Glossary of Financial Terms
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LEAPS
Long-term Equity Anticipation Securities, developed by the Chicago Board Options Exchange (CBOE) in 1990. They are essentially options on stocks and stock market indices with an initial maturity longer than one year. In fact, the maturity at issue can be as long as three years. While regular options allow investors to express a short-term view since their initial maturity is usually less than nine months, LEAPS allow investors to bet on a view extending much longer into the future. Of course, once the maturity of LEAPS shrinks to a few months, they are equivalent to regular short term options.
See “Option.”
Leverage
A way to magnify returns. Take stock investment as an illustration. For example, you have $100 to invest. You are interested in a stock that is selling for $10 per share. Suppose that after a year, the stock price becomes $14. If you invest all your money in this stock, you will end up with $140 in a year, representing a return of 40%. Now, suppose you borrow $50 at 10% p.a. and use the $150 (your own $100 and the $50 you borrowed) to purchase 15 shares. A year later, you sell the 15 shares for $1415=$210. You then are able to repay the loan plus interest, which is $50(1+0.1) = $55, and eventually left with $210 $55 = $155. In this instance, your return is 55%. This is essentially leverage: borrowing money for investment. Leverage enhances the overall return whenever the investment return (40% in our example) is higher than the interest rate (10% in our example). Naturally, leverage will hurt when the investment turns out to be a poor venture. To continue the example, if the ending stock price is $8, then you lose $20 (or a loss of 20%) if you don’t leverage; if you borrow $50 at 10% p.a., then you lose $35 altogether, corresponding to a loss of 35%. (Here is the calculation: gross return is $815=$120, net return after repaying the loan is $120 $55 = $65, and the total loss is therefore $100 $65 = $35, which is 35% of the initial $100.)
For a firm, borrowing money in the form of debt, we say it engages in a financial leverage.
Leverage Buyout
See “Buyout.”
LIBOR
Shortened version of “London Interbank Offer Rate.” It is an average of the rates at which the most creditworthy banks in London lend to each other. LIBOR is quoted for various major currencies and maturities typically shorter than one year (mostly 1, 3, 6 or 12 months). LIBOR is known to be the most widely used interest rate index. The rates on several international loans are based on LIBOR. LIBOR is published everyday by the British Bankers Association (BBA). They based the LIBOR rates on a dozen major banks’ rates in more than 10 currencies surveyed at 11 a.m. London time.
In 2012, a major scandal broke out which led to investigations followed by certain disciplinary actions. In summary, several LIBOR-rate-contributing banks (i.e., banks being surveyed everyday by the BBA) colluded and rigged the LIBOR rate. They were charge fines for their fraudulent activities. Barclays Bank was the first to admit the dishonest behavior.
Limit Order
A trading request to purchase a stock at or lower than a specified price, or to sell a stock at or above a specified price. For example, you may submit an order that instructs your broker to buy 1000 shares of Company XYZ’s stock at $8 or less. In this case, the broker will purchase shares for you only if the stock is exactly $8 a share or cheaper. As opposed to market orders, a limit order can avoid buying stocks too expensively or selling stocks too cheaply.
See also “Market Order.”
Line of Credit
It is an agreement between a certain bank and a borrower (possibly an individual or a firm) that allows the borrower to borrow up to a pre-determined amount within a specified period of time. The limit is based on the borrower’s credit-worthiness and the period is typically for one year, which can be renewed afterwards. Take a fictitious illustration. Ryan Reynolds just negotiated a line of credit with Royal Bank for the amount of $80,000 and a period of one year. In this instance, Ryan can go to the bank to borrow any amount of money as he would like within the year, as long as the total borrowed amount is not more than $80,000. Naturally, he can also repay any amount as he wishes. The foremost advantage of a line of credit is its flexibility and convenience. You borrow however much you need, without negotiating with the bank each time you need funds.
Liquidity
Ease with which a security can be turned into cash. Stocks and bonds can be liquid assets because they can be sold quickly for cash; but antiques and real estates are illiquid assets as they cannot be sold quickly for cash and they. Liquidity management is important for corporations because poor liquidity translates to a failure of meeting interest payments to creditors, which in turn can result in bankruptcy.
Long
Holding status of a security. “Mark longs Air Canada stock” means “Mark has bought and is holding Air Canada stock.” So basically, “long” means “buy” or “hold.”
Also see “Short.”
Loss Aversion
It is an important building block of the so-called Prospect Theory. It describes the tendency for people to be more affected by losses than by gains of equal amount. As an example, suppose you win a lottery of $100. You will be elated and perhaps treat your family to a good meal. The event will quickly fade away from your mind and you will go on with your daily routines as per usual. Now, imagine an entirely scenario. Suppose you just found out that you lost a $100 bill (it slipped from your pocket). You will be distressed and be disappointed at yourself for not being careful enough. Most likely, the displeasure from the loss won’t fade away easily. You will constantly think about where you might have lost it, and what you could have done with the $100, and so on.
This natural tendency to attach more weight to losses than gains has great implications for decision making. It heightens our risk aversion.