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Definition of Principal

Principal Image 1


1) The total amount of money being borrowed or lent.
2) The party affected by agent decisions in a principal-agent relationship.


The original amount loaned, which is repaid plus interest. See face value.


The obligation due under a debt instrument exclusive of interest.

Related Terms:

Generally Accepted Accounting Principals (GAAP)

A technical accounting term that encompasses the
conventions, rules, and procedures necessary to define accepted accounting practice at a particular time.

Notional principal amount

In an interest rate swap, the predetermined dollar principal on which the
exchanged interest payments are based.

Principal-agent relationship

A situation that can be modeled as one person, an agent, who acts on the behalf
of another person, the principal.

Principal amount

The face amount of debt; the amount borrowed or lent. Often called principal.

Principal Amount

Generally, refers to the face value of a debt.

Principal Image 2

Principal of diversification

Highly diversified portfolios will have negligible unsystematic risk. In other
words, unsystematic risks disappear in portfolios, and only systematic risks survive.

Principal only (PO)

A mortgage-backed security in which the holder receives only principal cash flows on
the underlying mortgage pool. The principal-only portion of a stripped MBS. For PO securities, all of the
principal distribution due from the underlying collateral pool is paid to the registered holder of the stripped
MBS based on the current face value of the underlying collateral pool.

Principal value

See Par value.

Remaining principal balance

The amount of principal dollars remaining to be paid under the mortgage as of
a given point in time.

Value additivity principal

Prevails when the value of a whole group of assets exactly equals the sum of the
values of the individual assets that make up the group of assets. Stated differently, the principle that the net
present value of a set of independent projects is just the sum of the net present values of the individual projects.

Accrual bond

A bond on which interest accrues, but is not paid to the investor during the time of accrual.
The amount of accrued interest is added to the remaining principal of the bond and is paid at maturity.

Agency costs

The incremental costs of having an agent make decisions for a principal.

Agency pass-throughs

Mortgage pass-through securities whose principal and interest payments are
guaranteed by government agencies, such as the Government National Mortgage Association ("Ginnie Mae"), Federal Home Loan Mortgage Corporation ("Freddie Mac") and Federal National Mortgage Association ("Fannie Mae").

Agency theory

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


The decision-maker in a principal-agent relationship.


This term has two quite different meanings. First, it may
refer to the allocation to expense each period of the total cost of an
intangible asset (such as the cost of a patent purchased from the inventor)
over its useful economic life. In this sense amortization is equivalent
to depreciation, which allocates the cost of a tangible long-term operating
asset (such as a machine) over its useful economic life. Second, amortization
may refer to the gradual paydown of the principal amount of a debt.
principal refers to the amount borrowed that has to be paid back to the
lender as opposed to interest that has to be paid for use of the principal.
Each period, a business may pay interest and also make a payment on
the principal of the loan, which reduces the principal amount of the loan,
of course. In this situation the loan is amortized, or gradually paid down.


The reduction of debt by regular payments of interest and principal sufficient to pay off a loan by maturity.

Amortization (Credit Insurance)

Refers to the reduction of debt by regular payments of interest and principal in order to pay off a loan by maturity.

Amortization Schedule

A schedule that shows precisely how a loan will be repaid. The schedule gives the required payment on each specific date and shows how much of it constitutes interest and how much constitutes repayments of principal.


To liquidate on an instalment basis; an amortized loan is one on which the principal amount of the loan is repaid in instalments during the life of the loan.

Amortizing interest rate swap

Swap in which the principal or national amount rises (falls) as interest rates
rise (decline).

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.

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

Baker Plan

A plan by U.S. Treasury Secretary James Baker under which 15 principal middle-income debtor
countries (the Baker 15) would undertake growth-oriented structural reforms, to be supported by increased
financing from the World Bank and continued lending from commercial banks.

Balloon maturity

Any large principal payment due at maturity for a bond or loan with or without a a sinking
fund requirement.


Bonds are debt and are issued for a period of more than one year. The U.S. government, local
governments, water districts, companies and many other types of institutions sell bonds. When an investor
buys bonds, he or she is lending money. The seller of the bond agrees to repay the principal amount of the
loan at a specified time. Interest-bearing bonds pay interest periodically.


A long-term debt instrument in which the issuer (borrower) is
obligated to pay the investor (lender) a specified amount of
money, usually at specific intervals, and to repay the principal
amount of the loan at maturity. The periodic payments are based
on the rate of interest agreed upon at the time the instrument is


Usually a fixed interest security under which the issuer contracts to pay the lender a fixed principal amount at a stated date in the future, and a series of interest payments, either semi-annually or annually. Interest payments may vary through the life of bond.

Bull-bear bond

Bond whose principal repayment is linked to the price of another security. The bonds are
issued in two tranches: in the first tranche repayment increases with the price of the other security, and in the
second tranche repayment decreases with the price of the other security.


Mortgages in which monthly payments consist of principal and interest, with portions of these
payments during the early period of the loan being provided by a third party to reduce the borrower's monthly

Cash flow coverage ratio

The number of times that financial obligations (for interest, principal payments,
preferred stock dividends, and rental payments) are covered by earnings before interest, taxes, rental
payments, and depreciation.

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

Commercial Mortgage

A loan made on real estate collateral, other than a residential property, in which a mortgage is given to secure payment of principal and interest.

Compound interest

Interest paid on previously earned interest as well as on the principal.

Compound Interest

Interest paid on principal and on interest earned in previous

compound interest

a method of determining interest in which interest that was earned in prior periods is added to the original investment so that, in each successive period, interest is earned on both principal and interest

Compound Interest

Interest earned on an investment at periodic intervals and added to principal and previous interest earned. Each time new interest earned is calculated it is on a combined total of principal and previous interest earned. Essentially, interest is paid on top of interest.

concentration banking

System whereby customers make payments to a regional collection center which transfers funds to
a principal bank.

Continuous Compounding

The process of continuously adding interest to a principal plus
interest amount and calculating the resulting compound amount

Corporate financial management

The application of financial principals within a corporation to create and
maintain value through decision making and proper resource management.

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.

Debt relief

Reducing the principal and/or interest payments on LDC loans.

Debt service

Interest payment plus repayments of principal to creditors, that is, retirement of debt.

Debt-service coverage ratio

Earnings before interest and income taxes plus one-third rental charges, divided
by interest expense plus one-third rental charges plus the quantity of principal repayments divided by one
minus the tax rate.

Debt service parity approach

An analysis wherein the alternatives under consideration will provide the firm
with the exact same schedule of after-tax debt payments (including both interest and principal).


Failure to make timely payment of interest or principal on a debt security or to otherwise comply
with the provisions of a bond indenture.


The failure by a debtor to make a principal or interest payment in a timely


Failure of a debtor to make timely payments of principal and interest as they become due.

Default risk

Also referred to as credit risk (as gauged by commercial rating companies), the risk that an
issuer of a bond may be unable to make timely principal and interest payments.

Discount bond

Debt sold for less than its principal value. If a discount bond pays no interest, it is called a
zero coupon bond.

Discrete Compounding

The process of adding interest to a principal plus interest amount
and calculating the resulting compound amount at specific
intervals, such as monthly or annually

Dual-currency issues

Eurobonds that pay coupon interest in one currency but pay the principal in a different

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 Interest Rate

The rate of interest actually earned on an investment. It is
calculated as the ratio of the total amount of interest actually
earned for one year divided by the amount of the principal.


One of two principal clearing systems in the Eurobond market. It began operations in 1968, is
located in Brussels, and is managed by Morgan Guaranty Bank.

Event risk

The risk that the ability of an issuer to make interest and principal payments will change because
of rare, discontinuous, and very large, unanticipated changes in the market environment such as (1) a natural
or industrial accident or some regulatory change or (2) a takeover or corporate restructuring.


The marketplace in which shares, options and futures on stocks, bonds, commodities and indices
are traded. principal US stock exchanges are: New York Stock Exchange (NYSE), American Stock Exchange
(AMEX) and the National Association of Securities Dealers (NASDAQ)

Face value

The maturity value of a security. Also known as par value,
principal value, or redemption value.

Face Value

The payoff value of a bond upon maturity. Also called par value. See principal.


Type of financial service whereby a firm sells or transfers title to its accounts receivable to a factoring company, which then acts as principal, not as agent.

Flat trades

1) A bond in default trades flat; that is, the price quoted covers both principal and unpaid,
accrued interest.
2) Any security that trades without accrued interest or at a price that includes accrued
interest is said to trade flat.

Fully modified pass-throughs

Agency pass-throughs that guarantee the timely payment of both interest and
principal. Related: modified pass-throughs
Functional currency As defined by FASB No. 52, an affiliate's functional currency is the currency of the
primary economic environment in which the affiliate generates and expends cash.

GEMs (growing-equity mortgages)

Mortgages in which annual increases in monthly payments are used to
reduce outstanding principal and to shorten the term of the loan.


Mortgage-backed securities (MBS) on which registered holders receive separate principal and
interest payments on each of their certificates, usually directly from the servicer of the MBS pool. GNMA-I
mortgage-backed securities are single-issuer pools.


Mortgage-backed securities (MBS) on which registered holders receive an aggregate principal and
interest payment from a central paying agent on all of their certificates. principal and interest payments are
disbursed on the 20th day of the month. GNMA-II MBS are backed by multiple-issuer pools or custom pools
(one issuer but different interest rates that may vary within one percentage point). Multiple-issuer pools are
known as "Jumbos." Jumbo pools are generally longer and offer certain mortgages that are more
geographically diverse than single-issuer pools. Jumbo pool mortgage interest rates may vary within one
percentage point.

Government National Mortgage Association (Ginnie Mae)

A wholly owned U.S. government corporation
within the Department of Housing & Urban Development. Ginnie Mae guarantees the timely payment of
principal and interest on securities issued by approved servicers that are collateralized by FHA-issued, VAguaranteed,
or Farmers Home Administration (FmHA)-guaranteed mortgages.

Grace Period

Length of time during which repayments of loan principal are excused. Usually occurs at the start of the loan period.

Graduated-payment mortgages (GPMs)

A type of stepped-payment loan in which the borrower's payments
are initially lower than those on a comparable level-rate mortgage. The payments are gradually increased over
a predetermined period (usually 3,5, or 7 years) and then are fixed at a level-pay schedule which will be
higher than the level-pay amortization of a level-pay mortgage originated at the same time. The difference
between what the borrower actually pays and the amount required to fully amortize the mortgage is added to
the unpaid principal balance.

Guaranteed investment contract (GIC)

A pure investment product in which a life company agrees, for a
single premium, to pay the principal amount of a predetermined annual crediting (interest) rate over the life of
the investment, all of which is paid at the maturity date.

Interest-only strip (IO)

A security based solely on the interest payments form a pool of mortgages, Treasury
bonds, or other bonds. Once the principal on the mortgages or bonds has been repaid, interest payments stop
and the value of the IO falls to zero.

Interest payments

Contractual debt payments based on the coupon rate of interest and the principal amount.

Interest rate swap

A binding agreement between counterparties to exchange periodic interest payments on
some predetermined dollar principal, which is called the notional principal amount. For example, one party
will pay fixed and receive variable.

Letter of credit (L/C)

A form of guarantee of payment issued by a bank used to guarantee the payment of
interest and repayment of principal on bond issues.

Level pay

The characteristic of the scheduled principal and interest payments due under a mortgage such that
total monthly payment of P&I is the same while characteristically the principal payment component of the
monthly payment becomes gradually greater while the monthly interest payment becomes less.

Loan amortization schedule

The schedule for repaying the interest and principal on a loan.


For a bond, the date on which the principal is required to be repaid. In an interest rate swap, the
date that the swap stops accruing interest.

MBS servicing

The requirement that the mortgage servicer maintain payment of the full amount of
contractually due principal and interest payments whether or not actually collected.

Modified pass-throughs

Agency pass-throughs that guarantee (1) timely interest payments and (2) principal
payments as collected, but no later than a specified time after they are due. Related: fully modified passthroughs

Mortgage pass-through security

Also called a passthrough, a security created when one or more mortgage
holders form a collection (pool) of mortgages sells shares or participation certificates in the pool. The cash
flow from the collateral pool is "passed through" to the security holder as monthly payments of principal,
interest, and prepayments. This is the predominant type of MBS traded in the secondary market.

Negative amortization

A loan repayment schedule in which the outstanding principal balance of the loan
increases, rather than amortizing, because the scheduled monthly payments do not cover the full amount
required to amortize the loan. The unpaid interest is added to the outstanding principal, to be repaid later.

Net Cash after Operations

Cash flow available for debt service—the payment of interest and principal on loans. Generally calculated as cash provided by operating activities before interest

Original face value

The principal amount of the mortgage as of its issue date.

Pass-through securities

A pool of fixed-income securities backed by a package of assets (i.e. mortgages)
where the holder receives the principal and interest payments. Related: mortgage pass-through security

Planned amortization class CMO

1) One class of CMO that carries the most stable cash flows and the
lowest prepayement risk of any class of CMO. Because of that stable cash flow, it is considered the least risky CMO.
2) A CMO bond class that stipulates cash-flow contributions to a sinking fund. With the PAC,
principal payments are directed to the sinking fund on a priority basis in accordance with a predetermined
payment schedule, with prior claim to the cash flows before other CMO classes. Similarly, cash flows
received by the trust in excess of the sinking fund requirement are also allocated to other bond classes. The
prepayment experience of the PAC is therefore very stable over a wide range of prepayment experience.

Pool factor

The outstanding principal balance divided by the original principal balance with the result
expressed as a decimal. Pool factors are published monthly by the Bond Buyer newspaper for Ginnie Mae,
Fannie Mae, and Freddie Mac(Federal Home Loan Mortgage Corporation) MBSs.


Payments made in excess of scheduled mortgage principal repayments.

Present Value

The amount due on an obligation less any interest on that obligation that would
be expected to accrue under market interest-rate conditions over the period prior to settlement. On
an interest-bearing liability, the amount owed on the liability, the principal, is its present value.
Interest is paid in addition to that present value amount. On a noninterest-bearing liability, the
amount owed is considered to include interest. To calculate present value, the liability must be discounted to remove that interest. The liability amount, excluding interest, would be the noninterest-
bearing liability's present value.


A prepayment model based on an assumed rate of prepayment each month of the then unpaid principal
balance of a pool of mortgages. PSA is used primarily to derive an implied prepayment speed of new
production loans, a 100% PSA assumes a prepayment rate of 2% per month in the first month following the
date of issue, increasing at 2% per month thereafter until the 30th month. Thereafter, 100% PSA is the same as
6% CPR.

Pure-discount bond

A bond that will make only one payment of principal and interest. Also called a zerocoupon
bond or a single-payment bond.

Rate of interest

The rate, as a proportion of the principal, at which interest is computed.

Record date

1) Date by which a shareholder must officially own shares in order to be entitled to a dividend.
For example, a firm might declare a dividend on Nov 1, payable Dec 1 to holders of record Nov 15. Once a
trade is executed an investor becomes the "owner of record" on settlement, which currently takes 5 business
days for securities, and one business day for mutual funds. Stocks trade ex-dividend the fourth day before the
record date, since the seller will still be the owner of record and is thus entitled to the dividend.
2) The date that determines who is entitled to payment of principal and interest due to be paid on a security. The record
date for most MBSs is the last day of the month, however the last day on which they may be presented for the
transfer is the last business day of the month. The record date for CMOs and asset-backed securities vary with each issue.

Regulatory accounting procedures

Accounting principals required by the FHLB that allow S&Ls to elect
annually to defer gains and losses on the sale of assets and amortize these deferrals over the average life of the
asset sold.


One who receives the principal of a trust when it is dissolved.

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.

return of capital

the recovery of the original investment (or principal) in a project

Scheduled cash flows

The mortgage principal and interest payments due to be paid under the terms of the
mortgage not including possible prepayments.

Serial bonds

Corporate bonds arranged so that specified principal amounts become due on specified dates.
Related: term bonds.







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