Finance jargon-buster: what's everyone talking about?
Financial news has dominated the headlines since the US sub-prime mortgage crisis hit in December 2007. Does this mean anything to you?
Can you tell your GFCs from your GDPs?
Read our jargon-buster to help navigate the acronyms and technical terms of the finance world.
Sub-prime mortgage crisis: Over the past few years, many US Banks gave loans to borrowers with bad credit histories. When they defaulted, it had adverse implications for the value of sub-prime mortgage backed securities, the global financial system and house prices.
Mortgage-backed securities: From 2001 to 2006, many Wall Street firms bought the mortgages on a large number of houses, pooled them and then sold slices of the whole pool of mortgages to investors around the world. The repackaged debt from this mortgage pool was traded and re-traded, freeing up funds to lend to more homeowners. When the sub-prime borrowers started defaulting on their loans, this adversely affected the value of some of these securities.
Bull market: An upward trend in share market performance. When company earnings and investor confidence is high and more people are buying stocks, share prices increase.
Bear market: The opposite to a bull market, a downward trend or falling market. When earnings decline and investors are wary and uncertain, stock values decrease.
Recession: The popular definition is two consecutive quarters of negative growth in Gross Domestic Product (GDP), or national income. A better definition is a sustained period when most sectors or industries in the economy are suffering declines in output. In these times, unemployment tends to rise substantially over an extended period and GDP falls for consecutive quarters.
Economic stimulus: Economic aid granted by a government to citizens and/or industry to try and spur growth within the economy.
Cash rate: The interest rate set by The Reserve Bank of Australia (RBA) for banks to pay or charge to borrow funds from other banks on an overnight unsecured basis.
Credit crunch: When banks drastically reduce their lending to each other and others because they are unsure about how much money they have and whether the borrower can pay it back. This leads to more expensive loans and mortgages.
Inflation: A measure of the increase in the general level of prices. The Consumer Price Index (CPI) is a general measure of price inflation for the household sector compiled by the Australian Bureau of Statistics (ABS).
Liquidity: The capacity to sell an asset quickly without significantly affecting the price of that asset.
Commodities: Products that are all the same in their basic form and have the same market price, so it makes little difference where or from whom you buy them. For example, iron ore- you pay the same price regardless of which mine it comes from. Commodities include energy, agriculture and metals – access to which will be gained through derivatives markets including the use of futures. Commodity futures are financial contracts based on the underlying physical assets – meaning transactions are in cash rather than the physical commodities.
Derivatives: Derivatives are a common tool used to enhance returns or manage risk. They are financial contracts that have a value derived from an external reference (eg anything from the price of coffee to interest rates or what the weather is like). Credit derivatives are based on the risk of borrowers defaulting on their loans, such as mortgages.
Hedge fund: A private investment fund with a large, unregulated pool of capital, managed by experienced investors. These funds use a range of sophisticated strategies to maximise returns – including hedging, leveraging and derivatives trading.
Short-selling: A technique used by investors who think the price of an asset, such as shares, currencies or oil contracts, will fall. The aim is to borrow a stock, sell it at a high price and buy it back when it is trading at a lower price, pocketing the difference.
Leveraging: Using debt to supplement investment. The more you borrow on top of the funds (or equity) you already have, the more highly leveraged you are. This has a positive impact when investment returns are positive and an adverse impact when returns are negative.
Stagflation: The feared combination of inflation and stagnation – an economy that is not growing while prices continue to rise.
Write-down: Reducing the book value of an asset to reflect a fall in its market value. For example, the write-down of a company’s value after a big drop in its share prices.
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