Investment related terms
CAGR
The cumulative average growth rate (CAGR) is the average rate at which an investment (or anything else) changes by assuming compounding effects, e.g. if an investment doubles in 5 years (100% growth), then the CAGR would be 14.86% per year rather than 20%
Compound interest
Compound interest is the amount of money earned on a given amount of money with compounding effects. E.g. if ₹1,00,000 is invested at 10% a year for 5 years, then the total interest year is ₹61,051 vs ₹50,000 for simple interest. However, in the case of simple and compound interest, the interest in the first year would be ₹10,000 as no compounding takes place in the first year in this example. Compounding can happen in any time period, e.g. daily, weekly, monthly etc, and this will affect the future value.
Future value
The future value is the estimated value of an investment in the future for a given period of time and growth. Here, compounding is implicitly assumed, e.g. if an investment of ₹10,000 grows at a rate of 15% for 5 years, its future value would be ₹20,113.57
Internal rate of return
The internal rate of return (IRR) is the discount rate of a given series of cashflows that take place in regular intervals of time such that their net present value is equal to 0. The IRR tells us what the minimum threshold of an investment should be in order for it to be considered, e.g. if the IRR defined by a person is 10%, then only investments which have an IRR larger than 10% would be considered.
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The IRR can be used to compute the returns on SIPs and other investments but it neglects "when" these cashflows take place. If its a yearly SIP, IRR can be used accurately but it's a simplification if the periods are irregular and conceals the real picture. For irregular periods and more accuracy, XIRR should be used.
Lumpsum investment
A lumpsum investment is when an amount of money is invested directly in some instrument like shares, bonds, fixed deposits, gold, etc at a point of time, e.g. ₹10,00,000 is invested on 12.1.24.
Net present value
Money has time value associated with it. The value of income received (from investments, a business project etc) in the future has a lower value than the same amount received today. In other words, the value of money today is more than the value of money in the future. The net present value (NPV) is the sum of the present value of the cash outflow and all expected cash inflows. It is calculated by discounting the cashflows with a discount rate. The larger the discount rate, the lower the value of money in the future is. If the NPV is positive, the series of cashflows (an investment with one or more cash inflows) is profitable. If a project or investment has a negative NPV, it means that the investment has lost money. The NPV is affected by the cashflows and the discount rate. If the NPV of two projects/investments is equal, then the duration should be looked at as well since realistically, a project which is profitable in a shorter period of time is better.
Present value
The present value (PV) is the value that money has in the current moment. In other words, ₹100,000 can buy goods today worth ₹100,000. But at a discount rate equal to 10%, it would only be able to buy goods worth ₹90,909,09 1 year in the future. You can use this formula to calculate the equivalent purchasing power of money over time due to inflation, or the value of an expected income based on today's terms.
Simple interest
Simple interest is the amount of money earned on a given amount of money without compounding effects. E.g. if ₹1,00,000 is invested at 10% a year for 5 years, then the interest per year is ₹10,000. In the case of compound interest, the interest in the first year would also be ₹10,000 but would be larger for other years due to compounding effects.
SIP
An SIP, or systematic investment plan, refers to the process of regularly investing an amount of money in pre-determined time intervals, e.g. a person invests ₹20,000 every month into a mutual fund. The process is usually automated (direct debits from bank account) but a person could also manually do a series of "lumpsums" at fixed periods of time.
XIRR
The extended internal cash flow (XIRR) calculates the average annualised return on an investment. Unlike CAGR (which only considers the initial and final value between 2 points of time), XIRR considers all in- and outflows along with their dates which makes it ideal for computing returns on an investment that happens at different points of times such as SIPs. Note: Currently this feature is not offered and is in development.
Loan related terms
Duration
The duration of a loan is the length of time for which a loan is held. The duration can be calculated mathematically for a given interest rate, amount and EMI.
EMI
An EMI, or equated monthly instalment, refers to a constant monthly payment made to a lender. This term is used when a loan is paid back in instalments over a period of time.
Interest
When referring to a loan, interest can be understood as the "income" of the lender in return of giving out a loan. The interest is basically the cost that the borrower bears in return of receiving a sum of money to buy something. Interestingly, the interest of certain types of loans offer a tax benefit under certain conditions to the borrower. Therefore, while preparing a business case to asses buying outright vs on loan, the tax benefit should be considered.
Interest amount
Loans get repaid in EMIs. The EMI consists of two parts - the interest and principal amount. The interest amount is the amount of an EMI in a given period that goes towards repaying the interest due on a loan in the period. Over time, the interest amount of the EMI decreases, while the principal amount increases.
Monthly interest rate
The monthly (or daily, weekly, quarterly, half-yearly, or yearly) interest rate is the interest rate that applied for a month (or day, week, quarter, half-year, or year respectively). The conversions from a smaller (e.g. monthly) frequency to a larger (e.g. yearly) frequency can be done by means of a simplification which neglects compounding or by considering compounding. A monthly interest rate that uses compound interest results in a larger interest rate than one that uses simple interest. Over small periods of time (and/or small quantities) the effects are negligible but over longer periods of time and with larger amounts, the differences become very noticeable.
Mortgage
A mortgage involves money being borrowed for a purpose and a property being given as collateral. A home loan can therefore be understood to be a type of mortgage.
Principal
When referring to loans, the principal is the amount of money borrowed in a loan.
Principal amount
Loans get repaid in EMIs. The EMI consists of two parts - the interest and principal amount. The principal amount is the amount of an EMI in a given period that goes towards repaying the principal of a loan in the period. Over time, the principal amount of the EMI increases, while the principal amount decreases. Visualise the effects over time in this calculator
Prepayment
Most loans are repaid in the form of EMIs. Some lenders allow borrowers to pay more than the agreed upon EMI (some allow it freely, some allow it under certain conditions; the rules can be found in the loan documents). Suppose, the EMI is 30,000 per month, and a user pays 75,000 in a given month, then the excess or 45,000 can be viewed as a prepayment or faster loan repayment. The impact can be significant especially if this is done early in the loan duration, leading to significant savings in money and a shorter loan repayment duration. View the effects of this in this calculator.
Rate
The rate refers to the interest rate applied on a loan for a given unit of time. If a yearly rate of12% is mentioned, then the monthly rate is 1% if simple interest is applied or 0.948879% if monthly compounding occurs. Understanding how the rate is applied can make a big difference to a loan as the duration for large amounts is typically in years or decades. Conversely, 1% compounding monthly implies a yearly rate of 12.682503% if monthly compounding occurs. When a yearly rate is divided by 12 months, it is a simplification if compounding actually happens, e.g. on a monthly other basis.
Investment products and terminology
Bonds
Bonds are fixed income instruments. Typically governments or corporates issue bonds to or borrow money from people, countries, companies etc and pay them a fixed interest rate in return. Some types of bonds may have tax advantages associated with them. Bonds are also typically rated to reflect their risk (e.g. risk of default). The higher the risk, the higher the interest rate offered. Risk is rated in different notations by different assessors, e.g. AAA, A, AA, A+ etc
Debt
With regard to personal finance, being in debt implies that a person has borrowed money from or owes money to someone else and may be paying a certain interest rate on that loaned amount. With regard to investments, debt refers to investors lending or giving money to others (corporates, governments, etc) in return for income in the form of interest.
Equity
Equity investments are those investments done by buying shares of listed companies. Equity and stock investments can be understood to be synonyms for each other.
Futures
Futures are derivative investment products which can be bought (long) or sold (short) by investors. The price of the future is derived from the price of the stock it tracks (underlying) and can quote at a premium (more than) or discount (less than) the underlying. Futures are high risk investment products as one can take significantly larger positions with a smaller sum of money. This has a magnifying effect on both profits and losses and needs to be treated with caution.
Greeks - Delta
Delta is the rate of change in the option price for a unit change in the underlying price, i.e. by how much does the option price change if the underlying increases or decreases by 1 unit, if all other variables such as time, volatility etc are kept constant
Greeks - Gamma
Gamma is the rate of change of delta for a unit change in the underlying price. It tells us by how much the delta will change if the price changes by 1 unit with all other influencing variables like time, volatility, etc are kept constant
Greeks - Rho
Rho is the sensitivity of the option price to the risk free interest rate.
Greeks - Theta
Delta is the rate of change in the option price for a unit change in time, i.e. by how much does the option price change if time changes by 1 unit, e.g. 1 day, if all other variables such as price, volatility, etc are kept constant
Greeks - Vega
Vega is the rate of change of option price for a change in volatility. A rapid rise in volatility can lead to large mark-to-market losses on short options
Implied volatility
The implied volatility is the volatility of an option that is calculated by using option price and other inputs such as underlying price, strike price, days to expiry, and the interest rate as an input and reverse solving for the variable volatility. The calculation involves using an iterative process such as Newton Raphson's method etc.
Options
There are different classes of options, e.g. American, European etc. In this website, we consider European options and within that calls and puts. Each call or put can be bought or sold.
A call option is a contract which gives the buyer the right to buy the option at a particular price (strike price) in return of paying a certain price (premium). Conversely, the seller of a call is obligated to sell at the strike price. The risk of the buyer is limited to his premium while that of the seller is theoretically unlimted.
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A put option is a contract which gives the buyer the right to sell the option at a particular price (strike price) in return of paying a certain price (premium). Conversely, the seller of a put is obligated to buy at the strike price. Like with calls, the risk of the buyer is limited to his premium while that of the seller is unlimted.
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There are many different models to calculate the price of an option. On this website, we use Black Scholes method and neglect the impact of dividends.
Payoff
The payoff curve refers to a graph which maps out the profit and loss of an investment. The payoff curve can change its shape depending on what instruments are being considered, e.g. the payoff curve for buying 100 shares of a company is a straight line with a constant slope of 45°. Other products (or combinations) will have different shapes.
Business terms
Consumption tax (VAT, GST)
A consumption tax is a tax that is charged on users who use, buy, consume etc a product or service. There are many types of consumption taxes. In this website, we compute the effects of VAT and/or GST on the price of a product.
Depreciation
Depreciation is the rate at which an asset loses its value. e.g. a new machine , mobile, or car is worth less in the future due to wear and tear. While many assets depreciate, some can be claimed as tax benefits, usually by companies. There are different ways to depreciate a product. This site currently offers a calculator for the straight line method but more calculators are in the pipeline.
Commission
Many companies sell products via dealers, agents etc, e.g. an FMCG may sell its products via distributors, who in turn sell to wholesalers who may sell to retailers. The fee that each such parties takes is called commission. There are different forms of commission, e.g. when buying a house or a piece of art, using a payment service etc.
Inflation
Inflation is basically the rate at which money loses its purchasing power, e.g. ₹1,000 after a year will buy less than it can today if inflation is positive. Inflation is a vast topic and is influenced by various things such as political decisions, monetary decisions, war, natural catastrophes, etc. What's important to know is that even when inflation goes down, e.g. from 6 % to 4%, money still loses value, just at a slower pace than before.