Glossary of Economic Terms

Glossary of Economic Terms

Assets
Things that have earning power or some other value to their owner. Fixed assets (also known as long-term assets) are things that have a useful life of more than one year, for example buildings and machinery; there are also intangible fixed assets, like the good reputation of a company or brand. Current assets are the things that can easily be turned into cash and are expected to be sold or used up in the near future.

Bear market
In a bear market, prices are falling and investors, anticipating losses, tend to sell. This can create a self-sustaining downward spiral.

Bond
A debt security - or more simply an IOU. The bond states when a loan must be repaid and what interest the borrower (issuer) must pay to the holder. Banks and investors buy and trade bonds.

Bubble
A description of rapidly rising equity prices, usually in a particular sector (for example, housing, technology), that some investors feel is unfounded. The term is used because, like a bubble, the prices will reach a point at which they pop and collapse violently.

Bull market
A bull market is one in which prices are generally rising and investor confidence is high.

Capital
The wealth - cash or other assets - used to fuel the creation of more wealth. Within companies, often characterized as working capital or fixed capital.

Chapter 11
The term for bankruptcy protection in the US. It postpones a company's obligations to its creditors, giving it time to reorganise its debts or sell parts of the business, for example.

Collateralized debt obligations (CDOs)
A collateralised debt obligation is a financial structure that groups individual loans, bonds or assets in a portfolio, which can then be traded.
In theory, CDOs attract a stronger credit rating than individual assets due to the risk being more diversified. But as the performance of some assets has fallen, the value of many CDOs have also been reduced.

Commercial paper
Unsecured, short-term loans issued by companies. The funds are typically used for working capital, rather than fixed assets such as a new building.

Commodities
Commodities are products that, in their basic form, are all the same so it makes little difference from whom you buy them. That means that they have a market price. You would be unlikely to pay more for iron ore from a particular mine, for example.

Credit crunch
The situation created when banks hugely reduced their lending to each other because they were uncertain about how much money they had. This in turn resulted in more expensive loans and mortgages for ordinary people.

Credit default swap
A swap designed to transfer credit risk. The buyer of the swap makes periodic payments to the seller in return for protection in the event of a default. A bank which owns a lot of mortgage debt could swap it, but would have to make a pay-out if those mortgages were not repaid.
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Derivatives
Derivatives are a way of investing in a particular product or security without having to own it. The value can depend on anything from the price of coffee to interest rates or what the weather is like. Derivatives can be used as insurance to limit the risk of a particular investment. Credit derivatives are based on the risk of borrowers defaulting on their loans, such as mortgages.

Equity
In a business, equity is how much all of the shares put together are worth. In a house, your equity is the amount your house is worth minus the amount of mortgage debt that is outstanding on it.

Fundamentals
Fundamentals determine a company, currency or security's value. A company's fundamentals include its assets, debt, revenue, earnings and growth.

Futures
A futures contract is an agreement to buy or sell a commodity at a predetermined date and price. It could be used to hedge or to speculate on the price of the commodity.

Hedge fund
A private investment fund with a large, unregulated pool of capital and very experienced investors. Hedge funds use a range of sophisticated strategies to maximize returns - including hedging, leveraging and derivatives trading.

Hedging
Making an investment to reduce the risk of price fluctuations to the value of an asset. For example, if you owned a stock and then sold a futures contract agreeing to sell your stock on a particular date at a set price. A fall in price would not harm you - but nor would you benefit from any rise.

Investment bank
Investment banks provide financial services for governments, companies or extremely rich individuals. They differ from commercial banks where you have your savings or your mortgage.

Leveraging
Leveraging means using debt to supplement investment. The more you borrow on top of the funds (or equity) you already have, the more highly leveraged you are. Leveraging can maximise both gains and losses. Deleveraging means reducing the amount you are borrowing.

Libor
London Inter Bank Offered Rate. The rate at which banks lend money to each other.

Limited liability
Confines an investor's loss in a business to the amount of capital they invested. If a person invests £100,000 in a company and it goes under, they will lose only their investment and not more.

Liquidity
The liquidity of something is how easy it is to convert it into cash. Your current account, for example, is more liquid than your house. If you needed to sell your house quickly to pay bills you would have drop the price substantially to get a sale.

Loans to deposit ratio
For financial institutions, the sum of their loans divided by the sum of their deposits. Currently important because using other sources to fund lending is getting more expensive.

Mortgage-backed securities
These are securities made up of mortgage debt or a collection of mortgages. Banks repackage debt from a number of mortgages which can be traded. Selling mortgages off frees up funds to lend to more homeowners. See securities.

Nationalization
The act of bringing an industry or assets like land and property under state control.

Negative equity
Refers to a situation in which the value of your house is below the amount of the mortgage that still has to be paid off.

Preference shares
A class of shares that usually do not offer voting rights, but do offer a superior type of dividend, paid ahead of dividends to ordinary shareholders. Preference shareholders often also have superior status in the event of a liquidation.

Profit warning
When a company issues a statement indicating that its profits will not be as high as it had expected.

Rating
Bonds are rated according to their safety from an investment standpoint - based on the ability of the company or government that has issued it to repay. Ratings range from AAA, the safest, down to D, a company that has already defaulted.

Recapitalization
To inject fresh money into a firm, thus reducing the debts of a company. For example, when a government intervenes to recapitalize a bank, it might give cash in exchange for some form of guarantee, such as a stake in the company. Taxpayers can then benefit if the bank recovers.

Recession
A period of negative economic growth. In most parts of the world a recession is technically defined as two consecutive quarters of negative economic growth - when real output falls. In the United States, a larger number of factors are taken into account, like job creation and manufacturing activity. However, this means that a US recession can usually only be defined when it is already over.

Retained earnings
Money not paid out as dividend and held awaiting investment in the company.

Securities lending
Security lending is when one broker or dealer lends a security to another for a fee. This is the process that allows short selling.

Securitization
Turning something into a security. For example, taking the debt from a number of mortgages and combining them to make a financial product which can then be traded. Banks who buy these securities receive income when the original home-buyers make their mortgage payments.

Security
Essentially, a contract that can be assigned a value and traded. It could be a stock, bond or mortgage debt, for example.

Short selling
A technique used by investors who think the price of an asset, such as shares, currencies or oil contracts, will fall. They borrow the asset from another investor and then sell it in the relevant market. The aim is to buy back the asset at a lower price and return it to its owner, pocketing the difference. Also shorting.

Stagflation
The dreaded combination of inflation and stagnation - an economy that is not growing while prices continue to rise.

Sub-prime mortgages
These carry a higher risk to the lender (and therefore tend to be at higher interest rates) because they are offered to people who have had financial problems or who have low or unpredictable incomes.

Swap
An exchange of securities between two parties. For example, if a firm in one country has a lower fixed interest rate and one in another country has a lower floating interest rate, an interest rate swap could be mutually beneficial.

Toxic debts
Debts that are very unlikely to be recovered from borrowers. Most lenders expect that some customers cannot repay; toxic debt describes a whole package of loans where it is now unlikely that it will be repaid.

Underwriters
When used of a rights issue, the institution pledging to purchase a certain number of shares if not bought by the public.

Warrants
A document entitling the bearer to receive shares, usually at a stated price.

Write-down
Reducing the book value of an asset to reflect a fall in its market value. For example, the write-down of a company's value after a big fall in share prices.

Zombie Bank
Refers to a financial institution with an economic net worth that is less than zero, but which continues to operate because its ability to repay its debts is shored up by implicit or explicit government credit support.