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Investing
Published: August 6, 2009
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- Investments Vocabulary
- All Vocabulary Words (Without Definitions) mp3
- Part I . Investment Setting (Part 1 Audio) mp3
- Arithmetic mean (AM)
- A measure of mean return equal to the sum of annual holding period yields divided by the number of years.
- Business risk
- Uncertainty due to the nature of a firm's business that affects the variability of sales and earnings.
- Coefficient of variation (CV)
- A measure of relative variability that indicates risk per unit of return. It is equal to: standard deviation divided by the mean value. When used in investments, it is equal to: standard deviation of returns divided by the expected rate of return.
- Country risk
- Uncertainty due to the possibility of major political or economic change in the country where an investment is located. Also called political risk.
- Exchange rate risk
- Uncertainty due to the denomination of an investment in a currency other than that of the investor's own country.
- Financial risk
- Uncertainty due to the method by which a firm finances its investments.
- Geometric mean (GM)
- The nth root of the product of the annual holding period returns for n years minus 1.
- Holding period return (HPR)
- The total return from an investment, including all sources of income, for a given period of time. A value of 1.0 indicates no gain or loss.
- Holding period yield (HPY)
- The total return from an investment for a given period of time stated as a percentage.
- Investment
- The current commitment of dollars for a period of time in order to derive future payments that will compensate the investor for the time the funds are committed, the expected rate of inflation, and the uncertainty of future payments.
- Liquidity risk
- Uncertainty due to the ability to buy or sell an investment in the secondary market.
- Mean rate of return
- The average of an investment's returns over an extended period of time.
- Real risk-free rate (RFR)
- The basic interest rate with no accommodation for inflation or uncertainty. The pure time value of money.
- Required rate of return
- The return that compensates investors for their time, the expected rate of inflation, and the uncertainty of the return.
- Risk
- The uncertainty that an investment will earn its expected rate of return.
- Risk averse
- The assumption about investors that they will choose the least risky alternative, all else being equal.
- Risk premium (RP)
- The increase over the nominal risk-free rate that investors demand as compensation for an investment's uncertainty.
- Security market line (SML)
- The line that reflects the combination of risk and return of alternative investments.
- Standard deviation
- A measure of variability equal to the square root of the variance.
- Systematic risk
- The portion of an individual asset's total variance that is attributable to the variability of the total market portfolio.
- Variance
- A measure of variability equal to the sum of the squares of a return's deviation from the mean, divided by n.
- Yield spread
- The difference between yields of investments at a point in time.
- Part II. Asset Allocation Decision (Part 2 Audio) mp3
- Accumulation phase
- Phase in the investment life cycle during which individuals in the early-to-middle years of their working career attempt to accumulate assets to satisfy short-term needs and longer-term goals.
- Actuarial rate of return
- The discount rate used to find the present value of a defined benefit pension plan's future obligations and thus determine the size of the firm's annual contribution to the plan.
- Asset allocation
- The process of deciding how to distribute an investor's wealth among different asset classes for investment purposes.
- Asset class
- A collection of securities that have similar characteristics, attributes, and risk/return relationships.
- Basis of an asset
- For tax purposes, the cost of an asset.
- Benchmark portfolio
- A comparison standard of risk and assets included in the policy statement and similar to the investor's risk preference and investment needs, which can be used to evaluate the investment performance of the portfolio manager.
- Capital appreciation
- A return objective in which the investor seeks to increase the portfolio value, primarily through capital gains, over time to meet a future need; generally a goal of an investor willing to take on risk to meet a goal.
- Capital preservation
- A return objective in which the investor seeks to minimize the risk of loss; generally a goal of the risk-averse investor.
- Consolidation phase
- Phase in the investment life cycle during which individuals who are typically past the mid-point of their career have earnings that exceed expenses and invest them for future retirement or estate planning needs.
- Current income
- A return objective in which the investor seeks to generate income rather than capital gains; generally a goal of an investor who wants to supplement earnings with income to meet living expenses.
- Fiduciary
- A person who supervises or oversees the investment portfolio of a third party, such as in a trust account, and makes investment decisions in accordance with the owner's wishes.
- Gifting phase
- Phase in the investment life cycle during which individuals use excess assets to financially assist relatives or friends, establish charitable trusts, or construct trusts to minimize estate taxes.
- Liquid
- Term used to describe an asset that can be quickly converted to cash at a price close to fair market value.
- Long-term, high priority goal
- A long-term financial investment goal of personal importance that typically includes achieving financial independence, such as being able to retire at a certain age.
- Lower-priority goal
- A financial investment goal of lesser personal importance, such as taking a luxurious vacation or buying a car every few years.
- Near-term, high priority goal
- A short-term financial investment goal of personal importance, such as accumulating funds for making a house down payment or buying a car.
- Objectives
- The investor's goals expressed in terms of risk and return and included in the policy statement.
- Overfunded plan
- A defined benefit pension plan in which the present value of the pension liabilities is less than the plan's assets.
- Personal trust
- An amount of money set aside by a grantor and often managed by a third party, the trustee; often constructed so one party receives income from the trust's investments and another party receives the residual value of the trust after the income beneficiary's death.
- Policy statement
- A statement in which the investor specifies investment goals, constraints, and risk preferences.
- Realized capital gains
- Capital gains that result when an appreciated asset has been sold; realized capital gains are taxable.
- Part III. Selecting Investments in a Global Market
- American Depository Receipts (ADRs)
- Certificates of ownership issued by a U.S. bank that represent indirect ownership of a certain number of shares of a specific foreign firm. Shares are held on deposit in a bank in the firm's home country.
- Call options
- Options to buy a firm's common stock within a certain period at a specified price called the striking price.
- Call provisions
- Specifies when and how a firm can issue a call for bonds outstanding prior to their maturity.
- Capital market instruments
- Fixed-income investments that trade in the secondary market.
- Certificates of deposit (CDs)
- Instruments issued by banks and S&Ls that require minimum deposits for specified terms and that pay higher rates of interest than deposit accounts.
- Collateral trust bonds
- A mortgage bond wherein the assets backing the bond are financial assets like stocks and bonds.
- Common stock
- An equity investment that represents ownership of a firm, with full participation in its success or failure. The firm's directors must approve dividend payments.
- Convertible bonds
- A bond with the added feature that the bondholder has the option to turn the bond back to the firm in exchange for a specified number of common shares of the firm.
- Debentures
- Bonds that promise payments of interest and principle but pledge no specific assets. Holders have first claim on the issuer's income and unpledged assets.
- Equipment trust certificates
- Mortgage bonds that are secured by specific pieces of transportation equipment like boxcars and planes.
- Eurobonds
- Bonds denominated in a currency not native to the country in which they are issued.
- Fixed-income investments
- Loans with contractually mandated payment schedules from investors to firms or governments.
- Futures contract
- An agreement that provides for the future exchange of a particular asset at a specified delivery date in exchange for a specified payment at the time of delivery.
- Income bonds
- Debentures that stipulate interest payments only if the issuer earns the income to make the payments by specified dates.
- Indenture
- The legal agreement that lists the obligations of the issuer of a bond to the bondholder including payment schedules, call ed provisions, and sinking funds.
- International domestic bonds
- Bonds issued by a foreign firm, denominated in the firm's native currency, and sold within its own country.
- Investment company
- A firm that sells shares of the company and uses the proceeds to buy stock, bonds, or other financial instruments.
- Money market funds
- Investment companies that hold portfolios of high-quality, short-term securities like T-bills. High liquidity and superior returns make them a good alternative to bank savings accounts.
- Mortgage bonds
- Bonds that pledge specific assets such as buildings and equipment. The proceeds from the sale of these assets are used to pay off bondholders in case of bankruptcy.
- Options
- The right to buy or sell a firm's common stock at a specified price for a stated period of time.
- Portfolio
- A group of investment. Ideally, the investments should have different patterns of returns over time.
- Preferred stock
- Andequity investment that stipulates that dividend payment either as a coupon or a stated dollar amount. The firms directors may withhold payments.
- Put options
- Options to sell a firm's common stock within a certain period at a specified price.
- Real estate investment trusts (REITs)
- Investment funds that hold portfolios of real estate investment.
- Senior secured bonds
- The most senior bonds in a firm's capital structure. They have a first claim on specific assets of the firm in case of bankruptcy.
- Sinking fund
- A provision that specifies payments the issuer must make to redeem a given percentage of an outstanding bond issue prior to maturity.
- Subordinated bonds
- Debentures that, in case of default, entitle holders to claims on the issuer's assets only after the claims of holders of senior debentures and mortgage bonds are satisfied.
- Warrant
- An instrument that allows the holder to purchase a specified number of shares of the firm's common stock from the firm at a specified price for a given period of time.
- Yankee bonds
- Bonds sold in the United States and denominated in U.S. dollars but issued by a foreign firm or government.
- Zero coupon bond
- A bond sold at a discount from par value that promises no interest payment during the life of the bond, only the payment of the par value (principle) at maturity.
- Part IV. Organization and Functioning of Securities Markets
- Call market
- A market in which trading for individual stocks only takes place at specified times. All the bids and asks available at the time are combined and the market administrators specify a single price that will possibly clear the market at that time.
- Commission brokers
- Employees of a member firm who buy and sell for the customers of the firm.
- Continuous market
- A market where stocks are priced and traded continuously either by an auction process or by dealers during the time the market is open.
- Floor brokers
- Independent members of an exchange who act as brokers for other members.
- Fourth market
- Direct trading of securities between owners, usually institutions, without any broker intermediation.
- Initial public offering (IPO)
- A new issue by a firm that has no existing public market.
- Limit order
- An order that lasts for a specified time to buy or sell a security when and if it trades at a specified price.
- Liquidity
- The ability to buy or sell an asset quickly and at a price which is not substantially different from the prices of prior transactions.
- Margin
- The percent of cash a buyer pays for a security, borrowing the balance from the broker. This introduces leverage which increases the risk of the transaction.
- Market
- The means through which buyers and sellers are brought together to aid in the transaction of goods and/or services.
- Market order
- An order to buy or sell a security immediately at the best price available.
- National Association of Securities Dealers Automated Quotation (NASDAQ) system
- An electronic system for providing bid-ask quotes on OTC securities.
- Price continuity
- A feature of a liquid market in which prices change little from one transaction to the next due to the depth of the market.
- Primary market
- The market in which newly issued securities are sold by their issuers.
- Private placement
- A new issue sold directly to a small group of investors, usually institutions.
- Registered competitive market makers (RCMM)
- Members of an exchange who are allowed to use their memberships to buy or sell for their own account within the specific trading obligations set down by the exchange.
- Secondary market
- The market in which outstanding securities are bought and sold by owners other than the issuers.
- Short sale
- The sale of borrowed stock with the intention of repurchasing it later at a lower price and earning the difference.
- Third market
- Over-the-counter trading of securities listed on an exchange.
- Transaction cost
- The cost of executing a trade. Low costs characterize an internally efficient market.
- Treasury bill
- A negotiable U.S. government security with a maturity of less than one year that pays no periodic interest but yields the difference between its par value and its discounted purchase price.
- Treasury bond
- A U.S. government security with a maturity of more than ten years that pays interest periodically.
- Treasury note
- A U.S. government security with maturities of one to ten years that pays interest periodically.
- Part V. Security Market Indicator Series
- Price-weighted series
- An indicator series calculated as an arithmetic average of the current prices of the sampled securities.
- Security-market indicator series
- An index created as a statistical measure of the performance of an entire market or segment of a market based on a sample of securities from the market or segment of a market.
- Value-weighted series
- An indicator series calculated as the total market value of the securities in the sample.
- Underweighted index
- An indicator series affected equally by the performance of each security in the sample regardless of price or market value. Also referred to as an equal weighted series.
- Part VI. Intro to Portfolio Management
- Correlation coefficient
- A standardized measure of the relationship between two series that ranges from -1.00 to +1.00.
- Covariance
- A measure of the degree to which two variables, such as rates of return for investment assets, move together over time relative to their individual mean returns.
- Efficient frontier
- The curve that defines the set of portfolios with the maximum rate of return for every given level of risk, or the minimum risk for a given rate of return.
- Optimal portfolio
- The efficient portfolio with the highest utility for a given investor, found by the point of tangency between the efficient frontier and the investor's highest utility curve.
- Part VII. Intro to Asset Pricing Models
- Arbitrage pricing theory (APT)
- A theory concerned with deriving the expected or required rates of return on risky assets based on the asset's systematic relationship to several risk factors. This multifactor model is in contrast to the single-factor CAPM.
- Beta
- A standardized measure of systematic risk based upon an asset's covariance with the market portfolio.
- Capital asset pricing model (CAPM)
- A theory concerned with deriving the expected or required rates of return on risky assets based on the assets' systematic risk levels.
- Capital market line (CML)
- The line from the intercept point that represents the risk-free rate tangent to the original efficient frontier; it becomes the new efficient frontier.
- Completely diversified portfolio
- A portfolio in which all unsystematic risk has been eliminated by diversification.
- Estimated rate of return
- The rate of return an investor anticipates earning from a specific investment over a particular future holding period.
- Market portfolio
- The portfolio that includes all risky assets with relative weights equal to their proportional market values.
- Market risk premium
- The amount of return above the risk-free rate that investors expect from the market in general as compensation for systematic risk.
- Risk-free asset
- An asset with returns that exhibit zero variance.
- Risky asset
- An asset with uncertain future returns.
- Separation theorem
- The proposition that the investment decision, which involves investing in the market portfolio on the capital market line, is separate from the financing decision, which targets a specific point on the CML based on the investor's risk preference.
- Systematic risk
- The variability of returns that is due to macroeconomic factors that affect all risky assets. Because its affects all risky assets, it cannot be eliminated by diversification.
- Unsystematic risk
- Risk that is unique to an asset, derived from its particular characteristics. It can be eliminated in a diversified portfolio.
- Part VIII. Efficient Capital Markets
- Abnormal rate of return
- The amount by which a security's return differs from the market's expected rate of return based on the market's rate of return and the security's relationship with the market.
- Anomalies
- Security price relationships that appear to contradict a well-regarded hypothesis; in this case, the efficient market hypothesis.
- Autocorrelation test
- A test of the weak-form efficient market hypothesis that compares security price changes over time to check for predictable correlation patterns.
- Earnings surprise
- A company announcement of earnings that differ from analysts' prevailing expectations.
- Efficient capital market
- A market in which security prices rapidly reflect all information about securities.
- Event study
- Research that examines the reaction of a security's price to a specific company or world event or news announcement.
- Expected rate of return
- The return that analysts' calculations suggest a security should provide, based on the market's rate of return during the period and the security's relationship to the market.
- Filter rule
- A trading rules that recommends security transactions when price changes exceed previously determined percentage.
- Informationally efficient market
- A more technical term for an efficient capital market that emphasizes the role of information.
- Runs test
- A test of the weak-from efficient market hypothesis that checks for trends that persist longer in terms of positive or negative price changes that one would expected for a random series.
- Semistrong-form efficient market hypothesis
- The belief that security prices fully reflect all publicly available information, including information from security transactions and company, economic and political news.
- Strong-form efficient market hypothesis
- The belief that security prices fully reflect all information from both public and private sources.
- Trading rule
- A formula for deciding on current transactions based on historical data.
- Weak-form efficient market hypothesis
- The belief that security prices fully reflect all security market information.
- Part IX. Analysis of Financial Statements
- Balance sheet
- A financial statement that shows what assets the firm controls at a fixed price in time and how it has financed these assets.
- Business risk
- The variability of operating income arising from the characteristics of the firm's industry. Two sources of business risk are sales variability and operating leverage.
- Common size statements
- The normalization of balance sheet and income statement items to allow for easier comparison of different-size firms.
- Cross-sectional analysis
- An examination of a firm's performance in comparison to other firms in the industry with similar characteristics to the firm being studied.
- DuPont analysis
- A method of examining ROE by breaking it down into three component parts.
- Financial risk
- The variability of future income arising from the firm's fixed financing costs, for example, interest payments. The effect of fixed financial costs is to magnify the effect of changes in operating profit on net income or earnings per share.
- Free cash flow
- This cash flow measure equals cash flow from operations minus capital expenditures and dividends.
- Generally accepted accounting principles (GAAP)
- Accounting principles formulated by the Financial Accounting Standards Board and used to construct financial statements.
- Income statement
- A financial statement that shows the flow of the firm's sales, expenses, and earnings over a period of time.
- Internal growth rate
- A measure of how quickly the firm can increase its sales and assets without external financing.
- Internal liquidity (solvency) ratios
- Relationships between items of financial data that indicate the firm's ability to meet short-term financial obligations.
- Operating efficiency ratios
- Ratios that measure a firm's utilization of its assets and capital.
- Operating leverage
- The use of fixed-production costs in the firm's operating cost structure. The effect of fixed costs is to magnify the effect of a change in sales on operating profits.
- Operating profitability ratios
- Ratios that measure the ability of the firm to earn returns on sales.
- Quality financial statements
- A term analysts use to describe financial statements that are conservative and a good reflection of reality.
- Statement of cash flows
- A financial statement that shows the effects on the firm's cash flow of income flows and changes in its balance sheet.
- Sustainable growth rate
- A measure of how fast a firm can grow using internal equity and debt financing to keep the capital structure constant over time.
- Time-series analysis
- An examination of a firm's performance data over a period of time.
- Trading turnover
- The percentage of outstanding shares traded during a period of time.
- Part X. Intro to Security Valuation
- Dividend discount model (DDM)
- A technique for estimating the value of a stock issue as the present value of all future dividends.
- Earnings multiplier model
- A technique for estimating the value of a stock issue as a multiple of its earnings per share.
- Growth company
- A firm that has the opportunity to earn returns on investments that are consistently above its required rate of return.
- Investment decision process
- Estimation of value for comparison with market price to determine whether or not to invest.
- Overweighted
- A condition in which a portfolio, for whatever reason, includes more of a class of securities than the relative market value alone would justify.
- Perpetuity
- An investment without any maturity date. It provides returns to its owner indefinitely.
- Price/earnings (P/E) ratio
- The number by which earnings per share is multiplied to estimate a stock's value; also called the earnings multiplier.
- Underweighted
- A condition in which a portfolio, for whatever reason, includes less of a class of securities than the relative market value alone would justify.
- Valuation process
- Part of the investment decision process in which you estimate the value of a security.
- Part XI. Economic and Market Analysis
- Bottom-up approach
- A forward-looking approach to evaluating securities in which trends are forecast based on an analysis of microeconomics, or firm-specific, factors.
- Coincident index of economic indicators
- An indicator series that consists of a set of economic variables whose values reach peaks and troughs at about the same time as the aggregate economy.
- Discount rate
- The interest rate at which banks can borrow from the Federal Reserve Board.
- Econometric model
- A statistical estimation of mathematical relationships between economic variables as posited by economic theory.
- Exchange rate
- The price of one nation's currency in terms of another nation's currency.
- Expectational analysis
- A forecasting approach that includes an analysis of the current environment, the analyst's assumptions, and a procedure for monitoring data and events to identify changes in the environment or violations of the analyst's assumptions.
- Federal funds rate
- The interest rate banks charge each other for short-term loans.
- Fiscal policy
- The use of government spending and taxing powers.
- Free reserves
- The amount of reserves available to the banking system; it is equal to the excess reserves of the banking system less bank borrowing from the Federal Reserve Board.
- Gross domestic product (GDP)
- The sum total of the goods and services produced within a nation's borders. The five major components of GDP are consumption spending, investment spending, government expenditures, export production, and import production.
- Lagging index of economic indicators
- An indicator series consisting of a set of economic variables whose values reach peaks and troughs after the aggregate economy.
- Index of leading economic indicators
- An indicator series consisting of a set of economic variables whose values reach peaks and troughs in advance of the aggregate economy.
- Monetary policy
- The use of the Federal Reserve Board's power to affect the money supply and aggregate economic activity.
- Open market operations
- The most frequently used tool of monetary policy in which the Federal Reserve Board buys and sells securities from any market participant.
- Reserve requirement
- The ratio of required reserves to total deposits at a bank.
- Top-down approach
- A forward-looking approach to evaluating securities in which trends are forecast based on an analysis of macroeconomic factors.
- Part XII. Industry Analysis
- Competitive environment
- The level of intensity of competition among firms in an industry, determined by an examination of five competitive forces.
- Competitive strategy
- The search by a firm for a favorable competitive position within an industry, which affects evaluation of the industry's prospects.
- Cyclical change
- A type of economic trend resulting from the ups and downs of the business cycle.
- Industry
- A set of businesses producing similar products used by customers for similar purposes.
- Industry life-cycle analysis
- An analysis that focuses on the industry's stage of development.
- Strategic group
- A group of firms in an industry that follows similar strategies in their product or market approaches.
- Structural change
- A type of economic trend resulting from a major organizational change in the economy or in how it functions.
- Theme investing
- An investment strategy that tries to identify megatrends, that is, economic, demographic, social, technological, and political trends that should persist long enough to have a major influence on industry and corporate profits in clearly defined areas.
- Part XIII. Company Analysis and Stock Selection
- Cyclical company
- A firm whose earnings rise and fall with general economic activity.
- Cyclical stock
- A stock with a high beta; its gains typically exceed those of a rising market and its losses typically exceed those of a falling market.
- Defensive company
- Firms whose future earnings are likely to withstand an economic downturn.
- Growth company
- A company that consistently has the opportunities and ability to invest in projects that provide rates of return that exceed the firm's cost of capital. Because of these investment opportunities, it retains a high proportion of earnings, and its earnings grow faster than those of average firms.
- Growth stock
- A stock issue that generates a higher rate of return than other stocks in the market with similar risk characteristics.
- Offensive strategy
- A competitive strategy in which the firm uses its strengths to affect the competitive forces in the industry.
- Speculative company
- A firm with a great degree of business or financial risk, or both, with commensurate high earnings potential.
- Speculative stock
- A stock that appears highly overpriced compared to its reasonable valuation.
- SWOT analysis
- An examination of a firm's internal strengths and weaknesses and its external opportunities and threats.
- Value stocks
- Stocks that appear undervalued for reasons beside earnings growth potential. These stocks are usually identified based on low P/E ratios or low price-to-book ratios.
- Part XIV. Technical Analysis
- Declining trend channel
- The range defined by security prices as they move progressively lower.
- Diffusion index
- An indicator of the number of stocks rising during a specified period of time relative to the number of stocks declining and not changing price.
- Downtick
- A price decline in a transaction price compared to the previous transaction price.
- Flat trend channel
- The range defined by security prices as they maintain a relatively steady level.
- Group rotation
- The tendency for demand to shift among industry groups or other market segments.
- Moving average
- The continually recalculated average of security prices for a period, often 200 days, to serve as an indication of the general trend of prices and also as a benchmark price.
- Relative-strength index
- The ratio of a stock price or an industry index value to a market indicator series, indicating performance relative to the overall market.
- Resistance level
- A price at which a technician would expect a substantial increase in the supply of a stock to reverse a rising trend.
- Rising trend channel
- The range defined by security prices as they move progressively higher.
- Support level
- A price at which a technician would expect a substantial increase in price and volume for a stock to reverse a declining trend that was due to profit taking.
- Technical analysis
- Estimation of future security price movements based on past movements.
- Trough
- The culmination of a bear market at which prices stop declining and begin rising.
- Uptick
- An incremental movement upward in a transaction price over the previous transaction price.
- Uptick-Downtick ratio
- A ratio of the number of uptick block transactions (indicating buyers) to the number of downtick block transactions (indicating sellers of blocks). An indicator of institutional investor sentiment.
- Part XV. Bond Fundamentals
- Bearer bond
- An unregistered bond for which ownership is determined by possession. The holder receives interest payments by clipping coupons attached to the security and sending them to the issuer for payment.
- Benchmark issue
- A Japanese government bond selected to dominate trading in that market.
- Certificates for automobile receivables (CARs)
- Asset backed securities backed by pools of loans to individuals for financing car purchases.
- Collateral trust bond
- A bond secured by financial assets held by a trustee for the benefit of the bondholders.
- Collateralized mortgage obligation (CMO)
- A debt security based on a pool of mortgage loans that provides a relatively stable stream of payments for a relatively predictable term.
- Coupon
- Indicates the interest payment on a debt security. It is the coupon rate times he par value that indicates the interest payment on a debt security.
- Equipment trust certificate
- A debt security issued by a transportation firm to finance the purchase of equipment (railroad rolling stock, airplanes), which serves as collateral for the debt.
- Flower bond
- A Treasury issue that can be redeemed at face value in payment of federal estate taxes.
- General obligation bond (GO)
- A municipal issue serviced from and guaranteed by the issuer's full taxing authority.
- High-yield bond
- A bond rated below investment grade. Also referred to as speculative-grade bonds or junk bonds.
- Money market
- The market for short-term debt securities with maturities of less than one year.
- Municipal bond guarantees
- An irrevocable insurance policy on a bond issue (paid for by the issuer) whereby a bond insurance company guarantees to make principal and interest payments on an issue in the event that the issuer for the bond defaults.
- Notes
- Intermediate-term debt securities with maturities longer than one year but less than ten years.
- Principal (par value)
- The original value of the debt underlying a bond that is payable at maturity.
- Public bond
- A long-term, fixed-obligation debt security in a convenient, affordable denomination for sale to individuals and financial institutions.
- Refunding issue
- Bonds that provide funds to prematurely retire another bond issue. These bonds can be either a junior or senior issue.
- Registered bond
- A bond for which ownership is registered with the issuer. The holder receives interest payments by check directly from the issuer.
- Revenue bond
- A bond that is serviced by the income generated from specific revenue-producing projects of the municipality.
- Secured (senior) bond
- A bond backed by a legal claim on specified assets of the issuer.
- Serial obligation bond
- A bond issue that has a series of maturity dates.
- Subordinated (junior) debenture
- An unsecured bond that possesses a claim on income and assets that is subordinated to other debentures.
- Term bond
- A bond that has a single maturity date.
- Term to maturity
- Specifies the date or the number of years before a bond matures or expires.
- Unsecured bond (debenture)
- A bond backed only by the promise of the issuer to pay interest and principal on a timely basis.
- Variable-rate note
- A debt security for which the interest rate changes to follow some specified short-term rate, for example, the T-bill rate.
- Zero-coupon bond
- A bond that pays its par value at maturity, but no periodic interest payments. Its yield is determined by the difference between its par value and its discounted purchase price. Also called a minicoupon bond or an original-issue discount (OID) bond.
- Part XVI. The Valuation of Bonds
- Bond price volatility
- The percentage changes in bond prices over time.
- Convexity
- A measure of the degree to which a bond's price-yield curve departs from a straight line. This characteristic affects estimates of a bond's price volatility.
- Crossover point
- The price at which it becomes profitable for an issuer to call a bond. Above this price, yield to call is the appropriate yield measure.
- Current yield
- A bond's yield as measured by its current income (coupon) as a percentage of its market price.
- Discount
- A bond selling at a price below par value due to capital market conditions.
- Duration
- A composite measure of the timing of a bond's cash flow characteristics taking into consideration its coupon and term to maturity.
- Ending-wealth value
- The total amount of money derived from investment in a bond until maturity, including principal, coupon payments, and income from reinvestment of coupon payments.
- Equivalent taxable yield (ETY)
- A yield on a tax-exempt bond that adjusts for its tax benefits to allow comparisons with taxable bonds.
- Interest-on-interest
- Bond income from reinvestment of coupon payments.
- Internal rate of return (IRR)
- The discount rate at which cash outflows of an investment equal cash inflows
- Modified duration
- A measure of Macaulay duration adjusted to help you estimate a bond's price volatility.
- Nominal yield
- A bond's yield as measured by its coupon rate.
- Premium
- A bond selling at a price above par value due to capital market conditions.
- Promised yield to call (YTC)
- A bond's yield if held until the first available call date, with reinvestment of all coupon payments at the yield-to-call rate.
- Promised yield to maturity
- The most widely used measure of a bond's yield that states the fully compounded rate of return on a bond bought at market price and held to maturity with reinvestment of all coupon payments at the yield to maturity (YTM) rate.
- Realized (horizon) yield
- The expected compounded yield on a bond that is sold before it matures assuming the reinvestment of all cash flows at an explicit rate.
- Term structure of interest rates
- The relationship between term to maturity and yield to maturity for a sample of comparable bonds at a given time. Popularity known as the yield curve.
- Yield
- The promised rate of return on an investment under certain assumptions.
- Yield illusion
- The erroneous expectation that a bond will provide its stated yield to maturity without recognizing the implicit reinvestment assumption related to coupon payments.
- Yield spread
- The difference between the promised yields of various bond issues or market segments at a given time.
- Part XVII. Intro to Derivative Investments
- American option
- An option that allows the holder to exercise the option any time up to and including the expiration day.
- At-the-money option
- An option with an exercise price approximately equal to the stock's market price.
- Option
- An investment instrument that grants to the owner the right to buy or sell something at a fixed price, either on a specific date or any time up to a specific date.
- Option premium
- The price paid for an option.
- Out-of-the-money option
- An option with an unfavorable exercise price in relation to the stock's market price.
- Price spread
- Simultaneously buying and selling options that are identical except for their exercise prices.
- Protective put
- A put option strategy that involves the purchase of a put accompanied by a long position in the stock.
- Put/call parity
- The relationship between put and call options on the same underlying asset with the same exercise price.
- Settlement price
- The approximate closing price of the futures contract determined by a special exchange committee at the end of each trading day.
- Spot market
- The trading market in which cash and asset ownership are transferred between the buyer and the seller.
- Synthetic call
- Another name for a protective put; so called because the payoff diagram for a protective put resembles that of a call option.
- Synthetic put
- A put-like position that arises from having a short stock position together with a long call position in the same stock.
- Time spread
- Simultaneously buying and selling options that are identical except for their expiration dates.
- Uncovered (naked) call option
- Selling an option contract on a stock that you do not own; you would have to acquire it if the option owner called for the stock.
- Part XVIII. Advanced Derivatives, Warrants, and Convertible Securities
- Bond value
- The price at which a debenture would have to sell as a straight debt instrument. Also referred to as bond value or floor value.
- Breakeven time
- The time required for the added income from the convertible relative to the stock to offset the conversion premium. Also referred to as payback period.
- Call provisions
- Indenture provisions describing the date, price, and other circumstances under which the issuer may redeem a convertible.
- Conditional call
- Indenture provision that permits the company to call a convertible security prior to the stated call date if the common stock price rises above a preset level. Typically expressed as a percentage (such as 140 percent or 150 percent) of the specified conversion price.
- Conversion parity price
- The market value of a convertible bond divided by the number of shares into which it can be converted (its conversion ratio).
- Conversion premium
- The excess of the market value of the convertible over its equity value if immediately converted into common stock. Typically expressed as a percentage of the equity value.
- Conversion (or exercise price)
- The price at which common stock can be obtained by surrendering the convertible instrument at par value.
- Conversion ratio
- The number of shares of common stock for which a convertible security may be exchanged.
- Conversion value
- The value of the convertible security if converted into common stock at the stock's current market price. Also referred to as parity or conversion value.
- Convertible preferred stock
- A preferred stock issue that the holder can exchange for a stated number of shares of common stock.
- Convertible security
- A security that gives the holder the right to convert one type of security into a stipulated amount of another security at the investor's discretion.
- Currency exchange warrant
- A warrant contract that allows investors to acquire a specific number of U.S. dollars at a specified exchange rate of a non-U.S. currency.
- Equity equivalent
- A convertible with price behavior dominated by changes in the common stock price, with relatively little sensitivity to changes in interest rates.
- Equity value
- The value of the convertible security if converted into common stock at the stock's current market price. Also referred to as parity or conversion value.
- Fixed income equivalent
- A convertible with price behavior dominated by changes in interest rates, with relatively little sensitivity to changes in common stock price.
- Forced conversion
- If an issuer attempts to redeem a convertible for cash by issuing a call, and if the equity value exceeds the exemption price, the investor is "forced" to convert the bond into common stock in order to obtain the higher equity value.
- Hard call
- A convertible that does not have any provisional call feature is said to have hard call protection.
- Initial premium
- The conversion premium at the time a new convertible security is offered.
- Investment premium
- The difference between a convertible's market price and its investment value, expressed as a percentage of market price. (Also called downside risk)
- Investment value
- The price at which a debenture would have to sell as a straight debt instrument. Also referred to as bond value or floor value.
- Options on Futures
- An options contract where the underlying security is a futures contract.
- Payback
- The time required for the added income from the convertible relative to the stock to offset the conversion premium. Also referred to as payback period.
- Provisional call
- Indenture provision that permits the company to call a convertible security prior to the stated call date if the common stock price rises above a preset level. Typically expressed as a percentage (such as 140 percent or 150 percent) of the specified conversion price.
- Unit offering
- A combination of notes and warrants that is issued as a unit but may subsequently be traded either separately or as a unit. Also referred to as synthetic convertibles.
- Warrant
- An option to buy a stated number of shares of common stock from the company at a specified price at any time during the life of the warrant.
- Warrant conversion ratio
- The number of shares of stock that can be purchased for each warrant.
- Yield advantage
- The difference between the current yield of the convertible bond and the current yield of the common stock.
- Yield to first call
- Rate of return at the current price, assuming the issue is called at the first call date and at its call price.
- Yield to first put
- Rate of return at the current price, assuming the issue is called at the first put call data and at its put price.
- Part XIX. Equity Portfolio Management
- Active equity portfolio management
- An attempt by the manager to outperform, on a risk-adjusted basis, a passive benchmark portfolio.
- Backtest
- A method of testing a quantitative model in which computers are used to examine the composition and returns of portfolios based on historical data to determine if the selected strategy would have worked in the past.
- Benchmark portfolio
- A passive portfolio whose average characteristics (in terms of beta, dividend yield, industry weight, firm size, and so on) match the risk-return objectives of the client and serves as a basis for evaluating the performance of an active manager.
- Completeness fund
- A specialized index used to form the basis of a passive portfolio whose purpose is to provide diversification to a client's total portfolio by excluding those segments in which the client's active managers invest.
- Earnings momentum
- A strategy in which portfolios are constructed of stocks of firms with rising earnings.
- Full replication
- A technique for constructing a passive index portfolio in which all securities in an index are purchased in proportion to their weights in the index.
- Growth stocks
- Stocks of firms enjoying above-average-earnings-per-share increases and that usually have above average ratios of price/book and price/earnings.
- Passive equity portfolio management
- A long-term-buy-and-hold strategy so that returns will track those of an index over time.
- Price momentum
- A portfolio strategy in which you acquire stocks that have enjoyed above-market stock price increases.
- Quadratic optimization
- A technique that relies on historical correlations in order to construct a portfolio that seeks to minimize tracking error with an index.
- Sampling
- A technique for constructing a passive index portfolio in which the portfolio manager buys a representative sample of stocks that comprise the benchmark index.
- Sector rotation strategy
- An active strategy that involves purchasing stocks in specific industries or stocks with specific characteristics (low P/E, growth, value) that are anticipated to rise in value more than the overall market.
- Style investing
- Involves constructing portfolios in such a way to capture one or more of the characteristics of equity securities.
- Tracking error
- The difference between a passively managed portfolio's returns and that of the index it seeks to imitate.
- Value stocks
- Stocks that appear to be underpriced because their price/book or price/earning ratio is low, or their dividend yield is high, compared to the rest of the market.
- Part XX. Fixed Income Portfolio Management Strategies
- Barbell Strategy
- With this bond portfolio strategy, about one-half of the funds are invested in short-duration securities and the remainder are invested in long-duration securities. This combines high return, high income potential of long-term bonds with lower risk, high liquidity aspects of shorter-term securities.
- Bond swap
- An active bond portfolio management strategy that exchanges one position for another to take advantage of some difference between them.
- Buy-and-hold strategy
- A passive bond portfolio management strategy in which bonds are bought and held to maturity.
- Cheapest-to-deliver (CTD) bond
- The bond the seller of a Treasury bond futures contract will deliver to the buyer to settle the futures contract, because the bond specified in the futures contract (8 percent coupon, fifteen years to maturity or first call) rarely exists.
- Conversion factor
- Used to adjust the value of the CTD bond to reflect the cost to deliver the 8 percent coupon, fifteen-years-to-maturity Treasury bond specified in the T-bond futures contract.
- Credit analysis
- An active bond portfolio management strategy designed to identify bonds expected to experience changes in rating. This strategy is critical when investing in high-yield bonds.
- Dedication
- A portfolio management technique in which the portfolio's cash flows are used to retire a set of liabilities over time.
- Dedication with reinvestment
- A dedication strategy in which portfolio cash flows may precede their corresponding liabilities. Such cash flows can be reinvested to earn a return until the date the liability is due to be paid.
- Delivery
- The settlement of a Treasury-bond futures contract made in the actual underlying security, a T-bond.
- Duration adjustment factor
- A factor that reflects the difference in interest rate sensitivity between the bond portfolio and the cheapest-to-deliver Treasury bond.
- Duration strategy
- A portfolio management strategy employed to reduce the interest rate risk of a bond portfolio by matching the modified duration of the portfolio with its investment horizon. For example, if the investment horizon is ten years, the portfolio manager would construct a portfolio that has a modified duration of ten years. This strategy is referred to as immunization of the portfolio.
- Hedge ratio
- The appropriate number of futures to buy or sell to hedge against a position.
- Portfolio immunization
- A bond portfolio management technique of matching modified duration to the investment horizon of the portfolio to eliminate interest rate risk.
- Indexing
- A passive bond portfolio management strategy that seeks to match the composition, and therefore the performance, of a selected market index.
- Interest rate anticipation
- An active bond portfolio management strategy designed to preserve capital or take advantage of capital gains opportunities by predicting interest rates and their effects on bond prices.
- Interest rate risk
- The uncertainty of returns on an investment due to possible changes in interest rates over time.
- Investment horizon
- The time period used for planning and forecasting purposes or the future time at which the investor requires the invested funds.
- Ladder strategy
- This portfolio strategy places an equal amount of portfolio's holdings in a wide range of maturities. Maturing bonds are reinvested in the longest-term bonds. To reduce reinvestment risk, coupon income is reinvested across the maturity spectrum.
- Maturity strategy
- A portfolio management strategy employed to reduce the interest rate risk of a bond portfolio by matching the maturity of the portfolio with its investment horizon. For example, if the investment horizon is ten years, the portfolio manager would construct a portfolio that will mature in ten years.
- Price risk
- The component of interest rate risk due to the uncertainty of the market price of a bond caused by possible changes in market interest rates.
- Pure cash-matched dedicated portfolio
- A conservative dedicated portfolio management technique aimed at developing a bond portfolio that will provide payments exactly matching the specified liability schedules.
- Reinvestment risk
- The component of interest rate risk due to the uncertainty of the rate at which coupon payments will be reinvested.
- Tracking error
- The difference between the return of a portfolio that is constructed to replicate an index and the return on the index itself.
- Valuation analysis
- An active bond portfolio management strategy designed to capitalize on expected price increases in temporarily undervalued issues.
- Wash sale
- The term for selling an issue for a capital loss and repurchasing it within thirty days. In such cases the IRS does not allow the loss.
- Weighted-average-durations approach
- An approach used to determine how many futures contracts should be bought or sold to quickly increase or decrease a portfolio's duration.
- Part XXI. Portfolio Management Using Investment Companies - 1 - General Mutual Fund terms.
- Accumulation (periodic payment) plan
- An arrangement through which an investor can purchase mutual fund shares periodically in large or small amounts, usually with provisions for the reinvestment of income dividends and capital gains distributions in additional shares.
- Advisor
- The organization employed by a mutual fund to give professional advice on the management of its assets.
- Asked (offering) price
- The price at which you can purchase a mutual fund's shares equal to the net asset value per share plus, at times, a sales charge.
- Automatic reinvestment
- A provision of most mutual funds by which the investor can automatically reinvest income dividends and capital gains distributions in additional shares.
- Bid (redemption) price
- The price at which a mutual fund redeems (buys back) its shares, usually equal to the net asset value per share.
- Bookshares
- A modern share recording system that eliminates the need for share certificates, but gives fund shareowners records of their holdings.
- Broker-dealer (dealer)
- A firm that retails mutual fund shares and other securities to the public.
- Capital gains distributions
- Payments, usually annual, to mutual fund shareholders for gains realized on the sale of the fund's portfolio securities.
- Capital growth
- An increase in the market value of a mutual fund's securities that is reflected in the NAV of its shares. Maximizing this factor is a long-term objective of many mutual funds.
- Closed-end investment company
- An investment company that issues only a limited number of shares, which it does not redeem (buy back). Instead, closed-end shares are traded in securities markets at prices determined by supply, and demand.
- Contingent deferred sales load
- A mutual fund that imposes a sales charge when the investor sells or redeems shares. Also referred to as rear-end load or redemption charge.
- Contractual plan
- A program for the accumulation of mutual fund shares in which the investor agrees to invest a fixed amount on a regular basis for a specified number of years. A substantial portion of the sales charge application to the total investment is usually deducted from early payments.
- Conversion (exchange) privilege
- A provision that enables a mutual fund shareholder to transfer an investment, if needs or objectives change, from one fund to another within the same fund group, sometimes with a small transaction charge.
- Custodian
- The organization (usually a bank) that holds the securities and other assets or a mutual fund in custody and safekeeping.
- Dollar-cost averaging
- Investing equal amounts of money at regular intervals regardless of whether the stock market is moving upward or downward. This reduces the average share costs in periods of lower securities prices, and the number of shares purchase in periods of higher prices.
- Exchange privilege
- A provision that enables a mutual fund shareholder to transfer an investment, if needs or objectives change, from one fund to another within the same fund group, sometimes with a small transaction charge.
- Income dividends
- Payments to mutual fund shareholders of dividends, interest, and short-term capital gains earned on the fund's portfolio after deduction of operating expenses.
- Investment advisor
- The organization employed by a mutual fund to give professional advice on the management of its assets.
- Investment company
- A corporation, trust, or partnership in which investors pool their money to obtain professional management and portfolio diversification. Mutual funds are the most popular type of investment company.
- Investment objective
- The goal, such as long-term capital growth or current income, that an investor or a mutual fund pursues.
- Investment management company
- A company, separate from the investment company, that manages the portfolio and performs administrative functions.
- Load
- An amount charged to purchase shares in most mutual funds that are sold by brokers or other members of a sales force. Typical charges range from 4 to 8.5 percent of the initial investment. The charge is added to the net asset value per share to determine the offering price.
- Low-load fund
- A mutual fund that imposes a moderate front-end sales charge when the investor buys the fund, typically about 3 to 4 percent.
- Management fee
- The compensation an investment company pays to the investment management company for its services. The average annual fee is about .5 percent of fund assets.
- Mutual fund
- An investment company that pools money from shareholders and invests in a variety of securities, including stocks, bonds, and money market securities. A mutual fund ordinarily stands ready to buy back (redeem) its shares at their current net asset value, which depends on the market value of the fund's portfolio of securities at the time. Mutual funds generally continuously offer new shares to investors.
- Net asset value (NAV) per share
- The market value of an investment company's assets (securities, cash, and any accrued earnings) after deducting liabilities, divided by the number of shares outstanding.
- No-load fund
- A mutual fund that sells its shares at net asset value without adding sales charges.
- Open-end investment company
- The more formal name for a mutual fund, which derives from the fact that it continuously offers new shares to investors and redeems them (buys them back) on demand.
- Payroll deduction plan
- An arrangement offered by some employers through which an employee may accumulate shares in a mutual fund. Employees authorize the employer to deduct specified amounts from their salaries at stated times and transfer the proceeds to the designated fund or funds.
- Periodic payment plan
- A program for the accumulation of mutual fund shares in which the investor agrees to invest a fixed amount on a regular basis for a specified number of years. A substantial portion of the sales charge application to the total investment is usually deducted from early payments.
- Prospectus
- A booklet that describes a mutual fund and offers its shares for sale. It contains information required by the Securities and Exchange Commission on such subjects as the fund's investment objective and policies, services, investment restrictions, officers and directors, procedures for buying or redeeming shares, charges, and financial statements.
- Redemption price
- The price at which a mutual fund redeems (buys back) its shares, usually equal to the net asset value per share.
- Reinvestment privilege
- A provision of most mutual funds by which the investor can automatically reinvest income dividends and capital gains distributions in additional shares.
- Sales charge
- An amount charged to purchase shares in most mutual funds that are sold by brokers or other members of a sales force. Typical charges range from 4 to 8.5 percent of the initial investment. The charge is added to the net asset value per share to determine the offering price.
- Short-term fund
- An industry designation for money market and short-term municipal bond funds.
- Transfer agent
- The organization employed by a mutual fund to prepare and maintain records relating to the accounts of fund shareholders.
- 12b-1 fee
- A fee charged by some funds, named after the SEC rule that permits it. Such fees pay for distribution costs, such as advertising, or for brokers' commissions. The fund's prospectus details any 12b-1 charges that apply.
- Underwriter (principal underwriter)
- The organization that acts as the distributor of a mutual fund's shares to broker-dealers and the public.
- Unit investment trust
- An investment company that purchases a fixed portfolio of income-producing securities to create a trust and sells units in the trust to investors through brokers.
- Variable annuity
- A contract under which an annuity is purchased with a fixed amount of money that is converted into a varying number of accumulation units. At retirement, the annuitant is paid a fixed number of monthly units, which are converted into varying amounts of money. The value of both accumulation and annuity units varies with performance of a portfolio of equity securities.
- Variable life insurance
- An equity-based life insurance policy the reserves of which may be invested in common stock. The death benefit is guaranteed never to fall below the face value, but it would increase if the value of the securities were to increase. This kind of policy may have no guaranteed cash-surrender value.
- Voluntary plan
- A flexible accumulation plan that states no definite time period or total amount to be invested.
- Withdrawal plan
- A mutual fund provision that allows shareholders to receive payments from their investments at regular intervals. These payments typically are drawn from the fund's dividends and capital gains distributions, if any, and from principal, as needed. Many mutual funds offer these plans.
- Part XXI. Portfolio Management Using Investment Companies - 2 - Types of Mutual Funds
- Aggressive growth fund
- A fund that seeks maximum capital gains as its investment objective. Current income is no a significant factor. Some may invest in stocks on the fringes of the mainstream, such as those fledgling companies, new industries, companies fallen on hard times, or industries temporarily out of favor. They may also use specialized investment techniques such as option writing. The risks are obvious, but the potential for handsome rewards should accompany them.
- Balanced fund
- A fund with , generally, a three-part investment objective: 1. to conserve the investors' principal, 2. to pay current income, and 3 to increase both principal and income. The fund aims to achieve this by owning a mixture of bonds, preferred stocks, and common stocks.
- Corporate bond fund
- Like an income fund, this type of fund seeks a high level of income. It does this by buying bonds of corporations for the majority of the portfolio. Some part of the portfolio may be in U.S. Treasury and other government bonds.
- Flexible portfolio fund
- A fund that invests in common stocks, bonds, money market securities, and other types of debt securities. The portfolio may hold up 100 percent of any one of these types of securities or any combination of them, depending on market conditions.
- Global bond fund
- A fund that invests in bonds issued by companies from countries worldwide, including the United States.
- Global equity fund
- A fund that invests in the stock of both U.S. and foreign companies.
- GNMA (Ginnie Mae) fund
- A fund that invests in the government-backed mortgage securities of the Government National Mortgage Association. To qualify for this category, the majority of fund's portfolio must always be invested in mortgage-backed securities.
- Growth and income fund
- A fund that invests mainly in the common stock of companies with longer track records - companies that combine the expectation of higher share values and solid records of paying dividends.
- Growth fund
- A fund that invests in the common stock of more settled companies, but again, with the primary aim of building the value of its investments through capital gains rather than steady flow of dividends.
- High-yield bond fund
- A corporate bond fund that invests predominantly in bonds rated below investment grade. In return for a generally higher yield, investors bear great risk than more highly rated bonds require.
- Income equity fund
- A fund that invests primarily in stocks of companies with good dividend-paying records.
- Income-bond fund
- A fund that invests in a combination of government and corporate bonds to generate income.
- Income-mixed fund
- A fund that seeks a high level of current income, often by investing in the common stock of companies that have good dividend-paying records. Often corporate and government bonds are also part of the portfolio.
- International stock fund
- A fund that invests in the stocks of companies located outside the United States.
- Long-term municipal bond fund
- A fund that invests in bonds issued by local governments, such as cities and states, which use the money to build schools, highways, libraries, and the like. Because the federal government does not tax income earned on most these securities, the fund can pass the tax-free income through to shareholders.
- Long-term state municipal bond fund
- A fund that invests predominantly in long-term municipal bonds issued within a single state. These issues are exempt from both federal income tax and state taxes for residents of the same state.
- Money market mutual fund
- A fund that invests in short-term securities sold in the money market. (Large companies, banks, and other institutions also invest their surplus cash in the money market for short periods of time.) In the entire investment spectrum, these are generally the safest, most stable securities available. They include Treasury bills, certificates of deposit of large banks, and commercial paper (short-term IOU's of large corporations).
- Option/income fund
- A fund that seeks a high current return by investing primarily in dividend-paying common stocks on which call options are traded on national securities exchanges. Current returns generally consist of dividends and premiums from writing call options, but other sources include short-term gains from asset sales, often to satisfy exercised options, and profits from closing purchase transactions.
- Short-term municipal bond fund
- A fund that invests in municipal securities with relatively short maturities issued in a single state. Such issues are exempt from state taxes for residents of the same state.
- U.S. Government Income Fund
- A fund that invests in a variety of government securities, including U.S. Treasury bonds, federally guaranteed mortgage-backed securities, and other government issues.
- Part XXI. Portfolio Management Using Investment Companies - 3 - Retirement Plans
- Federal income tax laws permit the establishment of various tax-deferred retirement plans, each of which may be funded with mutual fund shares.
- Corporate and self-employed retirement plan
- A tax-qualified pension and profit-sharing plan that can be established by corporations or self-employed individuals. Changes in the tax laws have made retirement plans for corporate employees essentially comparable to those for self-employed individuals. Contributions to a plan are tax deductible and earnings accumulate on a tax-deferred basis. The maximum annual amount that may be contributed to such a plan on behalf of an individual is limited to the less or 25 percent of the individual's compensation or $30,000.
- Individual retirement account
- Any wage earner under the age of 70.5 may set up an individual retirement account (IRA) and may contribute as much as 100 percent of his or her compensation each year up to $2,000.
- Qualified retirement plan
- A private retirement plan that meets the rule sand regulations of the Internal Revenue Service. In almost all cases, contributions to a qualified retirement plan are tax deductible and earnings on such contributions are always exempt from taxes until the investor retires.
- Simplified employee pension (SEP)
- An employer-sponsored plan that may be viewed as an aggregation of separate IRAs. In a SEP, the employer contributes up to $30,000 or 15 percent of compensation, whichever is less, to an individual retirement account maintained for the employee.
- Section 403(b) plan
- Section 403(b) of the Internal Revenue Code permits employees of certain charitable organizations and public school systems to establish tax-sheltered retirement programs. These plans may be invested in either annuity contracts or mutual fund shares.
- Section 401(k) plan.
- A particularly popular type of plan that may be offered by either corporate or noncorporate entities. A 401(k) plan is a tax-qualified profit-sharing plan that includes a "cash or deferred" arrangement, which permits employees to have a portion of their compensation contributed to a tax-sheltered plan on their behalf or paid to them directly as additional taxable compensation. An employee may elect to reduce his or her other taxable compensation with contributions to a 401(k) plan, where those amounts will accumulate tax-free. The Tax Reform Act of 1986 established new, tighter antidiscrimination requirements for 401(k) plans and curtailed the amount of elective deferrals that may be made by all employees. Nevertheless, 401(k) plans remain excellent and popular retirement savings vehicles.
- Part XXII. Evaluation of Portfolio Management
- Analysis effect
- The difference in performance of a bond portfolio from that of a chosen index due to acquisition of temporarily mispriced issues that then move to their correct prices.
- Benchmark error
- An inaccuracy in evaluation of portfolio performance due to poor representation of market performance because of the market indicator series chosen as a proxy for the market portfolio.
- Benchmark portfolio
- A portfolio that represents the performance evaluation standard for a portfolio manager. The benchmark portfolio is usually a passive index or portfolio with an asset allocation equal to that specified in the investor's policy statement.
- Characteristics analysis
- Characteristic analysis is based on the belief that the portfolio's current make-up will be a good predictor for the next period's returns. The methodology uses a complex decision-tree approach to classify a portfolio's stocks relative to fundamental characteristics of indexes.
- Income effect
- The known component of the total return for a bond during a period of time if the shape and position of the yield curve did not change. Also known as the yield-to-maturity effect.
- Interest rate anticipation effect
- The difference in return caused by changing the duration of the portfolio during a period as compared with the portfolio's long-term policy duration.
- Interest rate effect
- The return on a bond portfolio caused by changes in the term structure of interest rates during a period.
- Management effect
- A combination of the interest rate anticipation effect, the analysis effect, and the trading effect.
- Normal portfolio
- A specialized or customized benchmark constructed to evaluate a specific manager's investment style or philosophy.
- Policy effect
- The difference in performance of a bond portfolio from that of a chosen index due to differences in duration, which result from a fund's investment policy.
- Price change effect
- The unknown component of the total return for a bond portfolio during a period of time due to the interest rate effect, sector/quality effect, and residual effect.
- Residual effect
- The return on a bond portfolio not caused by the yield-to-maturity, interest rate, and sector/quality effects.
- Returns-based analysis or effective mix analysis
- Returns-based analysis compares the historical return pattern of the portfolio in question to the historical returns of various well-specified indexes. The analysis uses sophisticated quadratic programming techniques to indicate what styles or style combinations were most similar to the portfolio's actual historical returns.
- Sector/quality effect
- The return on a bond portfolio caused by changing yield spreads between bonds in different sectors and with different quality ratings.
- Trading effect
- The difference in performance of a bond portfolio from that of a chosen index due to short-term changes in the composition of the portfolio.
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Mr Michaels "I want what all men want...I just want it more" 5W2H