Finance Jargon that everyone needs to know

You will feel right at home in discussions involving finance after reading this 😉

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Inflation is the sustained increase in the general level of prices for goods and services. To give an example, a movie ticket in the 80’s cost about $3 and now it’s about $10, which means if you posses a $10 bill from 1980, it would buy two fewer movie tickets now than it would have nearly four decades earlier.

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Net worth

The difference between your assets and liabilities is referred to as net worth. Assets are, in simple terms, things that put money into your pocket. Liabilities are things which take away money from your pocket (something you owe). Examples of assets include stocks, bonds. Real estate and liabilities include loans, material goods like cars, mobile phones, furniture.

Net worth = Assets - Liabilities

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Credit Score

A credit score is a numeric representation of a person’s creditworthiness. It is used by lenders to assess whether a person will be able to clear off his debts.

Consider an example that you want to buy a house for $700,000 and you go to a bank to take out a mortgage. The bank checked your credit score and found out that it was 815/900. This indicates that you are most likely to pay off the whole amount without breaking a sweat and the bank trusts you in lending the money and also might offer you a lower interest rate on that.

On the contrary, let’s say your credit score is just 650/900; this means that you are a risky person in the bank’s perspective as you might not repay back the loan as you are very credit hungry.

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Equity is the ownership of any asset after any liabilities associated with the asset are cleared. For example, if you own a car worth $25,000, but you owe $10,000 on that vehicle, the car represents $15,000 in equity. Equity also means the amount of capital invested or owned by the owner of a company.

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Bonds (Debt)

In simple terms, a bond is a loan from an investor to a borrower, such as a company or government. The borrower uses the money to fund its operations, and the investor receives interest on the investment. The market value of a bond can change over time.

Consider an example where Apple as a company needs $100 to run its operations and is in short of that money. Apple can raise the money via bonds where you and me can lend that $100 to Apple in exchange of the bonds where Apple is entitled to pay us the $100 after a certain period of time (Eg. 10 Years) as well as an additional interest for borrowing money from us for that 10 year duration.

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Interest Rate

Interest rate is an additional amount paid by a borrower to a lender for using the financial asset. It is calculated as a certain percentage from the owed sum. Usually, interest is paid on an annual basis. The principal sum can be paid back either entirely at the end of the term or via monthly payments.

Let’s consider the bond example of Apple which I have mentioned before. Apple is entitled to pay me $100, which is the principle amount. Added to that Apple also needs to pay me an interest let’s say 5 % which is $5 every year until the tenure of the Bond, which is $50 as the interest amount for the 10 Years, which means after the 10 Year tenure I will receive $100 + $50 = $150. This is considering Simple Interest and there is another Interest called Compound Interest which is a bit different.

Simple Interest = Principal x Interest Rate x Time

Compound Interest = Principal x [(1 + interest rate)n — 1], where n is the number of compounding periods.

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Appreciation & Depreciation

Appreciation is an increase in the value of an asset over time. For example, a house bought in 2010 worth $500,000 might be worth $750,000 today as the value of the house appreciated over time.

Depreciation is the opposite of appreciation where in the value of the asset decreases over time. For example, a car bought 2 years ago worth $35,000 will eventually lose its value over time and will be worth $20,000 now.

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Liquidity describes how quickly your assets can be converted into cash. Because of that, cash is the most liquid asset. The least liquid assets are items like real estate or land, because they can take weeks or months to sell.

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Return on Investment (ROI)

Return on Investment is a simple calculation used to determine the expected return of an activity in comparison to the cost of the investment, typically shown as a percentage.

Let’s say you bought an iPhone worth $800 and try to sell it off to another party for $1000, your ROI would be (1000 – 800)/800 * 100 =25 %

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Amortization is the repayment of a debt in fixed, periodic payments over a period of time.

Let’s say you get a loan to buy a car, and it is to be repaid in 24 months. The bank calculates the interest that you will have to pay in that period, adds it to the principal and divides the total in 24 installments so that at the end of the 24 months you will have repaid the loan completely.

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