“Withdrawal symptoms are what you experience every time you go near your bank” – Anonymous.
All industries and disciplines have their very own unique sets of jargon – and the AltFi (that’s an abbreviation for “alternative finance”, by the way) industry is no different.
Here’s Part 2 of The Route – Finance’s alternative finance terminology guide to help you navigate the marketplace. Part 1 (A-F) can be found here.
A gearing ratio is used by investors to assess how well a borrowing company may or may not survive an economic downturn. The ratio is calculated by measuring the value of any loans that a business has taken against how much equity has been invested in the business to date.
Gearing ratios describe a company’s financial leverage. They demonstrate the extent to which a business uses its own capital to fund activities versus the use of creditors’ funds.
A going-concern assumption refers to a business that will be continue to function without intent or need to liquidate for the foreseeable future – i.e. at least the next 12 months. The assumption means that it is assumed that the business will be able to carry out its commitments and objectives during this period.
- 1. Adj. total amount before deductions – i.e. a gross sum of money/income/profit before deductions are taken for costs, taxes, etc.
- 2. Adj. flagrant and extreme: “Whoah – you don’t even want to know the interest rate my bank wants to charge for lending me a tenner. Talk about gross.”
A hedge fund is an alternative investment fund that pools together capital from a number of private sophisticated and/or institutional investors, which is often then used to invest in a wide range of securities in both domestic and foreign markets. Typically, hedge funds will require a large initial minimum investment, and will only be open to a limited number of accredited investors.
Hedging is an investing strategy whereby an investor makes one investment to limit the risk of another, the two of which are negatively correlated. It is a technique that is used to reduce the risk of uncertainty about unknown future price movements in financial security, commodity and foreign exchange investments. It doesn’t allow for increased profits, but prevents significant losses. Like taking out an insurance policy, hedging comes at a cost, and this cost may never pay-out.
For example, if a pop company wanted to hedge against the threat of a rise in sugar prices, they might “invest” in an instrument that allows them to buy sugar at a set price on a specified date in the future. If sugar prices indeed rise, the pop company’s hedge will have paid off – they will save a significant amount of money buying sugar at the pre-negotiated price. However, if sugar prices drop below the pre-negotiated price, the company will have lost a chance for potential savings. Here you can see how hedging is able to prevent losses; but the assurances that it brings may also come at a cost.
High Net Worth Individual (HNWI)
A HNWI is a categorisation used to indicate that an individual or family has a high net worth in liquid financial assets, usually amounting to more than £1 million. When the individual has assets worth over £5 million, they are described as “very HNWI”. With more than £30 million in wealth, the term “ultra HNWI” is used.
Holding Period Return/Yield
The holding period return refers to the total return on a portfolio or asset during the period that it was held. It represents the entire loss or gain that the ownership of an asset accrues over time. The HPR is calculated by taking into account the total returns from the portfolio or asset plus changes in value.
Assets that are deemed difficult to sell. Real estate, antiques, and private company interests are all examples of such assets.
Illiquid assets normally demand a premium as compensation for taking on the additional risk and effort should the asset need to be sold. The terms liquidity and illiquidity premium are generally interchangeable, chosen depending on where the premium lies. The liquidity premium will usually be presented as a reduced price for the illiquid asset – and a higher price for a liquid asset. In contrast, the Illiquidity premium is attributed to the asset’s interest. In general, the premium refers to the overall difference in price of the asset due to its liquidity.
Income refers to all monies an individual or business receives in exchange for providing goods and services, or through the investment of capital. Income is subject to taxation.
“You should always live within your income, even if you have to borrow to do so.” – Josh Billings
An indenture is the legally binding contract, agreement or other document between two or more parties, within which all purchase and/or debt obligations between the parties are covered. For example, indentures are the legal contracts behind bonds.
Inflation describes the rate at which the general level of prices for goods and services in an economy rise over time. Consequently, as inflation occurs, the value of money falls.
“Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair.” – Sam Ewing
Insolvency describes the situation whereby a business reaches a state when it cannot raise enough cash to meet its obligations, like paying off debts to lenders.
Intangible assets are those that are not physical in nature, though nonetheless have a long-term value to the owner. Examples include reputation, brand recognition, intellectual property (including copyrights, trademarks and patents, as well as things like industry knowledge, “know how” and trade secrets), client lists, and business methodologies.
Institutional investors are large organisations with considerable cash reserves to be invested. Examples include banks, insurance companies, finance companies, pension funds, and hedge funds.
Interest (on Loans)
Interest is the amount paid by a borrower to a lender in return for use of money. It is usually represented as a percentage.
Invoice factoring/discounting is the term used to describe the situation where an invoice is sold to a third party (i.e. a “factor”) for a discount. The factor pays a percentage of the money owed on the invoice upfront, with the difference (minus the discount) paid upon collection of the full payment from the initial invoice.
ISA and IFISA
ISA stands for individual savings account, which is a scheme that allows individuals to hold cash, unit trusts and shares free from taxation. Currently the annual ISA allowance stands at £15,240, but is set to rise to £20,000 from April 2017.
The innovative finance ISA or IFISA was introduced in 2016. This allows individuals to lend up to £15,240 per year through P2P platforms, again with tax free returns. This helps to stimulate the economy by providing more loan opportunities for businesses to use and grow.
A joint venture refers to an arrangement made by two or more businesses, where resources are pooled together to drive a new project or activity. All parties involved share ownership and responsibility for risks and returns of the specific activity. A joint venture will form a completely separate entity from the involved parties’ other business interests.
Key Performance Indicators (KPIs)
KPIs are the metrics that businesses use to gauge success or progress in relation to specific goals over time. In financial terms, KPIs are the metrics that most commonly concern profit margins and revenue, such as net and gross profits.
Lagging Economic Indicators
Lagging indicators are financial market and economic indicators which only begin to come to light after a change in the overall economic cycle. In other words, the effect of an economic event or change lags significantly behind its cause.
“You fool! You’re 30 cents away from having a quarter!” – Sweet Dick Willie (Robin Harris), Do the Right Thing
Leading Economic Indicators
Leading economic indicators are economic factors that change before the larger economy begins to follow a pattern or trend. They are signals – though not always accurate ones – that are used to gain some foresight into the economy’s future direction.
Leverage refers to an investment strategy where a party borrows money to magnify its gains. Just as a lever allows you to lift something much heavier than you would be capable of lifting alone, borrowing money can allow you to purchase things and gain access to opportunities to which you otherwise would not be privy. You input a small amount, and get a much larger return than would otherwise be possible.
However, leveraging also creates increased risk. For example, a property developer might borrow money to build a house. Just before the developer intends to sell the house, the housing market slumps. The developer is then unable to pay back the loan on time, and ends up defaulting on the loan, paying penalty interest, and possibly going bankrupt.
Liabilities are the existing financial obligations that a party has to lenders and suppliers. Liabilities include loans, accrued expenses, deferred revenues and accounts payable.
Liquid assets are a company’s assets that can be easily and quickly converted into cash with little or zero loss in value.
Liquidation occurs when a company becomes insolvent (see above), meaning that its operations come to an end, and that its free assets are sold for cash which will be used to pay off unsecured creditors.
A limited company describes an organisation that is its own entity, meaning that it is responsible in its own right for all activities and finances. Any profit generated by a limited company is owned by the company. After corporation tax is paid, the company can then divide the remaining profits amongst shareholders.
A limited company’s shareholders are not personally liable for the firm’s debts, which means they have limited liability and only ever stand to lose as much as they each have invested should the company become insolvent.
A listed company is a firm whose shares are quoted (i.e. listed) for public trading on a stock exchange.
Loan covenants are the conditions set out in an indenture that confirm certain activities will not be carried out. Typically, these will limit a borrower’s freedom to take on additional debt during the loan term, make certain purchases, and increase salaries or pay bonuses. Covenants are put in place by lenders to minimize the risk of borrowers defaulting on loans.
Loan to Value (LTV)
The LTV ratio is the ratio between the value of the asset and the loan you require to complete the purchase. Typically, the higher the LTV ratio, the more it will cost a borrower to borrow (i.e. through higher interest rates).
A loan note is a contract for a loan issued by the lender that specifies the details for repayment and the interest payable. Loan notes contain all of the terms of the loan, and are considered as a legally binding agreement.
To be continued in Part 3…
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