Dictionary

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Letter A

• Aliquot interest return

  Bonds are normally bought exactly one period before the first coupon payment. This results in two problems. This affects the discount period in the case of each cash flow and this represents a daily problem of "accrual" of interest for the bondholder.

  The buyer of a bond therefore pays the agreed price of the bond plus the accrued interest or the aliquot interest return.

• Allocation effectiveness

  Financial markets should operate in such a way as to allocate savings to the most productive companies, i.e. so that they are allocated effectively. Such opportunities are attractive for individual investors, as they lead to maximum profit at minimum risk.

  If the managers of a financial institution invest creditors funds into companies with a low yield or a high rate of risk, then investors re-invest their funds, increase the price that they demand for the funds (i.e. increase the interest rates) or limit the investments made by the financial institutions into certain companies on their behalf.

• American depositary receipts

  American depositary receipts (ADR) are part of the GDR group. They are traded only on stock exchanges in the US.

  ADRs were the first to originate, with the term GDR being used when the receipts began to be traded outside the US.

  Their popularity among US investors is based on the fact that trading with ADRs is conducted in the same manner as trading with US shares. Trade settlement is also conducted pursuant to US regulations.

• Annuity

  The term annuity (from the Latin annuus – annual) is a constant stream of fixed payments over a contractually specified period of time.

  These payments comprise the principal and interest..Their amount remains unchanged in the elected period; only the ratio of the payment (annuity) and interest changes steadily, with the ratio of interest to the paid principal is higher in the beginning. At the end of the period, this ratio falls.

• Arbitrage

  This is a process that ensures that equilibrium is attained between identical securities i.e. securities with the same (risk/return) profile, which are being sold at the same price (the one price law). If two such securities are being sold at two differing prices (e.g. CZK 1100 and CZK 1120), then it can be expected that there will be demand for the cheaper security. The increase in demand will lead to an increase in its price, until the time when equilibrium is attained.

  If there are any arbitrage opportunities available, then prices are not in equilibrium. Arbitrage profit ceases to exist when the transaction costs associated with the purchase of the cheaper security and the sale of a more expensive security exceed the difference in the prices of both securities (i.e. CZK 1120 – CZK 1100).

  Transaction costs result in the imprecise application of the one price law. The lower the transaction costs are, the more effective the market mechanism will be.

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