Definition of Tax Reform Act of 1986

Tax Reform Act of 1986

A 1986 law involving a major overhaul of the U.S. tax code.

Look-thru

A method for calculating U.S. taxes owed on income from controlled foreign corporations that
was introduced by the tax reform act of 1986.

MACRS (Modified Accelerated Cost Recovery System)

A depreciation method created by the IRS under the tax reform act of 1986. Companies must use it to depreciate all plant and equipment assets installed after December 31, 1986 (for tax purposes).

ADF (annuity discount factor)

the present value of a finite stream of cash flows for every beginning $1 of cash flow.

fractional interest discount

the combined discounts for lack of control and marketability. g the constant growth rate in cash flows or net income used in the ADF, Gordon model, or present value factor.

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.

Act of state doctrine

This doctrine says that a nation is sovereign within its own borders and its domestic
actions may not be questioned in the courts of another nation.

Active

A market in which there is much trading.

Active portfolio strategy

A strategy that uses available information and forecasting techniques to seek a
better performance than a portfolio that is simply diversified broadly. Related: passive portfolio strategy

Actuals

The physical commodity underlying a futures contract. Cash commodity, physical.

After-tax profit margin

The ratio of net income to net sales.

After-tax real rate of return

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

Amortization factor

The pool factor implied by the scheduled amortization assuming no prepayemts.

Annuity factor

Present value of $1 paid for each of t periods.

Asset activity ratios

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

Asymmetric taxes

A situation wherein participants in a transaction have different net tax rates.

Average tax rate

taxes as a fraction of income; total taxes divided by total taxable income.

Before-tax profit margin

The ratio of net income before taxes to net sales.

Break-even tax rate

The tax rate at which a party to a prospective transaction is indifferent between entering
into and not entering into the transaction.

Bullet contract

A guaranteed investment contract purchased with a single (one-shot) premium. Related:
Window contract.

Cash flow after interest and taxes

Net income plus depreciation.

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.

Characteristic line

The market model applied to a single security. The slope of the line is a security's beta.

Collection fractions

The percentage of a given month's sales collected during the month of sale and each
month following the month of sale.

Conditional sales contracts

Similar to equipment trust certificates except that the lender is either the
equipment manufacturer or a bank or finance company to whom the manufacturer has sold the conditional
sales contract.

Contract

A term of reference describing a unit of trading for a financial or commodity future. Also, the actual
bilateral agreement between the buyer and seller of a transaction as defined by an exchange.

Contract month

The month in which futures contracts may be satisfied by making or accepting a delivery.
Also called value managers, those who assemble portfolios with relatively lower betas, lower price-book and
P/E ratios and higher dividend yields, seeing value where others do not.

Conversion factors

Rules set by the Chicago Board of Trade for determining the invoice price of each
acceptable deliverable Treasury issue against the Treasury Bond futures contract.

Corporate tax view

The argument that double (corporate and individual) taxation of equity returns makes
debt a cheaper financing method.

Corporate taxable equivalent

Rate of return required on a par bond to produce the same after-tax yield to
maturity that the premium or discount bond quoted would.

De facto

Existing in actual fact although not by official recognition.

Deferred taxes

A non-cash expense that provides a source of free cash flow. Amount allocated during the
period to cover tax liabilities that have not yet been paid.

Depreciation tax shield

The value of the tax write-off on depreciation of plant and equipment.

Discount factor

Present value of $1 received at a stated future date.

Double-tax agreement

Agreement between two countries that taxes paid abroad can be offset against
domestic taxes levied on foreign dividends.

Earnings before interest and taxes (EBIT)

A financial measure defined as revenues less cost of goods sold
and selling, general, and administrative expenses. In other words, operating and non-operating profit before
the deduction of interest and income taxes.

Equivalent taxable yield

The yield that must be offered on a taxable bond issue to give the same after-tax
yield as a tax-exempt issue.

Exact matching

A bond portfolio management strategy that involves finding the lowest cost portfolio
generating cash inflows exactly equal to cash outflows that are being financed by investment.

Factor

A financial institution that buys a firm's accounts receivables and collects the debt.

Factor analysis

A statistical procedure that seeks to explain a certain phenomenon, such as the return on a
common stock, in terms of the behavior of a set of predictive factors.

Factor model

A way of decomposing the factors that influence a security's rate of return into common and
firm-specific influences.

Factor portfolio

A well-diversified portfolio constructed to have a beta of 1.0 on one factor and a beta of
zero on any other factors.

Factoring

Sale of a firm's accounts receivable to a financial institution known as a factor.

Floating-rate contract

A guaranteed investment contract where the credit rating is tied to some variable
("floating") interest rate benchmark, such as a specific-maturity Treasury yield.

Foreign tax credit

Home country credit against domestic income tax for foreign taxes paid on foreign
derived earnings.

Forward contract

A cash market transaction in which delivery of the commodity is deferred until after the
contract has been made. It is not standardized and is not traded on organized exchanges. Although the
delivery is made in the future, the price is determined at the initial trade date.

Forward forward contract

In Eurocurrencies, a contract under which a deposit of fixed maturity is agreed to
at a fixed price for future delivery.

Futures contract

Agreement to buy or sell a set number of shares of a specific stock in a designated future
month at a price agreed upon by the buyer and seller. The contracts themselves are often traded on the futures
market. A futures contract differs from an option because an option is the right to buy or sell, whereas a
futures contract is the promise to actually make a transaction. A future is part of a class of securities called
derivatives, so named because such securities derive their value from the worth of an underlying investment.

Futures contract multiple

A constant, set by an exchange, which when multiplied by the futures price gives
the dollar value of a stock index futures contract.

Glass-Steagall Act

A 1933 act in which Congress forbade commercial banks to own, underwrite, or deal in
corporate stock and corporate bonds.

Going-private transactions

Publicly owned stock in a firm is replaced with complete equity ownership by a
private group. The shares are delisted from stock exchanges and can no longer be purchased in the open
markets.

Guaranteed insurance contract

A contract promising a stated nominal interest rate over some specific time
period, usually several years.

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.

Hell-or-high-water contract

A contract that obligates a purchaser of a project's output to make cash
payments to the project in all events, even if no product is offered for sale.

Highly leveraged transaction (HLT)

Bank loan to a highly leveraged firm.

Imputation tax system

Arrangement by which investors who receive a dividend also receive a tax credit for
corporate taxes that the firm has paid.

Intercompany transaction

Transaction carried out between two units of the same corporation.

Interest equalization tax

tax on foreign investment by residents of the U.S. which was abolished in 1974.

Interest tax shield

The reduction in income taxes that results from the tax-deductibility of interest payments.

Investment tax credit

Proportion of new capital investment that can be used to reduce a company's tax bill
(abolished in 1986).

Limited-tax general obligation bond

A general obligation bond that is limited as to revenue sources.

Manufactured housing securities (MHSs)

Loans on manufactured homes - that is, factory-built or
prefabricated housing, including mobile homes.

Marginal tax rate

The tax rate that would have to be paid on any additional dollars of taxable income earned.

Market impact costs

Also called price impact costs, the result of a bid/ask spread and a dealer's price concession.

Maturity factoring

Factoring arrangement that provides collection and insurance of accounts receivable.

Most distant futures contract

When several futures contracts are considered, the contract settling last.
Related: nearby futures contract

Multifactor CAPM

A version of the capital asset pricing model derived by Merton that includes extramarket
sources of risk referred to as factor.

Nearby futures contract

When several futures contracts are considered, the contract with the closest
settlement date is called the nearby futures contract. The next futures contract is the one that settles just after
the nearby futures contract. The contract farthest away in time from settlement is called the most distant
futures contract.

Net benefit to leverage factor

A linear approximation of a factor, T*, that enables one to operationalize the
total impact of leverage on firm value in the capital market imperfections view of capital structure.

Next futures contract

The contract settling immediately after the nearby futures contract.

Nexus (of contracts)

A set or collection of something.

Old-line factoring

Factoring arrangement that provides collection, insurance, and finance for accounts receivable.

One-factor APT

A special case of the arbitrage pricing theory that is derived from the one-factor model by
using diversification and arbitrage. It shows the expected return on any risky asset is a linear function of a
single factor.

Open contracts

Contracts which have been bought or sold without the transaction having been completed by
subsequent sale or purchase, or by making or taking actual delivery of the financial instrument or physical
commodity.

Optimal contract

The contract that balances the three types of agency costs (contracting, monitoring, and
misbehavior) against one another to minimize the total cost.

Options contract

A contract that, in exchange for the option price, gives the option buyer the right, but not
the obligation, to buy (or sell) a financial asset at the exercise price from (or to) the option seller within a
specified time period, or on a specified date (expiration date).

Options contract multiple

A constant, set at $100, which when multiplied by the cash index value gives the
dollar value of the stock index underlying an option. That is, dollar value of the underlying stock index = cash
index value x $100 (the options contract multiple).

Overreaction hypothesis

The supposition that investors overreact to unanticipated news, resulting in
exaggerated movement in stock prices followed by corrections.

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.

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.

Present value factor

Factor used to calculate an estimate of the present value of an amount to be received in
a future period.

Price impact costs

Related: market impact costs

Progressive tax system

A tax system wherein the average tax rate increases for some increases in income but
never decreases with an increase in income.

Reaction

A decline in prices following an advance. Opposite of rally.

Receivables balance fractions

The percentage of a month's sales that remain uncollected (and part of
accounts receivable) at the end of succeeding months.

Reported factor

The pool factor as reported by the bond buyer for a given amortization period.

Round-trip transactions costs

Costs of completing a transaction, including commissions, market impact
costs, and taxes.

Security characteristic line

A plot of the excess return on a security over the risk-free rate as a function of
the excess return on the market.

Set of contracts perspective

View of corporation as a set of contracting relationships, among individuals
who have conflicting objectives, such as shareholders or managers. The corporation is a legal contrivance that
serves as the nexus for the contracting relationships.

Short-run operating activities

Events and decisions concerning the short-term finance of a firm, such as
how much inventory to order and whether to offer cash terms or credit terms to customers.

Short-term tax exempts

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

Single factor model

A model of security returns that acknowledges only one common factor.
See: factor model.

Split-rate tax system

A tax system that taxes retained earnings at a higher rate than earnings that are
distributed as dividends.

Structured arbitrage transaction

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

Tactical Asset Allocation (TAA)

An asset allocation strategy that allows active departures from the normal
asset mix based upon rigorous objective measures of value. Often called active management. It involves
forecasting asset returns, volatilities and correlations. The forecasted variables may be functions of
fundamental variables, economic variables or even technical variables.

Take-or-pay contract

A contract that obligates the purchaser to take any product that is offered to it (and pay
the cash purchase price) or pay a specified amount if it refuses to take the product.

TANs (tax anticipation notes)

tax anticipation notes issued by states or municipalities to finance current
operations in anticipation of future tax receipts.

Tax anticipation bills (TABs)

Special bills that the Treasury occasionally issues that mature on corporate
quarterly income tax dates and can be used at face value by corporations to pay their tax liabilities.

Tax books

Set of books kept by a firm's management for the IRS that follows IRS rules. The stockholder's
books follow Financial Accounting Standards Board rules.

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