Glossary of Financial Terms

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Margin/Margin Investment

It generally refers to leveraged investments. For instance, if you have only $100 and you borrow another $80 and invest the $180 in stocks, then you have a margin investment. Typically, your broker lends you the money, up to 50% of total investment or 100% of your own money. In other words, if you start with $100, you may borrow up to $100 and purchase stocks worth $200.

Margin Account

A brokerage account that allows investors, margin investments. Holders of a margin account can borrow money from their brokers that would allow them to leverage their investments.

See also “Margin Investment” and “Margin Call.”

Margin Call

A demand coming from brokers for additional funds on a margin account due to adverse price movements. For protection of their loans, brokers set a specific minimum value to be maintained in a margin account at all times. When the account balance falls below the said minimum value due to adverse price movements, a margin call is then made to ask for addition funds.

See also “Margin Account.”

Market Efficiency

It talks about how efficiently the market incorporates new information. In an efficient market, prices are often unbiased and no one can consistently defeats the market. If you ever make a superior return, it would be very fortunate. A University of Chicago professor, Eugene Fama, classified market efficiency into three categories: weak-form efficient, semi-strong efficient market, strong-form efficient market. In a weak-form efficient market, stock prices reflect all historical information (such as past price patterns and trading volumes) so that no person can make a superior return by studying price history; in a semi-strong efficient market, stock prices reflect both historical information, but also current information (such as news from the media); in a strong-form efficient market, stock prices reflect all existing information which includes inside information (such as things discussed by the board of directors that have yet to be released to the public).

It is still under discussion as to whether the market is efficient. Supporters of market efficiency cite such evidence as many mutual fund managers not able to beat the market; critics of market efficiency point to the many instances that contradict efficiency (e.g., the mad rush to dotcom stocks in the 90’s and the downfall of those stocks). The jury is still out regarding this matter. The truth is, if you happen to know something that others don’t, for instance, your uncle serving on company ABC’s board told you that they have just approved a merger deal to buy company XYZ and this will be officially make known next week, then you should waste no time to buy company XYZ’s stock. Most probably, when the actual announcement is made the following week, XYZ’s stock price will shoot up, and you will make a handsome profit. Although, you and your uncle will also have a good chance to find yourselves in jail since your transaction is considered as illegal insider trading.

Perhaps intentionally to emphasize the unresolved status of the debate on market efficiency, the Nobel Prize committee awarded the 2013 Nobel Prize in Economics

(The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, more specifically) to Eugene Fama, Robert Shiller and Lars Peter Hansen. Robert Shiller from Yale University has been insisting that the market is far from being efficient and is often propelled by irrational behaviors. (Professor Hansen, from University of Chicago as well, was awarded the Prize for his contribution to econometrics.)

Market Maker

Also referred to as “Specialist.” An individual or a firm that makes the market for stocks, bonds or other securities. Frequently, it refers to those who make the market for stocks. What does “making the market” mean exactly? It is a service that matches buyers and sellers. For instance, a market maker for a stock would stand ready to buy or sell the stock she deals. She simultaneously posts bid and ask prices for specific quantities and prepared to transact at those prices. Suppose Sharon is a market maker for Stock ABC and she posts $28.01 and $28.04 as bid and ask prices at a particular moment. Then she would buy at $28.01 and sell at $28.04. The 3-cent spread (what is otherwise called bid-ask spread) is her earnings.

In the earlier days, all trading was done through market makers or specialists. In recent times, with powerful computers, many stock exchanges (e.g., TSX) match trade orders using computers instead of relying on market makers. Some exchanges (e.g., NYSE) still utilize the service market makers while at the same time adopt computer order matching.

See also “Bid-ask Spread,” “TSX” and “NYSE.”

Market Order

A trading request to purchase or sell a stock at the market price. Typically, your broker will ensure that you provide the most advantageous price possible. That is assuming you submit a buy order, your broker will then execute your order at the lowest asking price among all asking prices; and if you submit a sell order, your broker will then execute your order at the highest bidding price among all bidding prices. A positive thing about market order is that you are almost always sure that your order will be executed. Naturally, you may also get your order executed at a price that is not quite what you wanted. A limit order will consistently guarantee the price you desire, but it may not get executed.

See also “Limit Order.”

Marketable Securities

These are securities that can be sold on short notice. Typical examples would include high-grade, short-term debt instruments issued by governments such as T-bills. Marketable securities are part of a firm’s current assets and are typically used by firms to manage their liquidity.

Also see “Current Assets” and “Liquidity.”

Marking to Market

It is referring to the process of adjusting a trading book, a contract position, or any asset or liability to its market value on a continual basis. A trader working for a bank may perform numerous transactions during the day which may either result to an increase or decrease of the total value of his/her holdings or the trading book. An simple and unambiguous way of looking at the daily gains or losses is to re-evaluate the holdings at the closing prices of the day. The process of updating the value of a trading book, a contract position or a portfolio with the use of market prices is called marking to market. The calculation of the unit value of mutual funds (i.e., NAV) at the end of the day is a clear example of marking to market. Futures trading is also an obvious example. The balance of a futures contract account is updated at the end of each day and a margin call may be performed if the position has lost a notable amount of money.

Please see “Futures Contract” and “Margin Call” for details.

Mergers and Acquisitions (M&A)

It is said to be one of the most exciting events in corporate finance. The term Mergers and Acquisitions (M&A or M&As) talks about any type of transactions that involve combining two companies into one. “Mergers” refers to the combining of two existing companies (of roughly the same size) consequently forming a new identity. A well- known example is Exxon Mobil which came about when a merger between Exxon and Mobil happened in 1999. “Acquisitions” on the other hand refers to a transaction whereby a larger company acquires a smaller one and afterwards erasing the identity of the acquired. There are several examples of such, especially in the software developers market. There are also many acquisitions whereby the freshly acquired company keeps its identity and product brand. In this case, the acquisition is solely a matter of solidifying ownership and market share. A specific example is Rogers and Fido. Rogers acquired Fido in 2004 but allowed Fido operate almost as an independent carrier.

M&As tend to happen in waves, with more activities in economic booms. The reasons and rationales for M&As are several, ranging from CEOs urge of empire building all the way to strategic market-share-capturing. In any case, investment banks appreciate the high tides since they make tons of money as advisors.

Also see “Investment Banking.”

Money Market Instruments

Talks about short-term, highly liquid debt instruments such as T-bills and commercial papers. Most mutual fund companies provide Money Market Funds that invest in the said securities. Investors may utilize money market funds as a temporary parking place for their money, because the return on these funds are much higher than the interest rate of a typical bank account.

Money Market Mutual Funds

See “Money Market” and “Mutual Funds.”

Monthly Compounding

Please see “Compounding Frequency.”

Mortgage

Money borrowed from a bank to invest in real estate properties. A residential mortgage is for a private dwelling such as a house while a commercial mortgage is for a commercial property such as a restaurant. The total amount of borrowed money is called “principal,” and the number of years over which the mortgage is to be paid off is referred to as “term” or “amortization period.” For example, you can take out a mortgage of $600,000 to be amortized over 25 years. In this instance, “amortization” means you make equal periodical payments that include both principal repayment and interest. The payment period is usually monthly, although bi-weekly payment is also quite common. By the end of year 25, you will have completely paid off the mortgage amount. The rate based on which the periodical payments is calculated can be either variable or fixed. Please see “Fixed-rate Mortgage” and “Variable- rate Mortgage” for more details.

Also see “Amortization.”

Mortgage-backed Securities

Shares of a certain type of “mutual fund” which invests in a pool of residential mortgages. Initially, the mortgages are arranged by banks and then sold or “securitized.” As an illustration, numerous house buyers borrow money from CIBC in the form of mortgages. To the bank, these mortgages are just similar to other loans in that the borrowers pay interest as well as repaying the principal. The bank can certainly package or bundle up individual mortgages and turnaround sell them as mortgage-backed securities. By doing this, the bank can free up money and loan it out again as new mortgages. What does the bank gain in the process? It profits from the fee! Each time a mortgage is arranged, the bank charges a fee. Thus, in essence, investors of mortgage-backed securities collectively provide financing to the many invisible house buyers, while the bank earns a fee every time it bridges the house buyers and the investors. The investment return on mortgage-backed securities is gathered from monthly mortgage payments by the many house buyers.

Mortgage-back securities and similar securitization products were regarded as some of the main culprits of the 2007 financial crisis.

See “Securitization,” “Financial Crisis” and “Mortgage.”

Mutual Funds

Various investment products offered by mutual fund companies. A mutual fund is a basket of shares. For instance, you invest with mutual fund company ABC. ABC gets money from you and in turn invests the money in different stocks. The types of stocks and the proportion of the investments in each are decided on by the mutual fund companies. But strictly speaking, funds are specialized. For example, a single mutual fund company can offer several specialized funds such as fixed-income fund, equity fund, and Asia fund. A fixed-income fund would invest in just fixed- income securities such as T-bills and bonds. Likewise, an Asia fund would invest in just stocks in Asia (e.g., Hong Kong, Japan and Singapore). Since a mutual fund is a basket of different securities, the fund value is more stable compared to a single share price.

Mutual funds have somewhat been less favored as ETFs become better known amount investors. Mutual fund companies make money by charging an annual management fee ranging anywhere between 1% and 2.5%. In comparison, the fees with ETFs are extremely low, mostly in two-digit basis points. Some even have a fee as low as a few basis points. Those who continue to invest in mutual funds (as opposed to ETFs) either don’t know what they are doing or still believe that their fund managers can deliver superior returns (thus the higher fees are worth it).

See also “ETF” and “Basis Point.”