Call provision: A provision in the indenture of a fixed income security that allows the issuer of the security to pay it off before its final maturity.
Call date: The date at which a bond indenture, or agreement, allows a bond to be redeemed early by the issuer. By “early” we mean before the final maturity date.
Capital: The total amount of cash that has been invested in the operations of a business since its inception. That includes both internally generated capital and externally generated capital. Internally generated capital comes from reinvestment of excess cash flow made from day to day operations. Externally generated capital includes borrowed money and proceeds of stock sales.
Cost of capital: The return a firm must earn on its total invested capital to satisfy all its investors. For example, the cost of debt capital is the interest required by lenders, and the cost of equity capital is the rate of return required by equity investors to compensate for the risk of being equity investors.
Duration: The actual life expectancy of a debt instrument. For example, a callable bond with a ten-year guaranteed maturity will have a duration of less than ten years if call provisions cause some probability that the bond will be called before its maturity.
Economic profit or EVA™[1] (Economic Value Added): The difference between the return on an investment and the cost of capital invested in it. Stock prices have a very high correlation to the amount of economic profit generated by a business.
Free Cash Flow: The cash generated by a business that its owner can pocket. It can be roughly estimated by adding depreciation and amortization to net profit and then subtracting capital expenditures.
Indenture: The agreement between a bond issuer and its original buyer. After-market buyers of the bond assume the indenture.
Intrinsic Value: There are two ways to calculate this, both leading to the same number. 1) The present value of all economic profit an investment is projected to earn for its owners over all future years, plus the amount of capital employed in the business on the date of valuation. 2) The present value of all free cash flow distributed to creditors and owners of the business over its entire life.
NOPAT (Net Operating Profit After Tax): The cash profit of a business available to provide a return to all providers of financial capital to the business. NOPAT consists of after-tax operating profits before financing costs and non-cash-bookkeeping entries such as amortization, interest on non-capitalized leases, etc. Depreciation is considered a good estimate of the expense of replacing assets consumed in producing revenues, and is the only non-cash expense included in the calculation of NOPAT.
Reinvested Capital: Cash flow generated by a business that is reinvested into the business. The object of reinvesting is to grow the business. An example of a growth investment would be building a new plant. If the cash generated by the plant exceeds the cost of capital invested to build it, the business gets richer. If the cash generated is less than the cost of capital, value is destroyed.
Risk-free rate of return: The rate of return paid on a risk-free instrument, such as a US Treasury obligation of short duration. The three-month Treasury bill is an example of a risk-free instrument.
Turnover: In referring to mutual funds and stock portfolios, this term describes how often the total value of the portfolio or fund is bought or sold.
Yield terms:
Yield to Call: The yield a bond owner earns if the bond is redeemed at a call date. Technically speaking, it is the discount rate at which the present value of all cash flows from a bond held to a call date, including principle and interest, equals the purchase price.
Yield to Maturity: The yield a bond owner earns if the bond is redeemed at maturity. Technically speaking, it is the discount rate at which the present value of all interest and principal cash flows from a bond held to maturity equals the purchase price.
Current Yield: The annual interest coupon on a bond divided by the price paid for the bond.
Realized compound yield: The yield one receives on a bond taking into account “interest on interest”, the amount of interest actually earned on the interest coupons paid every six months by a bond.
[1] EVA is a registered trademark of Stern Stewart & Co.
