Glossary of Key Investment Terms

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ABSOLUTE RETURN
The percentage change in the value of an asset or portfolio over a given period of time. The portfolio’s or asset’s absolute return can be compared with a benchmark relative return such as the Dow Jones Industrial Average for a US mutual fund.
ABSOLUTE-RETURN STRATEGY
An investment strategy that seeks to generate the highest possible absolute return specified, often multiple, asset classes without the construction limitations imposed when managing against a specific benchmark. By separating itself from a benchmark, an absolute-return strategy seeks to generate a positive return regardless of the positive or negative performance of relevant markets.
ACTIVE RETURN
The performance difference between a portfolio and a benchmark that is attributable to an investment manager’s decisions to construct a portfolio of securities that differs from the benchmark’s construction. For example, if a portfolio of securities selected by an investment manager returned 5% while the benchmark returned 3%, the portfolio’s “active return” is 2%. Active return is only possible when a manager takes on extra (active) risk.
ACTIVE RISK
The risk that the performance of a portfolio will differ from a benchmark and the risk that is attributable to an investment manager’s decisions to construct a portfolio of securities that differs from the benchmark’s construction
ADJUSTABLE-RATE MORTGAGE (ARM)
A mortgage whose interest rate is raised or lowered periodically in accordance with a stated reference rate. ARM refers both to the original homeowner loan and to a securitized pool of such loans.
AGENCY
A bond issued by a government agency or quasi-government agency to finance that entity. Securities repackaged by an agency, as with mortgage-backed securities, are not considered agency debt. Unlike debt issued directly by the federal government or its agencies, quasi-government agency debt is not backed by the full faith and credit of the federal government but is nevertheless very highly rated.
ALPHA
Alpha is a beta-adjusted measure of return. Positive alpha indicates that an investment portfolio has earned, on average, a premium above what is expected for the level of market variability (beta). A negative alpha indicates that the investment portfolio has received, on average, a premium lower than that expected for the level of market variability.
ANNUITY
An investment with a consistent payment/receipt combining return of capital and return. They are normally used to provide a retirement income or estate planning.
ARBITRAGE
A trade that exploits price differences between two or more markets involving similar financial instruments—the profit being the price spread between the prices in the different markets. Arbitrage is common in the currency, stock and bond markets. For instance, an investor may identify an exchange-rate disparity for a given currency in two countries. The investor may sell a given currency in the US where the exchange rate is higher and then repurchase the same currency in the UK where the exchange rate is lower, pocketing the difference.
ASK PRICE (OFFER PRICE)
Typically the lowest price that a seller is willing to accept for a security—the counterpart of the bid price, which is the highest price that the buyer is willing to pay. The difference between the ask price and bid price is known as the bid-ask spread.
ASSET-BACKED SECURITY (ABS)
A fixed-income security created by pooling together loans of a similar type, such as home-equity loans, car loans or credit-card receivables . In Canada, which has a fairly large mortgage-backed securities market, mortgages are not considered a type of ABS as the mortgages within the MBS are guaranteed by the Federal Government.
ASSET CLASS
The asset class is what the money from your investment is actually put into, e.g. shares, bonds, property and cash/cash equivalents.
BANKRUPTCY
A judicial, regulatory or administrative proceeding or filing that is triggered when a company is unable to meet its debt obligations. Bankruptcies typically end either with reorganization and debt relief or with liquidation of the company.
BASIS POINT
One hundredth of one percentage point (0.01%).
BEAR (MARKET)
Is an investor with a negative outlook on an individual investment, economy, or a stock market. A bear market is a market condition in which the prices of securities are falling, and widespread pessimism causes the negative sentiment to be self-sustaining. As investors anticipate losses in a bear market and selling continues, pessimism only grows. Although figures can vary, for many, a downturn of 20\% or more in multiple broad market indexes, such as the Dow Jones Industrial Average (DJIA) or Standard & Poor’s 500 Index (S&P 500), over at least a two-month period, is considered an entry into a bear market
BENCHMARK
A standard barometer against which investments can be measured in terms of performance, characteristics, construction and similar criteria. Sometimes widely recognized instruments (e.g., Canada bond rate) or interest rates (e.g., the Canadian bank rate or LIBOR) serve as benchmarks. More commonly, a benchmark is composed of an unmanaged group of securities with the same general characteristics as the portfolio being measured against it. Stock indices such as the TSX, S&P 500, the FTSE 100 and the Nikkei 225 are commonly used for equities, while indices such as the Lehman Aggregate or the Nomura Bond Performance Index are commonly used in fixed income.
BETA
A measure of the expected change of a security’s or portfolio’s return relative to that of the market. By definition, the beta of a benchmark index is 1.00. A security with a beta of more than 1.00 tends to rise or fall more than the market; a security with a beta of less than 1.00 tends to rise or fall less. An investment with a beta of 1 performs the same as the underlying market.
BID-ASK (BID-OFFER) SPREAD
The difference between the selling and purchasing price of an asset.
BID PRICE
The purchase price that a buyer is willing to pay for an asset.
BLUE-CHIP STOCK
Blue chip stocks are shares in major well known companies, with well documented high (record) earnings, predictable dividend payments, and overall price stability.
BOND
A security that pays interest. The issuer agrees to pay the bondholder a regular set sum based on the amount borrowed and the bond’s coupon, and to repay the principal amount of the loan at a future date. Many variations exist on this basic format, including bonds with no coupon and with variable coupons; bonds may also contain call or put provisions. The price of a bond is quoted assuming a par value of 100. A bond selling above 100 is said to be trading at a premium; at 100, at par; and below 100, at a discount. The price varies over the life of the bond as interest rates, perceived credit quality and other factors fluctuate, and as the bond approaches its maturity date. A bond’s price is inversely related to its yield: It rises when the bond’s yield falls and declines when the yield rises. Bonds belong to the fixed-income asset class
BOOK VALUE
An accounting term that defines the net value of an asset as it appears on a company’s balance sheet; a company’s book value is equal to its total assets minus its total liabilities.
BROKER
An agent who acts as an intermediary between buyers and sellers, usually for payment of a commission.
BULL (MARKET)
A bull is an investor with a generally positive outlook on an investment, economy or market. A bull market is an investment, market or economy that is experience a generally positive trend with increasing prices.
CALL OPTION
A contract that gives an investor the right to buy a specified asset at a predetermined price and date prior to the security’s stated maturity, if any (common stock doesn’t have a maturity), or the date that the issuer makes the final payment to the security holder. (See Put Option.)
CALL PROVISION
A bond feature that allows the issuer to retire the debt, in full or in part, prior to the bond’s stated maturity date. Such a feature is favorable to the borrower, who can retire the bond and replace it with a lower-coupon issue if market rates fall. Conversely, such a feature is detrimental to the investor, who risks losing the higher-coupon bond when rates fall. Because of this disadvantage to the investor, callable bonds typically yield more than otherwise comparable bonds without a call provision.
CAP-WEIGHTED INDEX
An index weighted by the market capitalization of each security in the index. Larger-cap companies thus account for a greater portion of the index. For example, if a company’s market capitalization is $1 billion and the market capitalization of all securities in the index is $100 billion, the company would be 1% of the index. An index may also be fixed weighted, with each security, sector or country having a specified weight; fixed-weight indices are often equal weighted.
CAPITAL
The money you initially invest.
CAPITAL GROWTH
This is any increase in the original amount you invested, after costs, charges and appreciation/depreciation.
CASH EARNINGS
Net earnings, excluding intangibles such as goodwill. The higher the proportion of cash earnings to reported earnings, the higher a company’s earnings quality is deemed to be.
CANADIAN DEPOSIT INSURANCE CORPORATION (CDIC)
A crown corporation owned by the Canadian government that insures bank deposits up to C$100,000 per personal account held in member Canadian banks in the event that the financial institution fails. The corporation was formed under the Financial Administration Act and Canada Deposit Insurance Corporation Act in 1967. The CDIC is similar to the Federal Deposit Insurance Corporation in the United States.
CENTRAL BANK
A centralized entity responsible for overseeing and managing the monetary system of a nation, or group of nations. Duties of a central bank include providing a stable currency valuation, low inflation, full employment, and the amount of money in circulation in that economic system.
COLLATERALIZED DEBT OBLIGATION (CDO)
A fixed-income security created by pooling together bonds or loans of a similar type, such as corporate bonds (collateralized bond obligation) or mortgage-backed securities (collateralized mortgage obligation).
COLLATERALIZED MORTGAGE OBLIGATION (CMO)
A fixed-income security created by pooling together mortgage-backed securities. A CMO parses expected and unexpected cash flows from the underlying assets into multiple tranches according to a set of rules specified in the CMO’s prospectus. Thus, the various tranches are subject to different amounts of risk and are suitable for different types of investors or investment purposes.
COMMERCIAL MORTGAGE-BACKED SECURITY (CMBS VERSUS RESIDENTIAL MBS)
A mortgage-backed security collateralized by commercial rather than residential mortgage loans. Unlike residential mortgage-backed securities, CMBSs are not usually subject to prepayment risk, as most underlying loans do not permit prepayment without substantial penalties.
COMMON SHARES/STOCK
Represents a share of ownership in a corporation. Holders of common stock of a company hold control by electing boards of directors, and voting on corporate structure and direction. Although common stock holders have more say in the direction of the company, they are also the lowest within the ownership structure. This means that in the event of liquidation or bankruptcy common shareholders will have last access to corporate assets behind, bondholders, preferred stock holders, and other debt issuers.
COMPOUND INTEREST
This is the cumulative effect of earning interest on your savings and leaving your interest in the savings account.
COMPRESSED VALUATIONS
When the difference between the highest- and lowest-priced segments of a stock market is much smaller than usual. This limits an investor’s opportunity to buy value stocks trading at deep discounts but increases the ability to buy faster-growing stocks at a lower-than-usual premium to the market.
CONVERTIBLE BOND
A bond that, at the option of the issuer or the investor, can be exchanged for common stock of the issuing company, at a predetermined conversion ratio and at predetermined dates. Some convertible bonds are convertible throughout their lives. Although a convertible bond is chiefly a fixed-income instrument, its price tends to be highly influenced by the stock price.
CORPORATE BOND
Debt issued by a corporation. As creditors, corporate bondholders have a prior legal claim over common and preferred stockholders.
COUPON
The rate at which a bond pays interest, expressed in percentage terms. A bond with a 2% coupon and a principal value of $5,000 would pay $100 annually to the bondholder. Coupon payments are typically made either annually or semi-annually, according to the terms of the bond’s covenant. The coupon may be fixed or variable.
CREDIT DEFAULT SWAP (CDS)
An instrument that transfers the credit risk of a specific entity (usually a corporation, financial institution or sovereign government) from a protection buyer to a protection seller in exchange for a regular payment until the contract expires or a credit event occurs.
CREDIT RATING
A measure of credit quality. Bond-rating agencies such as Moody’s Investors Service, Standard & Poor’s and Fitch Ratings publish issuer ratings that, in their view, reflect the likelihood that the issuer will default on interest and principal payments. Rating systems vary from agency to agency; generally, however, bonds rated triple A (AAA or Aaa) are of the highest quality (exp. Government of Canada), while those rated below triple B (BBB or Baa) are of the lowest quality and are considered speculative or non-investment grade.
CREDIT RISK
The risk that a bond issuer may default on its debt obligations or that a counterparty will default on a payment in the sale or purchase of a negotiable instrument. (See Default.)
CURRENCY FORWARD
A contract that obligates participants to buy or sell a specified quantity of a currency at a specified price on a specified future date. Investors often use these contracts to lock in the current value of a foreign currency that the investor expects to lose value against his or her home market.
CURRENT COUPON
The prevailing coupon rate in the new-issue market for securities that are priced at or close to par.
CYCLICAL STOCK
Equity in a company that makes products or provides services that tend to be in demand during periods of strong economic growth and out of favor when the economy is weak. Examples include commodities and durable goods, both of which are in greater demand during economic booms. (See Defensive Stock.)
CYCLICAL TREND
Recurring movements in prices or interest rates, usually linked to different stages in a business cycle.
DEBENTURES
Bonds that are issued by corporations and tend to be higher risk than bonds. Many bonds have guarantees attached to them such as backed by real estate of the company. Debentures do not provide any collateral like these bonds. Yields tend to be higher on these investments to offset the higher risk. They are liquid and trade on a daily basis
DEBT-TO-EQUITY RATIO
A company’s debt (borrowings) divided by the market value of its shareholder equity.
DEFAULT
An event triggered when a debt obligor fails to pay the interest or principal of its obligations and a specified grace period has expired.
DEFENSIVE STOCK
Refers to a company that tends to produce goods or services that are in demand irrespective of economic cycles, such as healthcare companies or utilities.
DEFLATION
It is the contraction of money supply in an economy. Deflation results in the general price decrease of typical goods and services used in everyday life.
DERIVATIVE
A tradable financial instrument that derives its value from underlying assets—such as stocks, bonds, market indices, commodities and livestock. It is typically a contract based on the buyer’s/seller’s assumptions regarding the future price of the underlying assets. Given the uncertainty of future prices, participants often hedge their bets by entering into a contract for a future sale or purchase at a specified price. This contract, or financial instrument, is the derivative.
DISCOUNT COUPON
A rate below current coupon. Bonds with discount coupons are typically priced below par.
DISCOUNT TO FAIR VALUE
A measure of the valuation difference between the lowest-valued segment of a stock market, such as the cheapest 20%, relative to the overall market. It indicates whether the value opportunity is strong or muted at any given time relative to long-term history.
DIVERSIFICATION
Moving your investable assets among different asset classes (cash, fixed income and stocks) as well as different sectors in each category.
DIVIDEND
Regular sums of money paid from the profits or reserves of a corporation to shareholders on a per share basis. Dividends are one way that investors can seek to gain profits from company performance. The other method is through share price appreciation.
DIVIDEND YIELD
Is the ratio of how much of a dividend a company pays in relation to the price of an individual share in the company.
DURATION
A measure of a bond’s price sensitivity to changes in interest rates, expressed in years. Duration approximates how much a bond’s price will change if interest rates change by a given amount. For each year of duration, a bond’s price will fall (or rise) roughly one percentage point for each one-percentage-point increase (or decrease) in yield. Thus, a bond with a longer duration will perform worse when rates rise than a bond with a shorter duration; conversely, it will perform better when rates fall.
EARNINGS PER SHARE (EPS)
A company’s net profit divided by the number of common shares outstanding.
EBITDA (EARNINGS BEFORE INTEREST, TAXES, DEPRECIATION AND AMORTIZATION)
A measure of a company’s cash flow, excluding the impact of its financial structure or tax position, both of which could be altered.
EMERGING-MARKET DEBT
Debt issued by governments of and corporations within developing economies. A country may issue such securities in its own currency or, commonly, in US dollars or the currency of another major economy. Many emerging-market issuers are rated below investment grade.
EQUAL-WEIGHTED INDEX
An index in which all the securities are given equal weight. As soon as the price of one security changes, it is no longer equal weighted. Therefore, such indices are rebalanced on a quarterly, semi-annual or annual basis.
EQUITY
Ownership of a company in the form of shares that represent a claim on the corporation’s earnings and assets. Common stockholders have the right to vote on directors and other key matters. While preferred stockholders lack voting rights, they have priority in dividend payments. A corporation can authorize additional classes of stock, each with its own set of contractual rights.
EQUITY RISK PREMIUM
A forward-looking estimate of how much equities are likely to outperform bonds. Equity investors typically demand a higher return due to their greater risk of not receiving cash flows for their investment.
EXCESS RETURN
Difference between returns, which may be applied to managers or sectors. When referring to a manager or portfolio, the excess return is typically the same as the active return—the difference between the manager’s/portfolio’s return and the benchmark’s. A fixed-income sector’s excess return is the difference between its return and that of a comparable-duration government bond. If short-term corporate debt returns 6% and a short-term government security returns 4%, the excess return is 2%.
EXCHANGE-TRADED FUND (ETF)
An instrument that provides exposure to an index and is traded on a stock exchange. The price of these units depends on the prevailing market prices of the underlying index components. ETFs offer investors a low-cost, liquid means to invest in indices; they are essentially an alternative to an index portfolio and are considered an excellent option to higher cost mutual funds.
FACTOR RISK
A common trait that causes many securities to trade together. Equity factor risks include industry or sector, home country, currency, valuation, earnings variability, growth rate and market capitalization; fixed-income factor risks include sector, industry, rating and currency.
FAIR VALUE
A price deemed to accurately reflect the value of a company, asset or financial instrument and thought to be equitable for both buyer and seller. Fair value is generally calculated based on measurable financial performance and potential.
FUNDAMENTAL SUCCESS
When a company is well positioned to outperform over the long term due to the growth or stability of earnings or cash flow and balance-sheet strength. Longer-term investors tend to focus more on such fundamental strengths than on periods of underperformance due to such things as market volatility, technical factors or short-term difficulties.
FUTURES
an investor can purchase the future price of an index, different commodities, currencies, precious metal etc. They trade through futures exchanges. These are leveraged investments that provide high return and risk. Some use futures market to hedge, others use them to speculate.
GOVERNMENT BOND
Debt issued directly by a country’s government in its own currency. Government bonds of the major developed countries are often considered free of credit risk, although in today’s world with such high sovereign debt levels, that belief may be changing.
GROWTH FACTOR RISK
A benchmark-relative measure of a portfolio’s exposure to characteristics typically associated with the style and, thus, should outperform when growth stocks are in favor; the higher the reading, the higher this leverage. For example, a growth factor risk of 0.2 typically means that a portfolio is 20% more leveraged to the growth style than the index. Conversely, a negative reading would indicate that the portfolio is less exposed than its benchmark to growth and will likely underperform when growth is in favor, and outperform when growth is out of favor.
GROWTH STOCK
A company that is expected to generate above-average revenue and earnings growth relative to its industry or the overall market. Such companies usually pay little or no dividend, preferring to use excess cash to finance expansion. However, because of the company’s rapid earnings growth, investors typically expect the stock’s price appreciation over time to more than compensate for the lack of short-term dividends.
HEDGING
A method used by traders to minimize losses on an investment from price fluctuations in the market. The process involves balancing a current investment position with one that will profit from the opposite outcome happening. This ensures that even if the original desired outcome does not occur the investor can minimize losses by profiting from the actual outcome.
HEDGE FUND
These are privately owned, and actively managed investment funds that use high risk, high reward investment strategies. These funds have high levels of capital investment and use an aggressive mix of strategies involving short-selling, leveraged investment, derivative positions, and foreign markets to seek profits.
HIGH-YIELD BOND
A fixed-income security with a rating of BB or lower and thus considered non-investment, or speculative, grade. These instruments tend to offer substantially higher yields than investment-grade credits due to their greater likelihood of default.
HYBRID SECURITY
A security that combines characteristics of two or more financial instruments, generally debt and equity. The most common type of hybrid is a so-called convertible bond, which is a fixed-income security that can be exchanged for common stock.
INFLATION
An increase in the level of prices of goods and services in the economy. It is measured by examining a typical basket of goods and services. The cause is increased demand for goods/services and increased money supply.
INFLATION-LINKED SECURITY
A bond indexed to and intended to protect the investor against inflation. A number of governments and some corporations issue such debt.
ISHARES
Index funds traded like shares on stock markets. Each share represents a proportion of ownership in the collection of stocks that make up an index. This investment vehicle enables smaller investors to diversify their holdings by giving them exposure to a potentially large number of companies without the necessity of buying each stock.
LEVERAGE
In a financial context, the degree to a business or asset is financed by borrowing. High financial leverage is generally regarded as a negative for a company, since it increases the risk of bankruptcy in the event of a financial squeeze and can make future borrowing more difficult and/or expensive. However, leverage to finance highly profitable new ventures, for example, can result in higher returns to shareholders. “Leveraged investing” is when investors borrow money to purchase more securities or other assets than they could with cash. This allows an investor to capture more of the upside if a security appreciates, but increases the loss if the security depreciates.
LIABILITY
A legal obligation to pay a specific amount within a defined time frame. For businesses, this typically includes debt payments, accounts payable, taxes, wages and similar pending expenses recorded on a company’s balance sheet. Short-term liabilities are those payable within the next year, and long-term liabilities are those payable over a longer time frame.
LIBOR
(London Inter Bank Offered Rate) The interest rate that banks charge one another in the short-term international interbank market. It applies to loans borrowed anywhere from one day to five years. LIBOR is officially fixed each day by a handful of large London banks, although the actual rate changes throughout the day. It is also used as a benchmark to set other short-term interest rates, which are sometimes set as specific increments relative to LIBOR (e.g., LIBOR plus 3%).
LIQUID ASSET
An asset that can be quickly, easily and inexpensively turned into cash.
LIQUIDITY
Refers to the ease at which an investment can be bought or sold (converted into cash) in the market place. Having a large number of buyers and sellers, in combination with a high trading volume add to the liquidity of an investment.
LONG-DURATION ASSETS
Securities or other assets whose cash flows to investors tend to be further out in the future. In equity markets, these are typically companies that pay little or no dividends, often because they are reinvesting most of their earnings. The term is most typically used in conjunction with growth stocks but may also apply to emerging-market stocks and other assets.
MARKET CAPITALIZATION (MARKET CAP)
Market Cap is the total value of all outstanding shares of a company. This is calculated by multiplying the total amount of shares outstanding by the current stock price. This measure helps gauge the overall size of a company rather than its performance or assets.
MARKET VALUE
The current price of a security in the market, as reflected by the last reported price on an exchange, or the current bid-ask price if the security is traded over the counter.
MARKET WEIGHT
When a portfolio allocates the same percentage assets to a specific security or group of securities as its benchmark. Also known as a “neutral weight.”
MARK TO MARKET
To record the value of open positions in a security, a portfolio or an account based on current prices, not the purchase price or “cost basis.” This technique allows any interim gain or loss to be recognized for tax or accounting purposes even though the positions have not yet been closed out.
MATURITY
The date when, or the remaining time until, an issuer is obligated to deliver the final coupon and principal payments owed to a bondholder. Bonds with a remaining term to maturity of one to five years are generally considered short-term; those maturing between six and 12 years out are considered intermediate-term; and those with maturities beyond 12 years are considered long-term. Bonds maturing in less than one year are categorized as cash equivalents.
MONEY MARKETS
A segment of the financial market where short-term and very liquid financial instruments are traded. Participants in these markets use them in order to find short-term borrowing, in the hopes of minimizing costs. Instruments that are traded within money markets are Certificates of Deposit (CDs), T-Bills, Commercial Paper, short-term GIC’s etc.
MORTGAGE-BACKED SECURITY (MBS)
A fixed-income security, especially a mortgage “pass-through,” created by pooling together home mortgage loans with similar interest rates and other characteristics. The pool of mortgages forms the collateral behind the mortgage-backed security. Bondholders receive cash flows based on the pooled mortgages’ collective interest and principal payments, including prepayments of principal, less a fee reserved for the originator of the MBS. Originators are predominantly government or quasi-government agencies.
MUTUAL FUND
An investment vehicle where investors buy a share in the fund, as if it were its own company. From here the fund invests shareholder money in a diversified portfolio of investments, and is professionally managed. Shareholders are rewarded by strong performance of the fund with higher share prices, and dividends from profits.
NET ASSET VALUE (NAV)
The dollar value of a mutual-fund share, calculated by dividing the fund’s total net assets (assets minus liabilities) by the total number of shares outstanding. NAV, which is typically calculated at the end of each day, can change constantly to reflect changes in the value of a fund’s holdings.
OPEN ENDED INVESTMENT COMPANY (OEIC)
A type of pooled investment fund, open ended investment funds can create new shares or cancel existing shares in issue.
OPTION
A contract that provides the right to buy or sell a specific asset such as a stock, a commodity or a currency at a particular price during a defined period of time. The right to buy is referred to as a “call option,” while the right to sell is known as a “put option.” Although option holders have the right to buy or sell, they are not obligated to do so.
ORDINARY SHARES
A class of share usually associated with UK stock market investments. Shareholders have the right to receive distributed profits and vote at annual general meetings.
OVER THE COUNTER (OTC)
Securities not listed on an established such as the Toronto or New York Stock Exchanges, but rather traded by broker-dealers who negotiate directly with one another over computer networks and by telephone. Stocks traded over the counter may be more speculative, since these companies often have not yet met the size or stability requirements for listing on an established exchange and have less accurate pricing data and other information readily available. Still, these trades tend to fall under the oversight of relevant regulatory bodies. Many bonds trade over the counter rather than on an exchange. Also known as “unlisted securities.”
OVERWEIGHT
When a portfolio allocates a larger percentage of assets to a specific security or group of securities than its benchmark does.
PAPER LOSS
Also known as unrealised loss, this is where an asset or investment has decreased in value before you come to cash it in, i.e. your investment is worth less ‘on paper’.
PAR OR FACE VALUE
The amount of principal that the issuer must pay the bondholder at maturity. Although an individual bond typically has a par value of $1,000, the term “par” is often used interchangeably with 100 in the context of a bond’s price.
PENSION
In simple terms this is an income plan for income to be taken in retirement.
POOLED INVESTMENT
Many people putting their money together into a single investment fund.
PORTFOLIO
A collection of investments that can include any or all asset types.
PREMIUM COUPON
A rate above current coupon. Bonds with premium coupons are typically priced above par.
PRICE-TO-BOOK RATIO (P/B)
A comparison of a stock’s market value with its book value, calculated by dividing the current closing price of the stock by the latest quarter’s book value per share.
PRICE-TO-EARNINGS RATIO (P/E)
The most common measure of a stock’s value, calculated by dividing the market value per share by after-tax earnings per share. The higher the P/E ratio, the more the market is willing to pay for each unit of earnings. One has to be careful to exclude extraordinary income sources or write-downs and only include operational earnings, unless the source of write-down may reoccur.
PRICE-TO-GROWTH RATIO (PEG)
A ratio used to determine a stock’s current value per unit of earnings growth. It is calculated by dividing the price/earnings ratio by the annual earnings-per-share growth and indicates a stock’s potential value. A lower PEG means that the company’s growth is priced more attractively than its peers.
PUT OPTION
A financial contract that gives the holder the right, but not the obligation, to sell an asset at a predetermined price on or before a particular date.
PUT PROVISION
A bond feature that allows the investor to redeem the bond at par value before the bond’s stated maturity date. A put provision is typically valid only for predetermined dates and would only be attractive to the investor if the bond’s market value declined below par. Such a feature is favorable to the investor and detrimental to the issuer. Because of their potential advantage to the investor, putable bonds typically yield less than otherwise comparable bonds without a put provision.
RELATIVE RETURN
An asset’s or a portfolio’s return over a period of time relative to that of a chosen benchmark. It is calculated as the difference between the asset’s absolute return and the benchmark’s performance.
RETURN ON EQUITY (ROE)
A measure of how much profit a company is able to generate with the capital provided by shareholders. Calculated by dividing after-tax income for a specified time period (e.g., trailing 12 months, trailing five years, forward 12 months) by the book value. ROE is expressed as a percentage.
RISK
In common parlance, the chance of loss or of something bad occurring. In financial parlance, it usually means the uncertainty of outcomes due to one or many causes; it can be positive as well as negative. Return is usually measured by the standard deviation of returns—in other words, the extent to which returns may vary from the norm. Volatile assets tend to have a wider range of possible returns and thus are said to be higher-risk.
RISK-FREE RATE
An investment with a predictable rate of return. An example is a short-term government bond. A short-term government bond has the explicit backing of a government, and the time period before the bond matures is short enough to minimize the risks of inflation and market interest-rate changes. Its yield is therefore considered risk-free.
RISK PREMIUM
The expected return above the risk-free rate that investors demand to compensate for the volatility of returns or the possibility of default of risky assets.
SECULAR TREND
A long-term change attributable to an important fundamental shift in the economy or business environment that is not related to seasonal or cyclical factors. Industrialization and globalization are examples of secular trends.
SECURITIZATION
The process of creating a tradable financial instrument from a pool of underlying assets, such as loans or mortgages, which generate an income stream for the issuers. Securitization allows issuers to remove assets from their balance sheets, thereby freeing up capital for other uses. It also allows investors to better diversify risk.
SHARE BUYBACK
A company’s repurchase of its own shares. It typically increases the market price of the remaining shares because each of the remaining shares represents a larger claim on earnings and assets, in effect pushing the earnings up artificially.
SHORT SELLING (SHORTING)
Short-Selling is the selling of a security that the investor does not actually own. Short sellers assume that they can sell a share at its current price, and will be able to buy it back in a set period of time, at a lower price before returning it to the actual owner. The investor profit comes from the difference being the profit per share.
SOVEREIGN BOND
Debt issued directly by a country’s government in a currency other than its own.
SPREAD
The difference between two variables, such as a security’s bid and ask prices (bid-ask spread). In the bond market, the “yield spread” is the difference in yield between bonds, most often between the yield of a bond and a benchmark such as a government bond, swap or LIBOR. Valuation spreads measure the difference between expensive and cheap segments of the market.
STANDARD DEVIATION
A statistical measure of risk that shows how aligned or at variance the returns of an asset, industry or fund are relative to their historical performance.
STYLE DRIFT
The tendency of a portfolio manager to stray from its investment philosophy and process to boost short-term returns.
SWAP
A contract between two parties to exchange future cash flows based on a set principal amount. An interest-rate swap normally involves swapping fixed-rate and floating-rate payments in the same currency. Other common types include currency swaps and credit default swaps.
SYSTEMIC RISK
A risk or event that affects an entire financial market or system, such as a stock market crash or a banking-system failure. Systemic risks cannot be avoided through diversification.
TOTAL RETURN
The return on an investment, including price appreciation and depreciation, as well as income from dividends or interest.
TRACKING ERROR
The variance of a portfolio’s investment returns relative to those of its benchmark or index.
TRANCHE
When a bond’s cash flows are repackaged as a collateralized debt obligation (CDO) or a portfolio of mortgage securities is repackaged as a collateralized mortgage obligation (CMO), the various securities constituting the CDO or CMO are called tranches. Each tranche within a deal has a different risk/return profile, and the tranches trade separately from one another.
TRANSACTION COSTS
The costs incurred when buying or selling an asset security, such as commission, fees and any indirect taxes.
UNDERWEIGHT
When a portfolio allocates a smaller percentage of assets to a specific security or group of securities than its benchmark does.
UNIT TRUST
A pooled fund that is established under trust.
VALUATION
The worth of an asset or a company using various techniques or the value of an investment portfolio’s holdings at a specific date.
VALUE RISK PREMIUM
The anticipated return premium of value stocks versus the broader market.
VALUE STOCK
A stock that is underpriced by the market relative to its long-term fundamentals, such as dividends, earnings and sales. Such stocks tend to have a high dividend yield, low price-to-book ratio and/or low price-to-earnings ratio.
VOLATILITY
The extent to which the price of a financial asset or market fluctuates, measured by the standard deviation of its returns. Volatility is a commonly cited risk measure.
VOLUME
The amount of shares involved in transactions on a given day.
WARRANT
A certificate entitling the holder to buy or sell a certain quantity of an underlying instrument at a predetermined price. The right to buy the underlying instrument is referred to as a call warrant; the right to sell it is known as a put warrant. In this respect, a warrant is similar to an option. Warrants typically have much longer time available to exercise that option.
YIELD
Refers to the income earned from an investment. This generally refers to the interest or dividends received from an investment and are usually displayed as a percentage of the cost of the investment.
YIELD CURVE
A line connecting the yields of bonds from one end of the maturity spectrum to the other (30 day papers all the way up to 30 year bonds). Because yields typically rise sharply at the short end of the maturity spectrum and rise more gradually at longer maturities, the plotted line usually forms a curve. Normalized yield curves where short term rates are lower than longer term rates usually signals a relatively healthy economy. Inverted yield curve where short-term rates are higher than long-term, signals a recession is near or at least poor economic conditions.
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