FICO score

A number used by banks and other financial institutions to measure a borrower’s credit worthiness. FICO is an acronym for the Fair Isaac Corporation, a company that came up with the methodology for calculating a credit score based on several factors, including payment history, length of credit history and total amount owed.

FICO scores range from 300 to 850, and the higher the score, the better the terms you may receive on your next loan or credit card. People with scores below 620 may have a harder time securing credit at a favorable interest rate.

ABNORMAL RATE OF RETURN

Definition: Abnormal rate of return or ‘alpha’ is the return generated by a given stock or portfolio over a period of time which is higher than the return generated by its benchmark or the expected rate of return. It is a measure of performance on a risk-adjusted basis.

Description: The abnormal rate of return on a security or a portfolio is different from the expected rate of return. It is the return generated by a security or a portfolio which is in excess of its benchmark or the return predicted by an equilibrium model such as capital asset pricing model (CAPM). Abnormal rate of return can either be positive or negative depending on how the security or a fund has performed in comparison to its benchmark. The normal rate of return can be a forecasted return based on model or it can be the return on an index, such as S&P BSE Sensex or 50-share Nifty index.

The abnormal return on an investment is calculated as follows (1): RAbnormal = RActual – RNormal An investment’s abnormal return could be positive or negative. It essentially measures how the stock or a fund has performed over a given period of time. Abnormal rate of return as a measure of performance is useful to investors as a valuation tool and for comparing returns to market performance (2).

Example:

Suppose a stock ABCD experiences a 30% return in a given year. Analysts expected ABCD to experience a return of 20% for that year. The (positive) abnormal rate of return ABCD is:

30% actual return – 30% projected return = 10% positive abnormal return

ABCD experience a positive abnormal return of 10% during that year.


CHATTEL MORTGAGE

Definition: Chattel mortgage is a loan extended to an individual or a company on a movable property. Here, the ‘chattel’ or the movable personal property which could be a car or a mobile home can be used as a security to extend the loan.

Description: Chattel mortgages are secured loans attached to a personal movable property which is used to extend the loan to an individual or a business owner. In the traditional setup, a loan is given to a person based on the security he/she provides which is usually in the form of land, house, etc.

But with chattel mortgage, a loan is extended to a borrower secured by ‘chattel’, in which the bank holds a lien until the entire amount is repaid. Usually, the rate of interest levied on such mortgages is lower.

Chattel mortgage generally carries a lower rate of interest, flexible payment structure, and thus proves to be better especially for business owners.

Let’s understand chattel mortgage with the help of an example. If you are a contractor involved in repairing job or construction then you would need a vehicle to carry the goods as well as construction material.

One feature of chattel mortgage which differs from consumer loan is that your bank or the mortgage company will secure the loan using the ‘chattel’ or the vehicle which you are planning to purchase. It could be a tow truck or mini-van etc.

The most important advantage to a mortgage company is that assets which are kept as security are movable and can be sold off quickly in an event of a default. Automobiles, yacht or boats, mobile homes or trailers, electronic items, and appliances are all examples of movable property.


ABANDONMENT VALUE

Definition: Abandonment value is the equivalent cash value of a project if it is liquidated immediately after reducing all debts which need to be repaid.

Description: Abandonment value is also known as liquidation value of an asset. The general rule for deciding to discontinue the product is that if the product’s salvage value is greater than the net present value (NPV) of its expected cash flows, the project is abandoned.

It is important for companies to know the profitability of a project and if it is not profitable it is better to discontinue the same. It is an important factor in bankruptcy filings where assets are generally sold at a discount.

Theoretically, the optimal economic life of an asset is 4 years, but the project’s expected cash flows may change over the life of the asset. The company should also estimate the future abandonment values in the initial investment phase. It would help the manager to effectively gauge the optimal economic life of an asset.

For example:

A company’s cost of capital is 10%, and the initial investment cost to be incurred at the beginning of the project is Rs 3,50,000. Future cash flows expected in the next 4 years are 2,00,000, 1,50,000, 10,0000 and 50,000.

Now, if we calculate the net present value of each of the cash flows and subtract it with the initial investment value, it still comes out positive, which is Rs 65,067.

Considering the fact that NPV is still greater than zero, the company should continue with the project and not exercise the option.