Personal Finance Jargon – What does it all mean?
There are many constantly changing and confusing terms in the world of finance. Below we attempt to explain a few of them in simple to understand language.
An investment with debt and equity characteristics issued by companies as a form of long-term finance. Usually issued at $100 when floated on the Australian Stock Exchange, it pays a dividend (usually a fixed percentage above the 90 day bank bill swap rate) for a certain term. At the end of the term (and depending on the specific investment), there are a number of options the issuer can choose such as conversion of the hybrid to ordinary shares, repayment of the hybrid security in cash or continuation of the hybrid security with a higher ‘step-up’ dividend going forwards.
Bank Bill Swap Rate (BBSW)
It is the average mid rate for short term bank funding in Australia and is closely linked with the Reserve Bank of Australia’s (RBA) ‘cash rate’. It is quoted on 30, 60, 90 & 180 day terms. The BBSW is determined with future RBA cash rate decisions in mind. If banks predict the RBA will raise the cash rate over the next 12 months, the 180 BBSW will be higher than the 30 day BBSW.
Collateralised Debt Obligation (CDO)
A structure that raises money from investors through issuing bonds and then purchasing assets with that money. The assets purchased include bundled (collateralised) residential home loans for risky borrowers (sub-prime borrowers). Different bonds are issued with varying degrees of credit risk (risk of default). The riskier bonds pay a higher yield to the bondholder but have the most exposure to any losses on trust assets in the CDO. The collapse of the CDO market was due to massive underestimation of losses that could occur on assets (default level of sub-prime loans) and lead to what we know as the “sub-prime crisis”.
Management Expense Ratio (MER)
Paid by investors of a managed fund and expressed as a % of the funds value. It represents the cost of investment management, marketing, trusteeship, legal, accounting and auditing costs incurred by the investment manager.
The price to earnings ratio represents the number of years it would take for the net earnings per share of a company to purchase 1 share in that company. For example, if the net earnings per share of company XYZ was 10c and the current share price was $1, the P/E ratio would be 10. It would take 10 years of the current net income per share to purchase 1 share in the company. Simplistically, the higher the P/E ratio the more expensive the company is on a valuation basis.