Wednesday, November 19, 2008

Definition Of Terms You'll Hear Daily During This Financial Crisis

Investing and financial terms are being thrown around in the media with very few people understanding what those terms mean. Many of you are left scratching your heads when you hear terms like "CDO's" and "Credit Default Swaps". I will explain these Financial Terms and others so you can clearly understand what is being reported by the financial and investment media.

The terms I will explain include: CPM-Commercial Paper Market, CDO-Collateralized Debt Obligations, Derivative, Securitization, LIBOR-London Interbank Offered Rate, Hedge Fund, CDS-Credit Default Swap, Equity, FDIC-Federal Deposit Insurance Corp., Basis Point, Debt, HELOC-Home Equity Line Of Credit, Leverage, MBS-Mortgage-backed Security, and Liquidity.

CPM- Commercial Paper Market: This is a low cost source of cash that companies take advantage of when they have short term financing needs. This funding source is preferred over bank lines of credit because it's a less expensive means of borrowing.

CDO- Collateralized Debt Obligations: This is a security backed by fixed-income assets and underlying bonds.

Derivative: A financial instrument whose value depends on its underlying assets, such as stocks, mortgages or any tradable commodities. Stock futures and Credit default swaps are types of derivatives.

CDS- Credit Default Swap: This is a contract that is a form of insurance that a debt security will be repaid in case of default.

Securitization: The practice of packaging hundreds or thousands of individual mortgages or other assets together and then selling ownership stakes to investors.

LIBOR- London Interbank Offered Rate: This is the rate that international banks charge for short term loans to each other.

Hedge Fund: These are privately held investment funds that gather investments from rich private investors, state retirement funds, pension funds and others and use techniques to try to produce high returns, usually with high levels of debt to increase leverage.

Equity: Current market value of one's home minus the amount the homeowner owes the bank on the mortgage. With stocks, it's the ownership in a company expressed in the shares of stock one owns.

FDIC-Federal Deposit Insurance Corp.: This is a government agency that insures deposits in banks and thrifts. The insured amount has temporarily been raised from $100,000 to $250,000 per qualified account.

Basis Point: A basis point equals One one-hundredth of 1 percentage point.

Debt: The money that a person or company owes a creditor through the use of bonds or loans.

HELOC-Home Equity Line Of Credit: A line of credit secured by a home. Borrowers can draw on the line of credit, With limits set by the lender, for a fixed period, usually 5 to 10 years.

Leverage: The use of borrowed money to invest or finance operations by individuals or companies. The more leveraged a company or individual is, the more risk they take on.

MBS-Mortgaged-backed Security: A bond or security backed by a pool of mortgages which provides a cash flow based on the principal and interest payments of the underlying mortgages.

Liquidity: The more quickly or easily an asset or an investment can be sold, the more liquid it is. Checking and savings accounts are examples of maximum liquidity shy of money under the mattress.

I hope I've helped you a little in understanding what these terms mean. It can be confusing, if you're not in the financial field, to get a grasp on what's going on in financial and investment markets. We are in a full fledged recession that may have dire consequences to the average household. Education is still the key to help you navigate through this critical time in our economy.