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Instructions: This handout comprises a compilation of certain basic financial, accountingand economic terms. This is only a representation and students are requested not to limittheir learning to this handout only.

Finance

Stock- A type of security that signifies ownership in a corporation and represents a claim onpart of the corporation's assets and earnings. There are two main types of stock: common andpreferred. Common stock usually entitles the owner to vote at shareholders' meetings and toreceive dividends. Preferred stock generally does not have voting rights, but has a higher claimon assets and earnings than the common shares. For example, owners of preferred stockreceive dividends before common shareholders and have priority in the event that a companygoes bankrupt and is liquidated. Also known as "shares" or "equity". A holder of stock (ashareholder) has a claim to a part of the corporation's assets and earnings. In other words, ashareholder is an owner of a company. Ownership is determined by the number of shares aperson owns relative to the number of outstanding shares. For example, if a company has 1,000shares of stock outstanding and one person owns 100 shares, that person would own and haveclaim to 10% of the company's assets. Stocks are the foundation of nearly every portfolio.Historically, they have outperformed most other investments over the long run.

Bonds- A Company needs funds to expand into new markets, while governments need moneyfor everything from infrastructure to social programs. The problem large organizations run intois that they typically need far more money than the average bank can provide. The solution isto raise money by issuing bonds (or other debt instruments) to a public market. Thousands ofinvestors then each lend a portion of the capital needed. Really, a bond is nothing more than aloan for which you are the lender. The organization that sells a bond is known as the issuer.You can think of a bond as an IOU given by a borrower (the issuer) to a lender (the investor).

Of course, nobody would loan his or her hard-earned money for nothing. The issuer of a bondmust pay the investor something extra for the privilege of using his or her money. This "extra"comes in the form of interest payments, which are made at a predetermined rate andschedule. The interest rate is often referred to as the coupon. The date on which the issuer has

to repay the amount borrowed (known as face value) is called the maturity date. Bonds areknown as fixed-income securities because you know the exact amount of cash you'll get back ifyou hold the security until maturity.

For example, say you buy a bond with a face value of $1,000, a coupon of 8%, and a maturity of10 years. This means you'll receive a total of $80 ($1,000*8%) of interest per year for the next10 years. Actually, because most bonds pay interest semi-annually, you'll receive two paymentsof $40 a year for 10 years. When the bond matures after a decade, you'll get your $1,000 back.

Municipal bond- Represents borrowing by state or local governments to pay for special projectssuch as highways or sewers. The interest that investors receive is exempt from some incomeaxes.

Debt Versus Equity - Bonds are debt, whereas stocks are equity. This is the importantdistinction between the two securities. By purchasing equity (stock) an investor becomes anowner in a corporation. Ownership comes with voting rights and the right to share in any futureprofits. By purchasing debt (bonds) an investor becomes a creditor to the corporation (orgovernment). The primary advantage of being a creditor is that you have a higher claim onassets than shareholders do: that is, in the case of bankruptcy, a bondholder will get paidbefore a shareholder. However, the bondholder does not share in the profits if a company doeswell - he or she is entitled only to the principal plus interest.

To sum up, there is generally less risk in owning bonds than in owning stocks, but this comes atthe cost of a lower return.

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Stock Market- The market in which shares are issued and traded either through exchangesor over-the-counter markets. Also known as the equity market, it is one of the most vital areasof a market economy as it provides companies with access to capital and investors with a sliceof ownership in the company and the potential of gains based on the company's futureperformance. This market can be split into two main sections: the primary and secondary

market. The primary market is where new issues are first offered, with any subsequent tradinggoing on in the secondary market. There are two main types of stocks:  common stock andpreferred stock.

Common Stock - Common stock is, well, common. When people talk about stocks theyare usually referring to this type. In fact, the majority of stock is issued is in this form. Webasically went over features of common stock in the last section. Common shares representownership in a company and a claim (dividends) on a portion of profits. Investors get one voteper share to elect the board members, who oversee the major decisions made by management.

Over the long term, common stock, by means of capital growth, yields higher returns thanalmost every other investment. This higher return comes at a cost since common stocks entail

the most risk. If a company goes bankrupt and liquidates, the common shareholders will notreceive money until the creditors, bondholders and preferred shareholders are paid.

Preferred Stock - Preferred stock represents some degree of ownership in a company butusually doesn't come with the same voting rights. (This may vary depending on the company.)With preferred shares, investors are usually guaranteed a fixed dividend forever. This isdifferent than common stock, which has variable dividends that are never guaranteed. Anotheradvantage is that in the event of liquidation, preferred shareholders are paid off before thecommon shareholder (but still after debt holders). Preferred stock may also be callable,meaning that the company has the option to purchase the shares from shareholders at anytimefor any reason (usually for a premium).

Some people consider preferred stock to be more like debt than equity. A good way to think of

these kinds of shares is to see them as being in between bonds and common shares.

Different Classes of Stock - Common and preferred are the two main forms of stock; however,it's also possible for companies to customize different classes of stock in any way they want.The most common reason for this is the company wanting the voting power to remain with acertain group; therefore, different classes of shares are given different voting rights. Forexample, one class of shares would be held by a select group who are given ten votes per sharewhile a second class would be issued to the majority of investors who are given one vote pershare. When there is more than one class of stock, the classes are traditionally designatedas Class A and Class B.

Cyclical stocks- The earnings on these stocks are tied very closely to the overall business cycleand economic state. Examples include the housing industry and industrial equipment

companies.

Defensive stocks- These remain stable in any economic conditions, such as food companies,drug manufacturers or utilities. These are stocks in companies that manufacture the necessitiesthat people will need in any economy.

Growth stocks- As the name might suggest, these stocks have strong growth potential. Theseare typically companies that are newer, busily doing research and developing products andservices in hopes of achieving growth. Much of the profits are fed back into the companiesthemselves.

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Income stocks - These pay higher-than-average dividends over a sustained period. They aretypically long-established companies with stable earnings or utilities such as phone companies.

Net worth- Total assets minus total liabilities of an individual or company. For a company,also called owner's equity or shareholders' equity or net assets.

Speculative stocks - These are stocks in emerging companies that are speculating on theirfuture earnings and revenue. These are risky investments since the company may or may notreach their intended future goals.

Value stocks- These are stocks in companies that, for one of many reasons, are undervalued.They are stocks that are selling at a low price, but when analyzing the company's sales,earnings and looking at other factors, give indications that they should be selling for a higherper share price.

The Bulls, The Bears And The Farm- On Wall Street, the bulls  and  bears are in a constantstruggle. If you haven't heard of these terms already, you undoubtedly will as you begin toinvest.

The Bulls - A financial market of a certain group of securities in which prices are rising or areexpected to rise. The term "bull market" is most often used in respect to the stock market, butreally can be applied to anything that is traded, such as bonds, currencies, commodities, etc.

A bull market is when everything in the economy is great, people are finding jobs, gross domestic product (GDP) is growing, and stocks are rising. Things are just plain rosy! Pickingstocks during a bull market is easier because everything is going up. Bull markets cannot lastforever though, and sometimes they can lead to dangerous situations if stocks becomeovervalued. If a person is optimistic and believes that stocks will go up, he or she is called a"bull" and is said to have a "bullish outlook".

Bull markets are characterized by optimism, investor confidence and expectations that strongresults will continue. Of course, no bull market can last forever, and sooner or later a bearmarket (in which prices fall) will come. It's tough if not impossible to predict consistently whenthe trends in the market will change. Part of the difficulty is that psychological effects andspeculation can sometimes play a large (if not dominant) role in the markets. The extremeon the high end is a stock-market bubble, and on the low end a crash.

The use of "bull" and "bear" to describe markets comes from the way in which each animalattacks its opponents. That is, a bull thrusts its horns up into the air, and a bear swipesits paws down. These actions are metaphors for the movement of a market: if the trend is up,it is considered a bull market. And if the trend is down, it is considered a bear market.

The Bears - A market condition in which the prices of securities are falling or are expected tofall. Although figures can vary, a downturn of 15-20% or more in multiple indexes (Dow or S&P500) is considered an entry into a bear market.

When you see a bear what do you do? Tuck in your arms and play dead! Fighting back can beextremely dangerous. It is quite difficult for an investor to make stellar gains during a bearmarket, unless he or she is a short seller. A bear market is when the economy is bad, recessionis looming and stock prices are falling. Bear markets make it tough for investors to pickprofitable stocks. One solution to this is to make money when stocks are falling using atechnique called short selling. Another strategy is to wait on the sidelines until you feel thatthe bear market is nearing its end, only starting to buy in anticipation of a bull market. If aperson is pessimistic, believing that stocks are going to drop, he or she is called a "bear" andsaid to have a "bearish outlook".

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The Other Animals on the Farm - Chickens and Pigs -Chickens are afraid to lose anything.Their fear overrides their need to make profits and so they turn only to money-market securities or get out of the markets entirely. While it's true that you should never invest insomething over which you lose sleep, you are also guaranteed never to see any return if youavoid the market completely and never take any risk,

Pigs are high-risk investors looking for the one big score in a short period of time. Pigs buy onhot tips and invest in companies without doing their due diligence. They get impatient, greedy,and emotional about their investments, and they are drawn to high-risk securities withoutputting in the proper time or money to learn about these investment vehicles. Professionaltraders love the pigs, as it's often from their losses that the bulls and bears reap their profits.

"Bulls make money, bears make money, but pigs just get slaughtered!"

Yield- In stocks and bonds, the amount of money returned to investors on their investments.Also known as rate of return. The annual income from a SECURITY, expressed as a percentageof the current market PRICE of the security. The yield on a SHARE is its DIVIDEND divided by itsprice. A BOND yield is also known as its INTEREST RATE: the annual coupon divided by themarket price.

Yield curve- Shorthand for comparisons of the INTEREST RATE on GOVERNMENT  BONDS ofdifferent maturity. If investors think it is riskier to buy a bond with 15 years until it maturesthan a bond with five years of life, they will demand a higher interest rate ( YIELD) on thelonger-dated bond. If so, the yield curve will slope upwards from left (the shorter maturities)to right. It is normal for the yield curve to be positive (upward sloping, left to right) simplybecause investors normally demand compensation for the added RISK of holding longer-termSECURITIES. Historically, a downward-sloping (or inverted) yield curve has been an indicator ofRECESSION on the horizon, or, at least, that investors expect the CENTRAL BANK to cut short-term interest rates in the near future. A flat yield curve means that investors are indifferent tomaturity risk, but this is unusual. When the yield curve as a whole moves higher, it means thatinvestors are more worried that INFLATION will rise for the foreseeable future and thereforethat higher interest rates will be needed. When the whole curve moves lower, it means that

investors have a rosier inflationary outlook.

Even if the direction (up or down) of a yield curve is unchanged, useful information can begleaned from changes in the SPREADS between yields on bonds of different maturities and ondifferent sorts of bonds with the same maturity (such as government bonds versus corporatebonds, or thinly traded bonds versus highly liquid bonds).

Yield gap- A way of comparing the performance of BONDS and SHARES. The gap is defined asthe AVERAGE YIELD on equities minus the average yield on bonds. Because shares are usuallyriskier investments than bonds, you might expect them to have a higher yield. In practice, theyield gap is often negative, with bonds yielding more than equities. This is not becauseinvestors regard equities as safer than bonds (see EQUITY RISK PREMIUM). Rather, it is that theyexpect most of the benefit from buying shares to come from an increase in their  PRICE 

(CAPITAL appreciation) rather than from DIVIDEND payments. Bond investors usually expectmore of their gains to come from coupon payments. They also worry that INFLATION will erodethe REAL VALUE of future coupons, making them value current payments more highly thanthose due in years to come. Moreover, the usefulness of the dividend yield as a guide to theperformance of shares has declined since the early 1990s, as increasingly companies havechosen to return cash to shareholders by buying back their own shares rather than paying outbigger dividends.

Capital asset pricing model (CAPM)- An economic theory that describes the relationshipbetween risk and expected return, and serves as a model for the pricing of risky securities. TheCAPM asserts that the only risk that is priced by rational investors is systematic risk, because

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that risk cannot be eliminated by diversification. The CAPM says that the expected return of asecurity or a portfolio is equal to the rate on a risk-free security plus a risk premium multipliedby the assets systematic risk. Theory was invented by William Sharpe (1964) and John Lintner(1965).

The rationale of the CAPM can be simplified as follows. Investors can eliminate some sorts of

RISK, known as RESIDUAL RISK or alpha, by holding a diversified portfolio of assets (see MODERN PORTFOLIO THEORY). These alpha risks are specific to an individual asset, for example, the riskthat a company’s managers will turn out to be no good. Some risks, such as that of a globalRECESSION, cannot be eliminated through diversification. So even a basket of all of the SHARES in a stockmarket will still be risky. People must be rewarded for investing in such a risky basketby earning returns on  AVERAGE above those that they can get on safer assets, such asTREASURY BILLS. Assuming investors diversify away alpha risks, how an investor values anyparticular asset should depend crucially on how much the asset’s PRICE is affected by the riskof the market as a whole. The market’s risk contribution is captured by a measure of relativevolatility, BETA, which indicates how much an asset’s price is expected to change when theoverall market changes.

Safe investments have a beta close to zero: economists call these assets risk free. Riskier

investments, such as a share, should earn a premium over the risk-free rate. How much iscalculated by the average premium for all assets of that type, multiplied by the particularasset’s beta.

But does the CAPM work? It all comes down to beta, which some economists have found ofdubious use. They think the CAPM may be an elegant theory that is no good in practice. Yet itis probably the best and certainly the most widely used method for calculating the cost ofcapital.

Capital controls- government-imposed restrictions on the ability of CAPITAL to move in or outof a country. Examples include limits on foreign INVESTMENT in a country’s  FINANCIAL MARKETS, on direct investment by foreigners in businesses or property, and on domesticresidents’ investments abroad. Until the 20th century capital controls were uncommon, but

many countries then imposed them. Following the end of the Second World War onlySwitzerland, Canada and the United States adopted open capital regimes. Other rich countriesmaintained strict controls and many made them tougher during the 1960s and 1970s. Thischanged in the 1980s and early 1990s, when most developed countries scrapped their capitalcontrols. The pattern was more mixed in developing countries. Latin American countriesimposed lots of them during the debt crisis of the 1980s then scrapped most of them from thelate 1980s onwards. Asian countries began to loosen their widespread capital controls in the1980s and did so more rapidly during the 1990s.

In developed countries, there were two main reasons why capital controls were lifted: freemarkets became more fashionable and financiers became adept at finding ways around thecontrols. Developing countries later discovered that foreign capital could play a part infinancing domestic investment, from roads in Thailand to telecoms systems in Mexico, and,

furthermore, that financial capital often brought with it valuable HUMAN CAPITAL. They alsofound that capital controls did not work and had unwanted side-effects. Latin America’scontrols in the 1980s failed to keep much money at home and also deterred foreigninvestment.

The Asian economic crisis and CAPITAL FLIGHT of the late 1990s revived interest in capitalcontrols, as some Asian governments wondered whether lifting the controls had left themvulnerable to the whims of international speculators, whose money could flow out of a countryas fast as it once flowed in. There was also discussion of a “Tobin tax” on short-term capitalmovements, proposed by James TOBIN, a winner of the NOBEL PRIZE FOR ECONOMICS. Even so,they mostly considered only limited controls on short-term capital movements, particularly

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movements out of a country, and did not reverse the broader 20-year-old process of globalfinancial and economic LIBERALISATION.

Mutual Fund- A portfolio of stocks, bonds, or other securities administered by a team of one ormore managers from an investment company who make buy and sell decisions on componentsecurities. Capital is contributed by smaller investors who buy shares in the mutual fund rather

than the individual stocks and bonds in its portfolio. The return on the fund's holdings isdistributed back to its contributors, or shareholders, minus various fees and commissions. Thissystem allows small investors to participate in the reduced risk of a large and diverse portfoliothat they could not otherwise build themselves. They also have the benefit of professionalmanagers overseeing their money who have the time and expertise to analyze and picksecurities. There are two types of mutual funds, open and closed-ended. Units in closed-endfunds, some of which are listed on Stock Exchanges, are readily transferable in the openmarket and are bought and sold, like other stock. These funds do not accept new contributionsfrom investors, but only reinvest the return on the existing portfolio.

Open-end funds sell their own new shares to investors, stand ready to buy back their oldshares, and are not normally listed on exchanges. Open-end funds are so called because theircapitalization is not fixed; they issue more units as people want them. Many open-ended funds

allow contributors extra perks, such as the ability to write cheques against their units. Alsothere are several open ended mutual funds which are insurance linked. It is basically marketingwith added benefits.

Mutual Funds: Different Types of Funds- each mutual fund has different risks and rewards. Ingeneral, the higher the potential return, the higher the risk of loss. Although some funds areless risky than others, all funds have some level of risk - it's never possible to diversify away allrisk. This is a fact for all investments. Each fund has a predetermined investment objectivethat tailors the fund's assets, regions of investments and investment strategies. At thefundamental level, there are three varieties of mutual funds:1) Equity funds (stocks)2) Fixed-income funds (bonds)3) Money market funds

All mutual funds are variations of these three asset classes. For example, while equity fundsthat invest in fast-growing companies are known as growth funds, equity funds that invest onlyin companies of the same sector or region are known as specialty funds.

Other funds-

Money Market Funds - The money market consists of short-term debt instruments, mostlyTreasury bills. This is a safe place to park your money. You won't get great returns, but youwon't have to worry about losing your principal. A typical return is twice the amount you wouldearn in a regular checking/savings account and a little less than the average certificate of deposit (CD).

Bond/Income Funds - Income funds are named appropriately: their purpose is to providecurrent income on a steady basis. When referring to mutual funds, the terms "fixed-income,""bond," and "income" are synonymous. These terms denote funds that invest primarily ingovernment and corporate debt. While fund holdings may appreciate in value, the primaryobjective of these funds is to provide a steady cash flow to investors. As such, the audience forthese funds consists of conservative investors and retirees.

Bond funds are likely to pay higher returns than certificates of deposit and money marketinvestments, but bond funds aren't without risk. Because there are many different types ofbonds, bond funds can vary dramatically depending on where they invest. For example, a fundspecializing in high-yield junk bonds is much more risky than a fund that invests in government

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securities. Furthermore, nearly all bond funds are subject to interest rate risk, which meansthat if rates go up the value of the fund goes down.

Balanced Funds - The objective of these funds is to provide a balanced mixture of safety,income and capital appreciation. The strategy of balanced funds is to invest in a combinationof fixed income and equities. A typical balanced fund might have a weighting of 60% equity and

40% fixed income. The weighting might also be restricted to a specified maximum or minimumfor each asset class.

A similar type of fund is known as an asset allocation fund. Objectives are similar to those of abalanced fund, but these kinds of funds typically do not have to hold a specified percentage ofany asset class. The portfolio manager is therefore given freedom to switch the ratio of assetclasses as the economy moves through the business cycle.

Equity Funds - Funds that invest in stocks represent the largest category of mutual funds.Generally, the investment objective of this class of funds is long-term capital growth with someincome. There are, however, many different types of equity funds because there are manydifferent types of equities.

The idea is to classify funds based on both the size of the companies invested in and theinvestment style of the manager. The term value refers to a style of investing that looks forhigh quality companies that are out of favor with the market. These companies arecharacterized by low P/E and price-to-book ratios and high dividend yields. The opposite ofvalue is growth, which refers to companies that have had (and are expected to continue tohave) strong growth in earnings, sales and cash flow. A compromise between value and growthis blend, which simply refers to companies that are neither value nor growth stocks and areclassified as being somewhere in the middle. For example, a mutual fund that invests in large-cap companies that are in strong financial shape but have recently seen their share prices fallwould be placed in the upper left quadrant of the style box (large and value). The opposite ofthis would be a fund that invests in startup technology companies with excellent growthprospects. Such a mutual fund would reside in the bottom right quadrant (small and growth).

Global/International Funds - An international fund (or foreign fund) invests only outside your

home country. Global funds invest anywhere around the world, including your home country.

It's tough to classify these funds as either riskier or safer than domestic investments. Theydo tend to be more volatile and have unique country and/or political risks. But, on the flipside, they can, as part of a well-balanced portfolio, actually reduce risk by increasingdiversification. Although the world's economies are becoming more inter-related, it is likelythat another economy somewhere is outperforming the economy of your home country.

Specialty Funds - This classification of mutual funds is more of an all-encompassing categorythat consists of funds that have proved to be popular but don't necessarily belong to thecategories we've described so far. This type of mutual fund forgoes broad diversification toconcentrate on a certain segment of the economy. Sector funds are targeted at specific sectorsof the economy such as financial, technology, health, etc. Sector funds are extremely volatile.

There is a greater possibility of big gains, but you have to accept that your sector may tank.

Regional funds make it easier to focus on a specific area of the world. This may mean focusingon a region (say Latin America) or an individual country (for example, only Brazil). Anadvantage of these funds is that they make it easier to buy stock in foreign countries, which isotherwise difficult and expensive. Just like for sector funds, you have to accept the high risk ofloss, which occurs if the region goes into a bad recession.

Socially-responsible funds (or ethical funds) invest only in companies that meet the criteria ofcertain guidelines or beliefs. Most socially responsible funds don't invest in industries such as

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tobacco, alcoholic beverages, weapons or nuclear power. The idea is to get a competitiveperformance while still maintaining a healthy conscience.

Index Funds - The last but certainly not the least important are index funds. This type ofmutual fund replicates the performance of a broad market index such as the S&P 500 or Dow Jones Industrial Average (DJIA). An investor in an index fund figures that most managers can't

beat the market. An index fund merely replicates the market return and benefits investors inthe form of low fees.

Load Fund- Mutual Fund that is sold for a sales charge by a brokerage firm or other salesrepresentative. Such funds may be stock, bond or commodity funds, with conservative oraggressive objectives.

Technical Analysis: The methods used to analyze securities and make investment decisions fallinto two very broad categories: fundamental analysis and technical analysis. Fundamentalanalysis involves analyzing the characteristics of a company in order to estimate its value.Technical analysis takes a completely different approach; it doesn't care one bit about the"value" of a company or a commodity. Technicians (sometimes called chartists) are onlyinterested in the price movements in the market. Despite all the fancy and exotic tools it

employs, technical analysis really just studies supply and demand in a market in an attemptto determine what direction, or trend, will continue in the future. In other words, technicalanalysis attempts to understand the emotions in the market by studying the market itself, asopposed to its components.

Fundamental Analysis:  Fundamental analysis is the cornerstone of investing. In fact, somewould say that you aren't really investing if you aren't performing fundamental analysis.Because the subject is so broad, however, it's tough to know where to start. There are anendless number of investment strategies that are very different from each other, yet almost alluse the fundamentals. The biggest part of fundamental analysis involves delving into thefinancial statements. Also known as quantitative analysis, this involves looking at revenue,expenses, assets, liabilities and all the other financial aspects of a company. Fundamentalanalysts look at this information to gain insight on a company's future performance. But there

is more than just number crunching when it comes to analyzing a company. This is wherequalitative analysis comes in - the breakdown of all the intangible, difficult-to-measure aspectsof a company.

Ratio Analysis: Fundamental Analysis has a very broad scope. One aspect looks at the general(qualitative) factors of a company. The other side considers tangible and measurable factors(quantitative). This means crunching and analyzing numbers from the financial statements. Ifused in conjunction with other methods, quantitative analysis can produce excellent results.

Ratio analysis isn't just comparing different numbers from the balance sheet, incomestatement, and cash flow statement. It's comparing the number against previous years, othercompanies, the industry, or even the economy in general. Ratios look at the relationshipsbetween individual values and relate them to how a company has performed in the past, and

might perform in the future.

For example current assets alone don't tell us a whole lot, but when we divide them by current liabilities we are able to determine whether the company has enough money to cover shortterm debts.

Futures Fundamentals: What we know as the futures market of today came from some humblebeginnings. Trading in futures originated in Japan during the eighteenth century and wasprimarily used for the trading of rice and silk. It wasn't until the 1850s that the U.S. startedusing futures markets to buy and sell commodities such as cotton, corn and wheat.

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• An over-the-counter is a derivative that is not traded on an exchange but is purchased from,say, an investment BANK.

• Exotics are derivatives that are complex or are available in emerging economies.

• Plain-vanilla derivatives, in contrast to exotics, are typically exchange-traded, relate to

developed economies and are comparatively uncomplicated.

These underlying assets may be foreign exchange, bonds, equities or commodities. Derivativestraded at exchanges are standardized contracts that have standard delivery dates and tradingunits. OTC derivatives are customized contracts that enable the parties to select the tradingunits and delivery dates to suit their requirements.

Market Open/Close Price - It is the last price a particular stock sold for the previous day.

Market Price - It is the price a particular stock is currently selling for during the operatinghours of the stock market.

Moving Average- A rolling set of averages calculated over a time series of values. A MovingAverage represents data in a manner that smoothens fluctuations and highlights possible trends

Intrinsic Value – can be explained as-

1. The value of a company or an asset based on an underlying perception of the value.

2. For call options, this is the difference between the underlying stock's price and thestrike price. For put options, it is the difference between the strike price and theunderlying stock's price. In the case of both puts and calls, if the difference betweenthe underlying stock's price and the strike price is negative, the value is given as zero.

3. Intrinsic value includes hidden things like the value of a brand name, which is difficultto calculate.

4. Intrinsic value in options is the in-the-money portion of the option's premium

Doing basic fundamental valuation is quite straightforward; all it takes is a little time andenergy. The goal of analyzing a company's fundamentals is to find a stock's intrinsic value, afancy term for what you believe a stock is really worth - as opposed to the value at which it isbeing traded in the marketplace. If the intrinsic value is more than the current share price,your analysis is showing that the stock is worth more than its price and that it makes sense tobuy the stock.

Although there are many different methods of finding the intrinsic value, the premise behind

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all the strategies is the same: a company is worth the sum of its discounted cash flows. In plainEnglish, this means that a company is worth all of its future profits added together. And thesefuture profits must be discounted to account for the time value of money, that is, the force bywhich the $1 you receive in a year's time is worth less than $1 you receive today.

The idea behind intrinsic value equaling future profits makes sense if you think about how a

business provides value for its owner(s). If you have a small business, its worth is the moneyyou can take from the company year after year (not the growth of the stock). And you can takesomething out of the company only if you have something left over after you pay for suppliesand salaries, reinvest in new equipment, and so on. A business is all about profits, plain oldrevenue minus expenses - the basis of intrinsic value.

Greater Fool Theory - One of the assumptions of the discounted cash flow theory is thatpeople are rational, that nobody would buy a business for more than its future discounted cashflows. Since a stock represents ownership in a company, this assumption applies to the stockmarket. But why, then, do stocks exhibit such volatile movements? It doesn't make sense for astock's price to fluctuate so much when the intrinsic value isn't changing by the minute.

The fact is that many people do not view stocks as a representation of discounted cash flows,but as trading vehicles. Who cares what the cash flows are if you can sell the stock tosomebody else for more than what you paid for it? Cynics of this approach have labeled it thegreater fool theory, since the profit on a trade is not determined by a company's value, butabout speculating whether you can sell to some other investor (the fool). On the other hand, atrader would say that investors relying solely on fundamentals are leaving themselves at themercy of the market instead of observing its trends and tendencies.

Dividend Discount Model – DDM- is the procedure for valuing the price of a stock by usingpredicted dividends and discounting them back to present value. The idea is that if the valueobtained from the DDM is higher than what the shares are currently trading at, then the stockis undervalued.

This procedure has many variations, and it doesn't work for companies that don't pay outdividends.

Risk Return Tradeoff- The principle that potential return rises with an increase in risk. Lowlevels of uncertainty (low risk) are associated with low potential returns, whereas high levels ofuncertainty (high risk) are associated with high potential returns. In other words, the risk-return tradeoff says that invested money can render higher profits only if it is subject to thepossibility of being lost. Because of the risk-return tradeoff, you must be aware of yourpersonal risk tolerance when choosing investments for your portfolio. Taking on some risk is theprice of achieving returns; therefore, if you want to make money, you can't cut out all risk.The goal instead is to find an appropriate balance - one that generates some profit, but stillallows you to sleep at night.

Money Market: The money market is better known as a place for large institutions andgovernment to manage their short-term cash needs.

Money Market: Repos- Repo is short for repurchase agreement. Repos are classified as amoney-market instrument. They are usually used to raise short-term capital. Those who deal ingovernment securities use repos as a form of overnight borrowing. A dealer or other holder ofgovernment securities (usually T-bills) sells the securities to a lender and agrees to repurchasethem at an agreed future date at an agreed price. They are usually very short-term, fromovernight to 30 days or more. This short-term maturity and government backing means reposprovide lenders with extremely low risk. Repos are popular because they can virtually

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eliminate credit problems. Unfortunately, a number of significant losses over the years fromfraudulent dealers suggest that lenders in this market have not always checkedtheir collateralization closely enough. There are also variations on standard repos:

• Reverse Repo - The reverse repo is the complete opposite of a repo. In this case, adealer buys government securities from an investor and then sells them back at a later

date for a higher price• Term Repo - exactly the same as a repo except the term of the loan is greater than 30

days.

ADR- Introduced to the financial markets in 1927, an American depositary receipt (ADR) is astock that trades in the United States but represents a specified number of shares in a foreigncorporation. ADRs are bought and sold on American markets just like regular stocks, and areissued/sponsored in the U.S. by a bank or brokerage.

ADRs were introduced as a result of the complexities involved in buying shares in foreigncountries and the difficulties associated with trading at different prices and currency values.For this reason, U.S. banks simply purchase a bulk lot of shares from the company, bundle theshares into groups, and reissues them on the New York Stock Exchange (NYSE), American Stock 

Exchange (AMEX) or the NASDAQ . In return, the foreign company must provide detailedfinancial information to the sponsor bank. The depositary bank sets the ratio of U.S. ADRs perhome-country share. This ratio can be anything less than or greater than 1. This is donebecause the banks wish to price an ADR high enough to show substantial value, yet lowenough to make it affordable for individual investors. There are three different types of ADR issues:

Level 1 - This is the most basic type of ADR where foreign companies either don't qualify ordon't wish to have their ADR listed on an exchange. Level 1 ADRs are found on the over-the-counter market and are an easy and inexpensive way to gauge interest for its securities inNorth America. Level 1 ADRs also have the loosest requirements from the Securities and Exchange Commission (SEC).

Level 2 - This type of ADR is listed on an exchange or quoted on NASDAQ. Level 2 ADRs haveslightly more requirements from the SEC, but they also get higher visibility trading volume.

Level 3 - The most prestigious of the three, this is when an issuer floats a public offering ofADRs on a U.S. exchange. Level 3 ADRs are able to raise capital and gain substantial visibility inthe U.S. financial markets. The advantages of ADRs are twofold. For individuals, ADRs are aneasy and cost-effective way to buy shares in a foreign company. They save money by reducingadministration costs and avoiding foreign taxes on each transaction. Foreign entities like ADRsbecause they get more U.S. exposure, allowing them to tap into the wealthy North Americanequities markets.

Preferred/Preferential stock - Stock that receives preferential treatment over common stockwith respect both to dividends and claims on assets in the event that the corporation goes outof business.

Mostly this type of stock that pays a fixed dividend regardless of corporate earnings, and whichhas priority over common stock in the payment of dividends. However, it carries no votingrights, and should earnings rise significantly the preferred holder is stuck with the same fixeddividend while common holders collect more. The fixed income stream of preferred stockmakes it similar in many ways to bonds.

NASDAQ Composite Index - The NASDAQ Composite Index measures all NASDAQ domestic andnon-U.S. based common stocks listed on The NASDAQ Stock Market. The Index is market value

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401k plan- A tax-deferred investment device for employees. 401k plans allow employees toinvest pre-tax dollars into individual retirement plan accounts. Employers may also matchemployee investments in the 401k.

Vesting- The period of time an employee must work at a firm before gaining access toemployer-contributed pension income. For 401k plans, employee contributions are immediately

vested, but employer contributions may be vested over a period of several years.

Adviser - An organization or person employed by a mutual fund to give professional advice onthe fund's investments and asset management practices (also called the investment adviser).

Automatic Reinvestment- A fund service giving shareholders the option to purchase additionalshares using dividend and capital gain distributions.

Average Portfolio Maturity- The average maturity of all the bonds in a bond fund's portfolio.What drives up a price of a share? Any investor worth his or her salt will quote ratios like EPS-earning per share or the PE-the price earning ratio-and possibly they will be right. After all,earnings are the bottom line and how much profit a company earns, is what separates thewinners from the losers. It all comes down to earnings. More than any other figure in a

financial report, earnings -- and the prospect of higher earnings in the future -- determineswhether investors will continue to bid up share prices. Earnings are the bottom line that showhow much money a company can use to reinvest in business growth or to pay dividends toshareholders. Earnings are usually summed up as earnings per share -- the company's netearnings divided by the number of common-stock shares outstanding. Earnings per share, orEPS, offers a handy way to compare past earnings to spot upward or downward trends. Someinvestors measure stocks almost entirely by how much profits grow from quarter to quarter andyear to year. EPS, however, only gives a starting point to evaluate stocks. It does not take intoaccount the stock's current price.

This is where the price-earnings ratio comes in. The price-earnings ratio, or P/E, is the price ofa company's stock divided by its EPS. It is one of the most widely used tools in sizing up stocks.Simply put, it is how much investors are willing to pay for a rupee of the company's earnings.

You may also hear it referred to as a "multiple." Theoretically when you calculate a P/E basedon the past year's earnings, the P/E is called "trailing, or historical." When you're consideringhistorical P/Es, a lower ratio is often more attractive because investors may be getting abargain. But things start to get a bit fuzzy when future projections come in to play, so here themarket tries to determine the forward PE based on the future earnings projections. This is the"forward" P/E (also referred to as the "anticipated" P/E). Now mostly in real life scenario whatwe see quoted as the PE is a measure which is a mixture of both. The PE ratio has alreadyincorporated into the price of the scrip any news –good or bad and projected earnings of thecompany for the coming year. This is exactly what the term "discounted the news and earnings"means. But how does one evaluate a company's growth? One common method is to look at theprice/earnings growth ratio. The price/earnings growth, or PEG, ratio is the P/E divided by theprojected earnings growth rate. First, determine the projected growth rate using current EPSand next year's estimated EPS. (est. EPS - current EPS) / current EPS = growth rate

Company A: ( 5.00 - 2.50 ) / 2.50 = 1 = 100%

Company B: ( 1.25 - 1.00 ) / 1.00 = 0.25 = 25%

Company A's earnings are expected to grow 100% over the next year, while Company B's shouldgrow 25%. Next, plug in the forward P/E, since the idea is to look at the company's futureprospects. The PEG calculation would look like this: forward P/E / growth rate = PEG

A: 21 / 100 = 0.21

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B: 28.8 / 25 = 1.152

Theoretically a PEG ratio of 1 is considered standard -- in other words, its growth rate isalready incorporated into the price of its stock. Anything higher than 1 means that the stockis trading at a premium to its growth rate. A PEG ratio lower than 1 shows that a stock maybe undervalued. Company A, with a PEG of 0.21, may look like a good buy, with good

potential for growth. Company B's stock price has already been bid up to incorporate itspotential growth over the next year. Investors would do well to keep an eye out for unusuallyhigh P/Es. The higher the P/E, the greater investors' expectations. The greater theexpectations, the faster the stock can plummet if those expectations aren't met.

Price-Earnings Ratio - P/E Ratio-A valuation ratio of a company's current share price comparedto its per-share earnings. Calculated as:

 

For example, if a company is currently trading at $43 a share and earnings over the last 12months 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 theestimates of earnings expected in the next four quarters (projected or forward P/E). A thirdvariation uses the sum of the last two actual quarters and the estimates of the next twoquarters. Also sometimes known as "price multiple" or "earnings multiple". In general, a highP/E suggests that investors are expecting higher earnings growth in the future compared tocompanies with a lower P/E. However, the P/E ratio doesn't tell us the whole story by itself.It's usually more useful to compare the P/E ratios of one company to other companies in thesame industry, to the market in general or against the company's own historical P/E. It wouldnot be useful for investors using the P/E ratio as a basis for their investment to compare theP/E of a technology company (high P/E) to a utility company (low P/E) as each industry hasmuch different growth prospects.

The P/E is sometimes referred to as the "multiple", because it shows how much investors arewilling to pay per dollar of earnings. If a company were currently trading at a multiple (P/E) of20, the interpretation is that an investor is willing to pay $20 for $1 of current earnings.

It is important that investors note an important problem that arises with the P/E measure, andto avoid basing a decision on this measure alone. The denominator (earnings) is based on anaccounting measure of earnings that is susceptible to forms of manipulation, makingthe quality of the P/E only as good as the quality of the underlying earnings number.

Price-To-Book Ratio - P/B Ratio- A ratio used to compare a stock's market value to its bookvalue. It is calculated by dividing the current closing price of the stock by the latest quarter'sbook value per share. Also known as the "price-equity ratio". Calculated as:

A lower P/B ratio could mean that the stock is undervalued. However, it could also mean thatsomething is fundamentally wrong with the company. As with most ratios, be aware thisvaries by industry. This ratio also gives some idea of whether you're paying too much for whatwould be left if the company went bankrupt immediately.

What PE ratios reveal -- and what they don't.

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Capital Gains Tax- A tax on the appreciation of the capital value of investments, not includingvalue increases that are due to inflation, i.e., the cost base is usually indexed along withmovements in the consumer price index.

Certificate Of Deposit (CD)- This is a negotiable interest-bearing debt instrument of specificmaturity issued by banks. A CD represents the title to a time deposit with a bank, but is a

liquid instrument since it can be traded in the Secondary Market. It is a Money Marketinstrument with a maturity of less than one year and is issued at a discount from the facevalue.

Collateral- A promise of some form of security by a borrower to secure payment of a loan.Also- It means an asset that is pledged against a loan.

Commercial Paper (CP)- It is an instrument by which blue chip companies raise funds from themarket. The company should have a minimum net worth of Rs four crore and a minimumworking capital requirement of Rs. four crore. Normally, the rate on commercial paper rangesfrom 8.50 to 10.75 per cent depending on the period, which is cheaper when compared tofinance from the bank.

Counter-Cyclical- An investment style where trading is performed in anticipation of a turn inthe business cycle.

 Current yield- The ratio of interest to the actual market price of the bond, stated as apercentage or t he coupon rate divided by the market price of the bond.

Dividend Yield (Stocks)- Annual dividends divided by present stock price.

Dividend Yield (Funds)- A depiction of the return on a share of a mutual fund held over thepast year.

Cushion bonds- Bonds with high coupon rate. These bonds provide a cushion in a falling

market.

Delivery Points- It refers to physical points at futures exchanges at which the physicalcommodity signified in a futures contract may be delivered in fulfillment of such a contract.

Dow Theory- A belief that major trends in the stock market are confirmed by more than oneindex. Only if a new high or low is recorded in two or more indexes can it be safely said thatthe market is headed in a certain direction.

Earnings Yield- It is calculated by dividing the Earnings Per Share (EPS) by the company’scurrent share price and multiplying the result by 100

Equity Risk Premium- The rate of return differential between low risk assets such asgovernment bonds, and higher risk assets such as shares.

Exercise- When an option is converted to its underlying asset.

Exercise (Option)- When the holder of a long option position purchases (if calls are owned) orsells (if puts are owned) the underlying security at the exercise (strike) price. The exercise isaccomplished when the customer holding the long position gives his broker instructions toexercise his position. This must be done in accordance with the rules pertaining to timingestablished by the exchanges and individual brokerage firms.

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classification of a particular liability, the banks are advised to approach RBI for necessaryclarification.

Demand Liabilities- 'Demand Liabilities' include all liabilities which are payable on demand andthey include current deposits, demand liabilities portion of savings bank deposits, margins heldagainst letters of credit/guarantees, balances in overdue fixed deposits, cash certificates and

cumulative/recurring deposits, outstanding Telegraphic Transfers (TTs), Mail Transfer (MTs),Demand Drafts (DDs), unclaimed deposits, credit balances in the Cash Credit account anddeposits held as security for advances which are payable on demand. Money at Call and ShortNotice from outside the Banking System should be shown against liability to others.

Time Liabilities- Time Liabilities are those which are payable otherwise than on demand andthey include fixed deposits, cash certificates, cumulative and recurring deposits, timeliabilities portion of savings bank deposits, staff security deposits, margin held against lettersof credit if not payable on demand, deposits held as securities for advances which are notpayable on demand and Gold Deposits.

Assets with the Banking System- Assets with banking system include balances with banks incurrent accounts, balances with banks and notified financial institutions in other accounts,

funds made available to banking system by way of loans or deposits repayable at call or shortnotice of a fortnight or less and loans other than money at call and short notice made availableto the Banking System. Any other amounts due from banking system which cannot be classifiedunder any of the above items are also to be taken as assets with the banking system.

Procedure for calculation of CRR- In order to improve the cash management by banks, as ameasure of simplification, a lag of one fortnight in the maintenance of stipulated CRR by bankshas been introduced with effect from the fortnight beginning 6th November 1999. Thus, allScheduled Commercial Banks are required to maintain the prescribed Cash Reserve Ratio(which is currently @ 5% per cent with effect from the fortnight beginning October 02, 2004 )based on their NDTL as on the last Friday of the second preceding fortnight.

Maintenance of CRR on daily basis - With a view to providing flexibility to banks in choosing an

optimum strategy of holding reserves depending upon their intra period cash flows, allScheduled Commercial Banks, are required to maintain minimum CRR balances upto 70 percent of the total CRR requirement on all days of the fortnight with effect from the fortnightbeginning December 28, 2002.

Statutory Liquidity Ratio (SLR)- In terms of Section 24 (2-A) of the B.R. Act, 1949 allScheduled Commercial Banks, in addition to the average daily balance which they are requiredto maintain under Section 42 of the RBI, Act, 1934, are required to maintain in India,

a) in cash, or

 b) in gold valued at a price not exceeding the current market price,

c) in unencumbered approved securities valued at a price as specified by the RBI from

time to time.

an amount which shall not, at the close of the business on any day, be less than 25 per cent orsuch other percentage not exceeding 40 per cent as the RBI may from time to time, bynotification in gazette of India, specify, of the total of its demand and time liabilities in Indiaas on the last Friday of the second preceding fortnight,

At present, all SCBs are required to maintain a uniform SLR of 25 per cent of the total of theirdemand and time liabilities in India as on the last Friday of the second preceding fortnightwhich is stipulated under section 24 of the B.R. Act, 1949.

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Procedure for computation of demand and time liabilities for SLR- The procedure tocompute total net demand and time liabilities for the purpose of SLR under Section 24 (2) (B)of B.R. Act 1949 is similar to the procedure followed for CRR purpose. However, it is clarifiedthat Scheduled Commercial Banks are required to include inter-bank term deposits / termborrowing liabilities of original maturities of 15 days and above and up to one year in 'Liabilitiesto the Banking System'. Similarly banks should include their inter-bank assets of term deposits

and term lending of original maturity of 15 days and above and up to one year in 'Assets withthe Banking System' for the purpose of maintenance of SLR. However, both the above liabilitiesand assets are not to be included in the liabilities to /assets with the banking system forcomputation of DTL/NDTL for the purpose of CRR as mentioned in para 2.3.7 above.

Floating Exchange rate- It is the exchange rate of a currency that is allowed to float, eitherwithin a narrow specified band around a reference rate or freely according to market forces.These forces of demand and supply are influenced by factors, such as, a nation's economichealth, trade performance and balance of payments position, interest rates and inflation.

Option- A contract that gives a holder the right to buy (Call Option) or sell (Put Option) acertain number of shares of a company at a specified price is known as the 'Striking Price' or'Exercise Price'.

Forex Open Position- A corporate/financial institution, which deals in buying and selling offoreign exchange, may keep their position either at 'overbought or 'oversold' which is exposedto exchange risk. Keeping their position as either 'overbought' or 'oversold' is known as OpenPosition.

VAR- Value at Risk- The new complexities of financial instruments makes the assessment ofrisk of the exposed positions inadequate. VAR is a simple and attractive model to computeportfolio risk by assigning probabilities of value-chain (asset-price data) quantified by ameasurement of their standard deviations.

Liquidity Risk - Measuring and managing liquidity is vital for effective operations in commercialbanks. The bank’s asset and liability as on a particular day can be put on various residual

maturity periods called 'time buckets' varying from 1 – 14 days, 15 – 28 days and so on. All theliability figures are outflows while the asset figures are inflows. The bank can find out the netoutflow or inflow in different periods and make their strategies so as to meet the mismatchesin outflows. By assuring a bank’s ability to meet its liabilities as they become due, liquiditymanagement can reduce the probability of an adverse situation arising.

Interest Rate Risk- The phased deregulation of interest rates and the operational flexibilitygiven to banks in pricing most of the assets and liabilities imply the need for the bankingsystem to hedge the Interest-Rate Risk. Interest Rate Risk is the risk where changes in marketinterest rates might adversely affect the Bank’s Net Interest Income. The gap report should begenerated by grouping interest rate sensitive liabilities, assets and off balance sheet positionsinto time buckets according to residual maturity or next re-pricing period, whichever is earlier.Interest rates on term deposits are fixed during their currency while the advance interest rates

are floating rates. The gaps on the assets and liabilities are to be identified on different timebuckets from 1–28 days, 29 days up to 3 months and so on. The interest changes should bestudied vis-à-vis the impact on profitability on different time buckets to assess the interestrate risk.

Rate Sensitive Assets and Liabilities- An asset or liability is normally classified as ratesensitive, if:

• Within the time interval under consideration, there is a cash flow,• The interest rate resets/re prices contractually during the interval,

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• RBI changes interest rates (i.e. interest rates on Savings Bank Deposits, DRI advances,Export Credit, Refinance, CRR balance, etc.) in cases where rates are administeredand,

• It is contractually pre-payable or withdrawal before the stated maturities.

Certain assets and liabilities receive/pay rates that vary with a reference rate. These assets

and liabilities are re priced at pre-determined intervals and are rate sensitive at the time of repricing.

Asset and Liability Management System- ALM is concerned with risk management and providesa comprehensive and dynamic framework for measuring, monitoring and managing liquidityinterest rate, foreign exchange and equity and commodity price risks of a bank that needs tobe closely integrated with the banks’ business strategy. ALM involves assessment of varioustypes of risks and altering asset-liability portfolio in a dynamic way in order to manage risks.

Gap Analysis- The various items of rate sensitive assets and liabilities and off-balance sheetitems are to be classified in the various time buckets such as 1-28 days, 29 days and upto 3months etc. and items non-sensitive to interest based on the probable date for change ininterest.

The gap is the difference between Rate Sensitive Assets (RSA) and Rate Sensitive Liabilities(RSL) in various time buckets. The positive gap indicates that it has more RSAS than RSLSwhereas the negative gap indicates that it has more RSLS. The gap reports indicate whetherthe institution is in a position to benefit from rising interest rates by having a Positive Gap (RSA> RSL) or whether it is a position to benefit from declining interest rate by a negative Gap (RSL> RSA).

Internal Rate of Return- IRR is the discount rate that makes the Net Present Value (NPV) of aproject equal to zero. This rate becomes the cut off rate to borrow money to finance theproject. If the cost of funds is above this rate, the project is financially not viable.

Depository services- A Depository holds securities of investors in electronic form and rendersservices related to transactions in securities. The purpose of establishing depository are toreduce paper work, to eliminate risks attached to physical form of certificates, to reducetransaction cost and to facilitate pledging of securities. Presently we have 2 depositoriesfunctioning in India:

(a) National Securities Depository Ltd (NSDL) promoted by IDBI, UTI, NSE and SBI;

(b) Central Depository Services Ltd. promoted by BSE, Bank of India, Bank of Baroda, SBIand HDFC Bank.

Depository Participants (DP)- A Depository interfaces with investors through agents known asDepository participants. Institutions which are eligible to function as D.P. are ScheduledCommercial Bank, Bank approved by RBI, Public Financial Institutions, State Financial

Corporation, Clearing Corporations, NBFC, SEBI registered brokers and SEBI registeredcustodians. The institution must have a minimum net worth of Rupees one crore. Theconcerned depository has the right to choose D.P. subject to approval of SEBI. A D.P. opensaccounts of the investors.

Yield to maturity- It is an annualized rate of return on investment. It indicates return earnedby an investor on a debenture or bond held till maturity. It is a discount rate which equates thepresent value of a security’s inflows to its purchase price. It is assumed that the periodicinflows are reinvested at the rate equal to the yield to maturity.

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Asset- It represents any tangible or intangible resources or items of value that an individual ora corporation owns. E.g. Property, Equipment, Cash, Long-term and Short investments.

Asset Backing- It means the company’s asset value when divided by its issued shares.

Asset Value- It shows the worth of the assets underpinning a security.

Collateral- An  ASSET  pledged by a borrower that may be seized by a lender to recover thevalue of a loan if the borrower fails to meet the required INTEREST charges or repayments.

Economics

Inflation: Inflation is defined as a sustained increase in the general level of prices for goodsand services. It is measured as an annual percentage increase. As inflation rises, every dollaryou own buys a smaller percentage of a good or service.

Deflation- is when the general level of prices is falling. This is the opposite of inflation. Since1930 it has been the norm in most developed countries for AVERAGE PRICES to rise year after

year. However, before 1930 deflation (falling prices) was as likely as INFLATION. On the eve ofthe first world war, for example, prices in the UK, overall, were almost exactly the same asthey had been at the time of the great fire of London in 1666. Deflation is a persistent fall inthe general price level of goods and SERVICES. It is not to be confused with a decline in pricesin one economic sector or with a fall in the INFLATION rate (which is known as DISINFLATION).

Sometimes deflation can be harmless, perhaps even a good thing, if lower prices lift realINCOME and hence spending power. In the last 30 years of the 19th century, for example,consumer prices fell by almost half in the United States, as the expansion of railways andadvances in industrial technology brought cheaper ways to make everything. Yet annual realGDP GROWTH over the period averaged more than 4%.

Deflation is dangerous, however, more so even than inflation, when it reflects a sharp slump in

DEMAND, excess CAPACITY and a shrinking MONEY SUPPLY, as in the Great DEPRESSION of theearly 1930s. In the four years to 1933, American consumer prices fell by 25% and real GDP by30%. Runaway deflation of this sort can be much more damaging than runaway inflation,because it creates a vicious spiral that is hard to escape. The expectation that prices will belower tomorrow may encourage consumers to delay purchases, depressing demand and forcingFIRMS to cut prices by even more. Falling prices also inflate the real burden of DEBT (that is,increase real INTEREST  rates) causing BANKRUPTCY and BANK failure. This makes deflationparticularly dangerous for economies that have large amounts of corporate debt. Most seriousof all, deflation can make MONETARY POLICY ineffective: nominal interest rates cannot benegative, so real rates can get stuck too high.

Hyperinflation- is unusually rapid inflation. In extreme cases, this can lead to the breakdownof a nation's monetary system. One of the most notable examples of hyperinflation occurred in

Germany in 1923, when prices rose 2,500% in one month!

Stagflation- is the combination of high unemployment and economic stagnation with inflation.This happened in industrialized countries during the 1970s, when a bad economy was combinedwith OPEC raising oil prices.

Causes of Inflation 

Demand-Pull Inflation - This theory can be summarized as "too much money chasing too few

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the production of goods and services. The output method adds the value of output from thedifferent sectors of the economy. The expenditure method totals spending on goods andservices produced by residents, before allowing for depreciation and capital consumption. Asone person's output is another person's income, which in turn becomes expenditure, thesethree measures ought to be identical. They rarely are because of statistical imperfections.Furthermore, the output and income measures exclude unreported economic activity that

takes place in the black economy but that may be captured by the expenditure measure.

GDP is disliked as an objective of economic policy by some because it is not a perfect measureof welfare. It does not include aspects of the good life such as some leisure activities. Nor doesit include economically valuable activities that are not paid for, such as parents teaching theirchildren to read. But it does include some things that lower the quality of life, such asactivities that damage the environment.

N.N.P- Net National Product is the value of the net output of the economy during a year. It isarrived at by deducting the value of depreciation or replacement allowance of the capitalassets from G.N.P.

Gross NPA- Gross Non Performing assets is the total outstanding of all the borrowers classified

as non-performing assets (viz, substandard, doubtful and loss asset).

Net NPA- Net Non Performing assets is the Gross NPA minus gross provision made, unrealizedinterest and unadjusted credit balances with regard to various NPA accounts.

Yield Curve- It is a graphical representation of the pattern of yields on a specific date forgovernment securities with varying maturities. Yield curve can take different shapes dependingupon the prevailing conditions at any point of time. Yield curve reflects the broad expectationsabout interest rates.

Time Buckets in ALM- The assets and liabilities of a bank’s balance sheet are nothing butfuture cash inflows or outflows. To measure the liquidity and interest rate risk, the use ofmaturity ladder and calculation of cumulative surplus or deficit of funds in different time slots

on the basis of statutory reserve cycle of 14 days are termed as time buckets. As per RBIguidelines, commercial banks have to distribute the outflows/inflows in different residualmaturity period known as time buckets, varying from 1–14 days, 15–28 days, 29 days up to 3months and so on.

Capital- Tier I and Tier II- Capital structure of banks is made up of 2 tiers.

Tier I refers to core capital consisting of Capital, Statutory Reserve, Revenue and otherreserves, Capital Reserve (excluding Revaluation Reserves) and unallocated surplus/profit butexcluding accumulated losses, investments in subsidiaries and other intangible assets.

Tier II is comprised of Property Revaluation Reserve, Undisclosed Reserves, Hybrid Capital,

Subordinated Term Debt and General Provisions. This is Supplementary Capital.

Capital adequacy is determined as a ratio of capital funds to total Risk Weighted Assets of thebank.

Bank Rate- Bank Rate is the rate at which RBI allows finance to commercial banks. Normally,different types of refinance facilities by RBI to banks are linked to a Bank Rate. Bank Rate is atool which RBI uses for short-term purposes. Any revision in Bank Rate by RBI is a signal tobanks to revise deposit rates as well as Prime Lending Rate. For greater effectiveness, this toolis used together with other measures like Cash Reserve Ratio and Repo Rate. At present, thebank rate is 6.5% p.a.

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Categorization and valuation of Bank’s investments - The entire investment portfolio of thebanks(including SLR and NON-SLR securities) will be classified under three categories, viz, 'Heldto Maturity', 'Available for Sale' and 'Held for Trading'. The securities acquired by the bankswith the intension to hold them up to maturity will be classified under Held to Maturity. Thesecurities acquired by the banks with the intension to trade by taking advantage of the short-term price/interest rate movements will be classified under Held for Trading. The securities

which do not fall within the above two categories will be classified under Available for Sale.

Market Value- The 'market value' for the purpose of periodical valuation of investmentsincluded in the Available for Sale and Held for Trading categories would be the market price ofthe scrip as available from the trades/quotes on the stock exchanges, price of SGLtransactions, price list of RBI.

Commercial paper (CP)- It is an instrument by which blue chip companies raise funds from themarket. The company should have a minimum NET WORTH of rupees four crores and having asanctioned working capital limit from a bank/FI. Normally, the rate on commercial paperranges from 8.50 to 10.75% depending on the period, which is cheaper when compared tofinance from the bank. Once the company repays commercial paper, the working capital limitshitherto availed from the bank is restored.

Ways and Means Advances-WMA- RBI has granted the facility of overdraft to the CentralGovernment as well to State Governments. These government borrowings result in highincrease in interest payments on public debt. This enlarged borrowing program of thegovernment has brought pressure on absorptive capacity of the market. With a view to checkthe adverse impact of government’s large borrowing program on interest rates, RBI announcedin June '98, its intention to accept private placement of government securities from time totime. In any case, fiscal deficit of government and its borrowing requirements are to be keptwithin reasonable limits.

Disclosure Norms- With a view to bring in transparency in banking transactions and for thebenefit of investors, depositors and general public, RBI has stipulated disclosure norms to beobserved by banks. These are as follows:

• Capital adequacy ratio.• Per employee business.• Per branch profit.

• Maturity profile of the rate sensitive assets and liabilities.• Average cost of funds and return on assets.• Movements of NPAs, quantum-wise gross and net NDA, opening balance and closing

balance.• Maturity pattern of deposits, loans, investments, borrowings foreign currency assets-

liabilities as per buckets prescribed under Asset-Liability Management guidelines.

Balance of payments on current account- That part of the balance of payments recording

current, i.e. non-capital transactions.

Budget Deficit- When government expenditure exceeds government income. Deficit- In the red– when more MONEY goes out than comes in. A BUDGET deficit occurs when PUBLIC SPENDING exceeds  GOVERNMENT  revenue. A current account deficit occurs when EXPORTS and inflowsfrom private and official TRANSFERS are worth less than IMPORTS and transfer outflows (seeBALANCE OF PAYMENTS).

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Budget surplus- When government income exceeds government expenditure. The budgetsurplus in the UK used to be called the Public Sector Debt Repayment. It is now termed as anegative Public Sector Net Cash Requirement.

Public Sector Borrowing Requirement (PSBR)- The difference between government incomeand expenditure which is financed by borrowing. The PSBR is now known as the Public Sector

Net Cash Requirement and can be either positive or negative.

Public Sector Net Cash Requirement (PSNCR)- This used to be called the Public SectorBorrowing Requirement (PSBR) and is the amount of money the government need to borrow tomeet their spending plans. In other words it the amount that their spending exceeds their taxrevenue by.

Economies of Scale- A reduction in long run unit costs which arise from an increase inproduction. Economies of scale occur when larger firms are able to lower their unit costs. Thismay happen for a variety of reasons. A larger firm may be able to buy in bulk, it may be able toorganize production more efficiently, it may be able to raise capital cheaper and moreefficiently. All of these represent economies of scale.

Buying economies of scale- The ability of large firms to purchase their inputs at a largerdiscount than small firms.

Diseconomies of Scale- Increases in long run costs which occur from an increase in the scale ofproduction.

Financial economies of scale- The ability of large firms to borrow money on more favorableterms than small firms.

Marketing economies of scale- The lower unit cost of advertising and promotion that isenjoyed by a large firm and which is unavailable to smaller companies

Black economy- Unrecorded production. The Black economy results from activity that has notbeen recorded through the tax system or other conventional means of recording.

 Parallel economy- The production that takes place outside of the declared and formal circularflow of income.

Long run average cost curve- Shows the minimum unit cost of producing each level of output,allowing the size of plant to vary.

Long Run Average Cost (Envelope) Curve- The long run average cost curve is derived from aseries of short run average cost curves and so is often described as the envelope curve. If afirm is producing in the most efficient way possible in the long run, but they then want to

expand, they will have to expand along a short run average cost curve as they will be limitedby their fixed factors. However, in the long run they can get more of the fixed factors and sowill move back down to the long run average cost curve. This is why the LRAC is made up of aseries of SRAC curves

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Average Propensity to Consume- The proportion of disposable income spent: APC = C/Y. Forexample, if a person spends £4,000 of a £10,000 income, then the APC is 0.4.

Average Propensity to save- The proportion of disposable income saved, APS = S/Y. Forexample, if a person spends £4,000 of a £10,000 income, then they have saved £6,000. The APSis therefore 0.6.

Marginal Propensity to save- The proportion of each extra pound of disposable income notspent

Average Cost pricing- Setting price equal to average cost

Abnormal loss- An abnormal loss is where total revenue does not cover total cost. It is asituation where a firm is making below normal profits. If abnormal losses persist in an industryfirms will tend to leave, prices will rise and normal profits will be restored.

Pure Monopoly- Only one producer who can therefore determine the market price on its own.

Monopolist- Loss- If the level of average cost is above the average revenue, then the firm willmake a loss (or below normal profit if normal profit is included in the cost curves).

Abnormal profits- Profits exceed the amount a firm must receive to carry on production. Alsoknown as supernormal profit. If abnormal profits persist in an industry this will tend to attract

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Contagion- The domino effect, such as when economic problems in one country spread toanother.

Deposit insurance- Protection for your SAVINGS, in case your BANK goes Bust. Arrangementsvary around the world, but in most countries deposit insurance is required by the GOVERNMENT and paid for by banks (and, ultimately, their customers), which contribute a small slice of their

ASSETS to a central, usually government-run, insurance fund. If a bank defaults, this fundguarantees its customers’ deposits, at least up to a certain amount. By reassuring banks’customers that their cash is protected, deposit insurance aims to prevent them from panickingand causing a bank run, and thereby reduces SYSTEMIC RISK. The United States introduced it in1933, after a massive bank panic led to widespread BANKRUPTCY, deepening its DEPRESSION.

The downside of deposit insurance is that it creates a MORAL HAZARD. By insulating depositorsfrom defaults, deposit insurance reduces their incentive to monitor banks closely. Also bankscan take greater risks, safe in the knowledge that there is a state-financed safety net to catchthem if they fall. There are no easy solutions to this moral hazard. One approach is to monitorwhat banks do very closely. This is easier said than done, not least because of the high cost.Another is to ensure CAPITAL adequacy by requiring banks to set aside, just in case, specifiedamounts of capital when they take on different amounts of RISK.

Alternatively, the state safety net could be shrunk, by splitting banks into two types: super-safe, government-insured “narrow banks” that stick to traditional business and invest only insecure assets; and uninsured institutions, “broad banks”, that could range more widely under amuch lighter regulatory system. Savers who invested in a broad bank would probably earn muchhigher RETURNS because it could invest in riskier assets; but they would also lose their shirts ifit went bust.

Yet another possible answer is to require every bank to finance a small proportion of its assetsby selling subordinated DEBT to other institutions, with the stipulation that the YIELD on thisdebt must not be more than so many (say 50) basis points higher than the rate on acorresponding risk-free instrument. Subordinated debt (uninsured certificates of deposit) is

simply junior debt. Its holders are at the back of the queue for their MONEY if the bank getsinto trouble and they have no safety net. Investors will buy subordinated debt at a yield quiteclose to the risk-free INTEREST RATE only if they are sure the bank is low risk. To sell its debt,the bank will have to persuade informed investors of this. If it cannot convince them it cannotoperate. This exploits the fact that bankers know more about banking than do theirsupervisors. It asks banks not to be good citizens but to look only to their profits. Unlike thepresent regime, it exploits all the available INFORMATION and properly aligns everybody’sincentives. This ingenious idea was first tried in Argentina, where it became a victim of thecountry's economic, banking and political crisis of 2001-02 before it really had a chance toprove itself.

Depression- A bad, depressingly prolonged RECESSION in economic activity. The textbookdefinition of a recession is two consecutive quarters of declining OUTPUT. A slump is whereoutput falls by at least 10%; a depression is an even deeper and more prolonged slump.

The most famous example is the Great Depression of the 1930s. After growing strongly duringthe “roaring 20s”, the American economy (among others) went into prolonged recession.Output fell by 30%. UNEMPLOYMENT soared and stayed high: in 1939 the jobless rate was still17% of the workforce. Roughly half of the 25,000 BANKS in the United States failed. An attemptto stimulate growth, the New Deal, was the most far-reaching example of active FISCAL POLICY then seen and greatly extended the role of the state in the American economy. However, thedepression only ended with the onset of preparations to enter the second world war.

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Why did the Great Depression happen? It is not entirely clear, but forget the popularexplanation: that it all went wrong with the Wall Street stockmarket crash of October 1929;that the slump persisted because policymakers just sat there; and that it took the New Deal toput things right. As early as 1928 the Federal Reserve, worried about financial SPECULATION and inflated STOCK  PRICES, began raising interest rates. In the spring of 1929, industrialproduction started to slow; the recession started in the summer, well before the stockmarket

lost half of its value between October 24th and mid-November. Coming on top of a recessionthat had already begun, the crash set the scene for a severe contraction but not for thedecade-long slump that ensued.

So why did a bad downturn keep getting worse, year after year, not just in the United Statesbut also around the globe? In 1929 most of the world was on the GOLD STANDARD, which shouldhave helped stabilise the American economy. As DEMAND in the United States slowed itsIMPORTS fell, its BALANCE OF PAYMENTS moved further into surplus and gold should haveflowed into the country, expanding the MONEY SUPPLY and boosting the economy. But the Fed,which was still worried about easy CREDIT and speculation, dampened the impact of thisadjustment mechanism, and instead the money supply got tighter. Governments everywhere,hit by falling demand, tried to reduce imports through TARIFFS, causing international trade tocollapse. Then American banks started to fail, and the Fed let them. As the crisis of confidence

spread more banks failed, and as people rushed to turn bank deposits into cash the moneysupply collapsed.

Bad MONETARY POLICY was abetted by bad fiscal policy. Taxes were raised in 1932 to helpbalance the budget and restore confidence. The New Deal brought DEPOSIT INSURANCE andboosted GOVERNMENT  spending, but it also piled taxes on business and sought to preventexcessive COMPETITION. Price controls were brought in, along with other anti-businessregulations. None of this stopped – and indeed may well have contributed to – the economyfalling into recession again in 1937–38, after a brief recovery starting in 1935.

Deregulation- Cutting red tape. The process of removing legal or quasi-legal restrictions on theamount of COMPETITION, the sorts of business done, or the PRICES charged within a particularindustry. During the last two decades of the 20th century, many governments committed to the

free market pursued policies of LIBERALISATION based on substantial amounts of deregulationhand-in-hand with the PRIVATISATION of industries owned by the state. The aim was todecrease the role of GOVERNMENT in the economy and to increase competition. Even so, redtape is alive and well. In the United States, with some 60 federal agencies issuing more than1,800 rules a year, in 1998 the Code of Federal Regulations was more than 130,000 pages thick.However, not all REGULATION  is necessarily bad. According to estimates by the AmericanOffice of Management and Budget, the annual cost of these rules was $289 billion, but theannual benefits were $298 billion.

Devaluation- A sudden fall in the value of a currency against other currencies. Strictly,devaluation refers only to sharp falls in a currency within a fixed EXCHANGE RATE system. Alsoit usually refers to a deliberate act of GOVERNMENT policy, although in recent years reluctantdevaluers have blamed financial SPECULATION. Most studies of devaluation suggest that its

beneficial effects on COMPETITIVENESS are only temporary; over time they are eroded byhigher PRICES (see J-CURVE).

Diminishing returns- The more you have, the smaller is the extra benefit you get from havingeven more; also known as diseconomies of scale (see ECONOMIES OF SCALE). For instance,when workers have a lot of CAPITAL  giving them a little more may not increase theirPRODUCTIVITY anywhere near as much as would giving the same amount to workers whocurrently have little or no capital. This underpins the CATCH-UP  EFFECT, whereby there is(supposedly) convergence between the rates of  GROWTH of DEVELOPING COUNTRIES anddeveloped ones. In the NEW ECONOMY, some economists argue, capital may not suffer from

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Treasury bills- A form of short-term  GOVERNMENT DEBT. Treasury bills usually mature afterthree months. They are used for managing fluctuations in the government’s short-run cashneeds. Most government borrowing takes the form of longer-term BONDS.

Econometrics- Mathematics and sophisticated computing applied to  ECONOMICS.Econometricians crunch data in search of economic relationships that have  STATISTICAL 

SIGNIFICANCE. Sometimes this is done to test a theory; at other times the computers churn thenumbers until they come up with an interesting result. Some economists are fierce critics oftheory-free econometrics.

Economic indicator- A statistic used for judging the health of an economy, such as GDP perhead, the rate of UNEMPLOYMENT or the rate of INFLATION. Such statistics are often subject tohuge revisions in the months and years after they are first published, thus causing difficultiesand embarrassment for the economic policymakers who rely on them

Elasticity- A measure of the responsiveness of one variable to changes in another. Economistshave identified four main types.

• Price Elasticity measures how much the quantity of SUPPLY of a good, or DEMAND for it,changes if its PRICE changes. If the percentage change in quantity is more than the percentagechange in price, the good is price elastic; if it is less, the good is INELASTIC.

• Income Elasticity of demand measures how the quantity demanded changes when incomeincreases.

• Cross-elasticity shows how the demand for one good (say, coffee) changes when the price ofanother good (say, tea) changes. If they are SUBSTITUTE GOODS (tea and coffee) the cross-elasticity will be positive: an increase in the price of tea will increase demand for coffee. Ifthey are COMPLEMENTARY GOODS (tea and teapots) the cross-elasticity will be negative. Ifthey are unrelated (tea and oil) the cross-elasticity will be zero.

• Elasticity of substitution describes how easily one input in the production process, such asLABOUR, can be substituted for another, such as machinery

Engel's law- People generally spend a smaller share of their BUDGET on food as their INCOME rises. Ernst Engel, a Russian statistician, first made this observation in 1857. The reason is thatfood is a necessity, which poor people have to buy. As people get richer they can afford better-quality food, so their food spending may increase, but they can also afford LUXURIES beyondthe budgets of poor people. Hence the share of food in total spending falls as incomes grow.

Enron- Until late 2001, Enron, an energy company turned financial powerhouse based inHouston, Texas, had been one of the most admired firms in the United States and the world. It

was praised for everything from pioneering energy trading via the internet to its innovativecorporate culture and its system of employment evaluation by peer review, which resulted inthose that were not rated by their peers being fired. However, revelations of accounting fraudby the firm led to its bankruptcy, prompting what was widely described as a crisis ofconfidence in American capitalism. This, as well as further scandals involving accounting fraud(WorldCom) and other dubious practices (many by Wall Street firms), resulted in efforts toreform corporate governance, the legal liability of company bosses, accounting, Wall Streetresearch and regulation.

Federal reserve system- America's central bank. Set up in 1913, and popularly known as theFed, the system divides the United States into 12 Federal Reserve districts, each with its own

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regional Federal Reserve bank. These are overseen by the Federal Reserve Board, consisting ofseven governors based in Washington, DC. monetary policy is decided by its Federal OpenMarket Committee.

Financial system- The firms and institutions that together make it possible for money to makethe world go round. This includes financial markets, securities exchanges, banks, pension

funds, mutual funds, insurers, national regulators, such as the Securities and ExchangeCommission (SEC) in the United States, central banks, governments and multinationalinstitutions, such as the imf and world bank.

Foreign direct investment- Investing directly in production in another country, either bybuying a company there or establishing new operations of an existing business. This is donemostly by companies as opposed to financial institutions, which prefer indirect investment abroad such as buying small parcels of a country's supply of shares or bonds. Foreign directinvestment (FDI) grew rapidly during the 1990s before slowing a bit, along with the globaleconomy, in the early years of the 21st century. Most of this investment went from one oecd country to another, but the share going to developing countries, especially in Asia, increasedsteadily.

There was a time when economists considered FDI as a substitute for trade. Building factoriesin foreign countries was one way of jumping tariff barriers. Now economists typically regardFDI and trade as complementary. For example, a firm can use a factory in one country tosupply neighboring markets. Some investments, especially in services industries, are essentialprerequisites for selling to foreigners. Who would buy a Big Mac in London if it had to be sentfrom New York? Governments used to be highly suspicious of FDI, often regarding it ascorporate imperialism. Nowadays they are more likely to court it. They hope that investors willcreate jobs, and bring expertise and technology that will be passed on to local firms andworkers, helping to sharpen up their whole economy. Furthermore, unlike financial investors,multinationals generally invest directly in plant and equipment. Mergers and Acquisitions are asignificant form of FDI. For instance, in 1997, more than 90% of FDI into the United States tookthe form of mergers rather than of setting up new subsidiaries and opening factories.

Giffen goods- Named after Robert Giffen (1837-1910), a good for which demand increases as itsprice rises. But such goods may not exist in the real world.

Gilts- Shorthand for gilt-edged securities, meaning a safe bet, at least as far as receivinginterest and avoiding default goes. The price of gilts can vary considerably over time, however,creating a degree of risk for investors. Usually the term is applied only to government bonds.

Gini coefficient- An inequality indicator. The Gini coefficient measures the inequality ofincome distribution within a country. It varies from zero, which indicates perfect equality, withevery household earning exactly the same, to one, which implies absolute inequality, with asingle household earning a country's entire income. Latin America is the world's most unequal

region, with a Gini coefficient of around 0.5; in rich countries the figure is closer to 0.3.

Hawala- An ancient system of moving money based on trust. It predates western  bank practices. Although it is now more associated with the Middle East, a version of hawala existedin China in the second half of the Tang dynasty (618-907), known as fei qian, or flying money.In hawala, no money moves physically between locations; nowadays it is transferred by meansof a telephone call or fax between dealers in different countries. No legal contracts areinvolved, and recipients are given only a code number or simple token, such as a low-valuebanknote torn in half, to prove that money is due. Over time, transactions in oppositedirections cancel each other out, so physical movement is minimised. Trust is the only capital 

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run the firm more efficiently than their predecessors. For this reason, some economists seeLBOs as a way of tackling AGENCY COSTS associated with corporate governance.

Transfer pricing- The PRICES  assumed, for the purposes of calculating tax liability, to havebeen charged by one unit of a multinational company when selling to another (foreign) unit ofthe same firm. FIRMS spend a fortune on advisers to help them set their transfer prices so that

they minimise their total tax bill. For instance, by charging low transfer prices from a unitbased in a high-tax country that is selling to a unit in a low-tax country, a firm can record a lowPROFIT in the first country and a high profit in the second. In theory, however, transfer pricesare supposed to be set according to the arm’s-length principle: that they should be the same aswould be charged if the sale was to a business unconnected in any way to the selling firm. Butwhen there is no genuinely independent market with which to compare transfer prices, whatan arm’s length price would be can be a matter of great debate and an opportunity for firmsthat want to lower their tax bill.

Overheating- When an economy is growing too fast and its productive CAPACITY cannot keepup with DEMAND. It often boils over into INFLATION.

Positional goods- Some things are bought for their intrinsic usefulness, for instance, a hammeror a washing machine. Positional goods are bought because of what they say about the personwho buys them. They are a way for a person to establish or signal their status relative topeople who do not own them: fast cars, holidays in the most fashionable resorts, clothes fromtrendy designers. By necessity, the quantity of these goods is somewhat fixed, because toincrease SUPPLY too much would mean that they were no longer positional. What would owninga Rolls-Royce say about you if everybody owned one? Fears that the rise of positional goodswould limit GROWTH, since by definition they had to be in scarce supply, have so far provedmisplaced. Entrepreneurs have come up with ever more ingenious ways for people to buystatus, thus helping developed economies to keep growing.

Purchasing power parity- A method for calculating the correct value of a currency, which may

differ from its current market value. It is helpful when comparing living standards in differentcountries, as it indicates the appropriate EXCHANGE RATE to use when expressing incomes andPRICES in different countries in a common currency. By correct value, economists mean theexchange rate that would bring DEMAND and SUPPLY of a currency into EQUILIBRIUM over thelong-term. The current market rate is only a short-run equilibrium. Purchasing power parity(PPP) says that goods and SERVICES should cost the same in all countries when measured in acommon currency.

PPP is the exchange rate that equates the price of a basket of identical traded goods andservices in two countries. PPP is often very different from the current market exchange rate.Some economists argue that once the exchange rate is pushed away from its PPP, trade andfinancial flows in and out of a country can move into DISEQUILIBRIUM, resulting in potentiallysubstantial trade and current account deficits or surpluses. Because it is not just traded goods

that are affected, some economists argue that PPP is too narrow a measure for judging acurrency’s true value. They prefer the fundamental equilibrium exchange rate (FEER), which isthe rate consistent with a country achieving an overall balance with the outside world,including both traded goods and services and CAPITAL flows. (See BIG MAC INDEX.)

Quantity theory of money- The foundation stone of  MONETARISM. The theory says that thequantity of MONEY available in an economy determines the value of money. Increases in theMONEY SUPPLY are the main cause of INFLATION. This is why Milton  FRIEDMAN  claimed that“inflation is always and everywhere a monetary phenomenon”.

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The theory is built on the Fisher equation, MV = PT, named after Irving Fisher (1867–1947). M isthe stock of money, V is the VELOCITY OF CIRCULATION, P is the average PRICE level and T isthe number of transactions in the economy. The equation says, simply and obviously, that thequantity of money spent equals the quantity of money used. The quantity theory, in its purestform, assumes that V and T are both constant, at least in the short-run. Thus any change in Mleads directly to a change in P. In other words, increase the money supply and you simply cause

inflation.

In the 1930s, KEYNES challenged this theory, which was orthodoxy until then. Increases in themoney supply seemed to lead to a fall in the velocity of circulation and to increases in realINCOME, contradicting the classical dichotomy (see MONETARY NEUTRALITY). Later,monetarists such as Friedman conceded that V could changein response to variations in M, butdid so only in stable, predictable ways that did not challenge the thrust of the theory. Even so,monetarist policies did not perform well when they were applied in many countries during the1980s, as even Friedman has since conceded.

Random walk- Impossible to predict the next step.  EFFICIENT MARKET THEORY says that thePRICES of many financial ASSETS, such as SHARES, follow a random walk. In other words, thereis no way of knowing whether the next change in the price will be up or down, or by how much

it will rise or fall. The reason is that in an efficient market, all the INFORMATION that wouldallow an investor to predict the next price move is already reflected in the current price. Thisbelief has led some economists to argue that investors cannot consistently outperform themarket. But some economists argue that asset prices are predictable (they follow a non-random walk) and that markets are not efficient.

Rate of return- A way to measure economic success, albeit one that can be manipulated quiteeasily. It is calculated by expressing the economic gain (usually PROFIT) as a percentage of theCAPITAL used to produce it. Deciding what number to use for profit is rarely simple. Likewise,totaling up how much capital was used can be tricky, especially if it is expanded to includeINTANGIBLE ASSETS and HUMAN CAPITAL. When FIRMS are evaluating a project to decidewhether to go ahead with it, they estimate the project’s expected rate of return and compareit with their COST OF CAPITAL. (See NET PRESENT VALUE and DISCOUNT RATE.)

Rate of return regulation- An approach to  REGULATION often used for a PUBLIC UTILITY tostop it exploiting MONOPOLY power. A public utility is forbidden to earn above a certain RATE OF RETURN decided by the regulator. In practice, this often encourages the utility to beinefficient, slow to innovate and quick to spend money on such things as big offices andexecutive jets, to keep down its PROFIT and thus the rate of return. Contrast with PRICE REGULATION.

Ratings- A guide to the risk attached to the FINANCIAL INSTRUMENT provided by a ratingsagency, such as Moody’s, Standard and Poor’s and Fitch IBCA. These measures of CREDIT quality are mostly offered on marketable GOVERNMENT and corporate DEBT. A triple-A or A++rating represents a low risk of DEFAULT; a C or D rating an extreme risk of, or actual, default.Debt PRICES and YIELDS often (but not always) reflect these ratings. A triple-A BOND has a lowyield. High-yielding bonds, also known as junk bonds, usually have a rating that suggests a highrisk of default. A series of financial market crises from the mid-1990s onwards led to growingdebate about the reliability of ratings, and whether they were slow to give warning ofimpending trouble. After the Enron debacle, which again the ratings agencies had failed topredict, some critics argued that the big three agencies had formed a cozy oligopoly and thatencouraging more competition was the way to improve ratings.

Real options theory- A recent theory of how to take INVESTMENT decisions when the future isuncertain, which draws parallels between the real economy and the use and valuation of

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marketing

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Advertising objective: The objective of your communication strategy. To inform of a newdevelopment, persuade or remind.

Benefit: The gain obtained from the use of a particular product or service. Consumerspurchase product/services because of their desire to gain these built in benefits.

Benefit Segmentation: Dividing a market according to the benefit they seek from aparticular product/service.

Brand extension strategy: The process of using an existing brand name to extend on to a newproduct/service e.g. The application of the brand name Virgin on a number of businessactivities.

Competitive Advantage: Offering a different benefit then that of your competitors.

Competitor Analysis: Process of understanding and analysing a competitors strengths andweaknesses, with the aim that an organisation will find a competitive positioning differencewithin the market.

Concept testing: Testing the idea of a new product or service with your target audience.

Brand repositioning: An attempt to change consumer perceptions of a particular brand. Forexample VW has successfully repositioned the Skoda brand.

Data mining: Application of artificial intelligence to solve marketing problems and aidingforecasting and prediction of marketing data.

Dichotomous question: Questions which limit the responses of the respondent eg YES/NO.

Direct marketing: The process of sending promotion material to a named person within anorganisation.

Diversification: A growth strategy which involves an organisation to provide new products orservices. The new products on offer could be related or unrelated to the organisations coreactivities.

Demography: A study of the population.

Demographic segmentation. Dividing the population into age, gender, income and socio-economic groups amongst other variables..

Engels Law: Suggest that peoples spending patterns change as their income rises.

Exclusive distribution: Limiting the distribution of a product to particular retail store to createan exclusive feel to the brand/product.

Econometric modeling: Application of regression techniques in marketing analysis

Focus Group: A simultaneous interview conducted amongst 6-8 respondents. The aim is toobtain qualitative information on the given topic.

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Primary data: The process of organizing and collecting data for an organization.

Product Development Strategy: The development of a new product/service aimed at theorganization existing market. The aim is to increase expenditure within the segment.

Product Cannibalization: Loosing sales of a product to another similar product within the

same product line.

Public relations: The process of building good relations with the organizations variousstakeholders.

Relationship marketing: Creating a long-term relationship with existing customers. The aim isto build strong consumer loyalty.

Sales promotion: An incentive to encourage the sale of a product/service e.g. money offcoupons, buy one, get one free.

Secondary data: Researching information which has already been published.

Segmentation: The process of dividing a market into groups that display similar behavior andcharacteristics.

Straight Rebuy: Where an organization reorders without modification to the specification.

SWOT analysis: A model used to conduct a self appraisal of an organization. The model looksat internal strengths and weaknesses and external environmental opportunities and threats.

Test marketing: Testing a new product or service within a specific region before nationallaunch.

Usage segmentation: Dividing you segment into non, light, medium or heavy users.

Core Competencies-Things a firm does extremely well, which sometimes gives it an advantageover its competition

Market opportunity-A combination of circumstances and timing that permits an organization totake action to reach a target market

Competitive advantage-The result of a company’s matching a core competency toopportunities in the market place. Types of competition-

Brand Competitors-Firms that market products with similar features and benefits to the samecustomers at similar prices.

Product competitors-Firms that compete in the same product class but have products withdifferent features, benefits and prices

Generic competitors-Firms that provide very different products that solve the same problemor satisfy the same basic customer need

Total budget competitors- Firms that compete for limited financial resources of the samecustomers

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GATT- General Agreement on tariffs and trade (GATT)- An agreement among nations toreduce worldwide tariffs and increase international trade. Originally signed by 23 nations in1947, GATT provides a forum for tariff negotiations and a place where international tradeproblems can be discussed and resolved. The General Agreement on Tariffs and Trade (typicallyabbreviated GATT) was originally created by the Bretton Woods Conference as part of a largerplan for economic recovery after World War II. The GATT's main purpose was to reduce barriers

to international trade. This was achieved through the reduction of tariff barriers, quantitative restrictions and subsidies on trade through a series of different agreements. The GATT was anagreement, not an organisation. Originally, the GATT was supposed to become a fullinternational organisation like the World Bank or IMF  called the International Trade Organisation. However, the agreement was not ratified, so the GATT remained simply anagreement. The functions of the GATT have been replaced by the World Trade Organisation which was established through the final round of negotiations in the early 1990s.

The history of the GATT can be divided into three phases: the first, from 1947 until theTorquay round, largely concerned which commodities would be covered by the agreement andfreezing existing tariff levels. A second phase, encompassing three rounds, from 1959 to 1979,focused on reducing tariffs. The third phase, consisting only of the Uruguay Round from 1986 to1994, extended the agreement fully to new areas such as intellectual property, services,

capital, and  agriculture. Out of this round the WTO was born. IMF describes itself as "anorganization of 184 countries, working to foster global monetary cooperation, secure financialstability, facilitate international trade, promote high employment and sustainable economicgrowth, and reduce poverty". With the exception of North Korea, Cuba, Liechtenstein, Andorra,Monaco, Tuvalu and Nauru, all UN member states either participate directly in the IMF or arerepresented by other member states.

Marketing Mix -- the blend of product, place, promotion, and pricing strategies designed toproduce satisfying exchanges with a target market.

Market Research -- the process of planning, collecting, and analyzing data relevant tomarketing decision-making. Using a combination of primary and secondary research tools tobetter understand a situation.

Personal Selling -- persuasive communication between a representative of the company andone or more prospective customers, designed to influence the person's or group's purchasedecision.

Place - the process of getting a product from the place it was manufactured into the hands ofconsumers in the right location at the right time.

Positioning -- developing a specific marketing mix to influence potential customers’ overallperceptions of a brand; to develop a specific image of the brand in the minds of consumers.

Price -- the money or other compensation or unit of value exchanged for the purchase or use ofa product, service, idea, or person.

Product -- a good, service, person, or idea consisting of a bundle of tangible and intangiblebenefits that satisfies consumers’ needs and wants.

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Where as the strengths and weaknesses analyze the core competencies and capabilities of thecompany in the context of the internal environment, the opportunities and threats are in thecontext of the competitive landscape in the external marketplace. The above is a time-honored framework to initiate any meaningful competitive analysis. It can be applied to acompany and also to its products and services.

Five C's- This is an elementary framework which can drive any strategic analysis. The five C'sstand for Company, Customers, Competition, Costs, and Channels. If one thinks throughthe answers raised under each term, one can analyze a Company's business problems stepby step as a means to proposing solutions which will improve the Company's business:

•

Company: What is the company size, i.e., is the company mid-sized (less than $500 Min revenue) or larger? Is it public or private? What are its products / product lines /services? What are its sustainable competitive advantages / core competencies? Whoare its key executives? Who are its board members?

• Customers: Are they consumers or businesses? What are their current / emergingproblems / needs? Does the company listen to its customers and solve their problems?What is the bargaining power of these customers? Will they switch to the competition,if the company increases its price? What are their preferences for company's productquality / availability / reliability / performance? How can the company segment thecustomer base to target its products at specific segments? If the customers are business/ industrial houses, is it appropriate to segment them as mid-market and Fortune 500;or does it make more sense to segment the market geographically? If these areindividual consumers, what are their demographic and psychographic patterns; what dothey crave that the company can't provide; what will they be buying over the next twoyears; and what will the next generation of customers need from the company?

• Competition: Who are the biggest competitors and how much market share do theyhold in each market segment the company plays in? What are their strategicadvantages? Is it tight appropriability of their product lines to the market segmentrequirements, is it complementary assets like better sales and marketing channels, or

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economic fundamentals where marginal revenues equal marginal costs, or is it basedon the competitive pricing in the marketplace?

• Place: What are the distribution channels for the product (please refer to Channelsunder the five C's framework)? Does the competition serve market segments which thecompany can't reach?

• Promotion: What marketing campaigns does the company use to reach its customers?

How effective are these campaigns? Can the Internet be used more effectively toimprove these campaigns?

Product Life Cycle- Product Life Cycle (PLC) as a concept was first introduced intomanagement literature by Ted Levitt in 1965. Since then, the world has changed, and GeoffreyMoore of Silicon Valley came up with a book called “Crossing the Chasm” where he introducedthe concept of a majority of new high-tech products falling into the chasm.

PLC divides the product lifecycle into four stages based on time: introductory, growth,maturity, and decline. On the other hand, Moore’s chasm is based on a now well-acceptedconcept called technology adoption which categorizes users of technology into four categories:early adaptors, early majority, late majority, and laggard.

It can be argued that this chasm, if it exists, will not let the product move to the  growth stagefrom the introductory stage, in the classic PLC diagram below, because the product will fallinto the chasm between the early adaptors and the early majority.

So, the PLC framework, if used for new product introduction strategies, should be used inconjunction with the concept of user adoption; this specially holds true for high-tech productcases involving technology adoption. Nevertheless, the PLC mapping is a useful framework toadopt for product cases in general, especially for established products, because as per the PLCcurve above, the products sales will grow during the  growth stage, will keep growing into thematurity  stage, and then decline with time. Before the product sales and profits enter thedecline stage, or at the beginning of the maturity stage, the company can take measures toextend the life cycle of the maturing product by introducing new products into the productmix, by stretching the product line vertically and horizontally, by making the product

compatible with the latest technologies, etc.

For example, enterprise software companies with maturing ERP (Enterprise Resource Planning)and CRM (Customer Relationship Management) software products, which were on-premise(deployable at the client’s premises) are now extending the PLC of these solutions byintroducing new ERP and CRM product lines which are on-demand  (web based, need not bedeployed at client sites, client can use the product on-demand through the Internet).

Double Marginalization-Double marginalization happens when there is market power at twochannel segments. This produces a double whammy effect of lower total channel profits,and higher retail prices. For example, let’s take a simple channel with two segments:manufacturer, and retailer. If both the retailer and manufacturer are monopolists, there ismarket power in both the segments of the channel. This is a simple case of doublemarginalization. which results in lower total channel profits, and higher retail prices.

In a simple example of double marginalization below, it is illustrated that if market powerexists in both the segments of a two layer channel, the end consumer pays a higher retailprice of $10.70 as opposed to $ 7.13 in case of no double marginalization (only themanufacturer has market power, and not the retailer). Further, it is illustrated that in case ofdouble marginalization, the total channel profits of $ 6625.36 are lower compared to theprofits of $ 8838.76 in case of no double marginalization.

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Game Theory- A firm's business decision is often affected by the moves made by itscompetitors. In other words, if the firm believes that its competitors are rational and act tomaximize their own profits, the firm has to take this into account while making its own profit-maximizing decisions. This is what gaming and strategic decision is all about, in a nut-shell. Themajor strategies in Game Theory are as follows:

Nash Equilibrium-This is a set of strategies such that each player is doing the best it can giventhe action of its competitors.

Dominant Strategy-This is a strategy that is optimal for a player regardless of what itscompetitors do.

Maximum Strategy-This is a strategy that maximizes the minimum gains that can be earned.

Tit-for-Tat Strategy-This is a strategy where the firm attempts to reach a cooperativeoutcome through sending appropriate signals, and punishes the competitor if thecompetitor fails to cooperate.

GE Portfolio Matrix- This 3 x 3 matrix is an outgrowth of a framework pioneered by General

Electric (GE) in the 1970s to assess its Strategic Business Units (SBUs) along two dimensions:industry attractiveness, and business strength. All business units of a firm can be representedby circles placed appropriately within the matrix. The size of the circle represents the industry/ market size. The market share of the SBU is represented by the smaller sector within thecircle. Thus, as you can see, this is a complex framework to evaluate an SBU along fourdimensions: market attractiveness, market size, market share, and business strength.

The strength of this framework is based on the premise that to be successful, a firm shouldenter attractive markets / industries for which it has the needed business strengths to succeed.However, over-reliance on this framework may lead to undue neglect of existing businesses.SBU owners / managers will also be susceptible to manipulate the parameters so that theirSBUs show up on the desired high or medium-high overall attractive zones. Thus, thisframework should be used with caution while crafting strategy.

Base point pricing- Is a geographic pricing policy that includes the price at factory, plus freightcharges from the base point nearest the buyer

Transfer Pricing- Prices charged in sales between organization’s units. The price is determinedby one of the following methods-

Actual full cost- calculated by dividing all fixed and variable expenses for a period into thenumber of units produced.

Standard Full Cost- calculated based on what it would cost to produce the goods at full plantcapacity.

Cost plus investment- calculated at full cost, plus the cost of a portion of the selling unitsassets used for internal needs

Market based cost- calculated at the market price less a small discount to reflect the lack ofsales effort and other expenses

Cost plus pricing- Assigning a specified dollar amount or percentage to the seller’s cost

Mark up pricing- Assigning to the cost of the product a pre determined percentage of the cost .

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