Financial and economic terms 1

I will introduce 5 financial and economic terms. Studying these terms will be very helpful for your economic news reading and economic study. This series of economic and financial term introductions will post many terms in a series.

1. Household Debt Risk Index, HDRI

This index assesses the risk of household debt by considering income and assets. It combines Debt Service Ratio (DSR) for income-based evaluation and Debt to Asset Ratio (DTA) for asset-based evaluation. It categorizes households as “risk” or “high-risk” based on their vulnerability in both income and assets, with further distinctions for high-risk households based on income (high DSR) or assets (high DTA). It’s meant to gauge debt repayment vulnerability, not current default or financial distress.

2. Personal Disposable Income, PDI

Personal Disposable Income (PDI) is the income that households can use freely and is a key indicator for measuring living standards. While per capita Gross National Income (GNI) is commonly used for this purpose, it includes income from businesses, financial institutions, and the government, making it less precise when these entities earn more than households. As a result, Per Capita Personal Gross Disposable Income (PGDI) is calculated by dividing total household disposable income by the population, providing a more accurate metric for assessing household purchasing power.

3. Operation Rate

This indicator is a percentage showing how much production facilities are being used compared to their capacity. Production capacity is the maximum potential output a business can achieve under normal conditions, considering equipment, workforce, and operating hours. The operating rate, as it’s known, is useful for assessing an economic sector because businesses adjust it based on their expectations for the future economy. However, a high operating rate isn’t always positive; in a downturn, it signals optimism about recovery, but in a strong economy, it can raise inflation concerns.

4. Spread

A “spread” is an extra interest rate added to a benchmark rate based on factors like creditworthiness. For example, in the context of a bank determining loan interest rates, the spread reflects the customer’s credit risk. When extending a loan’s maturity, the added interest rate is called the term spread. Typically, better creditworthiness results in a lower spread, while lower creditworthiness leads to a larger spread.

In the bond market, “spread” refers to the difference compared to the benchmark interest rate of a comparable financial product. When bonds are issued internationally, U.S. Treasury Bonds or LIBOR with the same maturity serve as benchmark rates, and a spread is added based on factors such as creditworthiness.

5. Indirect Financing / Direct Financing

In economics, there are surplus and deficit funds. “Indirect financing” involves financial institutions like banks, collecting public deposits and lending to businesses. Conversely, “direct financing” occurs when fund seekers raise money directly from financial markets, bypassing institutions.

In indirect financing, banks have a key role, while direct financing relies on capital markets for trading stocks and bonds. Both methods are competitive and complementary, promoting balanced development.

The preferred mix of direct and indirect financing varies with a country’s economic development stage and structure. For instance, economies with many small and medium-sized enterprises may benefit more from indirect financing, reducing information gaps. Innovative industries in a growing economy may favor direct financing. As financial markets advance, direct financing often gains prominence.