Glossary of Financial Terms
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Bank for International Settlements (BIS)
Initially established in 1930 to deal with the reparation payments imposed on Germany following the First World War (hence the name), the BIS has since taken the role to promote central bank cooperation for the pursuit of global monetary and financial stability.
The BIS has 60 member central banks and its headquarters being in Basel, Switzerland.
Aside from fostering monetary policy cooperation, the BIS also performs the following functions: 1) offering traditional banking services for the central bank community such as gold and foreign exchange transactions, 2) collecting, compiling and disseminating economic and financial statistics, and 3) putting in place global banking regulations such as capital requirements. In recent times, BIS has taken the role of coordinating global bank regulations. Most evidently, it is the originator of a series of bank regulations called the “Basel Accords.” The BIS is also called “the bank of central banks.”
See also “Central Bank,” and “Basel Accords.”
Bank of Canada
Is Canada’s central bank. Its functions include supervising monetary policy, printing bank notes, and overseeing the financial system. The principal role of the bank, as defined in the Bank of Canada Act, is “to promote the economic and financial welfare of Canada.”
Like other central banks, Bank of Canada, is not a commercial bank and does not offer banking services to the public.
See also “Central Bank.”
Bank Rate
It is an indicator of the general trend of interest rates in the economy. Officially, it is administered by the Bank of Canada. The Bank of Canada charges the bank rate when lending to chartered commercial banks and other final institutions. Announcements of the rate is made on a regular basis by the Bank of Canada, mostly on Tuesdays. The announcements do not necessarily come at fixed intervals, but the announcement dates are always published well ahead of time. Normally, there are about eight announcements a year and all the dates are published on the central bank’s home page at the start of the year.
The Bank has the prerogative to increase, decrease, or maintain the rate from the level established at the previous announcement. The central bank’s decisions rely upon the current economic situation. For example, if inflation is accelerating, then the central bank may increase the rate. A higher rate will suppress economic activities that will, in turn diminish inflation.
Banks usually don't adjust their lending/deposit rates every time the bank rate changes. On the other hand, banks may modify their borrowing/lending rate even though the bank rate hasn’t changed.
See also “Bank of Canada” and “Central Bank.”
Bankers' Acceptances
It is a promissory note drawn for payment by a corporation on a certain date. For example, a Canadian importer, Asian Trends, imports sweaters (worth $300,000) from South Korea. The Korean exporter demands that it receives the payment before shipments are made. But Asian trends does not have the cash yet. In this case, Asian Trends can go to its bank, Royal Bank of Canada, to ask for a draft of $300,000. (What is a draft? Look up “Draft” in this guide.) The draft will therefore be sent to the Korean exporter, which in then sends the draft to its Korean bank for money. The Korean bank will then, send the draft back to Royal Bank of Canada for acceptance. When the said draft is received, Royal Bank of Canada stamps “accepted” on the draft. The Korean bank will then credit $300,000 to the Korean exporter's account.
Bankers’ acceptances are short-term financing instruments which are guaranteed by the banks. Therefore, they are less risky. Once “accepted,” they represent real money thus can be bought and sold just like other securities such as stocks and bonds.
Basel Accords
It alludes to the global bank regulations originated by the Bank for International Settlements (BIS) in Basel, Switzerland. As of the October 2013, there have been three accords: Basel I (implemented in 1988), Basel II (implemented between 2007 and 2009), and Basel III (to be implemented between 2013 and 2019). Fundamentally, the accords stipulate how much capital a bank should have in order to cover various risks the bank incurs (e.g., trading risk, credit risk from loans, and risks arising from such events as frauds and technical glitches).
Basis Points
A term often seen in financial press that is used to express interest rate. One basis point is one-hundredth of a percentage point. For example, 25 basis points is 0.25%, 150 basis points is 1.5%, and so on.
Bear Spread
A combination of two call options on the same stock with the same time-to-maturity but different exercise prices. It is an option investment strategy. Characteristically, a bear spread takes a short position on a call option with a lower exercise price and a long position on a call with a higher exercise price. Essentially, it is a bet on a modestly bear market. When the stock price goes down, you get to keep the proceed from the short call since the option is not going to be exercised; when the stock price goes up significantly your gain from the long call will offset the loss from the short call so that you still get to keep the proceed from the short call (minus the purchase cost of the long call).
Why is it called a “bear spread” in options trading? “Bear” in that you are bearish; “spread” in that you have two call options in opposite directions (i.e., one short, one long).
See “Volatility,” “Call Option,” “Put Option,” “Long,” “Short” and related definitions for detail.
Also see “Straddle,” “Strip,” “Strap,” “Bull Spread” and “Butterfly.”
Behavioral Finance
An area of study focused on how psychological influences can affect market outcomes. The term was coined in reference to “conventional” or “classic” finance. The central part of the classic finance theories is “rationality”: agents are assumed to be rational and their financial decisions are sound. Theories of this kind are usually quite refined and easy to develop. However, they sometimes have a hard time explaining particularly prevalent, seemingly irrational behaviors (e.g., investors’ tendency to dump winner stocks too early and hang on to loser stocks for too long). “Behavioral economics” and “behavioral finance” were developed to explain such behaviors.
In a nutshell, “behavioral finance” aims to understand individuals’ financial decisions not only from a pure rational perspective, but also by taking into account individuals’ psychological, cognitive as well as social dimensions. In other words, “behavioral finance” allows decision makers to be influenced by such things as mood, peer pressure and fad. This appears to be a reasonable premise and should expectedly receive wide acceptance. In actuality, it does not. Although “behavioral finance” has gained a mainstream status in the academic sphere, the debate between the “classic” and the “behavioral” camps are far from being over. An in-depth treatment is way beyond the reach of this layman’s guide. Suffice to say that advancements are being made in this new “field” called “behavioral finance.”
As a known fact, the 2002 Nobel Prize in Economics (The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, to be precise) went to a esteemed founder of the field: Daniel Kahneman from Princeton (his Nobel Prize co-winner, Vernon Smith from George Mason University made related contributions to experimental economics research).
Beta
A concept that measures the expected move in a stock relative to movements in the overall market. It is a measure of a security’s systematic risk. A security’s return may change due to both firm specific events (such as re-shuffling of the management team) as well as market-wide events such as interest rate fluctuations. Beta measures the sensitivity of a security’s return to the overall market’s movements.
“Beta” is the English pronunciation of the second Greek alphabet, β. The authentic Greek sound of the alphabet is actually “veta.”
Also see “CAPM” and “Systematic Risk.”
Bid Price
Price at which a buyer is willing to pay for something, whether it be a security, asset, commodity, service, or contract. If you offer to pay $10 for a used bike at a garage sale, then the $10 is a bid price. Similarly, if a market maker offers a price of $15.25 to buy a stock, then the $15.25 is a bid price.
Also see “Ask Price,” “Bid-Ask Spread” and “Market Maker.”
Bid-ask Spread
You will first need to look up “Bid Price” and “Ask Price.” Bid-ask spread is basically the difference between ask and bid prices. If you offer to pay $10 (bid price) for a used bike at a garage sale, and the owner counters with a price of $12 (ask price), then the bid-ask spread is simply $12 − $10 = $2. Similarly, if a market maker posts a bid price of $15.25 and an ask price of $15.35 for a stock that he deals, then the bid-ask spread is simply $0.10. Bid-ask spread is also alternatively expressed in percentage terms. In the above example, the percentage bid-ask spread for the stock is $0.10/[($15.25 + $15.35)/2] = 0.65%.
See also “Market Maker.”
Black-Scholes Option Pricing Model/Formula
An option pricing model developed in 1973 by Fisher Black and Myron Scholes. In the same year, Robert Merton from MIT independently developed the same model. The model allows users to value an option with only five inputs: the current value of the underlying asset, the exercise price, the risk-free rate, time to maturity, and the underlying asset’s volatility.
Since its publication in 1973, the model has emerged an industry standard in basic option valuation. It is notable that two of the authors, Robert Merton and Myron Scholes, were awarded the Nobel Prize (The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, to be precise) in 1997 for developing this pricing model. (Fisher Black died of lung cancer in 1995. The Nobel Prize is only awarded to people who are alive.)
See also “Option” and “Volatility.”
Board of Directors
In the corporate setting, it refers to a group of members collectively overseeing the general operation of the company. Essentially, it oversees strategic matters such as appointing the Chief Executive Office (CEO) or general manager of the company and assess the overall direction and strategy of the company. The board is also in charge of approving the annual budget. A company’s board holds the ultimate decision power for the overall policy on behalf of shareholders.
In a company’s bylaw, the number of directors and how they are chosen are all specified. Typically, the entire board is re-elected each year at the shareholders’ annual meetings. Shareholders select a given number of directors (e.g. 10) from a pool of nominated candidates. The more shares a shareholder has, the more votes he/she is able to cast for each candidate.
In the recent decades, a new type of boards has marked the landscape of corporate governance, namely, “classified boards” or “staggered boards.” In a classified/staggered board only a subset of board members is re- elected each year. Accordingly, it works in the following way. From the beginning, the corporate bylaw specifies several classes (typically three) of board members, each of which having a different term. For instance, a company may have three classes of directors, with members of Classes I, II and III each serving a term of one, two and three years, respectively. Let’s say each class has four members and Class II and III members are gradually added each year. So for Class III, some directors are simply appointed (replacing those already serving for three years), some have served one year and some have served two years. At each shareholders annual meeting, only Class I director positions and those newly vacated Class II and III positions need to be filled via election.
The emergence of classified or staggered boards in the takeover wave in the 1980s was partly as an anti-takeover measure. A staggered board makes a hostile takeover challenging since it is impossible for the acquirer to replace the entire board in one year. The staggered board’s other apparent advantage is its continuity. The chance of all members being rookies is simply since only a fraction of directors are replaced each year. Notwithstanding the obvious appeal of staggered boards, its popularity has been in the decline starting from the late 1990s. The primary concern is, a staggered board could inadvertently encourage or induce management entrenchment (i.e., the management team cultivating the long-serving board members in favor of policies that benefit the management but not necessarily shareholders).
Regardless of whether the board is a staggered one or not, board members can also be classified into independent and non-independent directors. A non- independent board director is an individual directly related to the company (e.g., the CEO). On the other hand, an independent director is an individual who doesn’t hold any position in the company, is not related to the management team, and doesn’t have a pecuniary relationship with the company (other than receiving the director fee).
Most companies have moved forward to appoint independent directors to their boards in a bid to enhance corporate governance.
Another popular trend is to elect someone other than the CEO to be the board chairman. Since one of the board’s responsibilities is to monitor and evaluate the CEO’s performance, it is almost perverse to name the CEO as the chairman of the board. (Imagine this scene: The CEO-chairman announces to the board: “OK guys, the next item on the agenda is to evaluate my performance as CEO in the past year. So, what do you think of my performance?”) The push for better corporate governance gave rise to to remedies of this situation. However, there are still several companies whose boards are chaired by their CEOs. It should be noted that a board with a non-CEO chairman will not necessarily be a more independent one. More frequently, the chairman position is occupied by the original founder and/or the previous CEO who continues to wield tremendous amount of power. One example would be Bill Gates of Microsoft.