Finance Units 8–10: Financial Markets, Bonds, and Stocks

Vocabulary flashcards covering the economic balance sheet, financial markets, efficiency forms, bond mechanics, and equity valuation models from Units 8 through 10.

Economic balance sheet

A balance sheet structured like an accounting balance sheet, but recording assets and claims at market values rather than historic costs, with asset values equaling expected future cash flows discounted at the opportunity cost.

Bond

A long-term debt security with fixed terms and maturity where the security holder acts as a lender.

Common stock

Equity securities representing residual ownership in a corporation; common stockholders are paid last and vote for the board of directors.

Preferred stock

An equity security that pays a fixed dividend and usually carries no voting rights; valued as a perpetuity when there is no dividend growth.

Primary market

The financial market where a company creates and sells new securities directly to investors to raise capital.

Secondary market

The financial market where investors trade existing securities with one another without the issuing company's involvement.

Initial Public Offering (IPO)

A corporation's first sale of equity shares to the public.

Seasoned Offering (SEO)

An issue of new equity shares by a company that has already completed an initial public offering.

Rights offer

An equity offering giving current shareholders the first opportunity to purchase newly issued shares in order to maintain their proportionate ownership interest.

Direct financing

A financing method in which securities are sold directly to investors through financial markets, typically facilitated by an investment bank.

Indirect financing

A financing structure in which a financial intermediary (such as a commercial bank) sits between savers and borrowers to channel funds.

Broker

A financial intermediary who brings buyers and sellers together without ever taking ownership of the asset, earning a commission.

Dealer

A market participant who owns inventory and stands ready to buy and sell securities, earning profit from the bid-ask spread.

Auction market

A market structure, such as the NYSE, where brokers bring buyers and sellers together to transact at an exchange.

Dealer market

A market structure, such as the OTC market or NASDAQ, where dealers maintain inventories and trade directly with buyers and sellers.

Efficient Market Hypothesis (EMH)

The financial theory stating that security prices fully reflect available information, making the prevailing market price the best estimate of economic value.

Weak-form efficiency

The form of market efficiency in which prices reflect all historic market information (such as price trends and volume), implying that technical analysis cannot consistently generate excess returns.

Semistrong-form efficiency

The form of market efficiency in which prices reflect all publicly available information (including historic data), implying that fundamental analysis cannot beat the market.

Strong-form efficiency

The form of market efficiency in which prices reflect all information, both public and private.

Golden Cross

A technical analysis indicator in which a short-run moving average crosses above a long-run moving average, interpreted as a buy signal.

Death Cross

A technical analysis indicator in which a short-run moving average crosses below a long-run moving average, interpreted as a sell signal.

Survivor bias

A sampling error occurring when only the winning or surviving entities are observed while the losers or entities that dropped out are omitted.

Yield to Maturity (YTM)

The required return an investor earns by purchasing a bond at its current market price and holding it to maturity; functions as the discount rate and fluctuates with market conditions.

Coupon rate

The contractual rate fixed at issuance in the bond indenture that determines the periodic coupon cash flow as a percentage of face value.

Par bond

A bond whose market price equals its face value ($\$1{,}000$), occurring when the coupon rate equals the yield to maturity.

Premium bond

A bond whose market price exceeds its face value ($\text{Price} > \$1{,}000$), occurring when the coupon rate is greater than the yield to maturity.

Discount bond

A bond whose market price is less than its face value ($\text{Price} < \$1{,}000$), occurring when the coupon rate is less than the yield to maturity.

Interest rate risk

The risk that a bond's price fluctuates inversely with changes in prevailing market interest rates or required returns.

Default risk

The risk that a bond issuer fails to fulfill the obligations or schedule of payments specified in the bond indenture.

Indenture

The formal legal agreement (or deed of trust) between a bond issuer and lender that specifies terms, protective covenants, maturity date, and interest rates.

Debenture

An unsecured corporate bond that is not backed by any specific physical collateral.

Amortized loan

A loan structure, commonly used for consumption borrowing, in which each periodic payment contains both interest and principal repayment.

Zero-coupon bond

A bond that makes no periodic interest payments and sells at a deep discount, delivering its entire return as a single lump-sum face value payment at maturity.

Investment-grade bonds

Bonds carrying credit ratings from $AAA$ to $BBB$, characterized by lower default risk, lower yields, and eligibility to be held by institutions such as pension funds.

Speculative (junk) bonds

Bonds carrying credit ratings of $BB$ to $D$, characterized by higher default risk and higher required yields.

Dividend yield

The cash dividend component of a stock's total return, calculated as the expected next-period dividend divided by current stock price ($\frac{\text{Div}_1}{P_0}$).

Capital gains yield

The price appreciation component of a stock's total return, which equals the dividend growth rate ($g$) in constant growth dividend valuation models.

Sustainable growth rate ($g$)

The rate at which a firm's earnings and dividends grow, calculated as the retention ratio multiplied by return on equity ($g = \text{retention ratio} \times \text{ROE}$).

Additivity

The valuation principle stating that the new stock price of a firm equals its existing price plus the net present value per share of a newly adopted capital project ($\text{New price} = \text{old price} + \text{NPV per share}$).