Interest: Financial Terms Related To Interest

Financial Terms related to Interest
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INTEREST
Accrued interest
• Is the amount of interest which has accumulated since the last coupon interest
payment. It is the amount of interest which the holder is entitled but is not due until
the payment date. The buyer pays the seller of the bond the accrued interest.
• The accumulated coupon interest earned but not yet paid to the seller of a bond by
the buyer (unless the bond is in default).
• Interest due from issue or from the last coupon date to the present on an interest-
bearing security. The buyer of the security pays the quoted dollar price plus accrued
interest.
Amortizing interest rate swap
• Swap in which the principal or national amount rises (falls) as interest rates rise
(decline).
Base interest rate

www.ftpall.com 2|Page
• Related: Benchmark interest rate.
Benchmark interest rate
• Also called the base interest rate, it is the minimum interest rate investors will
demand for investing in a non-Treasury security. It is also tied to the yield to maturity
offered on a comparable-maturity Treasury security that was most recently issued (
on-the-run ).
Best interests of creditors test

• The requirement that a claim holder voting against a plan of reorganization must
receive at least as much as he would have if the debtor were liquidated.
Capitalized interest
• Interest that is not immediately expensed, but rather is considered as an asset and
is then amortized through the income statement over time.
Cash flow after interest and taxes
• Net income plus depreciation.
Compound interest
• Interest paid on previously earned interest as well as on the principal.
• Interest that is credited on both principal and previously credited interest.
Compounded interest
• Interest earned on a given deposit that has become part of the principal at the end
of a specified period.
Covered interest arbitrage
• A portfolio manager invests dollars in an instrument denominated in a foreign

currency and hedges his resulting foreign exchange risk by selling the proceeds of
the investment forward for dollars.
• Investing dollars in an instrument denominated in a foreign currency and hedging

the resulting foreign-exchange risk by selling the proceeds of the investment forward
for dollars.
Earnings before interest and taxes
• Abbreviated EBIT. A financial measure defined as revenues less cost of goods sold
and selling, general, and administrative expenses. In other words, operating and
non-operating profit before the deduction of interest and income taxes.
Earnings before interest, taxes, depreciation, and amortization

• Although it is not defined by GAAP, EBITDA can be used to analyze a company's
profitability. Differs from a Cash Flow statement by excluding changes in working
capital and payments for taxes and interest. Calculated by adding Net Income,
income taxes, Interest, Depreciation, and Amortization.
Effective annual interest rate
• An annual measure of the time value of money that fully reflects the effects of
compounding.
Effective interest rate international context
• The rate equal to the nominal rate plus (or minus) any forecast appreciation (or
depreciation) of a foreign currency relative to the currency of the MNC parent.
Equilibrium rate of interest
• The interest rate that clears the market. Also called the market-clearing interest
rate.
Forward interest rate
• Interest rate fixed today on a loan to be made at some future date.
Future value interest factor
• The multiplier used to calculate at a specified interest rate, the future value of a
present amount as of a given time.
Future value interest factor for an annuity
• The multiplier used to calculate the future value of an ordinary annuity at a

specified interest rate over a given period of time.
Gross interest
• Interest earned before taxes are deducted.
Guaranteed investment interest contract

• Abbreviated GIC. Debt instrument sold in large denominations often bought for
retirement plans. The word guaranteed refers to the interest rate paid on the GIC;
the principal is at risk.
Indication of interest
• Occurs when a client states his or her interest in purchasing a new issue before its
effective date. This interest is non-binding.
Interest
• Is either the interest rate or the income from a credit instrument.
• The return paid on debt financing. Interest income is taxable in the hands of the
investor at their personal marginal tax rate. Interest expense is usually a tax-
deductible expense of the corporate borrower.
• The charge for the privilege of borrowing money, usually expressed as an annual
percentage rate.
• The price paid for borrowing money. It is expressed as a percentage rate over a
period of time and reflects the rate of exchange of present consumption for future
consumption. Also, a share or title in property.
Interest calculations and related formulas

• Are quite varied yet interrelated. Some of the standard computations are:
 Interest Compounded Annually
 Interest Compounded Continuously
 Interest Discounted Annually (Present Value of Reversion)
 Interest Discounted Continuously
 Interest Impact on Accumulation of 1 Per Period
 Interest Impact on Instalment to Amortize or Amortization

 Interest Impact on Present Value of Ordinary Annuity of 1 Per Period
 Interest Impact on Sinking Fund Factor
These formulae are predicated on calculating values basis 1 unit of currency. Here,
it is one dollar. To adjust for other amounts such as five hundred or one thousand
dollars then multiply the resulting factor by 500 or 1,000, respectively. By solving for
the appropriate factor based on 1.0000 simplifies the analysis and verification
process.
Interest compounded annually
• Is calculated by the following formula:
Amount = (1 + interest rate)t where i is the interest rate and t is expressed decimally
(.05 for 5 percent). Also, t is the time and .5 refers to 1/2 of a year, 2 equals 2 years
and 7.75 equals 7 3/4 years.
Interest compounded continuously
Amount = eit where e is equal to 2.7183, i is the interest rate and t is expressed
decimally (.05 for 5 percent). Also, t is the time and .5 refers to 1/2 of a year, 2
equals 2 years and 7.75 equals 7 3/4 years.
Interest coverage
• The number of times all interest charges are earned by pre-tax, pre-interest
earnings, typically at least 3 times. The formula is the Interest expense plus pre-tax
income , and divide this sum by the interest expense.
Interest coverage ratio
• The ratio of the earnings before interest and taxes to the annual interest expense.
This ratio measures a firm's ability to pay interest.

Interest coverage test
• A debt limitation that prohibits the issuance of additional long-term debt if the
issuer's interest coverage would, as a result of the issue, fall below some specified
minimum.
Interest discounted annually present value of reversion
Amount = (1 + interest rate)-t or, Amount = __1___ (1 + i)t where i is the interest rate
and t is expressed decimally (.05 for 5 percent). Also, t is the time and .5 refers to
1/2 of a year, 2 equals 2 years and 7.75 equals 7 3/4 years.
Interest discounted continuously
Amount = e-it where e is equal to 2.7183, i is the interest rate and t is expressed
Interest equalization tax
• Tax on foreign investment by residents of the U.S. which was abolished in 1974.
Interest equivalent factor
• A tax-related adjustment that must be made that allows the before-tax dividend
yield on equity securities to be compared to the before-tax yield on debt securities.
Interest impact on accumulation of 1 per period
Amount = [(1+i)t-1]/i where i is the interest rate and t is expressed decimally (.05 for
5 percent). Also, t is the time and .5 refers to 1/2 of a year, 2 equals 2 years and
7.75 equals 7 3/4 years.
Interest impact on instalment to amortize or amortization

Amount = _____i_____ [ 1 -(1/1+i)t ] where i is the interest rate and t is expressed

Interest impact on present value of ordinary annuity of 1 per period
Amount = 1 -[1/(1+i)t] i where i is the interest rate and t is expressed decimally (.05
for 5 percent). Also, t is the time and .5 refers to 1/2 of a year, 2 equals 2 years and
7.75 equals 7 3/4 years.
Interest impact on sinking fund factor
Amount = ___i___ z(1+i)t-1 where i is the interest rate and t is expressed decimally
(.05 for 5 percent). Also, t is the time and .5 refers to 1/2 of a year, 2 equals 2 years
and 7.75 equals 7 3/4 years.
Interest on interest
• Interest earned on reinvestment of each interest payment on money invested. See:

compound interest.
Interest only
• Is a security whose value is predicated on a discounted interest rate structure.

Typically, this is a CMO type derivative product. Prepayment activity is a dominant
evaluation factor.
Interest only strip
• Abbreviated IO. A security based solely on the interest payments form a pool of
mortgages, Treasury bonds, or other bonds. Once the principal on the mortgages or
bonds has been repaid, interest payments stop and the value of the IO falls to zero.

Interest payments
• Contractual debt payments based on the coupon rate of interest and the principal
amount.
Interest rate
• The cost of money. The greater the risk of the debt security, the higher the interest
rate lenders will require. The compensation paid by the borrower of funds to the
lender; from the borrower's point of view, the cost of borrowing funds.
• This is the cost of borrowing. If the interest rate is 10% and you borrow $1,000,
then $100 must be paid as interest payments at the end of each year.
• Is either the coupon or floating rate attached to a credit instrument or lending

operation.
Interest rate agreement
• An agreement whereby one party, for an upfront premium, agrees to compensate

the other at specific time periods if a designated interest rate (the reference rate) is
different from a predetermined level (the strike rate).
Interest rate buydowns
• One form of government incentive used to encourage corporate capital

expenditures involving Government payments of interest on a loan on behalf of a

company.
Interest rate cap
• Also called an interest rate ceiling, an interest rate agreement in which payments
are made when the reference rate exceeds the strike rate.
Interest rate ceiling
• Related: interest rate cap.

Interest rate exposure
• Risk of gain or loss to which an institution is exposed due to possible changes in

interest-rate levels.
Interest rate floor
• An interest rate agreement in which payments are made when the reference rate
falls below the strike rate.
Interest rate on debt
• The firm's cost of debt capital.
Interest rate parity theorem
• Interest rates in different countries are generally different because of the

differences in inflation rates. Interest rate parity holds if the differences in interest
rates are exactly offset by differences in inflation rates and the resulting currency
depreciation. Assume that the risk-free interest rate in the US is 5% and in Mexico
15%. Assume that it takes 10 pesos to USD now and one-year forward price is
10.952381 MP/USD. If you invest $1000 now, next year, you end up with $1050
USD. If you convert $1000 into pesos now, you end up with 10,000 MP, lend them at
15%, and end up with 11,500 MP, convert them back into USD at the forward price
of 10.95, you end up with exactly $1050 USD next year, which is exactly the same
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as if you lent in the US. This is an example of interest rate parity.
• Interest rate differential between two countries is equal to the difference between
the forward foreign exchange rate and the spot rate.
Interest rate risk
• The chance that interest rates will change and thereby change the required return
and bond value. Rising rates, which result in decreasing bond values, are of greatest
concern.

• The risk that a security's value changes due to a change in interest rates. For
example, a bond's price drops as interest rates rise. For a depository institution, also
called funding risk, the risk that spread income will suffer because of a change in
interest rates.
• The risk of changes in value due to changes in interest rate is called interest rate
risk. Long lived assets lose more of their value when interest rates rise than short
lived assets. If a bank has more long-lived assets than liabilities, then the bank
worries about interest rate increases.
• Is the risk associated with changes in general interest rate levels or yield curves.
This compares to Prepayment Risk.
Interest rate risk management
• If a bank expects a rise in interest rates, it increases the maturity of its liabilities
and decreases the maturity of its assets. If a bank expects the interest rates to
remain the same or decline, it holds more long term assets than liabilities.
Interest rate swap
• An exchange by borrowers or asset holders of interest-rate payments at two

different rates (often one rate is fixed, the other floating). In a basis swap, both rates
are floating.
• The buyer of the swap agrees to make a number of fixed interest rate payments
periodically to the seller on some agreed upon notational amount. In return, the
seller agrees to make floating rate interest payment on the same dates to the buyer
on the same notational amount.
• A binding agreement between counterparties to exchange periodic interest

payments on some predetermined dollar principal, which is called the notional
principal amount. For example, one party will pay fixed and receive variable.
• Is the contract whereby one party typically agrees to exchange a floating rate for a
fixed coupon rate. There are many variations to this theme. Some of these other

swaps can be cross border, fixed-for-fixed, or floating-for floating. The common
denominator to these transactions is the swapping of cashflows and not principal
amounts. There are predetermined periodic adjustments in cash flow payments.
Interest subsidy
• A firm's deduction of the interest payments on its debt from its earnings before it
calculates its tax bill under current tax law.
Interest tax shield
• The reduction in income taxes that results from the tax-deductibility of interest
payments.
Minority interest
• An outside ownership interest in a subsidiary that is consolidated with the parent

for financial reporting purposes.
Net interest margin
• A ratio used for evaluating management for bank stocks. Measures the difference
between interest paid and interest collected.
• Is the difference between the interest revenue and the interest expense.
Sometimes, it is referred to as the spread.
Nominal interest rate
• The interest rate unadjusted for inflation.
Nominal interest rate international context
• The stated interest rate charged on financing when only the MNC parent's currency
is involved.
Nominal rate of interest
• The actual rate of interest charged by the supplier of funds and paid by the

demander.
Open interest
• The total number of derivative contracts traded that not yet been liquidated either
by an offsetting derivative transaction or by delivery. Related: liquidation
• Is the amount of open contracts for the futures and options markets. This amount
can fluctuate throughout the day and day-by-day. It represents the quantity of
contracts which are subject to offset by either liquidation of long positions, covering
of short positions or making and taking delivery. Sometimes referred to as
commitment or open commitment.
Pooling of interests
• An accounting method for reporting acquisitions accomplished through the use of

equity. The combined assets of the merged entity are consolidated using book
value, as opposed to the purchase method, which uses market value. The merging
entities' financial results are combined as though the two entities have always been
a single entity.
Present value interest factor
• The multiplier used to calculate at a specified discount rate the present value of an
amount to be received in a future period.
Present value interest factor for an annuity
• The multiplier used to calculate the present value of an annuity at a specified

discount rate over a given period of time.
Rate of interest
• The rate, as a proportion of the principal, at which interest is computed.
Real interest rate
• The real interest rate is the interest rate that would prevail in an economy with no

inflation and no risk. Real interest rate is determined by the propensity to save
(supply of funds) and by the demand for capital. Real interest rate equals nominal
interest rate minus expected inflation.
• The rate of interest excluding the effect of inflation; that is, the rate that is earned in
terms of constant-purchasing-power dollars. Interest rate expressed in terms of real
goods, i.e. nominal interest rate adjusted for inflation.
Real rate of interest
• The rate that creates an equilibrium between the supply of savings and the
demand for investment funds in a perfect world, without inflation, where funds
suppliers and demanders have no liquidity preference and all outcomes are certain.
Short interest
• The total number of shares of a security that have been sold short by customers
and securities firms. See also: Short Selling.
• This is the total number of shares of a security that investors have borrowed, then
sold in the hope that the security will fall in value. An investor then buys back the
shares and pockets the difference as profit.
Simple interest
• Interest calculated only on the initial investment. Related: compound interest.

Spot interest rate
• Interest rate fixed today on a loan that is made today. Related: forward interest
rates.
Stated annual interest rate
• The interest rate expressed as a per annum percentage, by which interest payment
is determined.
Swap interest rate

• The buyer of the Swap agrees to make a number of fixed interest rate payments
periodically to the seller or some agreed upon notional amount. In return, the seller
agrees to make floating rate interest payment on the same dates to the buyer on the
same notional amount. By entering into the swap, both parties attempt to hedge their
interest rate exposures.
Term structure of interest rates
• The relationship between the interest rate or rate of return (as measured by the
yield to maturity on a bond) and the time to maturity for similar risk debt securities.
• Relationship between \interest rates on bonds of different maturities usually

depicted in the form of a graph often depicted as a yield curve. Harvey shows that
inverted term structures (long rates below short rates) have preceded every
recession over the past 30 years.
Term structure of interest rates and volatility
• Refers to the variability of short-term rates relative to longer-term rates. It has been
documented that short-term rates exhibit greater variability or volatility than long-
term rates. However, longer-term instruments experience greater price sensitivity
than short-term instruments for a given change in the underlying rate. A quick
measure of this price sensitivity is provided by duration. Typically, debt instruments
without option features, explicit or implicit, have greater duration with longer
maturities. Zero coupon securities tend to have the greater price sensitivity relative
to coupon paying securities. See Duration.
Times interest covered
• Times Interest Covered refers to the earnings before interest and taxes (EBIT)
divided by the interest payments. Higher interest coverage makes the firm less risky.
Times interest earned ratio
• Measures the firm's ability to make contractual interest payments. Sometimes

called the interest coverage ratio.
• Earnings before interest and tax, divided by interest payments.
True interest cost
• For a security such as commercial paper that is sold on a discount basis, the
coupon rate required to provide an identical return assuming a coupon-bearing
instrument of like maturity that pays interest in arrears.

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Financial Terms related to Interest

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This document can be copied and distributed freely

Find thousands of financial terms at www.ftpall.com

Amortizing interest rate swap

Base interest rate

• Related: Benchmark interest rate.

Benchmark interest rate

Best interests of creditors test

Find thousands of financial terms at www.ftpall.com

Cash flow after interest and taxes

• Net income plus depreciation.

• Interest paid on previously earned interest as well as on the principal.

• Interest that is credited on both principal and previously credited interest.

Covered interest arbitrage

• A portfolio manager invests dollars in an instrument denominated in a foreign

• Investing dollars in an instrument denominated in a foreign currency and hedging

Earnings before interest and taxes

Earnings before interest, taxes, depreciation, and amortization

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Effective annual interest rate

Effective interest rate international context

Equilibrium rate of interest

Forward interest rate

• Interest rate fixed today on a loan to be made at some future date.

Future value interest factor

present amount as of a given time.

Future value interest factor for an annuity

• The multiplier used to calculate the future value of an ordinary annuity at a

• Interest earned before taxes are deducted.

Guaranteed investment interest contract

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• Is either the interest rate or the income from a credit instrument.

Interest calculations and related formulas

 Interest Compounded Annually

 Interest Compounded Continuously

 Interest Discounted Annually (Present Value of Reversion)

 Interest Discounted Continuously

 Interest Impact on Accumulation of 1 Per Period

 Interest Impact on Instalment to Amortize or Amortization

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 Interest Impact on Sinking Fund Factor

Interest compounded annually

• Is calculated by the following formula:

Interest compounded continuously

• Is calculated by the following formula:

Interest coverage ratio

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Interest discounted annually present value of reversion

• Is calculated by the following formula:

Interest discounted continuously

• Is calculated by the following formula:

Interest equalization tax

Interest equivalent factor

yield on equity securities to be compared to the before-tax yield on debt securities.

Interest impact on accumulation of 1 per period

• Is calculated by the following formula:

Interest impact on instalment to amortize or amortization

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Amount = _____i_____ [ 1 -(1/1+i)t ] where i is the interest rate and t is expressed

Interest impact on present value of ordinary annuity of 1 per period

• Is calculated by the following formula:

Interest impact on sinking fund factor

Amount = _i_ [ 1 -(1/1+i)t ] where i is the interest rate and t is expressed