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Finance GlossaryLiquidity Trap
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Liquidity Trap

Definition of Liquidity Trap

A Liquidity Trap is an economic event where the general public stashes cash in their bank savings account instead of investing in bonds because of the assumption that a rise in interest rates is imminent, even though interest rates are low.

Related Terms

Exit Load

Exit load is a type of premature withdrawal fee that mutual funds charge. The goal of charging an exit load is to ensure that investors think twice before exiting a fund, as premature withdrawals can affect existing investors.

Every mutual fund charges a different exit load based on the discretion of the fund manager. ETFs, liquid funds, and other debt funds typically have little to no exit load whereas equity funds do.

Butterfly Spread

A butterfly spread is an options strategy that combines bull and bear spreads to generate a small chunk of profit. To achieve this, a butterfly strategy consists of four positions in four options contracts that have the same expiration but different strike prices.

Free Cash Flow

In accounting and earnings reports, free cash flow refers to the amount of money a company has after paying its maintenance expenses, salaries, utility expenses, and other operating expenses as well as capital expenditures.

The formula to calculate free cash flow: Operating Cash Flow − Capital Expenditures

Free cash flow is an important metric, especially for investors because it is a direct indicator of the financial competence of a company. For example, the amount of FCF a company has can decide whether it has enough cash to offer dividends, expand business, buy back shares, etc.

Autoregressive Model

An autoregressive model uses one or more past values to forecast the current value of an asset.

The model assumes that past values can have an impact on the current value but the number of past values it takes into account can vary.
For example, an AR(1) model will use one preceding value, an AR(2) model will use two preceding values, and so on.

Face Value

The term face value refers to the actual price of a stock that’s obtained by dividing a company’s net value by its total shares outstanding. In India, the face value of shares can range from Rs. 1 to Rs. 100.

However, the market value of the share may vary. At times, the difference can be drastic. For example, the face value of an MRF share is Rs. 10 but the market value (LTP) of the same share is Rs. 86,313.45.

Face value is also known as nominal value or par value. The latter is used frequently in the case of bonds.

The face value of a bond is the amount that an investor receives from the issuer on maturity. Similar to stocks, bonds and other fixed income instruments may have a different face value and market value.

Debt To Equity Ratio

The debt to equity ratio is a measure of a company’s financial health that’s calculated by dividing liabilities from shareholder equity.

Debt to equity ratio: Total liabilities / Shareholder equity

A high debt to equity ratio means that a company is taking on more debt to run its business. A low debt to equity ratio means that a company is operating at low debt.

That’s why investors calculate the D/E ratio to understand a company’s ability to operate without debt. Generally, D/E is used for comparative analysis within sectors, not across industries because the ideal debt ratio may vary.



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