Glossary of Terms

Mergers and Acquisitions.

Capital structure theory. Modigliani and Miller.

Borrowings documentation. Material Adverse Change.

Duration is the weighted average timing of the cash flows of an instrument, weighted by the present values of the cash flows. Macaulay’s duration uses the yield to maturity of the instrument to work out the present values to use for weighting in the duration calculation.

Same as Macaulay duration.

Economic theory which studies economic aggregates, for example, inflation, employment and output.

(MICR). Standard used to encode bank/ branch numbers on the bottom of cheques with magnetic ink which is machine readable. This allows cheques to be cleared through automated systems.

The time interval outstanding between the time a cheque is mailed and its receipt at the designated address.

Management accounting is primarily concerned with the provision of information to internal managers for the purposes of planning, controlling and decision making.

The purchase of a business, as a going concern, by members of its management.

See Management fee.

Tax. An allowable expense of an investment company.

1. Banking. A fee charged to the borrower by the group of banks (or other lenders) providing or underwriting a syndicated credit or bond issue.

2. More generally, any fee charged for management services or for other related services.

3. A fee charged within a group of companies for management services, usually payable by a subsidiary company to a holding company.

Also known as a 'management charge', especially in the context of 2. and 3. above.

An authoritative command or instruction, for example to a bank by its customer.

Law. A positive form of injunction.

1. Accounting. Profit margin measures the surplus of revenues over relevant costs, often expressed as a percentage.

2. Bank lending. Lending margin is a percentage amount added to a market reference rate, to calculate the total rate of interest payable by a borrower.

3. Futures markets. Margin is a refundable cash deposit payable by market participants to protect other participants in the market against the risk of a default.

The margin of safety is the extent to which sales may fall below their existing level before break-even point is reached.

The increase in total production cost as a result of producing one more unit.

(MPC). The proportion of an increase in income which is spent.

(MPS). The proportion of an increase in income which is saved, defined as 1 - MPC.

The rate of tax at which a taxpayer would be effectively taxed on the additional income if his total taxable income increased by a small amount.

The rate of tax at which a taxpayer would effectively save tax on the additional tax relieved expenditure if the total tax relieved expenditure increased by a small amount.
For example the marginal rate of tax relief on debt servicing costs, assuming an increase in the total amount of debt finance.

The increase in total revenue as a result of selling one more unit.

Economics. The extra satisfaction gained from consuming one more unit of a good or service.

Risk management. A measure of the Value at Risk impact on a portfolio of small changes in a position.

1. In financial accounting, the recognition of assets and liabilities at their current market values, as at the end of the financial accounting period.

2. A basis of taxation which follows the mark to market basis of financial accounting.

3. UK tax. A method of allocating loan-related payments to the period in which they become due and payable and brings the value of loan relationships into account at fair value at the end of each period.

Market makers in an asset quote simultaneous bid prices and offer prices to the market, at which they are willing to deal with the market to buy (at the bid price) or sell (at the offer price) the market asset.

The interaction of demand and supply, resulting in an equilibrium quantity and price being set by the market.

The risk of losses resulting from adverse changes in market prices or other market rates.

1. Same as Nominal annual rate.

2. A rate or price in a market, quoted using the conventional basis of quotation for that particular market.

3. More generally, any rate or price derived from a market.

1. Market risk in the Capital Asset Pricing Model (CAPM) means the element of total risk which cannot be eliminated by holding a diversified portfolio of investments. Under the CAPM, only market risk is rewarded with additional returns. Market risk is often quantified by Beta, its designation in the CAPM. Also known as Systematic risk or Non-diversifiable risk.

2. More generally, the risk of losses resulting from adverse changes in market prices or in general market conditions.

(MRP). In the Capital Asset Pricing Model, the additional return to investors who invest in the market portfolio - additional to the risk free rate of return - which compensates them for accepting an average market level of risk.

Also known loosely as the Equity Risk Premium (ERP). But more strictly the market risk premium refers to the market of all traded assets, while the equity risk premium refers to equities only.

The fair price for which an asset might be sold if it was offered for sale. The price which might be agreed between an informed buyer and an informed seller.
This is distinct from the book value.

In the case of widely traded assets, the market value may be a readily observable quoted market price.

(MVA). The excess of the market value of a firm over its book value.

Taking a simplified example, for an all-equity financed firm with a market capitalisation of $130m and book value of equity $100m:
MVA = $130m - $100m = $30m.

In practice a number of adjustments would be made both to the market values and to the book values used in the calculation of the MVA. So in practice the assessment of MVA is both more complicated, and arguably more subjective, than the simple calculation illustrated above.

The market yield on a traded instrument is the internal rate of return of its cashflows, including the current market price.

Market value of a company's equity ÷ Equity shareholders' funds.

A bank account used in cash concentration to fund zero balance accounts automatically.

1. Arranging that in a portfolio of assets and liabilities the cash flows generated by the assets can be expected to meet the liability payouts either because the assets generate income of the right amount at the right time or because the market values of the assets are linked to the market values of the liabilities.

2. Equalising or approximating the modified duration of assets and liabilities in a portfolio, to manage interest rate risk.

3. Equalising or approximating both the modified duration and the modified convexity of assets and liabilities in a portfolio.

A clause in a loan agreement. Normally it is intended as a 'catch-all' clause and states that if there is a change in the circumstances of the lender that is both material and adverse, then this will constitute an event of default. Not surprisingly this is a contentious clause, depending on who defines 'material'.

This is a threshold at which insignificance becomes significance. Often it is defined for particular circumstances in loan agreements, for example cross default shall not apply for late payment of a trade creditor for an amount less than a given threshold figure.

Materiality is also a fundamentally important concept in financial accounting. Relevant accounting standards, principles and disclosures need only be applied to material items.

Similarly in risk management, only material risks require active management. (While non-material risks can be retained and monitored periodically to ensure that they remain non-material.)

1. In relation to a financial instrument evidencing a debt obligation, the remaining time until the principal is repayable to the holder.

2. The remaining life a derivative instrument, during which its value may continue to change.

3. In relation to a Defined Benefit pension scheme, the ratio of the accrued liabilities relating to the deferred and actual pensioners to those relating to the active members.

1. Interest rate risk management. Modified convexity.

2. Financial reporting. Management Commentary.

1. Modified duration.

2. Managing Director.

Financial reporting. Management Discussion and Analysis.

1. Same as Arithmetic mean.

2. The term is sometimes used more loosely, to refer to any measure of the mid-point of a set of data.

Statistics. Average of the deviations of all items from the mean (treating all of the deviations as positive in the calculation).

This is the assumed tendency for a stochastic process to remain near to, or to return over time towards, a long-run average. Interest rates, implied volatilities and stock market returns are believed by many people to exhibit mean reversion, but exchange rates and stock prices generally do not do so.

The mean-variance efficiency criterion says that rational investors should always prefer greater average returns and lower risk (measured by lower variances) of returns.
So that, given the choice, we should - and will in theory - always prefer investment portfolios that:

- Maximise the mean return for any given variance, or
- Minimise the variance of returns for any given mean.

The linking of the level of a state pension or supplementary benefit to the wealth or income of the recipient of the pension.

The middle value of an ordered distribution.

(MTNs). Medium Term Notes are debt securities that range in maturity from about nine months to several years (sometimes as long as 30 years) and are in bearer form. They are normally issued as part of an MTN programme where documentation exists to cover the programme and is regularly updated.

1. Pensions. A beneficiary under an occupational pension scheme.

Pension scheme members may be:
i. Active (still accruing benefits by virtue of current service), or
ii. Deferred (no longer accruing benefits through having left the scheme, but entitled to receive benefits in the future) or
iii. Pensioners (currently receiving benefits). This third category will also usually include widows and other dependants of former members.

2. Company law. In relation to a company, a shareholder.

Pensions. Under the Pensions Act 1995 (which permitted certain exceptions) and the Pensions Act 2004 (which does not), a minimum proportion of trustees must be nominated by the members of the scheme. This proportion is currently one third, but is expected to increase to one half by 2009. Also known as Employee Nominated Trustees.

Funds transfer. See Participant in an FTS.

Document submitted to the UK Registrar of Companies when seeking registration of a company. The memorandum sets out information including the company name, the company’s objects and the company’s registered office.

Merchant banks traditionally specialised in trade related finance (hence their former description as 'accepting houses'), underwriting of new issues and provision of corporate advice. The term 'investment banks' - which orginated in relation to similar banks in the US - is now more generally used for these banks. These banks provide a wide range of services in the money, capital and securities markets.

The combination of one business with another to form a single business.

Merger accounting regards two or more parties as combining their interests on an equal footing. The difference that arises on consolidation does not represent goodwill, but is instead added to (or deducted from) reserves.

Merger accounting is not allowed under the relevant international accounting standard IFRS 3 'Business combinations'.

Under UK domestic GAAP merger accounting is required - but under strictly limited circumstances - under FRS 6 'Acquisitions and Mergers'.

An accounting reserve which arises in group accounts on the application of Merger accounting to a business combination.

1. Noun. A measure. The term is often used in the context of shareholder value management. A value-based metric is a performance measure which is linked in a direct and understandable way with the creation of value for shareholders.

2. Adjective. In a wider and non-financial context the metric system of measurement is a decimal system based on the metre.

Mezzanine debt is capital designed to be in between equity and debt in respect of both risk and expected return. Often used in Venture Capital.

The term derives from 'in between' mezzanine floors in buildings.

Minimum Funding Requirement.

Magnetic Ink Character Recognition.

Economic theory which studies the behaviour of an individual or individual firm.

(MFR). Pensions. A historical requirement in the UK under the Pensions Act 1995 that for a Defined Benefit pension scheme the liabilities should not exceed the assets under a prescribed set of assumptions. MFR is being superseded by the Statutory Funding Objective.

The six minimum standards for the design and operation of cross-border and multi-currency netting schemes or systems. The standards are:
i. Netting systems should have a well-founded legal basis under all relevant jurisdictions;
ii. Netting scheme participants should have a clear understanding of the impact of the particular scheme on each of the financial risks affected by the netting process;
iii. Multilateral netting systems should have clearly defined procedures for the management of credit risks and liquidity risks which specify the respective responsibilities of the netting provider and the participants. These procedures should also ensure that all parties have both the incentives and the capabilities to manage and contain each of the risks they bear and that limits are placed on the maximum level of credit exposure that can be produced by each participant;
iv. Multilateral netting systems should, at a minimum, be capable of ensuring the timely completion of daily settlements in the event of an inability to settle by the participant with the largest single net debit position;
v. Multilateral netting systems should have objective and publicly disclosed criteria for admission which permit fair and open access; and
vi. All netting schemes should ensure the operational reliability of technical systems and the availability of backup facilities capable of completing daily processing requirements.

Also known as the Lamfalussy Standards.

The portfolio with smallest possible variance which can be constructed from the available securities.

Law. An individual less than 18 years of age.

Accounting. The value of net assets attributable to non group shareholders.

The performance of a legal act in an illegal manner.

An untrue statement of fact made by one party to a contract to the other party which induces that other party to enter into the contract.

See Risk mitigation.

An economy where resources are allocated by both the government and by the market mechanism.

An international holding company located in a country with an extensive double tax treaty network and minimal foreign exchange and overseas investment controls. Historically, the tax advantages of mixer companies included blending income streams from different tax jurisdictions, minimising the wastage of overseas tax credits, and so minimising the total tax liabilities of the group of companies.

Capital structure theory. Modigliani and Miller.

Abbreviation for Monopolies and Mergers Commission.

Abbreviation for Money Market Yield.

Multinational company.

Pensions. Member Nominated Trustee.

Statistics. The value of the data which occurs the most frequently in a distribution.

A representation of a real situation using a selected set of simplifying assumptions and relationships. Financial models are widely used as tools for valuation and to support financial decisions.

An important benefit of well-structured financial models is to facilitate sensitivity analysis.

US spelling of modelling.

Writing and using models, especially financial models.

Developed by Harry Markowitz in the 1950s, Modern portfolio theory (MPT) quantifies the expected return to a portfolio with reference to each component asset’s mean return and standard deviation of returns plus the covariance between component assets’ returns.

Modified convexity measures the curvature of an instrument’s price function, as yields change. It is the rate of change of modified duration with respect to yield.

The estimation of price change for a given change in yield can then be refined as follows:

Price change estimation using Modified Duration (MD) only:
= - Price x MD x Change in yield

Price change estimation using Modified Convexity (CMOD):
= - [Price x MD x (Change in yield)] + ½ x [Price x C_MOD x (Change in yield)²]

Therefore it is also possible to estimate the MD and the CMOD from given observations of Price and Yield, by running the price change estimation formulae in the other direction.
[Rearranging them to solve for MD and for CMOD.]

Modified duration is a straight line estimated measure of the market price sensitivity of an instrument, to changes in yield.
Often - but not always - the relevant yield is the annual effective yield ('EAR').

For changes in EAR, modified duration is calculated from Macaulay’s duration as:
MD = Duration/[1+EAR].

For changes in simple annual yields 'R', modified duration is calculated as:
MD = Duration/[1+(R/n)]
where n = number of compounding periods per year.

For example, say Duration = 5.00 years, Semiannual yield R = 6.00% (so n = 2) and so EAR = 6.09%.

With respect to the EAR:
MD = 5.00/1.0609 = 4.71

With respect to the Semiannual yield:
MD = 5.00/1.03 = 4.85

This shows that there will be a greater proportionate change in price for a 1% change in the Semiannual yield, than for a 1% change in the EAR.

The authors of a seminal paper in 1958 on capital structure, often referred to as MM. Their name is synonymous with their ideas on arbitrage: the total cost of capital for a business is determined by the characteristics of the business rather than by the way in which that business is financed. Therefore, whatever the proportions of equity and debt in the capital structure, the returns to both the debt component and the equity component will adjust to give adequate returns to their providers and a constant total cost of capital. These ideas were set out in their original work, later developed to accommodate the existence of tax-sheltered debt and high costs of financial distress to predict the existence of an optimal capital structure.

A school of economic thought, associated with Milton Friedman, which takes the view that the economy is self correcting and therefore active government intervention should be avoided. Monetarists believe that the only way to boost the economy is through supply side policies and influencing money supply.

Accounting. These include such items as property, plant, equity investments, stock.

Government policy to stimulate economic activity by influencing money supply or interest rates. Money supply may be altered through the use of open market operations, the central bank discount rate and reserve requirements.

Tax. A company which was non-resident for tax purposes and which was used to accumulate income, free of domestic tax, from the investment of surplus funds outside the domestic tax jurisdiction.

The monitoring of an organisation's cash to ensure the liquidity of the organisation and the cost-effective management and utilisation of its shorter term requirements and/or surpluses of funds.

Money markets trade short-term financial instruments, generally with a life up to one year. Securities are generally quoted on the basis of a simple nominal annual interest rate (or yield) or a simple nominal annual discount rate.

Important short term interest conventions are:
1. For GBP yield instruments: Actual/365 days
So Simple periodic interest = Quoted nominal annual rate x [Actual days]/365

For example a 272 day sterling yield instrument quoted at 4% would pay periodic interest of:
= 4% x 272/365
= 2.9808% per 272 day period

2. For EUR, USD and most other currencies yield instruments: Actual/360 days
So Simple periodic interest = Quoted nominal annual rate x [Actual days]/360
For example a 272 day USD yield instrument quoted at 4% pays periodic interest of:
= 4% x 272/360
= 3.0222% per 272 day period.

A deposit account which pays a floating interest rate based on the rates that short-term highly liquid financial instruments pay.

A low risk fund which invests only in liquid money market instruments of high credit quality.

Short-term uncommitted lines of credit available to corporate borrowers in the wholesale money markets.

(MMY). A conventional basis of short term yield quotation, which counts Actual days per 360 day conventional year.

An instrument used to remit money to the named payee, often used by persons who do not have a cheque account relationship with a financial institution, to pay bills or transfer money to another person or to a company. There are three parties to a money order: the remitter (payor), the payee and the drawee. Drawees are usually financial institutions or post offices. Payees can either cash their money orders or present them to their bank for collection.

Pensions. The same as Defined Contribution.

The total amount of money in an economy.

(MMC). The independent body established by the UK government (based on the recommendation of the UK Office of Fair Trading) to investigate and report on circumstances, particularly mergers and takeovers, which might or might not create monopolies.

A market form, characterised by many sellers, selling a differentiated product.

A market form, characterised by one seller, selling a product for which there are no close substitutes.

In Value at Risk analysis, an alternative method for calculating the probability distribution (rather than using the Delta-normal method or the Historical simulation method).

Monte Carlo simulations consist of two steps.
First, a stochastic process for financial variables is specified as well as process parameters. Both historical data and appropriate judgement can be used for such parameters as risk and correlations.
Second, fictitious price paths are simulated for all variables of interest. At each horizon considered, the portfolio is marked-to-market using full valuation. A distribution of returns is eventually produced, from which a VaR figure can be measured.

Comparing the methods:
The Delta-normal method is the simplest method to implement. The main drawbacks are the assumption that risk factors have normal distributions, and the assumption that the assets are linear (in other words, that they do not contain options).
The Historical simulation method is also relatively simple to implement. The main drawback is that the historical information used may not adequately represent future probability distributions. (This is also a drawback of the delta-normal method.)
Monte Carlo techniques are designed to address this shortcoming. Disadvantages of Monte Carlo methods include their relative complexity.

Moody's Investor Services, a leading credit rating agency.

The risk that an insured may attempt to take unfair advantage of an insurer, for example by suppressing information relevant to the assessment of a risk or by not acting in accordance with the terms of a policy. The UK Pensions Act 2004 contains a number of clauses specifically designed to reduce the risk of moral hazard.

A legal authorisation postponing for a specified time the payment of debts or obligations.

A review of the actuarial profession commissioned by the UK government subsequent to the Penrose Enquiry and submitted by Sir Derek Morris in 2005. It chiefly concerned the regulation of the actuarial profession, but also sets out some best practice recommendations for pension scheme trustees and makes certain recommendations in connection with the Government Actuary’s Department.

Pensions. A measure of the relative proportions of people who are expected to die within the period under review. Mortality is one of the key assumptions in the valuation of the liabilities of a pension scheme.

The average value of the observations in a time series that are the most recent in time.

1. Marginal propensity to consume.

2. Monetary Policy Committee.

Marginal propensity to save.

Modern Portfolio Theory.

Market Risk Premium.

Medium Term Note.

Facility for a series of MTN issues with common documentation which is updated regularly.

An occupational pension scheme operated on behalf of two or more employers connected by common ownership or management or some other close association.

An arrangement in which a financial institution or third-party reporting service gathers, consolidates, and reports account balances and transactions from various financial institutions with which the company maintains accounts.

A bank account that allows for the transfer of payments in any readily convertible currency to and from one designated account.

Funds transfer. The sum of the value of all the transfers received by a participant in a net settlement system during a certain period of time LESS the value of the transfers made by the participant to all other participants. If the sum is positive, the participant is in a multilateral net credit position; if the sum is negative, the participant is in a multilateral net debit position.

Funds transfer. A settlement system in which each settling participant settles (typically by means of a single payment or receipt) the multilateral net settlement position which results from the transfers made and received by it, for its own account and on behalf of its customers or non-settling participants for which it is acting.

An arrangement among three or more parties to net their obligations. The obligations covered by the arrangement may arise from financial contracts, transfers or both. The multilateral netting of payment obligations normally takes place in the context of a multilateral net settlement system. This system consolidates the cross-border payments of the various subsidiaries after conversion into a common, reference currency.

Statistics. Similar to a component bar chart, but the components are shown side by side rather than splitting an individual bar.

A method of business valuation which is based on a relevant measure and the ratio of value to that measure for a comparable business (or a comparable group of businesses).

The most widely used financial measure for this purpose for a mature business is accounting earnings.
For other types of businesses, relevant measures might include - for example - turnover, or numbers of subscribers.

An economic concept which states that an injection into the economy will increase the equilibrium level of national income by more than the amount of the injection. The multiplier is defined as 1/(1-MPC), where MPC = Marginal Propensity to Consume.
Hence the higher the MPC, the greater the increase in aggregate income as a result of the injection.

Economics. A measure of the effect on total national income of a unit change in some component of aggregate demand.

Events which can not occur at the same time.

Abbreviation for Market Value Added.

Pensions. A review of institutional investment sponsored in the UK by HM Treasury, originally published in 2000 and updated in 2004.
Myners was particularly concerned with investment by pension funds.