Financial Terms Residuals

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# Definition of Residuals

## Residuals

1) Parts of stock returns not explained by the explanatory variable (the market-index return). They
measure the impact of firm-specific events during a particular period.
2) Remainder cash flows generated by pool collateral and those needed to fund bonds supported by the collateral.

# 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.

## DLOM (discount for lack of marketability)

an amount or percentage deducted from an equity interest to reflect lack of marketability.

## NPV (net present value of cash flows)

Same as PV, but usually includes a subtraction for an initial cash outlay.

## PPF (periodic perpetuity factor)

a generalization formula invented by Abrams that is the present value of regular but noncontiguous cash flows that have constant growth to perpetuity.

## PV (present value of cash flows)

the value in todayâ€™s dollars of cash flows that occur in different time periods.
present value factor equal to the formula 1/(1 - r)n, where n is the number of years from the valuation date to the cash flow and r is the discount rate.
For business valuation, n should usually be midyear, i.e., n = 0.5, 1.5, . . .

## QMDM (quantitative marketability discount model)

model for calculating DLOM for minority interests r the discount rate

## 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.

## Acquisition of stock

A merger or consolidation in which an acquirer purchases the acquiree's stock.

## Adjustable rate preferred stock (ARPS)

Publicly traded issues that may be collateralized by mortgages and MBSs.

## Affirmative covenant

A bond covenant that specifies certain actions the firm must take.

## After-tax real rate of return

Money after-tax rate of return minus the inflation rate.

## American Stock Exchange (AMEX)

The second-largest stock exchange in the United States. It trades
mostly in small-to medium-sized companies.

## Annual fund operating expenses

For investment companies, the management fee and "other expenses,"
including the expenses for maintaining shareholder records, providing shareholders with financial statements,
and providing custodial and accounting services. For 12b-1 funds, selling and marketing costs are included.

## Annualized holding period return

The annual rate of return that when compounded t times, would have
given the same t-period holding return as actually occurred from period 1 to period t.

## Arithmetic average (mean) rate of return

Arithmetic mean return.

## Arithmetic mean return

An average of the subperiod returns, calculated by summing the subperiod returns
and dividing by he number of subperiods.

## Arms index

Also known as a trading index (TRIN)= (number of advancing issues)/ (number of declining
issues) (Total up volume )/ (total down volume). An advance/decline market indicator. Less than 1.0 indicates
bullish demand, while above 1.0 is bearish. The index often is smoothed with a simple moving average.

## Auction markets

markets in which the prevailing price is determined through the free interaction of
prospective buyers and sellers, as on the floor of the stock exchange.

## Auction rate preferred stock (ARPS)

Floating rate preferred stock, the dividend on which is adjusted every
seven weeks through a Dutch auction.

## Average accounting return

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

## 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 (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.

## Balanced fund

An investment company that invests in stocks and bonds. The same as a balanced mutual fund.

## Balanced mutual fund

This is a fund that buys common stock, preferred stock and bonds. The same as a
balanced fund.

## Bear market

Any market in which prices are in a declining trend.

## Beta (Mutual Funds)

The measure of a fund's or stocks risk in relation to the market. A beta of 0.7 means
the fund's total return is likely to move up or down 70% of the market change; 1.3 means total return is likely
to move up or down 30% more than the market. Beta is referred to as an index of the systematic risk due to
general market conditions that cannot be diversified away.

## Beta equation (Mutual Funds)

The beta of a fund is determined as follows:
[(n) (sum of (xy)) ]-[ (sum of x) (sum of y)]
[(n) (sum of (xx)) ]-[ (sum of x) (sum of x)]
where: n = # of observations (36 months)
x = rate of return for the S&P 500 index
y = rate of return for the fund

## Beta equation (Stocks)

The beta of a stock is determined as follows:
[(n) (sum of (xy)) ]-[(sum of x) (sum of y)]
[(n) (sum of (xx)) ]-[(sum of x) (sum of x)]
where: n = # of observations (24-60 months)
x = rate of return for the S&P 500 index
y = rate of return for the stock

## Black market

An illegal market.

## Bond indexing

Designing a portfolio so that its performance will match the performance of some bond index.

## Brady bonds

bonds issued by emerging countries under a debt reduction plan.

## Brokered market

A market where an intermediary offers search services to buyers and sellers.

## Bull market

Any market in which prices are in an upward trend.

## Bulldog market

The foreign market in the United Kingdom.

## Buying the index

Purchasing the stocks in the S&P 500 in the same proportion as the index to achieve the
same return.

## Capital market

The market for trading long-term debt instruments (those that mature in more than one year).

## Capital market efficiency

Reflects the relative amount of wealth wasted in making transactions. An efficient
capital market allows the transfer of assets with little wealth loss. See: efficient market hypothesis.

## Capital market imperfections view

The view that issuing debt is generally valuable but that the firm's
optimal choice of capital structure is a dynamic process that involves the other views of capital structure (net
corporate/personal tax, agency cost, bankruptcy cost, and pecking order), which result from considerations of
asymmetric information, asymmetric taxes, and transaction costs.

## Capital market line (CML)

The line defined by every combination of the risk-free asset and the market portfolio.

## Cash

The value of assets that can be converted into cash immediately, as reported by a company. Usually
includes bank accounts and marketable securities, such as government bonds and Banker's Acceptances. cash
equivalents on balance sheets include securities (e.g., notes) that mature within 90 days.

## Cash budget

A forecasted summary of a firm's expected cash inflows and cash outflows as well as its
expected cash and loan balances.

## Cash and carry

Purchase of a security and simultaneous sale of a future, with the balance being financed
with a loan or repo.

## Cash and equivalents

The value of assets that can be converted into cash immediately, as reported by a
company. Usually includes bank accounts and marketable securities, such as government bonds and Banker's
Acceptances. cash equivalents on balance sheets include securities (e.g., notes) that mature within 90 days.

## Cash commodity

The actual physical commodity, as distinguished from a futures contract.

## Cash conversion cycle

The length of time between a firm's purchase of inventory and the receipt of cash
from accounts receivable.

## Cash cow

A company that pays out all earnings per share to stockholders as dividends. Or, a company or
division of a company that generates a steady and significant amount of free cash flow.

## Cash cycle

In general, the time between cash disbursement and cash collection. In net working capital
management, it can be thought of as the operating cycle less the accounts payable payment period.

## Cash deficiency agreement

An agreement to invest cash in a project to the extent required to cover any cash
deficiency the project may experience.

## Cash delivery

The provision of some futures contracts that requires not delivery of underlying assets but
settlement according to the cash value of the asset.

## Cash discount

An incentive offered to purchasers of a firm's product for payment within a specified time
period, such as ten days.

## Cash dividend

A dividend paid in cash to a company's shareholders. The amount is normally based on
profitability and is taxable as income. A cash distribution may include capital gains and return of capital in
addition to the dividend.

## Cash equivalent

A short-term security that is sufficiently liquid that it may be considered the financial
equivalent of cash.

## Cash flow

In investments, it represents earnings before depreciation , amortization and non-cash charges.
Sometimes called cash earnings. cash flow from operations (called funds from operations ) by real estate and
other investment trusts is important because it indicates the ability to pay dividends.

## Cash flow after interest and taxes

Net income plus depreciation.

## 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.

## Cash flow from operations

A firm's net cash inflow resulting directly from its regular operations
(disregarding extraordinary items such as the sale of fixed assets or transaction costs associated with issuing
securities), calculated as the sum of net income plus non-cash expenses that were deducted in calculating net
income.

## Cash flow matching

Also called dedicating a portfolio, this is an alternative to multiperiod immunization in
which the manager matches the maturity of each element in the liability stream, working backward from the
last liability to assure all required cash flows.

## Cash flow per common share

cash flow from operations minus preferred stock dividends, divided by the
number of common shares outstanding.

## Cash flow time-line

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

## Cash-flow break-even point

The point below which the firm will need either to obtain additional financing
or to liquidate some of its assets to meet its fixed costs.

## Cash management bill

Very short maturity bills that the Treasury occasionally sells because its cash
balances are down and it needs money for a few days.

## Cash markets

Also called spot markets, these are markets that involve the immediate delivery of a security
or instrument.
Related: derivative markets.

## Cash offer

A public equity issue that is sold to all interested investors.

## Cash ratio

The proportion of a firm's assets held as cash.

## Cash settlement contracts

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

## Cash transaction

A transaction where exchange is immediate, as contrasted to a forward contract, which
calls for future delivery of an asset at an agreed-upon price.

## Cash-equivalent items

Temporary investments of currently excess cash in short-term, high-quality
investment media such as treasury bills and Banker's Acceptances.

## Cash-surrender value

An amount the insurance company will pay if the policyholder ends a whole life
insurance policy.

## Cashout

Refers to a situation where a firm runs out of cash and cannot readily sell marketable securities.

## Closed-end fund

An investment company that sells shares like any other corporation and usually does not
redeem its shares. A publicly traded fund sold on stock exchanges or over the counter that may trade above or
below its net asset value. Related: Open-end fund.

## Collateral

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

## Common market

An agreement between two or more countries that permits the free movement of capital
and labor as well as goods and services.

## Common stock

These are securities that represent equity ownership in a company. Common shares let an
investor vote on such matters as the election of directors. They also give the holder a share in a company's
profits via dividend payments or the capital appreciation of the security.

## Common stock/other equity

Value of outstanding common shares at par, plus accumulated retained
earnings. Also called shareholders' equity.

## Common stock equivalent

A convertible security that is traded like an equity issue because the optioned
common stock is trading high.

## Common stock market

The market for trading equities, not including preferred stock.

## Common stock ratios

Ratios that are designed to measure the relative claims of stockholders to earnings
(cash flow per share), and equity (book value per share) of a firm.

## Company-specific risk

Related: Unsystematic risk

## Complete capital market

A market in which there is a distinct marketable security for each and every
possible outcome.

## Compounding period

The length of the time period (for example, a quarter in the case of quarterly
compounding) that elapses before interest compounds.

## Confirmation

he written statement that follows any "trade" in the securities markets. Confirmation is issued
immediately after a trade is executed. It spells out settlement date, terms, commission, etc.

## 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.

## Consumer Price Index (CPI)

The CPI, as it is called, measures the prices of consumer goods and services and is a
measure of the pace of U.S. inflation. The U.S.Department of Labor publishes the CPI very month.

## Continuous random variable

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

## Convertible bonds

bonds that can be converted into common stock at the option of the holder.

## Convertible exchangeable preferred stock

Convertible preferred stock that may be exchanged, at the
issuer's option, into convertible bonds that have the same conversion features as the convertible preferred
stock.

## Convertible preferred stock

Preferred stock that can be converted into common stock at the option of the holder.

## Corner A Market

To purchase enough of the available supply of a commodity or stock in order to
manipulate its price.

## Corporate bonds

Debt obligations issued by corporations.

## Cost of funds

Interest rate associated with borrowing money.

## Credit period

The length of time for which the customer is granted credit.

## 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.

## Cumulative preferred stock

Preferred stock whose dividends accrue, should the issuer not make timely
dividend payments. Related: non-cumulative preferred stock.

## Cushion bonds

High-coupon bonds that sell at only at a moderate premium because They are callable at a
price below that at which a comparable non-callable bond would sell. Cushion bonds offer considerable
downside protection in a falling market.

## Dealer market

A market where traders specializing in particular commodities buy and sell assets for their
own accounts.

## Debt market

The market for trading debt instruments.

## Derivative markets

markets for derivative instruments.

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