Glossary of Terms

Risk management. Delaying foreign currency payments to take advantage of expected favourable foreign exchange rate movements.
This is a relatively unsophisticated form of foreign exchange risk management.

Funds transfer. Standards for cross-border currency netting systems.

Abbreviation for Local Area Network.

(LVTS). Canada. High-value/urgent clearing system.

A funds transfer system through which large-value and high priority funds transfers are made between participants in the system for their own account or on behalf of their customers. Although, as a rule, no minimum value is set for the payments they carry, the average size of payments passed through such systems is usually relatively large. Large-value funds transfer systems are sometimes known as wholesale funds transfer systems.

Payments, generally of very large amounts, which are mainly exchanged between banks or between participants in the financial markets and usually require urgent and timely settlement.

A weighted index using quantities entirely based on prior year data.

1. Accounting. See LIFO.

2. A method of selecting staff to be made redundant, the most recently joined staff being the first to be selected for redundancy.

An alternative name for the Central limit theorem.

Abbreviation for Letter of Credit.

Abbreviation for Lettre de change relevé.
An electronic bill of exchange used in France.

In relation to facilities provided by a group of banks, the lead bank is the bank which holds the primary deposit or lending relationship with a customer.

Foreign exchange risk management. Accelerating foreign currency payments to avoid the effects of expected adverse foreign exchange rate movements.

Economics. Income which does not flow back into the circular flow of income model, for example, savings, taxation and imports.

A contract whereby the owner of an asset (the lessor) offers rights to use the asset to another party (the lessee) for a certain period. In return the lessee makes payments of pre-determined amounts to the lessor.

Balance in a bank account that reflects all items that have been deposited or cleared through the account. It includes items which have been deposited but have not yet cleared for drawing down against.

A separate entity recognised in law.

The essential feature of a company is that it exists as a separate legal entity distinct from its members. This is the case even if one member owns all the shares. This is known as the separate personality principle. This principle underpins the whole of company law.

The most important consequence of the separate personality principle is that of limited liability. The company is liable without limit for its own debts but, in a limited company, the members, as distinct from the company, have limited liability.

1. The risk that transactions or business relationships may have unforeseen adverse legal consequences. For example, giving rise to additional costs or to the inability to enforce legal rights.

2. The risk that the administration of legal matters may be more costly - or otherwise more burdensome - than foreseen.

Legal risk may arise from existing laws and practice, or from changes in relevant laws and practice.

1. Tax. Taxation law derived from a Finance Act in the UK.

2. More generally, written law created by a central law-making body (rather than by the courts).

The risk of adverse effects arising from changes in relevant laws.

Body of the State with law making powers.

Pensions and tax. Abbreviation for Lower Earnings Limit.

See Leptokurtic frequency distribution.

A leptokurtic frequency distribution (or leptokurtotic distribution) has a larger number of values clustered at the peak and in the tails, than a comparable normal distribution with the same variance and mean.

Leptokurtosis is observed in many financial distributions. It means a more ‘pointy-headed’ and ‘fat tailed’ observed distribution than the distribution predicted by the normal and lognormal models. Importantly there is a fatter downside tail (‘left tail’) in the observed data. In other words the observed frequency of large negative returns is greater than predicted - for example - by the lognormal model of the distribution assumed in the Black Scholes pricing model.

Statistics. The same as leptokurtic.

In a lease contract, the user of the leased asset.

In a lease contract, the owner of the leased asset.

A formal letter written to a lender, normally by a parent company, indicating a willingness by the parent to accept some responsibility to honour the borrowing obligations of, or to otherwise support, a subsidiary or associated company, but without necessarily consituting a legal obligation to do so.

(LC). A promise document issued by a bank or another issuer to a third party to make a payment on behalf of a customer in accordance with specified conditions. Letters of credit are frequently used in international trade to make funds available in a foreign location.

Representations by management used by auditors as a source of evidence, which have been formally noted and signed by the directors of the company being audited.

1. The same as Gearing.

2. Debt divided by Debt plus Equity = D/[D+E].

The same as 'geared'.

Similar to a Leveraged takeover.

The acquisition of a company financed predominantly with debt, leaving the successor company highy geared.

The same as Geared.

1. Financial reporting. Obligations or amounts owed by the reporting entity to outside parties.
2. More generally, obligations or amounts owed to others (whether or not they are obligations of a reporting entity).

Company accounting. Short and long-term debts and obligations owed by the business - for example to creditors, vendors and banks - plus equity.

Acronym for London Interbank Bid Rate.

London InterBank Offered Rate, at which the quoting bank offers to lend to other first class banks.
Widely used as a reference rate.

LIBID means the rate which the quoting bank will pay on funds deposited with it. So LIBOR is the higher rate, and LIBID is the lower rate, by the amount of the spread.
So for example:
LIBOR = 5%
LIBID = 5% LESS 1/8% = 4 7/8% (= 4.8750%)

LIMEAN is the mid-rate around which the bid-offer prices are built. LIMEAN is the average of LIBOR and LIBID. For example:
= [5% + 4 7/8%]/2 = 4 15/16% (= 4.9375%).

Short-term LIBOR rates (up to one year) are quoted on a simple interest basis.
Longer-term rates (over one year) are quoted as effective annual rates.

A legal right to hold the property of another party or to have it sold or applied in payment of a claim.

Accounting. An abbreviation for Last In First Out. A method of allocating stock for valuation purposes which assumes that the stock acquired or produced last is used first.

Fees levied on the movement of funds between residents and non-residents, usually calculated on an ad valorem basis, for example, as a percentage of the transaction value.

Mid-rate between LIBID and LIBOR.

Abbreviation for Limited liability company. In a limited liability company the liability of the members is restricted to a predefined amount.

In the case of a company limited by shares the members' liability is restricted to the amount, if any, unpaid on the shares they hold. Most commercial companies are of this type.
In a company limited by guarantee the liability of the members is restricted to a predefined amount which the members guarantee to contribute (on the event of any winding up of the company).

The restriction of an investor's potential losses to the amount invested. Limited liability is one of the important advantages of incorporation.

Less commonly in the commercial context, a company member's liability may be limited to an amount guaranteed by the member.

(LLP). A Limited liability partnership shares many of the features of an unlimited partnership - but it also offers reduced personal responsibility to the partners for the business debts of the partnership. Unlike an unlimited partnership, the LLP itself is responsible for any debts that it runs up, not the individual partners.

LLPs were first allowed in law in the UK under the Limited Liability Partnerships Act 2000.

See Limited liability partnership.

(LPI). Pensions. The requirement in the UK that pensions in payment are increased annually in line with the Retail Price Index, subject to a minimum of 0% and a maximum of 2.5% from 2005 (previously the maximum was 5%).

Straight-line.

A straight-line estimation method, for an intermediate value.

For example, consider a set of cashflows which has a net present value of +4 at a yield of 5%, and a net present value of -4 at a yield of 6%.
Using linear interpolation, the estimated yield at which the cashflows have a net present value of Nil is given by:
5% + [+4/(+4 --4 = +8)] x (6 - 5)% = 5.5%.
5.5% is the estimated internal rate of return of the cashflows.

Another closely related linear estimation technique is extrapolation. This involves the straight-line estimation of values outside the range of the data used to do the estimation with. For example, using the data above, the estimated net present value at 7%, using extrapolation = -4 - 8 = -12.

A statistical technique which aims to establish whether a linear relationship exists between one quantity and another.

Corporate finance. The author of an influential study on dividend payout ratios in practice.

A clause in a contract stipulating the damages payable in the event of breach.

1. The sale of the assets of a company (or other entity) in order to pay off debts, commonly involving the winding up of the entity.

2. The closing of a market position.

The amount that may be realised if an asset or a group of assets is sold separately from the organisation that has been using them. Also known as the break-up value.

An insolvency practitioner appointed to wind up a company.

1. An asset's ability to be turned into cash quickly without significant loss compared with current market value.

2. An entity’s ability to pay its obligations when they fall due.

3. An entity's ability to source additional funds to meet its obligations.

4. A financial ratio designed to measure an entity's ability to meet its obligations when they fall due. For example, the current ratio or the quick ratio.

The analysis and management of an organisation's working capital and its sources of finance to ensure that it is able to pay its obligations when they fall due.

A desire to hold money in liquid form, for example cash or bonds. This may be due to the transactions motive, the precautions motive or the speculative motive.

1. A term used to explain a difference between two types of financial securities (e.g. stocks), that have all the same qualities except liquidity.

2. A premium that investors will demand when any given security can not be easily converted into cash, and converted at the fair market value. When the liquidity premium is high, then the asset is said to be illiquid, which will cause prices to fall, and interest rates to rise.

Liquidity is access to cash, and liquidity risk revolves around fluctuations in the ability to access cash when it is needed. It is very difficult to find a universally accepted definition of liquidity risk. However, it is commonly accepted that liquidity risk comes in two forms: i. Funding liquidity risk and ii. Market liquidity risk.

i. Funding liquidity risk is defined as a company’s inability to obtain funds to meet cashflow obligations.
ii. Market liquidity risk refers to the risk that market transactions will become impossible due to market disruptions or inadequate market depth.

The two forms cross over however. For example if commercial paper or bond markets dry up that is market risk, which will immediately become funding risk if the borrower has insufficient committed bank facilities to act as a stop gap.

A public company whose shares are held by a sufficiently wide class of investors and whose shares are listed on an exchange.

Securities which have been admitted for trading on an official exchange.

The acceptance of an issue of securities for trading on a recognised stock exchange.

A document published by companies which are seeking a listing for any securities, containing the information specified in the rules of the relevant exchange.

Abbreviation for Limited Liability Partnership.

A legal document setting out the terms under which lending is agreed and providing for remedy if the terms are breached.

Exists where a company holds or owes a debt as a result of lending or borrowing money.

(LAN). A network connecting computers within the same organisation.

A collection system in which a bank or a third party receives, processes, and deposits a company’s mail receipts. Also known as a lockbox processor.

See Lognormal frequency distribution.

A lognormal distribution is one where the natural logarithm ln(X) of the variable is normally distributed. Lognormal distributions have a minimum - usually 'worst case' - value, whilst having an infinitely high upside.

If share returns are lognormally distributed it means that the logarithm of [1 + the share return] has a normal probability distribution.

Normal distributions have infinitely long ‘tails’ both upside and downside - so implying unlimited downside potential when used for modelling share returns. But the theoretically worst outcome for a share investor is to lose the whole of their investment - in other words a negative return of -100%. It is not theoretically possible to suffer a return of worse than -100%.

Lognormal distributions - unlike normal distributions - also have a limited downside, so they do not suffer from this theoretical shortcoming.

Volatility of the underlying asset price can be estimated from: (i) historical underlying asset price data, or (ii) as implied volatility in the current market price of the option, if all of the other drivers of the current market price of the option (including the risk-free rate of return) are known.

The Gazette is the official newspaper where certain statutory notices are required to be published. For example notice of liquidation/winding-up.

(LIBID). The rate at which the quoting bank is willing to pay on deposits from other prime banks. LIBID is lower than LIBOR (the related borrowing rate), because deposit rates are lower than borrowing rates.

The full name of the reference rate commonly abbreviated to LIBOR.

1. Long term financial instruments are those with greater maturity.

2. See long position.

UK tax. An asset which has a useful economic life in excess of 25 years.

A party which buys a traded asset, has a long position in the asset. So they are long of it - for example in the case of a commodity, they would have a lot of it in storage once they had taken delivery of it.

Another example of a long position is the forward purchase of an asset. In this case the long position holder has a future entitlement to receive the asset, under the terms of the forward purchase contract.

Examples of traded assets include commodities, options, and underlying assets related to options (such underlying assets also being known as 'the physical').

Accounting. A project undertaken by an organisation which spans different accounting periods. This normally means a contract exceeding one year but in certain circumstances may be contracts of less than one year, but spanning a company's year end.

A long-term agreement between two parties to exchange a set of cash flows for a minimum of one year and up to 15 years in the future.

Debts and obligations that are payable in more than one year from the current date.

Obligations that are expected to be settled beyond one year or a normal accounting cycle.

Pensions. A measure of the life expectancy of current and future pensioners and other beneficiaries of a pension scheme. From the perspective of the pensions provider, there is therefore a related 'longevity risk'.

Longevity risk refers to the increased cost of providing pensions, resulting from improvements in health and increases in average life expectancy.

A closely related term in pensions valuation and management is 'mortality'. Mortality refers to the relative proportions of groups of pension scheme members who are expected to die in a given period. So as mortality rates decrease, average life expectancy increases accordingly.

See Correspondent banking.

1. Accounting. A deficit arising from the matching of revenues and expenditure.

2. More generally, any worsening of a position or outcome - especially a financial outcome - compared with the anticipated or expected outcome.

Also known as Loss-sharing rule.

An agreement between participants in a transfer system or clearing house arrangement regarding the allocation of any loss arising when one or more participants fail to fulfil their obligation. The arrangement stipulates how the loss will be shared among the parties concerned in the event that the agreement is activated. All known as Loss-sharing agreement.

UK VAT currently at a rate of 5%.

Abbreviation for Limited Price Indexation.

Pensions. The Rules of many occupational pension schemes permit an element of pension entitlement to be commuted to a lump sum on retirement. These payments may not be liable to tax.

Economics. A good with an income elasticity of demand greater than one.

Abbreviation for Large Value Transfer System.