1.

Present Value

The current value of one or more future cash payments, discounted at some
appropriate interest rate.

The present value of future payments discounted at the rate R is defined to

be the current bank balance in an account paying interest at the rate R that
would be required to replicate those future payments.

2. Net Present Value

The present value of an investment's future net cash flows minus the initial
investment. If positive, the investment should be made (unless an even
better investment exists), otherwise it should not.

3. Rate of return

The rate of return on an investment, expressed as a percentage of the total

amount invested. Rate of return is usually, but not always, calculated
annually. also called return.

4. Discount Factor

In a multi-period model, agents may have different utility functions for

consumption (or other experiences) in different time periods. Usually in such
models they value future experiences, but to a lesser degree than present
ones. For simplicity the factor by which they discount next period's utility
may be a constant between zero and one, and if so it is called a discount
factor. One might interpret the discount factor not as a reduction in the
appreciation of future events but as a subjective probability that the agent
will die before the next period, and so discounts the future experiences not
because they aren't valued, but because they may not occur.

5. Perpetuities

Perpetuity is a series of equal payments over an infinite time period into the
future. Consider the case of a cash payment C made at the end of each year
at interest rate i, as shown in the following time line:

Perpetuity Time Line

0 1 2 3
 PV C C C

6. Discount Rate

The Discount Rate, i%, used in the discount factor formulas is the
effective rate per period. It uses the same basis for the period (annual,
monthly, etc.) as used for the number of periods, n. If only a nominal interest
rate (rate per annum or rate per year)

7. Opportunity Cost

1. The cost of an alternative that must be forgone in order to pursue a

certain action. Put another way, the benefits you could have received by
taking an alternative action.
2. The difference in return between a chosen investment and one that is
necessarily passed up. Say you invest in a stock and it returns a paltry 2%
over the year. In placing your money in the stock, you gave up the
opportunity of another investment - say, a risk-free government bond
yielding 6%. In this situation, your opportunity costs are 4% (6% - 2%).

8. Cost of capital

The required return necessary to make a capital budgeting project, such as building a new
factory, worthwhile. Cost of capital includes the cost of debt and the cost of equity.

The cost of capital determines how a company can raise money (through a
stock issue, borrowing, or a mix of the two). This is the rate of return that a
firm would receive if it invested in a different vehicle with similar risk.

9. Inflation

The rate at which the general level of prices for goods and services is rising,
and, subsequently, purchasing power is falling. Central banks attempt to
stop severe inflation, along with severe deflation, in an attempt to keep the
excessive growth of prices to a minimum.

10. Nominal Interest Rate

The interest rate unadjusted for inflation. Not taking into account inflation
gives a less realistic number.
Market interest rate unadjusted to reflect the erosion of the purchasing
power due to inflation. See also real interest rate.

11. Real Interest Rate

An interest rate that has been adjusted to remove the effects of inflation to
reflect the real cost of funds to the borrower, and the real yield to the
lender. The real interest rate of an investment is calculated as the amount by
which the nominal interest rate is higher than the inflation rate.

Real Interest Rate = Nominal Interest Rate - Inflation (Expected or Actual)

12. Bond Valuation

A technique for determining the fair value of a particular bond. Bond

valuation includes calculating the present value of the bond's future interest
payments, also known as its cash flow, and the bond's value upon maturity,
also known as its face value or par value. Because a bond's par value and
interest payments are fixed, an investor uses bond valuation to determine
what rate of return is required for an investment in a particular bond to be
worthwhile.

13. Common Stock

A security that represents ownership in a corporation. Holders of common

stock exercise control by electing a board of directors and voting on
corporate policy. Common stockholders are on the bottom of the priority
ladder for ownership structure. In the event of liquidation, common
shareholders have rights to a company's assets only after bondholders;
preferred shareholders and other debt holders have been paid in full.
In the U.K., these are called "ordinary shares".

14. Secondary Market

A market where investors purchase securities or assets from other investors,

rather than from issuing companies themselves. The national exchanges -
such as the New York Stock Exchange and the NASDAQ are secondary
markets.
Secondary markets exist for other securities as well, such as when funds,
investment banks, or entities such as Fannie Mae purchase mortgages from
issuing lenders. In any secondary market trade, the cash proceeds go to an
investor rather than to the underlying company/entity directly.

15. Dividend Mean

1. A distribution of a portion of a company's earnings, decided by the board

of directors, to a class of its shareholders. The dividend is most often
quoted in terms of the dollar amount each share receives (dividends per
share). It can also be quoted in terms of a percent of the current market
price, referred to as dividend yield.
Also referred to as "Dividend Per Share (DPS)."
2. Mandatory distributions of income and realized capital gains made to
mutual fund investors.

16. Price-Earnings Ratio - P/E Ratio

A valuation ratio of a company's current share price compared to its per-

share earnings.

Calculated as:

For example, if a company is currently trading at $43 a share and earnings

over the last 12 months were $1.95 per share, the P/E ratio for the stock
would be 22.05 ($43/$1.95).

EPS is usually from the last four quarters (trailing P/E), but sometimes it can
be taken from the estimates of earnings expected in the next four quarters
(projected or forward P/E). A third variation uses the sum of the last two
actual quarters and the estimates of the next two quarters.

Also sometimes known as "price multiple" or "earnings multiple"

17. Book Value

1. The value at which an asset is carried on a balance sheet. To calculate,
take the cost of an asset minus the accumulated depreciation.

2. The net asset value of a company, calculated by total assets minus

intangible assets (patents, goodwill) and liabilities.

3. The initial outlay for an investment. This number may be net or gross of
expenses such as trading costs, sales taxes, service charges and so on.

Also known as "net book value (NBV)".

In the U.K., book value is known as "net asset value".

18. Liquidation Value

The total worth of a company's physical assets when it goes out of business
or if it were to go out of business. Liquidation value is determined by assets
such as the real estate, fixtures, equipment and inventory a company owns.
Intangible assets are not included in a company's liquidation value.
Intangible assets include a business's intellectual property, goodwill and
brand recognition.

19. Market-value balance sheet

Financial statement that uses the market value of all assets and liabilities.

20. Payout Ratio

The amount of earnings paid out in dividends to shareholders. Investors can

use the payout ratio to determine what companies are doing with their
earnings.

Calculated as:

21. Plowback Ratio

A fundamental analysis ratio that measures the amount of earnings retained

after dividends have been paid out. This is the opposite of the payout ratio,
which measures the amount of dividends that are paid out as a percentage
of earnings. Also known as "retention rate", "retention ratio" or the "earnings
retention ratio".
 22. Free Cash Flow - FCF

A measure of financial performance calculated as operating cash flow minus

capital expenditures. Free cash flow (FCF) represents the cash that a
company is able to generate after laying out the money required to maintain
or expand its asset base. Free cash flow is important because it allows a
company to pursue opportunities that enhance shareholder value. Without
cash, it's tough to develop new products, make acquisitions, pay dividends
and reduce debt. FCF is calculated as:

It can also be calculated by taking operating cash flow and subtracting

capital expenditures.