Finance Terms

Economic Hedge vs. Accounting Hedge When financial institutions manage risk, they often use derivatives and other tools to protect themselves from market movements. Two key concepts in this area are economic hedges and accounting hedges . While they both aim to reduce risk, they differ significantly in how they are treated on financial statements. Economic Hedge Definition: An economic hedge is a real-world strategy to reduce risk, regardless of whether it qualifies for special accounting treatment. Key Traits: Risk reduction is real: The institution is actively managing exposure, such as to interest rate changes. No special accounting designation needed: Even without hedge accounting treatment, the strategy serves its purpose economically. P&L volatility possible: Since the derivative’s fair value changes go through earnings, while the hedged item may not (or its fair value changes aren't recognized concurrently), volatility can arise on the income st...

Reciprocal Deposits Reciprocal deposits are a way for community banks to keep large customer deposits while making sure those deposits are fully covered by FDIC insurance. Here’s how it works: When a customer puts a large amount of money into a local bank, that amount may go over the FDIC insurance limit ($250,000 per depositor, per bank). To protect the full amount, the bank can use a reciprocal deposit network. Through this system, the bank places the excess funds into other banks in the network. In return, those banks place an equal amount of deposits back into the original bank. The customer’s money is now spread out across multiple banks, but from their point of view, it looks like one safe, insured deposit. For example, let’s say a small business wants to deposit $1 million at a local bank. The bank uses a reciprocal deposit program to divide that $1 million into smaller amounts and places them in partner banks. Each portion is under the FDIC limit, so the entire $1 milli...

Brokered Deposits Brokered deposits are funds that a bank receives through a third party, usually a deposit broker or financial advisor. Instead of coming directly from the bank’s own customers, these deposits are gathered from clients across the country who are looking for high interest rates. For example, a small community bank may want to quickly raise money to support new loans. Instead of waiting for local customers to deposit funds, the bank can offer a high interest rate and work with a broker to bring in deposits from investors nationwide. These deposits are then placed into the bank, even though the investors may never set foot in the branch. This is different from core deposits , which come from local customers who have checking or savings accounts with the bank. Core deposits are seen as more stable and loyal. In contrast, brokered deposits can move quickly if better rates are offered elsewhere, which makes them riskier. Because of this risk, regulators watch brok...

Core Deposits Core deposits are the funds that customers regularly keep in their bank accounts. These include checking accounts, savings accounts, and certificates of deposit (CDs) with low interest rates. Unlike money that moves in and out quickly, core deposits tend to stay in the bank for a long time. For example, when you get your paycheck deposited into your checking account and leave it there to pay bills or save for the future, that money becomes part of the bank’s core deposits. Banks use this stable money to make loans or invest in other income-generating activities. Since banks do not have to pay high interest on these deposits, they are considered a low-cost and reliable source of funding. Core deposits are especially important during times of market stress. When financial markets are unstable, customers are more likely to keep their funds in these safe, insured accounts rather than move them elsewhere. This gives banks a steady source of funding even when other sou...

Back to Basics: Paid-in Capital vs. Callable Capital Paid-in capital and callable capital are two important terms you might hear in the world of investing and private equity. They both relate to the money investors put into a company or fund, but they mean very different things. Paid-in capital is the actual money that investors have already sent to a company or fund in exchange for ownership, typically in the form of shares or fund units. It's cash in the bank and can be used right away. Callable capital , also known as committed capital, is money that investors have promised to provide in the future when requested. That promise is binding, but the money stays with the investor until the fund or company issues a capital call . For example, imagine an investor agrees to invest $1 million in a private equity fund. At first, the fund may only ask for $200,000. That $200,000 is paid-in capital. The remaining $800,000 is callable capital, which the fund can request later, of...

Multilateral Development Bank (MDB) A multilateral development bank (MDB) is an international financial institution formed by a group of countries to support economic development in poorer regions of the world. MDBs provide loans, grants, and expert advice to help fund projects that improve infrastructure, education, healthcare, and more. Some well-known examples include the World Bank , the Asian Development Bank , and the African Development Bank . These banks are backed by their member countries, which not only contribute paid-in capital but also provide callable capital. Callable capital is a commitment from member countries to provide additional funds if needed, serving as a critical safety net and a cornerstone of the MDBs' strong financial standing. Member countries also oversee how the money is used. In the context of MDBs, references to "the World Bank" generally mean the IBRD and IDA: International Bank for Reconstruction and Development ...

Back to Basics: Spread In finance, a spread is the difference between two related prices, interest rates, or yields. It’s a simple concept that shows the gap between what one party pays and what another receives. One common example is the bid-ask spread in stock trading. The bid is the highest price a buyer is willing to pay, while the ask is the lowest price a seller will accept. The difference between them is the spread. A narrow spread usually means there’s high trading activity (liquidity), while a wider spread could mean fewer trades or more risk. Another example is the yield spread between government and corporate bonds. If a corporate bond offers a higher yield than a Treasury bond, that extra yield—the spread—compensates investors for taking on more risk. Spreads are also used to understand credit risk and funding conditions. One well-known measure used to be the LIBOR-OIS spread, which tracked bank credit risk. However, LIBOR has been phased out. Today, markets...