Bank of Montreal 1997 Annual Report Download - page 96

Bank of Montreal 180th Annual Report 199790
Allowance for Credit Losses
The amount deemed adequate by
management to absorb potential cred it
losses in the Bank’s portfolio of
loans,
acceptances, guarantees, letters of
credit, deposits with other banks
and derivatives.
Assets under Administration and
under Management
Assets administered and/or managed
by a financial institution which are
beneficially owned by clients or in-
vestors and are therefore not reported
on the balance sheet of the financial
institution.
Bankers’ Acceptance
A bill of exchange or negotiable instru -
ment drawn by the borrower for
payment at maturity and accepted by
a bank. The acceptance constitutes
a guarantee of payment by the bank
and can be traded in the money
market. The bank earns a “stamping
fee” for providing this guarantee.
Basis Point
One one-hundredth of a percentage
point.
Capital Ratios
The percentage of risk-weighted
assets supported by capital, as defined
by the Superintendent of Financial
Institutions Canada under the
framework of risk-based capital
stan-
dards developed by the Bank for
International Settlements.
Counterparty
The other side of any transaction,
typically the Bank’s corporate or com-
mercial customers or another financial
institution. Counterparty risk refers
to the risk that the counterparty will
not be able to meet its financial oblig a-
tions under the terms of the con
tract
or transaction it has entered into.
Derivatives
A derivative is a contract whose value is
“derived” from interest rates, foreign
exchange rates, or equity or commodity
prices. Use of derivatives allows for the
transfer, modification or reduction of
current or expected risks from changes
in interest rates, foreign exchange rates,
and equity and commodity prices.
Duration
A measure of the average time inter-
val required for an expected stream
of cash flows to repay the original
investment, i.e. a shorter duration
means a faster recovery of the original
investment.
Forward Rate Agreement (FRA)
A type of derivative which obliges
two parties to make a cash settlement
at a future date for the difference
between a contracted rate of interest
and the current market rate, based
on a notional amount.
Forwards and Futures
Contractual agreements to either buy
or sell a specified currency or financial
instrument at a specific price and date
in the future. Forwards are customized
contracts transacted in the over-the-
counter market. Futures are transacted
in standardized amounts on regulated
exchanges and are subject to daily
cash margining.
Guarantees and Standby Letters
of Credit
Primarily represent our obligation
to make payments to third parties
on behalf of our customers if our
customers are unable to make the
required payments or meet other
contractual requirements.
Hedge
A technique used to manage interest
rate and foreign exchange exposures
arising from normal banking
operations.
Impaired Loans
Loans are classified as impaired when,
in the opinion of management, there
is no longer reasonable assurance of
the timely collection of principal
or interest.
Mark-to-Market
Valuation at market rates, as of the
balance sheet date, of securities and
derivatives held for trading purposes.
Net Interest Income
The difference between what a bank
earns on assets such as loans and
securities and what it pays on liabilities
such as deposits and subordinated
debentures.
Notional Amount
The amount to which a rate or price
is applied in order to calculate the
exchange of cash flows.
Off-Balance Sheet Financial Instrument
An asset or liability which is not
recorded on the balance sheet but
has the potential to produce posi-
tive or negative future cash flows if
a contingent event occurs.
Options
Contractual agreements that convey
the right but not the obligation to
either buy or sell a specific amount
of a financial instrument at a fixed
price either at a fixed future date or at
any time within a fixed future period.
Prepaid Pension Expense
The cumulative difference between
the pension expense and the actual
cash contributions we make into the
pension plan on our employees’ behalf.
Productivity Ratio
Non-interest expenses expressed as a
percentage of gross revenue which
includes net interest income and other
income. Used as a measure of produc-
tivity and for comparison with peers.
Provision for Credit Losses
A charge to income which represents
an appropriate expense given the
com position of our credit portfolios,
their probability of default, the eco-
nomic environment and the allowance
for credit losses already established.
Specific provisions are established
to reduce the book value of specific
assets (primarily loans) to establish
the amount expected to be recovered
from the loans. A country risk pro-
vision is established for loans to and
securities of countries identified by
the Superintendent of Financial Institu -
tions Canada that have restructured or
experienced difficulties in servicing all
or part of their external debt to com-
mercial banks. A general provision is
established for loans recognizing that
not all of the impairment in the loan
portfolio can be specifically identified
on a loan-by-loan basis.
Repurchase Agreement (Repo)
A type of transaction that involves
the sale of a security with the commit-
ment by the seller to repurchase the
security at a specified price and time.
Return on Equity (ROE)
Net income, less preferred share divi-
dends, expressed as a percentage of
average common shareholders’ equity.
Reverse Repurchase Agreement
(Reverse Repo)
See Securities Purchased under Resale
Agreements.
Risk
Credit Risk
Refers to the possibility that counter-
parties to financial instruments
transacted with a bank will be unable
to discharge their obligations under
the instruments and cause the bank
to suffer a loss.
Foreign Exchange Risk
Foreign exchange risk refers to pos-
sible losses resulting from exchange
rate movements. A foreign currency
devaluation, for example, could result
in losses on an overseas investment.
Interest Rate Risk
Interest rate risk is the potential
impact on a bank’s earnings and
economic value due to changes
in interest rates. Rising interest rates
could, for example, increase funding
costs and reduce the net interest
margin earned on a fixed yield mort-
gage portfolio.
Liquidity Risk
Refers to potential demands on a
bank for cash resulting from commit-
ments to extend credit, deposit matu-
rities and many other transactions.
Operational Risk
Operational risk is the potential for
loss caused by a breakdown in proce-
dures in transaction processing, risk
management and reporting.
Position Risk
Position risk is the risk of loss that
results from changes in interest rates,
foreign exchange rates, equity and
commodity prices and the volatility
of these rates and prices.
Risk-Weighted Assets
Used in the calculation of risk-based
capital ratios. The face amount of
lower risk assets is discounted using
risk weighting factors in order to reflect
a comparable risk per dollar among
all types of assets. The risk inherent in
off-balance sheet instruments is also
recognized, first by adjusting notional
values to balance sheet (or credit)
equivalents, and then by applying
appropriate risk weighting factors.
Securities Purchased under
Resale Agreements
A type of transaction that involves
the purchase of a security, normally a
government bond, with the commit-
ment by the buyer to resell the security
to the original seller at a specified
price on a specified date in the future.
Securities Sold Short
Transactions in which the seller sells
securities it does not own. The seller
borrows the securities in order to
deliverthemtothepurchaser.Ata
later date, the seller buys identical
securities in the market to replace the
borrowed securities. On the balance
sheet, this category represents our
obligation to deliver securities which
we did not own at the time of sale.
Swaps
Contractual agreements between two
parties to exchange a series of cash
flows. For interest rate swaps, counter-
parties generally exchange fixed and
floating rate interest payments based on
a notional value in a single currency.
For cross-currency swaps, fixed inter-
est payments and notional amounts
are exchanged in different currencies.
For cross-currency interest rate swaps,
principal amounts and fixed and float-
ing interest payments are exchanged
in different currencies.
Taxable Equivalent Adjustment
An addition to interest income to gross
up the tax-exempt income earned
on certain securities (primarily loan
substitute securities) to an amount
which, had it been taxable at the statu-
tory rate, would result in the same
after-tax net income as appears in the
financial statements, enabling a uni-
form measurement and comparison
of net interest income.
Volatility
A term which generally refers to a
measure of price variance, usually the
standard deviation of returns from
a security or a portfolio of securities
over a specified period of time.
Glossary of Financial Terms