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Glossary: Translating The Financial Crisis

By The Associated Press

Short definitions for key words and phrases in the financial crisis:

BASIS POINT: One one-hundreth of one percentage point. Changes in interest rates are measured in basis points. If the Federal Reserve’s target rate was 2 percent and it was cut by 50 basis points, the new rate would be 1.5 percent.

COLLATERALIZED DEBT OBLIGATIONS: Debt, including bonds or mortgages, that is pooled, sliced up and resold to investors.

COMMERCIAL PAPER: Short-term loans, issued primarily by corporations, to finance their daily needs, such as making payroll. Historically, a lower-cost alternative to bank loans.

CREDIT DEFAULT SWAPS: A form of insurance that promises payment to investors in mortgage securities and other bonds if the borrower defaults. The market, estimated at more than $62 trillion, is unregulated, prone to sloppy documentation and has no central clearinghouse.

DEBT: The money a company or individual owes a creditor.

DERIVATIVE: A contract whose value depends on the financial performance of its underlying assets, such as mortgages, stock or traded commodities. Credit default swaps are one form of derivative.

EQUITY: A share of ownership in a company, home or other asset. Companies issue shares of ownership through stock. With a home, equity equals its current market value minus the amount the borrower owes on the mortgage.

FDIC: The Federal Deposit Insurance Corp., the government agency that insures deposits in banks and thrifts.

HEDGE FUND: Private investment funds that gather investments from pension funds, state retirement funds and wealthy individuals and use sophisticated techniques to try to achieve higher returns than the stock market.

HOME EQUITY LINE OF CREDIT (HELOC): A line of credit secured by a home. Borrowers can draw on it for a fixed period set by the lender, usually five to 10 years.

LEVERAGE: Using borrowed money to invest or finance a business. The more leveraged companies or investors are, the more risk they take on.

LIBOR: The rate that international banks charge for short-term loans to each other. Libor, an acronym for the London Interbank Offered Rate, is calculated every business day.

LIQUIDITY: A measure of how quickly an asset or investment can be sold or redeemed. The faster it can be sold, the more liquid it is.

MARK to MARKET: An accounting requirement that securities must be valued at their current price, rather than the purchase price or the price they might fetch later. Also called “fair value.”

MORTGAGE: A loan secured by property. The contract between the borrower and the lender gives the lender the right to take possession and resell the property it if the borrower defaults.

MORTGAGE-BACKED SECURITY: A bond backed by home or commercial mortgage payments. These provide income from payments of the underlying mortgages.

REVERSE AUCTION: An auction where the winning bidder is the one willing to take the lowest price. In a reverse auction for subprime mortgage loans, for instance, a bank offering to sell a bundle of bad loans for 50 cents on the dollar would beat a bank offering to sell its loans for 60 cents on the dollar.

SECURITIZATION: Bundling together individual assets, such as mortgages, and selling stakes to investors.

SHORT SELLING: A technique in which investors borrow shares in a company from a broker and sell them, hoping to buy them back later at a lower price. Short selling is a bet that a stock’s price will fall.

SOLVENCY: The ability to pay expenses and debt on time and continue operating. An insolvent company typically has to seek bankruptcy protection from creditors.

TREASURIES: Securities sold by the federal government to investors to fund its operations, cover the interest on U.S. government debt and pay off maturing securities. Because it carries the full backing of the government, Treasuries are viewed as the safest investment.

WRITE DOWN: An accounting step a company makes when an asset or class of assets it holds falls in value. The decline in value is reflected in a reduction on the asset side of a company’s balance sheet.

(Copyright 2008 by The Associated Press. All Rights Reserved.)

Article Topic Follows: News

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