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Defining Financial Terms

Finance

Finance is a term that essentially describes the management of money and capital. It refers to many topics involved in the transaction of money, such as risk, rates, and time. The term is most commonly used with banks and businesses, but can also refer to individual money management.

Efficient Market

An efficient market is a market where business and investors interact, with the primary purpose being to generate profits. Supply and demand drive the prices of the market, and it will react quickly to any changes or external forces. This will prevent people from exploiting public information to make a profit.

Primary Market

A primary market is where new securities are traded for the first time. When dealing with stocks this will usually be an Initial Public Offering. A company can build long term capital by dealing stock directly to investors. For government bonds, it is simply the market where newly issued bonds are sold.

Secondary Market

The secondary market is where investors trade securities with other investors. This is where the majority of security trading takes place and provides liquidity to the market. In the USA, some of the major secondary markets are the NYSE and NASDAQ.

Risk

Risk is the probability that a negative outcome will occur when investing. If a security has a greater level or risk, then there is a better chance that it will not provide a positive return. In the stock market, risk is generally associated with high levels of volatility.

Security

A security is a financial instrument that can represent debt (Bonds) or equity (Stocks). Securities are sold to investors who are looking to make a return on the purchase price. They are associated with a certain level of risk, with some being higher than others.

Stock

Stocks represent ownership in a company, and are considered equity securities. In public companies, the board of directors will determine a set number of shares to be authorized. It share represents a unit of ownership in the company. Investors will typically buy shares when they speculate price increases, and sell shares when they speculate price decreases.

Bond

A bond is a debt security, where the entity issuing the bond becomes indebted to the purchaser. The issuer is obligated to pay the bond back at a later date along with interest accrued. Bonds are typically sold by corporations and governments.

Capital

Capital is the money used by businesses to purchase the items needed for their main operating activities. Capital may be provided by investors or banks. Banks typically provide capital in the form of a loan, and investors provide money looking for a return.

Debt

Debt is the amount of money that is owed by one entity to another. Debt can be used to raise capital to either start or expand existing operations. The borrower will normally pay back the creditor for the principle amount plus interest.

Yield

Yield is the amount of income that is generated by an investment. Many securities will pay annual or quarterly dividends. Yield can also refer to interest payments. This also includes fixed income investments, such as bonds.

Rate of Return

The rate of return is the ratio between the amount of money invested and the money gained that from the investment over a period of time. This is used to show us how well an investment is performing. The higher the rate of return, the more money it is generating. 

Return on Investment

Return on Investment is very similar to Rate of Return, but refers to the amount of money gained from an investment. This will give an investor the actual amount of profit or loss that was realized from an investment.

Cash Flow

Cash flow refers to the amount of cash that is being received or paid out by a company. A company does not necessarily need to generate a cash flow to be profitable, but it does provide liquidity.


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