Compound Annual Growth Rate (CAGR)

Compound Annual Growth Rate (CAGR)

Earnings Before Interest, Tax, Depreciation and Amortization (EBITDA)

What It Is:

Earnings Before Interest, Tax, Depreciation and Amortization (EBITDA) measures the profitability of a company without taking into account its capital structure, tax rate, or primary non-cash items of most companies, such as depreciation and amortization. Essentially, EBITDA measures the core income that a company earns before it covers its debt payments and pays its income taxes.

How It Works/Example:




EBITDA is calculated based on figures taken from the company’s income statement. For example,

In this example, EBITDA is $300,000 while net income is $100,000.

Why It Matters:

EBITDA provides investment analysts with useful information for evaluating a company’s operating performance and profitability. Disregarding other factors unrelated to operations such as interest expenses, tax rates, or large non-cash items like depreciation and amortization, EBITDA helps minimize variables that are unique from company to company, and allows investors to focus on operating profitability as a singular measure of performance. Such analysis is particularly important when comparing similar companies across a single industry, or companies operating in different tax brackets.

However, EBITDA can also be deceptive when applied incorrectly, and is especially unsuitable for firms saddled with high debt loads or those subject to frequent upgrades of costly equipment. Furthermore, day trader can also be trumpeted by companies with poor earnings in an effort to "window-dress" their profitability. Notice in the example above that Company XYZ's EBITDA was three times as high as its reported net income.

Also, because EBITDA isn't regulated by GAAP, investors are at the discretion of the company to decide what is, and is not, included in the calculation. There's also the possibility that a company may choose to include different items in their calculation from one reporting period to the next.

Therefore, when analyzing a firm's EBITDA, it is best to do so in conjunction with other factors such as capital expenditures, changes in working capital requirements, debt payments, and, of course, net income.

Bond Quote

What It Is:

A bond quote refers to a bond's market price.

How It Works/Example:


The market prices of bonds are quoted as a percentage of the bonds' par value. Bonds issued by companies are quoted in increments of 1/8th (0.125) and bonds issued by the government are quoted in increments of 1/32nd (0.03125).

For instance, a corporate bond with a par value of $1000 quoted at 80.125 would have a market value of $1,000 * 0.80125 = $801.25.

Likewise, a government-issued bond with a $1,000 par value quoted at 85.03125 would have a market value of $1,000 * 0.8503125 = $850.3125.

Why It Matters:

Bond quotes indicate to the prospective buyer whether a given bond is or was trading at discount or at a premium to par value.

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Municipal Bond

What It Is:

Commonly referred to as a "muni," a municipal bond is a debt security issued by a state or local government.

How It Works/Example:


The purchaser of a municipal bond is effectively loaning money to a government entity, which will make a predetermined number of interest and principal payments to the purchaser. Issuers typically use municipal bond proceeds to finance day-to-day operating activities or capital expenditures for the public good such as road, hospital, school, or infrastructure projects.

There are many kinds of municipal bonds, but the two most prominent are general obligation bonds and revenue bonds. General obligation bonds are repaid with taxes collected by the issuer. They are unsecured and generally have maturities of at least 10 years. Revenue bonds are repaid with the revenue generated by the projects financed with the bond proceeds (such as a toll road).

Municipal bonds may be purchased directly from the issuer at the time of issuance or in the secondary market through a broker/dealer. One of the most popular ways to invest in municipal bonds is by purchasing shares of a municipal bond fund.

Why It Matters:

One of the biggest advantages of investing in municipal bond s is their tax-advantaged status. That means many investors in high tax brackets particularly benefit from investing in municipal bonds. Furthermore, since they are issued by government entities, municipal bonds are more likely to repay their debts. This low-risk makes the bonds attractive to conservative investors. Finally, some investors feel a sense of civic pride by investing in projects that will positively affect the community they live in.

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Zero-Coupon Bond

What It Is:

A zero-coupon bond is a bond that makes no periodic interest payments and is sold at a deep discount from face value. The buyer of the bond receives a return by the gradual appreciation of the security, which is redeemed at face value on a specified maturity date.

How It Works/Example:


The price of a zero-coupon bond can be calculated by using the following formula:

P = M / (1+r)n

where:
P = price
M = maturity value
r = investor's required annual yield / 2
n = number of years until maturity x 2

For example, if you want to purchase a Company XYZ zero-coupon bond that has a $1,000 face value and matures in three years, and you would like to earn 10% per year on the investment, using the formula above you might be willing to pay:

$1,000 / (1+.05)6 = $746.22

When the bond matures, you would get $1,000. You would receive "interest" via the gradual appreciation of the security.

The greater the length until a zero-coupon bond's maturity, the less the investor generally pays for it. So if the $1,000 Company XYZ bond matured in 20 years instead of 3, you might only pay:

$1,000 / (1+.05)40 = $142.05

Zero-coupon bonds are very common, and most trade on the major exchanges. Corporations, state and local governments, and even the U.S. Treasury issue zero-coupon bonds. Corporate zero-coupon bonds tend to be riskier than similar coupon-paying bonds because if the issuer defaults on a zero-coupon bond, the investor has not even received coupon payments -- there is more to lose.

For tax purposes, the IRS maintains that the holder of a zero-coupon bond owes income tax on the interest that has accrued each year, even though the bondholder does not actually receive the cash until maturity. The IRS calls this imputed interest.

Why It Matters:

Zero-coupon bonds are usually long-term investments; they often mature in ten or more years. Although the lack of current income provided by zero-coupons bond discourages some investors, others find the securities ideal for meeting long-range financial goals like college tuition. The deep discount helps the investor grow a small amount of money into a sizeable sum over several years.

Because zero-coupon bonds essentially lock the investor into a guaranteed reinvestment rate, purchasing zero-coupon bonds can be most advantageous when interest rates are high. They are also more advantageous when placed in retirement accounts where they remain tax-sheltered. Some investors also avoid paying taxes on imputed interest by buying municipal zero-coupon bonds, which are usually tax-exempt if the investor lives in the state where the bond was issued.

The lack of coupon payments on zero-coupon bonds means their worth is based solely on their current price compared to their face value. Thus, prices tend to rise faster than the prices of traditional bonds when interest rates are falling, and vice versa. The locked-in reinvestment rate also makes them more attractive when interest rates fall.

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Interest Rate Risk

What It Is:


Interest rate risk is the chance that an unexpected change in interest rates will negatively affect the value of an investment.

How It Works/Example:


Let's assume you purchase a bond from Company XYZ. Because bond prices typically fall when interest rates rise, an unexpected increase in interest rates means that your investment could suddenly lose value. If you expect to sell the bond before it matures, this could mean you end up selling the bond for less than you paid for it (a capital loss). Of course, the magnitude of change in the bond price is also affected by the maturity, coupon rate, its ability to be called, and other characteristics of the bond.

One common way to measure a bond's interest rate risk is to calculate its duration.

Why It Matters:

In general, short-term bonds are less responsive to unexpected interest rate changes than long-term bonds are. This implies that short-term bonds carry less interest rate risk than long-term bonds, and some financial theorists cite this as support for a popular hypothesis that the higher yields of long-term bonds include a premium for interest rate risk.

It is interesting to note that bond investors who intend to hold their bonds to maturity are less exposed to interest rate risk for two reasons. First, these investors are not interested in interim price movements because they intend to hold the bond until it matures. Second, the amount of principal the investor receives at maturity is unaffected by changes in interest rates. However, the buy-and-hold bond investor is still exposed to the risk that interest rates will rise above the bond's coupon rate, therefore leaving the investor "stuck" with below-market coupon payments.

Interest rate risk accounts for approximately 90% of the risk involved with fixed income investing, according to research by BARRA International. Although analysts and investors spend countless hours analyzing interest rate trends and making forecasts, there is no way to tell for sure what rates will be tomorrow.

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Investment Bank

What It Is:

An investment bank is a financial intermediary that specializes primarily in selling securities and underwriting the issuance of new equity shares to raise capital funds. This is different from a commercial bank, which specializes in deposits and commercial loans.

How It Works/Example:


Investment banks mediate between companies that issue securities and the individuals or entities wishing to purchase them. In this respect, investment banks operate along two main lines: a "buy" side and a "sell" side. "Buy" side operations include services such as securities trading and portfolio management. "Sell" side activities include underwriting new lines of stock, marketing financial products, and publishing financial research.

To illustrate an investment bank's “buy side” role in securities trading, suppose an investor wants to purchase 100 shares of company XYZ. They can solicit the services of an investment bank, where a stock broker can place an order and deliver these shares.

To illustrate an investment bank's “sell side” role as an underwriter, suppose company XYZ plans to issue new shares of stock in an initial public offering (IPO). Company XYZ can solicit an investment bank to underwrite the shares, market and sell them to their clients. This way, the investment bank raises the funds that company XYZ hopes to gain from the issue of the new shares.

Regulation becomes a key issue for investment banks, because they operate on both (and often competing) sides of the same coin. Consequently, there is significant room for conflicts of interest between the buying and selling operations. Agencies such as the SEC provide strict guidelines to help ensure that operations on the "buy" and "sell" sides do not intersect and result in unfair market practices or ethics violations.

Why It Matters:

Investment banks bring investors together with companies that issue securities and broker securities. Investment banks are also beneficial to security-issuing companies, because, while they broker the securities a company may issue, they can help raise capital funds for such companies through underwriting new stock offerings.

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