Financial glossary

Traders at the Chicago Board Options Exchange What's the difference between a bull and a bear?

The current financial crisis has thrown terminology from the business pages onto the front pages of newspapers, with jargon now abounding everywhere from the coffee bar to the back of a taxi.

Here is a guide to many of the business terms currently cropping up regularly, as well as some of the more exotic words coined to describe some of the social effects of the financial crisis.

D

Dead cat bounce A phrase long used on trading floors to describe the small rebound in market prices typically seen following a sharp fall.

Debt restructuring A situation in which a borrower renegotiates the terms of its debts, usually in order to reduce short-term debt repayments and to increase the amount of time it has to repay them. If lenders do not agree to the change in repayment terms, or if the restructuring results in an obvious loss to lenders, then it is generally considered a default by the borrower. However, restructuring can also occur through a debt swap - a voluntary agreement by lenders to switch existing debts for new debts with easier easier repayment terms - in which case it can be very hard to determine whether the restructuring counts as a default.

Default Strictly speaking, a default occurs when a borrower has broken the terms of a loan or other debt, for example if a borrower misses a payment. The term is also loosely used to mean any situation that makes clear that a borrower can no longer repay its debts in full, such as bankruptcy or a debt restructuring.

A default can have a number of important implications. If a borrower is in default on any one debt, then all of its lenders may be able to demand that the borrower immediately repay them. Lenders may also be required to write off their losses on the loans they have made.

Deficit The amount by which spending exceeds income over the course of a year.

In the case of trade, it refers to exports minus imports. In the case of the government budget, it equals the amount the government needs to borrow during the year to fund its spending. The government's "primary" deficit means the amount it needs to borrow to cover general government expenditure, excluding interest payments on debts. The primary deficit therefore indicates whether a government will run out of cash if it is no longer able to borrow and decides to stop repaying its debts.

Deflation Negative inflation - that is, when the prices of goods and services across the whole economy are falling on average.

Deleveraging A process whereby borrowers reduce their debt loads. Primarily this occurs by repaying debts. It can also occur by bankruptcies and debt defaults, or by the borrowers increasing their incomes, meaning that their existing debt loads become more manageable. Western economies are experiencing widespread deleveraging, a process associated with weak economic growth that is expected to last years. Households are deleveraging by repaying mortgage and credit card debts. Banks are deleveraging by cutting back on lending. Governments are also beginning to deleverage via austerity programmes - cutting spending and increasing taxation.

Derivative A financial contract which provides a way of investing in a particular product without having to own it directly. For example, a stock market futures contract allows investors to make bets on the value of a stock market index such as the FTSE 100 without having to buy or sell any shares. The value of a derivative can depend on anything from the price of coffee to interest rates or what the weather is like. Credit derivatives such as credit default swaps depend on the ability of a borrower to repay its debts. Derivatives allow investors and banks to hedge their risks, or to speculate on markets. Futures, forwards, swaps and options are all types of derivatives.

Dividends An income payment by a company to its shareholders, usually linked to its profits.

Dodd-Frank Legislation enacted by the US in 2011 to regulate the banks and other financial services. It includes:

  • restrictions on banks' riskier activities (the Volcker rule)
  • a new agency responsible for protecting consumers against predatory lending and other unfair practices
  • regulation of the enormous derivatives market
  • a leading role for the central bank, the Federal Reserve, in overseeing regulation
  • higher bank capital requirements
  • new powers for regulators to seize and wind up large banks that get into trouble

Double-dip recession A recession that experiences a limited recovery then dips back into recession. The exact definition is unclear, as the definition of what counts as a recession varies between countries. A widely-accepted definition is one where the initial recovery fails to take total economic output back up to the peak seen before the recession began.

E

EBA The European Banking Authority is a pan-European regulator responsible created in 2010 to oversee all banks within the European Union. Its powers are limited, and it depends on national bank regulators such as the UK's Financial Services Authority to implement its recommendations. It has already been active in laying down new rules on bank bonuses and arranging the European bank stress tests.

Ebitda Earnings (or profit) before interest payments, tax, depreciation and amortisation. It is a measure of the cashflow at a company available to repay its debts, and is much more important indicator for lenders than the borrower's profits.

EBRD The European Bank for Reconstruction and Development is a similar institution to the World Bank, set up by the US and European countries after the fall of the Berlin Wall to assist in economic transition in Eastern Europe. Recently the EBRD's remit has been extended to help the Arab countries that emerged from dictatorship in 2011.

ECB The European Central Bank is the central bank responsible for monetary policy in the eurozone. It is headquartered in Frankfurt and has a mandate to ensure price stability - which is interpreted as an inflation rate of no more than 2% per year.

EIB The European Investment Bank is the European Union's development bank. It is owned by the EU's member governments, and provides loans to support pan-European infrastructure, economic development in the EU's poorer regions and environmental objectives, among other things.

ESM The European Stability Mechanism is a 500bn-euro rescue fund that will replace the EFSF and the EFSM from June 2013. Unlike the EFSF, the ESM is a permanent bail-out arrangement for the eurozone. Unlike the EFSM, the ESM will only be backed by members of the eurozone, and not by other European Union members such as the UK.

EFSF The European Financial Stability Facility is currently a temporary fund worth up to 440bn euros set up by the eurozone in May 2010. Following a previous bail-out of Greece, the EFSF was originally intended to help other struggling eurozone governments, and has since provided rescue loans to the Irish Republic and Portugal. More recently, the eurozone agreed to broaden the EFSF's mandate, for example by allowing it to support banks.

EFSM The European Financial Stability Mechanism is 60bn euros of money pledged by the member governments of the European Union, including 7.5bn euros pledged by the UK. The EFSM has been used to loan money to the Irish Republic and Portugal. It will be replaced by the ESM from 2013.

Equity The value of a business or investment after subtracting any debts owed by it. The equity in a company is the value of all its shares. In a house, your equity is the amount your house is worth minus the amount of mortgage debt that is outstanding on it.

Eurobond A term increasingly used for the idea of a common, jointly-guaranteed bond of the eurozone governments. It has been mooted as a solution to the eurozone debt crisis, as it would prevent markets from differentiating between the creditworthiness of different government borrowers.

Confusingly and quite separately, "Eurobond" also refers to a bond issued in a country which isn't denominated in that country's currency. For example, this is used to refer to bonds in US dollars issued in Europe.

Eurozone The 17 countries that share the euro.

F

Federal Reserve The US central bank.

Financial Policy Committee A new committee at the Bank of England set up in 2010-11 in response to the financial crisis. It has overall responsibility for ensuring major risks do not build up within the UK financial system.

Financial transaction tax See Tobin tax.

Fiscal policy The government's borrowing, spending and taxation decisions. If a government is worried that it is borrowing too much, it can engage in austerity; raising taxes and/or cutting spending. Alternatively, if a government is afraid that the economy is going into recession it can engage in fiscal stimulus, which can include cutting taxes, raising spending and/or raising borrowing.

Freddie Mac, Fannie Mae Nicknames for the Federal Home Loans Mortgage Corporation and the Federal National Mortgage Association respectively. They don't lend mortgages directly to homebuyers, but they are responsible for obtaining a large part of the money that gets lent out as mortgages in the US from the international financial markets. Although privately-owned, the two operate as agents of the US federal government. After almost going bust in the financial crisis, the government put them into "conservatorship" - guaranteeing to provide them with any new capital needed to ensure they do not go bust.

FTSE 100 An index of the 100 companies listed on the London Stock Exchange with the biggest market value. The index is revised every three months.

Fundamentals Fundamentals determine a company, currency or security's value in the long-term. 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. Futures contracts are a type of derivative, and are traded on an exchange.

G

G7 The group of seven major industrialised economies, comprising the US, UK, France, Germany, Italy, Canada and Japan.

G8 The G7 plus Russia.

G20 The G8 plus developing countries that play an important role in the global economy, such as China, India, Brazil and Saudi Arabia. It gained in significance after leaders agreed how to tackle the 2008-09 financial crisis and recession at G20 gatherings.

GDP Gross domestic product. A measure of economic activity in a country, namely of all the services and goods produced in a year. There are three main ways of calculating GDP - through output, through income and through expenditure.

Glass-Steagall A US law dating from the 1930s Great Depression that separated ordinary commercial banking from investment banking. Like the UK's planned ring-fence, the law was intended to protect banks which lend to consumers and businesses - deemed vital to the US economy - from the risky speculation of investment banks. The law was repealed in 1999, largely to enable the creation of the banking giant Citigroup - a move that many commentators say was a contributing factor to the 2008 financial crisis.

H

Haircut A reduction in the value of a troubled borrower's debts, imposed on, or agreed with, its lenders as part of a debt restructuring.

Hedge fund A private investment fund which uses a range of sophisticated strategies to maximise returns including hedging, leveraging and derivatives trading. Authorities around the world are working on ways to regulate them.

Hedging Making an investment to reduce the risk of price fluctuations to the value of an asset. Airlines often hedge against rising oil prices by agreeing in advance to to buy their fuel at a set price. In this case, a rise in price would not harm them - but nor would they benefit from any falls.

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