Glossary of Financial Terms
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A glossary of terms to help with your financial planning.
Bond: a fixed income security where the creditor ‘loans’ the debtor an amount (the face value/principal) over a fixed amount of time at a fixed interest rate (coupon rate). Can be issued by corporations (corporate bonds) or governments (government bonds).
Government bonds are known as gilts in the UK and once the bond reaches maturity, the investor’s money is repaid.
Defensive assets: these include fixed-interest investments such as bonds and gilts, alongside cash-based investments. They aim to provide stable returns over the long-term with relatively low volatility.
Asset allocation: the proportion of the different types of assets (shares, bonds, property and cash) a fund invests in.
Equity fund: a fund that invests primarily in shares. Equity funds are principally categorised by income or growth investment objectives, company size, sector and/or geography.
Bottom-up investing: focusing on company-specific fundamentals when deciding whether to buy or sell shares. Bottom-up factors include financial information, the management team, forecast earnings growth, market share and competitors.
Top-down investing: focusing on high-level economic factors when deciding whether to buy or sell shares. Top-down factors include interest rates, inflation, commodity prices and GDP as well as the outlook for the sector or industry.
Shares: units of ownership of a company or investment, also known as ‘stocks’ or ‘equities’.
Share capital: the funds invested in a company by its shareholders.
Bank or Base interest rate: the rate that a central bank, such as the Bank of England, charges to lend money to commercial banks.
Interest rate: an amount charged on a loan or deposit, expressed as a percentage of the principal. The ‘cost’ of borrowing or the ‘reward’ to saving.
Real vs Nominal: real variables are expressed in terms of a good, service or bundle of goods. Nominal variables are expressed in terms of money.
Yield: the income provided by an investment, usually shown as a percentage of the value of the investment.
Yield Curve: a graphical depiction of the different interest rates that an equivalent bond has over differing time periods. An inverted yield curve is a strong predictor of a recession.
Monetary Policy: relates to any activity by the central bank undertaken to achieve its objectives. Conducted via the use of interest (base) rates and the money supply. In the UK, the LIBOR (London Inter-Bank Overnight Rate) is the average rate at which private banks can lend, or borrow, overnight. It acts as the benchmark rate of inflation for many financial products. This measure is being replaced as the preferred benchmark by the SONIA (Sterling overnight index average) rate which measures the effective rate at which banks can borrow/lend for unsecured overnight transactions in the sterling market.
Fiscal policy: relates to anything regarding government spending or taxation. A budget deficit occurs when the total amount of government spending exceeds government revenue.
Business cycle: the simultaneous movement of macroeconomic variables, which can be separated into periods of expansion and contraction. The point at the ‘top’ of a period of expansion (just before a contraction begins) being referred to as a ‘peak’ and the lowest point of a contraction as the ‘trough’. The four periods of the business cycle are therefore: 1) Trough 2) Expansion 3) Peak and 4) Recession (contraction).
Quantitative easing: a form of monetary policy in which a central bank increases the supply of money by buying gilts and other securities. In turn, this reduces interest rates and stimulates economic growth.
Inflation: the sustained rise in price levels within an economy which causes a reduction in purchasing power. In the UK, the rate of inflation is calculated via the consumer price index (CPI) which is calculated as the weighted average change in price of a ‘representative’ basket of goods and services.
Volatility: a measure of how much the price of an investment moves up and down over the short-term.
Retail Prices Index (RPI): an index that measures the change in price that consumers pay for a basket of goods and services including mortgage interest payments. The Consumer Price Index (CPI) replaced the RPI as the basis for calculating the official inflation rate in 2011.
Liquidity: a measure of the ease at which an asset can be converted into cash.
Gross Domestic Product (GDP): The total value of the economic output of an economy and typically calculated as GDP = consumption + investment + government spending + (imports – exports).
FTSE (Financial Times Stock Exchange) 100: also known as the “Footsie”, this is a share index composed of the largest 100 companies listed on the London Stock Exchange by market capitalisation.
FTSE 250: an index of the 250 largest companies by market capitalisation, excluding the constituents of the FTSE 100 index.
If you would like help with any of these terms or would like any further help with your company’s financial planning, please contact [email protected] for an informal chat.