Glossary of Financial Terms

- S -

Samurai Bond

These are bonds issued in Japan by foreign companies or agencies, denominated in Japanese yen. For instance, if IBM issues bonds in Tokyo with a total par value of ¥10,000- million, then these bonds will be called samurai bonds. Since the bonds are denominated in yen, the coupons will likewise be paid in yen.

Sarbanes-Oxley Act

Eponymous to the U.S. Senator Paul Sarbanes and Representative Michael Oxley, the Sarbanes-Oxley Act (or simply SOX) became a law in July 2002 by President George W. Bush. The law was mainly enacted in response to several high-profile corporate bankruptcies (e.g., Enron and Worldcom) that were rooted in accounting scandals. Hence, the Act mainly aimed at tightening the standards concerning financial reporting and holding companies’ executives and board members more accountable. Ultimately, the goal was to protect investors by improving the accuracy and reliability of accounting information and other disclosures.

S&P/TSX Composite

A widely watched stock market index in Canada. It is a value-weighted or capitalization-weighted average of the prices of stocks of the largest companies listed on the Toronto Stock Exchange (TSX). “Value-weighted” indicates that the larger the company in market capitalization, the higher the weight its stock enjoys in the index calculation. The companies/stocks included in the index is not a fixed number. Rather, the index membership depends on a set of criteria concerning size and liquidity. Usually, the number of stocks varies between 200 and 300, and they represent a large portion of the entire Canadian equity market.

The name “S&P/TSX” is derived from the fact that the index is co-managed by Standard and Poor’s and the Toronto Stock Exchange. S&P/TSX 60, which contains the 60 largest companies within the S&P/TSX Composite is also widely watched since most of the derivative securities such as options and futures are based on this index.

S&P 500

A widely watched stock market index in the U.S. and in the world. Managed by Standard and Poor’s, the index is primarily a scaled average of the market capitalizations of the 500 leading U.S. stocks traded on either the NYSE or Nasdaq. In truth, the index membership is not based on size alone. Some other traits of the stock such as trading volume, liquidity and industry representation are also considered. The index, representing about 80% of the entire U.S. equity market capitalization, is regarded as the barometer of the U.S. equity market.

Securitization

A process wherein non-security assets such as mortgages, loans and accounts receivables are packaged together and sold as pass-through financial instruments. The newly packaged instruments are typically tradable securities, and that is the reason, this process is called securitization. Depending on the nature of the non-security assets being packaged, specific names are given to these newly born securities. Case in point, mortgage-backed securities are packaged out of residential mortgages while collateralized debt obligations (CDOs) are packaged out of bonds. As a whole, the newly created securities from securitization are called “asset-backed securities” or ABS.

See “Asset-backed Securities (ABS),” “Mortgage-backed Securities” and “CDO.”

Security

A general term that stands for a financial instrument. For instance, a stock is a security, a bond is a security, and so is a T-bill. Insofar as security refers to financial assets that are essentially money, it is no wonder that we all need “security.”

Securities and Exchange Commission (SEC)

You should initially look up “Ontario Securities Commission.” It is the U.S. counterpart of the Ontario Securities Commission except that it is for the entire United States of America. Created pursuant to the Securities Exchange Act of 1934, the Securities and Exchange Commission was primarily meant to restore confidence in and the order of the stock market following the 1929 market crash. Nowadays the SEC has a much broader mandate similar to any other modern securities commission.

The U.S. SEC is headquartered in Washington DC and has a dozen regional offices all around the country. The organization is under the leadership of five commissioners, all appointed with five-year stagger terms by the President of the United States of America. The President selects one of the five as Chairman who becomes the ultimate boss of the Commission. To guarantee nonpartisan nature of the Commission, no more than three commissioners can come from the same party.

Semi-annual Compounding

Please see “Compounding Frequency.”

Shanghai Composite

Also referred to as “Shanghai Stock Exchange Composite Index” or “SSE Composite Index.” It is a extensively watched stock market index in China. It is a market capitalization average of all the shares (both A-shares and B-shares) listed on the Shanghai Stock Exchange. Unlike most of the composite stock market indices in the world which represent a huge portion of the capital market of the country in question, the Shanghai Composite doesn’t accurately represent the overall Chinese capital market since many of the state-own companies are not yet publicly listed.

Short/Short Selling

It refers to selling a security you don’t own. Since you don’t own the security, you must initially borrow it. Needless to say, you must buy it back later to return it. Of course, you would short a security only if you anticipate its price to go down. As an example, suppose Jack believes that Company ABC’s stock will decline from today’s $65 to $50 in the near future. Therefore, John can borrow certain number of shares, say 100, from his broker, and sell them immediately for $6,500. After several days, if the share price in fact tumbles to $50, then Jack will purchase 100 shares for

$5,000 and give them back to his broker. In this process John makes $1,500. Very nice indeed, and John will have acquired some bragging rights at cocktail parties. But if the stock price continues to climb up, then John will lose money because he has to return the shares sooner or later. For instance, if the stock price is $85 when he has to return the shares, then he will lose $2000 in this process. (You can be sure that John won’t be too eager to chat about it at cocktail parties.)

Obviously, deciding whether to go long or short with an investment is no less tricky than deciding what to wear on an early summer day!

Also see “long.”

Simple Interest

Please see “Compound Interest.”

Sinking Fund

In general, the term refers to a situation whereby money is being periodically put into a fund which can be used to make capital purchases, retire debts or facilitate any other causes. More recently, especially in North America, the term is often used for a particular situation: gradual retiring of debt. When bonds are issued with a sinking fund feature, the issuer can purchase back a fraction of the issue each year so that it won’t have to face the difficulty of coming up with a large amount of money at the bond maturity. In some ways, bonds with a sinking fund feature are just like mortgages: once you make the last payment, you are debt free. In another sense, bonds with a sinking fund provision are also likened to callable bonds, except that in the latter, the entire issue is called back, and it is done to save financing costs.

Some believe that bonds with a sinking fund feature are also less risky to creditors. The reason is quite simple: when the borrower repays the debt gradually, there is a slight chance for it to default than if it has to repay the whole loan amount in one shot.

South Sea Bubble

A well-told story about stock price bubbles. But unlike its older cousin, the Tulipmania, the South Sea Bubble story involves several more dimensions than simple greed. The complete story would need delineations of colonial rivalry, international trade, government finance, and a myriad of dirty tricks such as deceptions and briberies, all beyond the scope of this simple guide. A rough sketch is provided below, instead.

Essentially, it is an event in England in the early 18th century that made many people rich and many others very poor, thanks to the spectacular rise and the subsequent, equally spectacular fall of South Sea Company’s stock, in a span of a few months.

What is the South Sea Company? It was founded in 1711 as a private company, but with a huge deal of government involvements. The company assumed the national debt from the British government (the debt itself was utilized to finance the British participation in the War of Spanish Succession, 1701-1714). In return, it would receive the interest payments on the debt and an ensured monopoly of trades with Spanish colonies in South America (e.g., Peru, Mexico and Chile, all of which were collectively called South Seas, hence the company’s name). The war ended in 1713 but it didn’t quite diminish Spain’s colonial dominance in South America. South Sea Company’s trade monopoly merely materialized to limited slave trade and one-voyage-per-year to South America with various limitations (e.g., capped total tonnage of goods to be shipped and a stingy profit-sharing plan imposed by Spain). In short, the company had no good prospect whatsoever.

This was when the rogue directors and other company executives began to engage in deceptions and briberies in the hope to hoist their stock price. More national debt was converted into the company’s shares (thanks to corrupted politicians who were willing and ready slaves of briberies) and other trickeries were to occur. Thus, the bubble was ready to be inflated.

The bubble began to form in January 1720 when the share was trading around

£130. Acquiring more national debt surely made the company more prominent, but the real air inflating the bubble emerged from downright deceptions. The company invented and spread tempting tales of super riches resulting from the splendid trading profits thanks to the bountiful supply of gold and silver from South America at virtually zero costs. Of course, none of the claim was true but the greedy and the foolish were basking themselves in the fanciful dreams of being rich and aided to push the stock price higher and higher: £175 in February, £330 in late March, and £550 in May.

The greedy and the foolish often help breed the rogue, and this axiom was at its best display in the South Sea Bubble saga. The creation of super riches dutifully inspired the dormant rogues who set up their own companies and promoted their shares on various kinds of luring promises, ranging from improving the art of making soap all the way to extracting silver from lead. The laziest yet perhaps the most intelligent of all venture promotions: “For carrying on an undertaking of great advantage; but nobody to know what it is.”

Inadvertently, these mushrooming ventures were nicknamed “bubbles” at the time. And the British government was definitely a bit concerned about the runaway bubble bubbling, so to speak. So much so that it passed the “Bubble Act” which stipulated that a legit company is required to apply for a royal charter. To the surprise of many, South Sea Company was the first to be granted the charter! This “prestigious” status as well as other maneuvers helped further propel its share to the peak price of £1,000 in early August. Not long after, the bubble burst. By the end of September, the stock price went as low as £150, more or less where it started in January.

The saga of the South Sea Company actually led to several consequences aside from creating super rich and sudden paupers. In 1721, a formal investigation lead to prosecutions and convictions of many high society figures which includes the chancellor of the exchequer.

Well, probably not all victims were greedy and foolish. Sir Isaac Newton was said to have lost £20,000 from the saga. When asked to provide a comment, he reportedly said “I can calculate the movement of heavenly bodies but not the madness of men.”

Did people learn a lesson from the South Sea Bubble, especially being that it already had a younger cousin (Tulipmania)? Read “Dotcom Bubble” to find out.

Speculation

The act of educated betting on the price movements of specific assets. It is synonymous to “risk-taking” or “betting.” By definition, risk-taking or betting can lead to either gains or losses. For example, Peter Pringle believes that the oil price will reach $100 a barrel in two years (while the market consensus is $80), and he enters into a forward contract to buy oil at $80 a barrel. In this instance, we say that he is speculating on the oil price. Two years later, if the market price is, say, $120 a barrel, then he would settle his forward contract by buying oil at $80 a barrel, turning around and selling it at $110 a barrel, pocketing $40 a barrel. Of course, he could lose a bundle if the price is low, e.g., at $60, since he still has to buy at $80.

Note that if a refiner enters into a forward contract to buy oil at $80 a barrel, then the refiner is hedging rather than speculating. Why? Because the refiner will not sell the oil; instead will use it for refining.

Also see “Forward Contract,” “Hedging,” “Dotcom Bubble,” “South Sea Bubble” and “Tulipmania.”

Spot Interest Rates

Interest rates currently applicable or “on the spot.” For instance, you go to a bank branch today and intend to purchase $1,000 worth of GIC. Depending on the number of years you prefer to lock your money in, the annual interest rate will be different. The one-year rate may be 2%, the two-year rate may be 2.5%, the three-year rate may be 2.75%, and so on. (Note: those rates are annual rates applicable to the period in question.) The rates that are prevailing today for different investment periods are referred to as spot rates.

Staggered Board

See “Board of Directors.”

Stock Repurchase

It refers to a firm’s purchase of a portion of its own shares. Once the shares are purchased back, they turn into so-called “treasury stocks” and are not included in the total number of shares outstanding. Hence, stock repurchase may improve a firm’s earnings per share and ROE when the firm is really doing well.

Stock Split

An artificial reset of stock price in accordance with the total number of shares outstanding. Suppose Company ABC’s stock is trading at $200 per share, and there are two million shares outstanding. If the stock undergoes a 2:1 split, then the new share price will be $100, the total number of shares outstanding will double to four million. Of course, shareholders are neither better off nor worse off with a stock split. Why then do companies undertake such stock splits? The reason is a practical one: When shares are trading at a higher price, they are less accessible to small investors, especially when shares are usually traded in the multiples of 100 (the so-called board lots). For instance, with $1,000 you could by 100 shares of a $10 stock, but it will merely get you an awkward 2.5 shares if the stock is trading at $400. You think $400 is too steep? Think again. At one point, Warren Buffett’s Berkshire Hathaway A-share was trading at around $173,500. He had been resisting splits for years, deliberately eschewing small investors (partly because he considered them as unsophisticated, whimsical, mad little gamblers). He eventually gave in sometime in 1996, creating the so-called Berkshire Baby Shares at $1,000 a pop (that baby was seriously overweight!). Then in 2010, a truly accessible Berkshire stock was created when the Baby Share (B-share) went through a 50:1 split. In 2013 it it was trading around $115. Still not quite lean and fit compared to most other babies out there!

A company may sometimes undertake a reverse stock split, only that in that case, the sheer reason is for survival. A reverse stock split refers to stock consolidations: combining many shares into a single one. When stocks are sliding to some low price levels, consolidation is utilized to either to shore up investors confidence or to avoid the stock being delisted by exchanges (most exchanges would delist a stock if the price is below $1). The one-time Canadian darling, Nortel, underwent a 1:10 reverse split with its stock in December of 2006. But obviously, that maneuver was to no avail.

Straddle

It is an option investment strategy that is a combination of one call option and one put option on the same stock, with the same exercise price and same time-to-maturity. In as much as as a call option is a bet on the upward price movement and a put option a bet on the downward movement, a combination of the two options is a simultaneous bet on both directions. Simply put, it is a bet on the stock’s volatility. If there are a lot of developments with a stock and its price may go up or down in the short-term, then holding a straddle would be sensible. Naturally, it can also be used the other way around. If you are quite confident that the stock price won’t move much in the next little while, then you can sell a straddle. If indeed the price didn’t move prior to the maturity of the option, you get to keep the proceeds from selling the straddle.

One should not get too excited just yet. One must understand that either bet can go sour. If one buys a straddle and nothing happens to the stock price, then one loses the entire investment. If you sell a straddle and the price moves a great deal in either direction, then the straddle holder will come back and exercise one of the options against you in which case the loss may be way more than your initial proceed. Unfortunately, it is no secret weapon.

Why is this option strategy then called a “straddle”? It should be more obvious now after reading the above. Evidently, each of your leg is betting on one direction of the market!

See “Volatility,” “Call Option,” “Put Option” and related definitions for detail.
Also see “Strip,” “Strap,” “Bull Spread,” “Bear Spread” and “Butterfly.”

Strap

You must first look up “Straddle” before reading on. Strap is another known option investment strategy. It is a two call options combined with one put option on the same stock with the same exercise price and time-to-maturity. Insofar as a straddle allows you to bet on both directions with equal conviction, a strap puts more importance on the upward movement than on the downward. Since a strap allows you to make more money than a straddle would when the stock price goes up, it also costs you more − you pay for one extra call option. Naturally, nothing is free!

Why is this option strategy called a “strap”? No one really knows. It perhaps symbolizes the extra call option attached (as a strap) to one of the two legs in reference to the description of straddle?

Strike Price

See “Exercise Price.”

Strip

You must first look up “Straddle” before reading on. Strip is yet another option investment strategy. It is a combination of one call option and two put options on the same stock with the same exercise price and time-to-maturity. Insofar as a straddle allows you to bet on both directions with equal conviction, a strip puts greater weight on the downward movement than on the upward. Because a strip allows you to make more money than a straddle when the stock price goes down, it also costs you more − you pay for one extra put option. Again, nothing is free!

Why is this option strategy called a “strip”? Nobody knows. It is probably similar to the reason for “strap” except that the extra piece is now attached to a different leg!

Strip Bond

The par part of a coupon bond, i.e., the part of a bond that remained after the coupons are stripped away. In essence, a strip bond is a discount bond. If a bond is issued without coupon, it is therefore called a discount bond; if a bond is issued as a regular coupon bond, and the coupons are subsequently stripped away, it is then called a strip bond. Usually, borrowers such as governments and corporations do not issue discount bonds due to their lower issuance proceeds (compared with coupon bonds), yet discount bonds play an important investment purpose (e.g., for those who want to invest for a three-year horizon without the need to worry about reinvesting coupons). As such, strip bonds are created to fill the gap. Strip bonds are traded over-the-counter, and one can purchase them from any investment broker. In Canadian markets, strip bonds are generally stripped from bonds issued by governments (federal or provincial) and crown corporations.

Also see “Discount Bond.”

Subprime Loans

Loans that are made to those with inferior credit worthiness such as unemployed individuals or people with low-wage jobs. Because of the higher-than- average credit risk, banks charge a higher interest rate for this category of loans. An extreme type of subprime loans is NINJA (loans made to people with No Income, No Job and Assets). Just before the 2007 financial crisis, many lenders offered subprime loans as mortgages.

Swap

It is an exchange of cash flows or financial securities. For example, a company may swap out of a floating rate loan and get into a fixed rate loan, or vice versa. In such case, it is an interest rate swap. In the same manner, a corporate borrower may exchange a U.S. dollar loan into a Japanese yen loan, in which case it is a currency swap. There also exists commodity swaps and equity swaps. Generally, swaps are used by corporations and financial institutions to hedge risk or to take advantage of certain market conditions.

Systematic Risk

The part of a financial asset’s risk that is greatly associated with the overall market risk and is measured by “beta.” A higher systematic risk indicates a higher chance for the asset’s return and the market return to move together. When we put many stocks in one portfolio, the portfolio’s risk is primarily systematic risk since all firm-specific risks would cancel each other. The movement of the portfolio’s return is result of market- wide factors only such as interest rate.

Glossary of Financial Terms

- S -

Samurai Bond

See also “Bond,” “Coupon Payments” and “Face Value” for the fundamentals of bonds. Also see “Bulldog Bond” and “Yankee Bond.”

Sarbanes-Oxley Act

S&P/TSX Composite

See Also “All ordinaries,” “CAC 40,” “CSI 300,” “DAX,” “Dow Jones Industrial Average,” “Euro Stoxx 50,” “FTSE 100,” “Hang seng index,” “Nasdaq Composite,” “Nikkei 225,” “Russell 2000,” “S&P 500,” and “Shanghai Composite.”

S&P 500

See Also “All ordinaries,” “CAC 40,” “CSI 300,” “DAX,” “Dow Jones Industrial Average,” “Euro Stoxx 50,” “FTSE 100,” “Hang seng index,” “Nasdaq Composite,” “Nikkei 225,” “Russell 2000,” “S&P/TSX,” and “Shanghai Composite.”