Glossary of Financial Terms
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Earnings per Share (EPS)
The total earnings divided by the total number of outstanding shares. If we divide the earnings per share by the share price, we will get something like earnings yield, which is the reverse of P/E ratio.
Please see P/E ratio.
EBIT
The expanded term is Earnings Before Interest and Taxes. It is the total income (operating and non- operating) before interest and tax deductions.
EBITDA
The acronym of Earnings Before Interest, Taxes, Depreciation and Amortization. It is the total income (operating and non-operating) prior to deductions of interest, taxes, depreciation and amortization. It measures a company’s profitability from business operations. In other words, it is a measure of a company’s performance before taking into account all other non-operating related factors such as financing decisions (interest expenses), jurisdictions (taxes), capital asset investments (depreciation), and the amount of goodwill (amortization). Obviously, EBITDA is a cleaner version of EBIT. Thus it is more favored by those who do company valuations for such purposes as mergers and acquisitions.
Effective Annual Rate (EAR)
To better understand EAR, you need to read up “compounding frequency” first. When the stated annual rate is compounded more than once a year, interest is earned more frequently. As illustrated in the explanations of “compounding frequency,” for the same annual rate, more frequent compounding will lead to a higher balance for the same initial amount of deposit. For instance, with an annual rate of 12%, regular annual compounding will lead to a balance of $1.12 after one year if the initial deposit is $1. But with semi-annual compounding, the ending balance will be (1+0.12/2)2 = $1.1236. In this instance, we can say that the effective annual rate due to semi-annual compounding is 12.36%. That goes to show that an annual rate of 12% compounded semi-annually is equivalent to an annual rate of 12.36% compounded annually. In general, if the stated annual rate is r and the compounding frequency is m times a year, then the EAR is solved from:
To give another illustration, with an annual rate of 8% and daily compounding, the EAR is (1+0.08/365)365 1 = 0.08328 = 8.328%.
Equity
The word may mean quite different things in different contexts. In the fields of finance and accounting, it refers to stock ownership or investment. When a company goes out to raise funds, it may issue either debt or equity. In this context, “issuing equity” also means issuing new shares. Since shareholders are the ultimate owners of the company, the moment they purchase the new shares, they become new owners. The shares can be subsequently traded on stock exchanges. Those who sold the shares have relinquished their ownership while those who purchased the shares have assumed ownership. In this instance, we say that the buyers have made some equity investment. In investment jargons, “equity” is the same meaning as stocks.
Equity Premium
It is the extra return (over and above the risk-free rate) investors demand from investing in equity. Since stocks or equity are risky, investors would require fair compensation for bearing the risks. That compensation is in the form of higher expected returns from investing in the stock. For example, if the GIC rate is 3%, then an investor investing in a stock may require the stock to return 8% per year. The 5% differential in this case is said to be the equity premium. Obviously, the riskier the stock, the higher the equity premium. How is the stock’s risk level measured? One measure is the so-called “beta,” which can be plugged into the CAPM to gain an expected return.
See also “Equity,” “Beta” and “Capital Asset Pricing Model (CAPM)” for details.
Equity Swap
Please first look up the word “Swap.” It is a swap that involves either a stock or a stock market index, with the preponderance being the latter. Basically, an equity swap allows an investor to obtain the return on a particular equity without actually acquiring that asset. For example, Ontario Teachers Pension Plan (OTPP) would like to diversify into the Japanese market. A direct approach would be to buy many Japanese stocks on the Tokyo Stock Exchange. This will be quite costly (e.g., paying commissions) and cumbersome. OTPP could instead enter into an equity swap with a counterparty whereby, within the next, say, five years, OTPP will receive the actual return on the Nikkei 225 index while paying LIBOR plus a spread every year (and the swap could be based on any principal amount desired, e.g., $100 million). The yearly payment based on the LIBOR can be considered as the financing cost of the investment. In this case, OTPP is able to diversify into the Japanese market without actually investing there. Obviously it also bypasses all the regulatory restrictions in both countries that concerns cross-border investments.
Needless to say, there is no reason why the returns on two stock market indices cannot be exchanged directly. To illustrate, OTPP may enter into an equity swap with a Japanese pension fund whereby they each receive the other country’s stock market return (Nikkei 225 versus S&P/TSX).
Please see “Nikkei 225” and “LIBOR.”
AND “Commodity Swap,” “CDS (Credit Default Swap),” “Asset Swap” and “Total Return Swap.”
ETF (Exchange-traded Fund)
A kind of investment funds traded on stock exchanges such as the TSX and NYSE. Unlike mutual funds whose main mandate is to deliver superior returns, ETFs typically track a well-known index, be it a stock market index or a commodity index or a bond index. This specific mandate means that trading is kept to the minimum, which necessitates a very low management fee. In fact, in many cases, the tracking is done via leveraged derivatives trading, which is an even cheaper kind of trading. For this reason, ETFs usually have extremely low management fees (measured in basis points). Competition is another important factor for low fees. The relatively low entry barrier allows many new players to join the foray. There are currently hundreds of ETFs available covering the entire spectrum of investment choices (e.g., market index ETFs, sector ETFs, country ETFs, etc.)
Another advantage of ETFs over mutual funds is that it enables investors to short them just like stocks.
Also see “Mutual Funds,” “Basis Point” and “Short/Short Selling.”
Euro
It is the unified currency adopted by the European Union. On the launch of the currency on January 1, 1999, the exchange rates among the member countries were frozen irrevocably after that date. The newly created currency went into circulation from January 1, 2002.
Euro Currency
Any existing currency transacted outside of the country of issue. For instance, if someone deposits ¥20 million into a bank account in Singapore, then the 20 million Japanese yen will be referred to as Euro yen.
Also see “Eurodollar.”
Euro Stoxx 50
It is a closely followed stock market index based on 50 stocks in the Eurozone. It was launched in 1998 by an index provider named Stoxx Limited which was then headquartered in Switzerland. The 50 stocks are issued by blue-ship companies representing the main sectors of a dozen Eurozone countries which includes France, Germany and The Netherlands. There exists liquid ETFs, futures and options on the index. In fact, Stoxx Limited offers a host of other indices some of which also serve as the underlying for ETFs, futures and options. Please see the company’s webpage for details.
Also see “All Ordinaries,” “CAC 40,” “CSI 300,” “DAX,” “Dow Jones Industrial Average,” “FTSE 100,” “Hang Seng Index,”
“Nasdaq Composite,” “Nikkei 225,” “Russell 2000,” “S&P/TSX,” “S&P 500” and “Shanghai Composite.”
Eurodollar
The term for U.S. dollars transacted outside of the United States. Since this type of transactions began in Europe (mostly in London) shortly after the Second World War (when Eastern European investors started shifting their U.S. dollar deposits out of the U.S. due to the cold war), the dollars were dubbed “Eurodollars.” But the term has since been generalized. Any currency that is transacted outside the country of issue is generally referred to as Euro currency. Hence, the Japanese currency borrowed or lent in Canada will be called Euro yen, and so on. Confusion started to develop as the European Union rolled in its own new currency in 2002 that is coincidentally called “Euro.” But the confusion is now gone since the currency euro is now more well known.
Euronext
An electronic stock exchange owned by NYSE Euronext, headquartered in Amsterdam. It was established in 2000 following the merger of Amsterdam Stock Exchange, Brussels Stock Exchange, and Paris Bourse. It acquired the London International Financial Futures and Options Exchange (LIFFE) in 2001, completing its dominance in Europe on listings of both equities and derivatives. Its clout got further enhanced in 2007 when it joined forces with NYSE Group, Inc. to form NYSE Euronext.
See also “NYSE Euronext,” “Equity,” and “Derivative Securities.”
European Option
An option that can be “exercised” only on a specified future date. Suppose you have a call option on a certain stock. The option matures on September 1, and it is now July 23. One such option allows you to buy one share at $80. Then, before September 1, there is nothing you can do no matter how high the share price is. You can only buy the share on September 1, should its price be above $80.
A European option can either be a call option or a put option. In this case, the word “European” does not have any geographical connotation though it may have a negative implication on Europeans. To see why, please see “American Option.”
See also “Options,” “Call Option,” “Put Option,” “American Option,” “Asian Option,” and “Exercise Price,” or “Strike Price.”
Ex-dividend Date
It on this date when the dividend leaves the share. Why does such a date exist in the financial industry? The purpose of such date is to avoid confusion and ensure fairness with respect to dividend payments when the shares are being bought or sold around the time the dividend is paid. For example, the company announces that it will make a quarterly dividend payment of $0.5 per share to those shareholders who are on record as of Friday, March 10. Suppose Mary Smith purchases 100 shares from John Turner on March 9 (Thursday). When the firm compiles its shareholders list, it has not received any notification from the broker who handled the transaction, and John Turner’s name is still on the list. Thus, the dividend goes to Mr. Turner. However, on March 10 when the dividend is paid, the share price will of course drop by $0.5. Poor Ms. Smith suffers a loss of $0.5100 = $50 for nothing! That will be quite unfair. To avoid such circumstance, the major exchanges in North America require two business days prior to the record date for recording ownership changes. The date two days prior to the record date is then referred to as the ex-dividend date. The dividend leaves the share on this specific day. In the illustration, Mr. Turner will not receive the dividend since it has already left the share. Instead, Ms. Smith will receive it, which will make up the $0.5 loss per share on March 10.
See also “Dividend.”
Exchange Rate
It is the units of a country’s given currency that can be purchased with one unit of another country’s currency. For example, in the first half of 2014, the exchange rate between the U.S. dollar and the Canadian dollar is about $0.90 US/CAD. This means that one Canadian dollar can buy 0.90 U.S. dollars.
Some would wonder why some currencies (e.g., the British pound) are so big while some other currencies (e.g., the Japanese yen) are so small. A smaller currency doesn’t indicate that the issuing country is poor; and a bigger currency doesn’t imply extra wealth either. There are two fundamental factors that determines the general magnitude of the exchange rate between two currencies: the total wealth of each country and the quantity of currency each government chooses to circulate. The former being endowed and the latter, man-made. Thus, the magnitude of the exchange rate per se doesn’t have any real consequence; but the change of exchange rate over time does have real consequences.
Executive Stock Options
Call options issued by the firm to its Chief Executive Officer (CEO) and other major executives for incentive purposes. The call options are given to the executives for free, and each option allows the holder to buy one share of the company’s stock at a fixed price (typically the stock price at the time of issue) on a future date (typically 5 to 10 years from the date of issue). The executive will supposedly have an incentive to work harder in improving the stock price since he will personally benefit from the higher stock price through exercising the options. Although an executive is restricted from selling the options. Furthermore, companies typically lay out some specific conditions under which the options can be exercised. The conditions usually include target earnings per share or ROE. Some companies also issue stocks to their executives for incentive purposes.
See also “Call Option,” “ROE.”
Exercise Price
It speaks of an option. It is the price at which the option owner can buy or sell the security. For example, a person owns a European call option on a stock that is trading at $46 now. If the exercise price is $48 and the maturity date of the option is three months from now. Then the person has the right to purchase a share at $48 three months later should the stock price be above $48. For instance, if the stock price is $55, then you profit $55 $48 = $7.
See also “Options,” “Call Option,” “Put Option,” “American Option,” “Asian Option,” and “European OPTION.”
Extendable Bond
A bond whose maturity can be extended at the preference of the bondholder. It is desirable to extend the maturity especially when the prevailing interest rate at maturity is lower than the coupon rate. Other things being equal, an extendable bond will sell better than a regular bond. An extendable bond is the opposite of a callable bond which can be retracted by the issuer when the interest rate increases.