Glossary of Financial Terms

What are derivatives, hedge funds and lenders of last resort? Check out our glossary of financial terms.

Bailouts

A common name for the IMF-coordinated emergency rescue loans to economies in crisis. The most immediate beneficiaries of bailouts are typically foreign investors, while citizens are left holding the IMF debt bill.

Balance of payments (BOP)

the total of all international transactions undertaken by a country during a given time. Sales to foreigners are recorded as credits while purchases of goods, services or assets are recorded as debits. The BOP statement includes summaries of both the current account and the capital account.

Bank for International Settlements (BIS)

acts as a clearinghouse for transactions between the world’s central banks and draws up banking regulations. Set up in 1930, its board is controlled by developed country governments.

Capital

wealth available for input into the economy. Real capital is invested in equipment, buildings and production. Finance capital is stored in banks or invested in financial instruments. Human capital is the economic value of people’s knowledge, skills and physical work.

Capital account

the section of a country’s balance of payments statement which totals all international purchases and sales of assets including foreign direct investment, portfolio investment, bank loans, other securities and foreign currency holdings.

Capital account liberalization

the process by which countries, often at the behest of the IMF, remove restrictions on the flow of foreign capital into and out of their countries.

Capital controls

measures enacted to control foreign exchange transactions in order to manage capital flows.

Capital flows

the movement of foreign exchange from one country to another. The types of transactions used to move money internationally include : loans and loan repayments, bond issues and payments, foreign direct investment and capital repatriation, and portfolio investment such as stocks, bonds and derivatives.

Central bank

is a country’s bank, controlled by the national government. It is responsible for issuing currency, setting monetary policy, interest rates, exchange rate policy and the regulation and supervision of the private banking sector.

Conditionality

the set of conditions that must be met before creditors disburse any loans. Since the early 1980s, for example, the vast majority of IMF and World Bank loans have required recipient countries to commit to “fiscal austerity” measures which include: the privatization of state-owned enterprises, the removal of restrictions on foreign imports and investment, and the weakening of state through budget and programme cuts. These requirements are know as structural adjustment conditions.

Currency transactions tax

measures implemented at the national level to tax foreign exchange transactions with a goal of reducing volatility and volume of flows.

Current account

the section of a country’s balance of payments statement which totals international transactions for import and export payments, interest on debts, profits from foreign direct investment and aid grants. The current account is a broad measure of a country’s trade balance.(a negative current account balance = a trade deficit)

Debt standstill

the temporary cessation of debt repayments designed to allow countries to reorganize and reschedule their debt repayment obligations.

Derivatives

a type of financial instruments whose value is ‘derived’ from the price of some underlying asset (e.g. an interest level or stock market index). They are designed to help companies “hedge” (protect themselves against the risk of price changes) or as speculative investments from which great profits can be made. The rapid growth in derivatives trading has played a major part in the growing volatility of the global financial system.

Devaluation

The drop in the value of one currency relative to another. Developing countries have often been encouraged to devalue their currency as part of IMF / World Bank structural adjustment programs as a means of increasing the costs of imports and decreasing the cost of exports, thereby increasing competitiveness.

Exchange rates

The price of one country’s currency relative to another (e.g. $1 Cdn = $.67 US.) Exchange rates can be managed according to three basic systems - floating, fixed or pegged.

Fiscal policy

Government macroeconomic policy that seeks to influence general economic activity through control of taxation and government spending (see also monetary policy).

Foreign direct investment (FDI)

the purchase of land, equipment or buildings or the construction of new equipment or buildings by a foreign company. FDI also refers to the purchase of a controlling interest in existing operations and businesses (known as mergers and acquisitions). Multinational firms seeking to tap natural resources, access lucrative or emerging markets, and keep production costs down by accessing low-wage labour pools in developing countries are FDI investors. Classic examples of FDI include American banks taking over Korean ones or Canadian mining companies building mines in Brazil. (see also portfolio investment)

Foreign exchange

is currency issued by a foreign government. Foreign exchange is required to pay for imported goods and to meet foreign debt repayment obligations. Most of the trade in foreign currencies occurs between large international banks. Unlike stock markets, the “foreign exchange market” does not exist in any specific location.

G-20

is a group composed of the Finance Ministers and central bankers of the following 20 countries: Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, the United Kingdom, the United States and the European Union. The IMF and the World Bank also participate. The G-20 was set up to respond to the financial turmoil of 1997-99 through the development of policies that “promote international financial stability”.

Globalization

refers to the increasing economic integration and interdependence of countries. Economic globalization in this century has proceeded along two main lines: trade liberalization (the increased circulation of goods) and financial liberalization (the expanded circulation of capital).

Hedge fund

This is a private, unregulated investment fund for wealthy investors (minimum investments typically begin at US$1 million) specializing in high risk, short term speculation on bonds, currencies, stock options and derivatives.

Hedging

the purchasing of foreign exchange in anticipation of future price changes. Hedging is an increasingly necessary business expense in times of high exchange rate volatility.

Herd behavior

the tendency of investors behave as a pack in response to rumoured market changes. This leads to panic in moments of crisis and the sudden withdrawal of enormous quantities of investment from countries suddenly perceived to be vulnerable to collapse(a phenomenon known as capital flight).

IMF (International Monetary Fund)

an international organization established in 1944 to provide short term financial assistance to countries needing to stabilize exchange rates of alleviate balance of payments difficulties. Since the 80’s the IMF has becoming increasingly involved in the economic decision-making of nations through the conditionality associated with its loans.

International financial architecture

a catchall phrase for the policies, programmes and institutions required to manage the increasingly globalized world of finance.

Lender of last resort

an institution, usually a central bank, that can step in and lend funds to a bank facing a panic (sudden withdrawal of funds by depositors) or when no other institutions will lend to an institution considered high-risk or near collapse.

Liquidity

the availability of sufficient resources to meet payments and obligations needs.

Monetary policy

government macroeconomic policy that seeks to influence general economic activity by controlling credit and interest rates and the domestic money supply (i.e. the amount of currency in circulation).

Moral hazard

a term based on the principle that if actors are allowed to escape the consequences of their risky actions, they are more likely to engage in reckless behavior in future. The moral hazard argument is often used to argue against the forgiveness of legally contracted debt; it has also been used to criticize IMF rescue packages, which bail out reckless bankers and private investors.

Mutual fund

a collection of stocks, bonds or other securities owned by a large group of often-small investors and managed by a professional fund manager.

Pension fund

Like a mutual fund, except that the investors are long-term and bound by some common workplace affiliation (such as a union). In many countries, pension funds represent the largest single institutional investors.

Portfolio investment

refers to the purchase of foreign stocks, bonds or other securities. In contrast to FDI, foreign portfolio investors have no controlling interest in the investment, which is typically a short-term one. The relative ease with which portfolio investment can enter and exit countries has been a major contributing factor to the increasing volatility and instability of the global financial system.

Reserves

the amount that banks are legally required to keep ‘on hand’ to meet short-term repayment obligations (for instance, if a large percentage of depositors suddenly decide to withdraw their money). The amount banks are required to keep in reserve varies by country and has generally declined over time through the process of financial liberalization.

Securities

These are financial instruments (such as bonds or stocks) that can be traded freely on the open market. ‘Securitization’ refers to the pooling of loans or assets for subsequent sale to investors.

Speculation

the act of betting on changes in exchange rates in hopes of profiting. A speculative “attack” occurs when a large number of investors anticipate a reduction in currency values and sell off large quantities of their holdings (thereby often creating the price crash they predicted). Speculators often work for major banks and investment firms.

Tobin tax

a proposal by Nobel-prize winning economist James Tobin to place a small tax on all foreign exchange transactions as a means of stabilizing currency markets. Tobin’s tax would also generate hundreds of billions of dollars annually.

Trillion

How much is a trillion? A million dollar pile of stacked $100 dollar bills would be 2 metres tall; a one trillion dollar pile would be over 40 times the height of Mt. Everest.

Volatility

the tendency of financial markets to change abruptly at the whims of investors. As national control over financial markets fall as a result of capital account liberalization and the volume of portfolio investment skyrockets, volatility is increasing in financial markets. While unstable markets are profitable for speculators (see speculation), the real economy cannot function properly when exchange rates are fluctuating wildly and capital is flowing in and more often out, of a country in tidal waves.