Financial Terms Normal backwardation theory

Definition of Normal backwardation theory

Normal backwardation theory

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

Related Terms:

CARs (cumulative abnormal returns)

a measure used in academic finance articles to measure the excess returns an investor would have received over a particular time period if he or she were invested in a particular stock.
This is typically used in control and takeover studies, where stockholders are paid a premium for being taken over. Starting some time period before the takeover (often five days before the first announced bid, but sometimes a longer period), the researchers calculate the actual daily stock returns for the target firm and subtract out the expected market returns (usually calculated using the firmâ€™s beta and applying it to overall market movements during the time period under observation).
The excess actual return over the capital asset pricing model-determined expected return market is called an â€˜â€˜abnormal return.â€™â€™ The cumulation of the daily abnormal returns over the time period under observation is the CAR. The term CAR(-5, 0) means the CAR calculated from five days before the
announcement to the day of announcement. The CAR(-1, 0) is a control premium, although Mergerstat generally uses the stock price five days before announcement rather than one day before announcement as the denominator in its control premium calculation. However, the CAR for any period other than (-1, 0) is not mathematically equivalent to a control premium.

Abnormal returns

Part of the return that is not due to systematic influences (market wide influences). In
other words, abnormal returns are above those predicted by the market movement alone. Related: excess
returns.

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.

Backwardation

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.

Bubble theory

Security prices sometimes move wildly above their true values.

Cumulative abnormal return (CAR)

Sum of the differences between the expected return on a stock and the
actual return that comes from the release of news to the market.

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

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.

Lognormal distribution

A distribution where the logarithm of the variable follows a normal distribution.
Lognormal distributions are used to describe returns calculated over periods of a year or more.

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.

Modern portfolio theory

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

Normal annuity form

The manner in which retirement benefits are paid out.

Normal deviate

Related: standardized value

Normal probability distribution

A probability distribution for a continuous random variable that is forms a
symmetrical bell-shaped curve around the mean.

Normal portfolio

A customized benchmark that includes all the securities from which a manager normally
chooses, weighted as the manager would weight them in a portfolio.

Normal random variable

A random variable that has a normal probability distribution.

Normalizing method

The practice of making a charge in the income account equivalent to the tax savings
realized through the use of different depreciation methods for shareholder and income tax purposes, thus
washing out the benefits of the tax savings reported as final net income to shareholders.

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.

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

Standardized normal distribution

A normal distribution with a mean of 0 and a standard deviation of 1.

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.

net cost of normal spoilage

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

normal capacity

the long-run (5â€“10 years) average production
or service volume of a firm; it takes into consideration
cyclical and seasonal fluctuations

normal cost system

a valuation method that uses actual
costs of direct material and direct labor in conjunction with
a predetermined overhead rate or rates in determining the
cost of Work in Process Inventory

normal loss

an expected decline in units during the production process

normal spoilage

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

theory of constraints (TOC)

a method of analyzing the bottlenecks
(constraints) that keep a system from achieving
higher performance; it states that production cannot take
place at a rate faster than the slowest machine or person
in the process

Normal (bell-shaped) distribution

In statistics, a theoretical frequency
distribution for a set of variable data, usually represented by a bell-shaped

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.

expectations theory of exchange rates

theory that expected spot exchange rate equals the forward rate.

pecking order theory

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

random walk theory

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

Debt levels are chosen to balance interest tax shields against the costs of financial distress.

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.

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.