for the second year, and 1% for the third year (also referred to as a 3-2-1 buydown).


The cost of buildings owned by the company.

Building a binomial tree

For a binomial option model: plotting the two
possible short-term price-changes values, and then the subsequent two values
each, and then the subsequent two values each, and so on over time, is known
as “building a binomial tree.” See Binomial model.

business process reengineering (BPR)

the process of combining information technology to create new and more effective
business processes to lower costs, eliminate unnecessary
work, upgrade customer service, and increase
speed to market

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.


Purchase of a controlling interest (or percent of shares) of a company's stock. A leveraged buy-out is
done with borrowed money.

capital asset

an asset used to generate revenues or cost savings
by providing production, distribution, or service capabilities
for more than one year

Capital asset

A fixed asset, something that is expected to have long-term usage within
a company, and which exceeds a minimum dollar amount (known as the capitalization
limit, or cap limit).

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.

Capital Asset Pricing Model (CAPM)

A model for estimating equilibrium rates of return and values of
assets in financial markets; uses beta as a measure of asset risk
relative to market risk

capital asset pricing model (CAPM)

Theory of the relationship between risk and return which states that the expected risk
premium on any security equals its beta times the market risk premium.

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.

Capitalized Cost An expenditure or accrual that is reported as an asset to be amortized against

future-period revenue.

Cash Flow Provided or Used from Financing Activities

Cash receipts and payments involving
liability and stockholders' equity items, including obtaining cash from creditors and repaying
the amounts borrowed and obtaining capital from owners and providing them with a return on,
and a return of, their investments.

Cash Flow Provided or Used from Investing Activities

Cash receipts and payments involving
long-term assets, including making and collecting loans and acquiring and disposing of
investments and productive long-lived assets.

Cash settlement contracts

Futures contracts, such as stock index futures, that settle for cash, not involving
the delivery of the underlying.

Change in Accounting Estimate

A change in accounting that occurs as the result of new information
or as additional experience is acquired—for example, a change in the residual values
or useful lives of fixed assets. A change in accounting estimate is accounted for prospectively,
over the current and future accounting periods affected by the change.

Change in Accounting Estimate

A change in the implementation of an existing accounting
policy. A common example would be extending the useful life or changing the expected residual
value of a fixed asset. another would be making any necessary adjustments to allowances for
uncollectible accounts, warranty obligations, and reserves for inventory obsolescense.

Cherry Picking

Selecting specific assets for sale so as to record desired gains or losses.

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 / Clearinghouse

An adjunct to a futures exchange through which transactions executed its floor are settled by a
process of matching purchases and sales. A clearing organization is also charged with the proper conduct of
delivery procedures and the adequate financing of the entire operation.

Clearing House Interbank Payments System (CHIPS)

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

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.

Collective wisdom

The combination of all of the individual opinions about a stock's or security's value.

Commission house

A firm which buys and sells future contracts for customer accounts. Related: futures
commission merchant, omnibus account.

Completed-Contract Method

A contract accounting Method that recognizes contract revenue
only when the contract is completed. All contract costs are accumulated and reported as expense
when the contract revenue is recognized.

constant-growth dividend discount model

Version of the dividend discount model in which dividends grow at a constant rate.

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.

Contra-asset account

An offset to an asset account that reduces the balance of the asset account.

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







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