Finance

Term Premium

1. What exactly is a term premium, anyway? It's the difference between what you get for locking up your money for an extended period and what you would get if you simply kept rolling over short-term instruments for the same amount of time. 2. Why reward holders of longer-term bonds? The longer you lend money to someone (or, in this case, a government), the more time there is for things to go wrong the term premium reflects the buffer that investors need to account for two key risks. One is changes in demand for or the supply of bonds, which can affect prices. The other is inflation, which would reduce the real value of future bond payments. When investors feel more uncertain on either point, they demand a higher premium. 3. How is that different from a yield curve? Yield curves are a way of measuring the difference between what someone gets for investing their money for entirely different periods, say for two years versus 10 years. That gap includes the term premium along with other variables including a premium for liquidity that reflects how hard or easy it is to trade the securities. 4. What's going on with term premia right now? It's upside down. Instead of longer-term debt providing extra yield for additional risk, there's a discount. And it's been that way for most of the time since late 2014, with the figure falling as low as minus 76 basis points in July 2016. 5. Why is that? Blame the Fed, and its intervention in the bond markets known as quantitative easing, or QE. The U.S. central bank cut its key interest rate to near zero after the 2008 market meltdown. When the economy failed to revive, it began massive bond purchases with the goal of reducing longer-term rates. It also swapped short-term debt it held for longer-term debt, in what became known as Operation Twist. By one Fed estimate, the moves cut the term premium by 100 basis points on 10-year Treasury yield. On top of that, the decision by other monetary authorities such as the Bank of Japan and the European Central Bank to slash their benchmarks to unprecedented lows means that U.S. debt is still relatively attractive, and the resulting global demand has added further downward pressure to the U.S. premium. 6. Where do strategists see the premium heading? The Fed has begun "unwinding" its swollen balance sheet by reducing the amount of debt it reinvests as it matures. And with the U.S. economy recovering, it's also in the process of slowly raising the interest rate it controls. The federal government's budget deficit is also projected to start rising again, which means an increase in the amount of new bonds the Treasury Department will have to issue. That combination of factors means the term premium ought to rise. 7. So, things are going back to normal? Not quite. Wall Street strategists are projecting the premium will rise by about half a percentage point, but that's less than half of its decline from the historical average. 8. Why won't it rise more? Fed officials say it's unlikely that their $4.5 trillion balance sheet will shrink all the way back to its pre-crisis level of roughly $900 billion. And those extraordinary monetary policies in Japan and Europe will keep foreigners coming back for U.S. debt. So long as that environment persists, interest rates and term premia are unlikely to climb back to their historical norms.

10/20/30 Rule

10 is a correction 20 is a bear market 30 is a crash

Asset Turnover Ratio

Asset turnover ratio is the ratio of the value of a company's sales or revenues generated relative to the value of its assets. The Asset Turnover ratio can often be used as an indicator of the efficiency with which a company is deploying its assets in generating revenue. Asset Turnover = Sales or Revenues / Total Assets

DJIA vs S&P 500

DJIA is Price-Weighted S&P 500 is Market Value-Weighted

Dumping

Dumping, in reference to international trade, is the export by a country or company of a product at a price that is lower in the foreign market than the price charged in the domestic market. As dumping usually involves substantial export volumes of the product, it often has the effect of endangering the financial viability of manufacturers or producers of the product in the importing nation.

Market Capitalization

Market capitalization refers the total dollar market value of a company's outstanding shares. Commonly referred to as "market cap," it is calculated by multiplying a company's shares outstanding by the current market price of one share. The investment community uses this figure to determine a company's size, as opposed to using sales or total asset figures.

Understanding Interest Rates, Inflation And Bonds

Ownership of a bond is the ownership of a stream of future cash payments. Those cash payments are usually made in the form of periodic interest payments and the return of principal when the bond matures. In the absence of credit risk (the risk of default), the value of that stream of future cash payments is simply a function of your required return based on your inflation expectations. If that sounds a little confusing and technical, don't worry, this article will break down bond pricing, define the term "bond yield" and demonstrate how inflation expectations and interest rates determine the value of a bond. Measures of Risk There are two primary risks that must be assessed when investing in bonds: interest rate risk and credit risk. Though our focus is on how interest rates affect bond pricing, otherwise known as interest rate risk, it's also important that a bond investor be aware of credit risk. Interest rate risk is the risk of changes in a bond's price due to changes in prevailing interest rates. Changes in short-term versus long-term interest rates can affect various bonds in different ways, which we'll soon discuss. Credit risk, meanwhile, is the risk that the issuer of a bond will not make scheduled interest and/or principal payments. The probability of a negative credit event or default affects a bond's price - the higher the risk of a negative credit event occurring, the higher the interest rate investors will demand for assuming that risk. Bonds issued by the United States Treasury to fund the operation of the U.S. government are known as U.S. Treasury bonds. Depending on the time until maturity, they are called bills, notes or bonds. Investors consider U.S. Treasury bonds to be free of default risk. In other words, investors believe there is no chance that the U.S government will default on interest and principal payments on the bonds it issues. For the remainder of this article, we will use U.S. Treasury bonds in our examples, thereby eliminating credit risk from the discussion. Calculation of a Bond's Yield and Price To understand how interest rates affect a bond's price, you must understand the concept of yield. While there are several different types of yield calculations, for the purposes of this article, we will use the yield-to-maturity (YTM) calculation. A bond's YTM is simply the discount rate that can be used to make the present value of all of a bond's cash flows equal to its price. In other words, a bond's price is the sum of the present value of each cash flow where the present value of each cash flow is calculated using the same discount factor. This discount factor is the yield. When a bond's yield rises, by definition, its price falls, and when a bond's yield falls, by definition, its price increases. A Bond's Relative Yield The maturity or term of a bond largely affects its yield. To understand this statement, you must understand what is known as the yield curve. The yield curve represents the YTM of a class of bonds (in this case, U.S. Treasury bonds). In most interest rate environments, the longer the term to maturity, the higher the yield will be. This should make intuitive sense because the longer the period of time before a cash flow is received, the more chance there is that the required discount rate (or yield) will move higher. Inflation Expectations Determine Investors Yield Requirements Inflation is a bond's worst enemy. Inflation erodes the purchasing power of a bond's future cash flows. Put simply, the higher the current rate of inflation and the higher the (expected) future rates of inflation, the higher the yields will rise across the yield curve, as investors will demand this higher yield to compensate for inflation risk.

Revolving Credit

Revolving credit is a line of credit where the customer pays a commitment fee and is then allowed to use the funds when they are needed. It is usually used for operating purposes and can fluctuate each month depending on the customer's current cash flow needs. Revolving lines of credit can be taken out by corporations or individuals.

U.S. yield curve spread

Short rates, the most sensitive to Fed policy expectations Longer-term yields: outlook for inflation and economic growth. With short-end yields climbing, the curve historically tends to flatten as longer-term rates rise more slowly The yield curve has proven a reliable indicator of impending economic slumps when it inverts, and short rates exceed longer-term yields The flattening trend may be a warning sign, or -- to borrow one of the phrases Gross helped to popularize -- it might just be "the new normal

The ABCs Of Stock Indexes

The Good Indexes are useful tools for tracking market trends. Despite the shortcomings discussed below, indexes are the only tool we have that provides a historical perspective to a market with a chronically short memory. By understanding how and why the indexes react in the economic trends over time, investors might gain insight that will help guide better investment decisions. For example, there have been a growing number of charts that compare recent index trends to the patterns from the 1929 Crash and the Japanese bubble. While there are many differences between the economies of then and now, studying the similarities and differences will help us prevent repeating the sins of our fathers (although this did not happen during the dotcom bubble). The Bad There are two main criticisms of indexes: 1. Calculation Bias (the way the indexes are calculated) - Most indexes are market-cap weighted, meaning that the stocks with the largest market capitalization have the larger weighting in and larger influence on the index. This overweighing means that if the "big dog" is sick, the whole market gets the flu, regardless of the strength in the smaller stocks that are in the index. It could be argued that market weighting is a legitimate way to capture an image of the market, because it represents the impact of the bigger stocks on the market being measured. However, this methodology will result in increased volatility because of the overweighed influence the big dogs have as they go up and down. A more equally-weighted index is more democratic and captures the impact of smaller stocks that may be rising. 2. Representative Bias (what the indexes do not measure) - By definition, an index is comprised of a small number of stocks, picked to represent some universe of stocks. Committees pick which stocks are included in the index, and these stocks are changed over time, in order to reflect the economy as it is for that year. Consequently, you cannot look at a historical chart of any index and assume that it represents the trading pattern of the same stocks over a long period of time. This also means that committees, being human, can make mistakes and pick the wrong stocks to be in the index. (Find out how to avoid costly surprises in Don't Judge An Index Fund By Its Cover.) The Ugly Because we are a lazy society with apparently no long-term memory (or else more people would have recognized the last bubble sooner), we have come to rely on indexes and 30-second trend analysis as reality, paying attention to soundbites instead of sound reasoning. Consequently, if the index is down, the bears are in town and we are down. We become more intent on watching the tickers on our computer screens and forget why we are at work. Maybe that is why the economy remains in a recession: everybody is watching CNBC instead of being productive. However, the market is more dynamic than the indexes are. There are many publicly-traded companies that have strong fundamentals and growing earnings, but they remain undervalued because nobody knows about them. Maybe that is why some say the economy is ahead of Wall Street. The Bottom Line Indexes are useful tools, if you know what they represent and what they don't represent. They provide a good historical perspective, but they should not be viewed as the market. Yes, Virginia, there is a bull market out there, but it isn't where Wall Street is looking. more than 50% of the index's value.

DV01

This measure is the absolute value of the change in price of a bond for a one basis point change in yield. It is another way to measure interest-rate risk. It does not matter if it is an increase or decrease in rates, because such a small move in rates will be about the same in either direction according to the second property of a bond's price . This is also know as Dollar Value of an 01 (DV01).

Basic Probability Concepts

To help make logical and consistent investment decisions, and help manage expectations in an environment of risk, an analyst uses the concepts and tools found in probability theory. A probability refers to the percentage chance that something will happen, from 0 (it is impossible) to 1 (it is certain to occur), and the scale going from less likely to more likely. Probability concepts help define risk by quantifying the prospects for unintended and negative outcomes; thus probability concepts are a major focus of the CFA curriculum. I. Basics Random Variable A random variable refers to any quantity with uncertain expected future values. For example, time is not a random variable since we know that tomorrow will have 24 hours, the month of January will have 31 days and so on. However, the expected rate of return on a mutual fund and the expected standard deviation of those returns are random variables. We attempt to forecast these random variables based on past history and on our forecast for the economy and interest rates, but we cannot say for certain what the variables will be in the future - all we have are forecasts or expectations. Outcome Outcome refers to any possible value that a random variable can take. For expected rate of return, the range of outcomes naturally depends on the particular investment or proposition. Lottery players have a near-certain probability of losing all of their investment (-100% return), with a very small chance of becoming a multimillionaire (+1,000,000% return - or higher!). Thus for a lottery ticket, there are usually just two extreme outcomes. Mutual funds that invest primarily in blue chip stocks will involve a much narrower series of outcomes and a distribution of possibilities around a specific mean expectation. When a particular outcome or a series of outcomes are defined, it is referred to as an event. If our goal for the blue chip mutual fund is to produce a minimum 8% return every year on average, and we want to assess the chances that our goal will not be met, our event is defined as average annual returns below 8%. We use probability concepts to ask what the chances are that our event will take place. Event If a list of events ismutually exclusive, it means that only one of them can possibly take place. Exhaustive events refer to the need to incorporate all potential outcomes in the defined events. For return expectations, if we define our two events as annual returns equal to or greater than 8% and annual returns equal to or less than 8%, these two events would not meet the definition of mutually exclusive since a return of exactly 8% falls into both categories. If our defined two events were annual returns less than 8% and annual returns greater than 8%, we've covered all outcomes except for the possibility of an 8% return; thus our events are not exhaustive. The Defining Properties of Probability Probability has two defining properties: The probability of any event is a number between 0 and 1, or 0 < P(E) < 1. A P followed by parentheses is the probability of (event E) occurring. Probabilities fall on a scale between 0, or 0%, (impossible) and 1, or 100%, (certain). There is no such thing as a negative probability (less than impossible?) or a probability greater than 1 (more certain than certain?). The sum of all probabilities of all events equals 1, provided the events are both mutually exclusive and exhaustive. If events are not mutually exclusive, the probabilities would add up to a number greater than 1, and if they were not exhaustive, the sum of probabilities would be less than 1. Thus, there is a need to qualify this second property to ensure the events are properly defined (mutually exclusive, exhaustive). On an exam question, if the probabilities in a research study are added to a number besides 1, you might question whether this principle has been met.

Case-Shiller Index

What Is the Case-Shiller Index? The Case-Shiller Index was developed in the 1980s by three economists: Allan Weiss, Karl Case and Robert Shiller. The trio later formed a company to sell their research; that company was purchased by Fiserv, Inc., which tabulates the data behind the index. The data is then distributed by Standard & Poor's. The national home price index, which covers nine major census divisions. It is calculated quarterly and published on the last Tuesday of February, May, August and November. The 10-city composite index, which covers Boston, Chicago, Denver, Las Vegas, Los Angeles, Miami, New York, San Diego, San Francisco and Washington, DC. The 20-city composite index, which includes all of the above cities plus Atlanta, Charlotte, Cleveland, Dallas, Detroit, Minneapolis, Phoenix, Portland (Oregon), Seattle and Tampa. Twenty individual metro area indexes for each of the cities listed above. Each index measures changes in the prices of single-family, detached residences (also known as houses) using the repeat-sales method, which compares the sale prices of the same properties over time. New construction is excluded - since these houses have not been previously sold, there is no way to calculate how their sale prices have changed until they have had two owners (at which point they are no longer new construction). Condos and co-ops are not included in any of the major indexes; however, there is a separate condo index that tracks condo prices in five major markets: Boston, Chicago, New York, Los Angeles and San Francisco. Why Home Prices Matter Obviously, if you're looking to buy or sell a residential property, you'll be interested in whether home prices are going up or down and by how much. If you're selling and prices seem to be increasing, you might want to hold off selling while you wait and see if prices keep going up. If you're buying and you see prices going up, you might want to speed up your purchase decision while there are still deals to be had. Or if prices are declining, you might want to see if you can hold off on your purchase while prices continue to sink. Of course, no person or index can really predict what will happen to home prices. Even if you're not buying or selling a home, home prices are an indicator of how the broader economy is performing. Do people feel confident that now is a good time to make a large, expensive investment? How well is a particular geographic region performing economically? How are businesses that have a large stake in the housing sector performing? The Case-Shiller Index provides insight into all of these questions. It's even possible to take advantage of changes in home prices indirectly by investing in S&P/Case-Shiller Home Price Indexes (CSI) futures and options. This type of investment is recommended for businesses such as property and real estate developers, banks, mortgage lenders and home suppliers to help them mitigate the risk of their large stakes in the housing sector. Even businesses that have little or nothing to do with housing may want to invest in these products to diversify the investment risks they are exposed to. Finally, many people have at least as much, if not more, invested in their homes as they do in stocks. Home price movements thus have a significant impact on the total value of their portfolios.

Derivative

What is a 'Derivative' A derivative is a security with a price that is dependent upon or derived from one or more underlying assets. The derivative itself is a contract between two or more parties based upon the asset or assets. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Derivatives either be traded over-the-counter (OTC) or on an exchange. OTC derivatives constitute the greater proportion of derivatives in existence and are unregulated, whereas derivatives traded on exchanges are standardized. OTC derivatives generally have greater risk for the counterparty than do standardized derivatives. BREAKING DOWN 'Derivative' Originally, derivatives were used to ensure balanced exchange rates for goods traded internationally. With differing values of different national currencies, international traders needed a system of accounting for these differences. Today, derivatives are based upon a wide variety of transactions and have many more uses. There are even derivatives based on weather data, such as the amount of rain or the number of sunny days in a particular region. Because a derivative is a category of security rather than a specific kind, there are several different kinds of derivatives in existence. As such, derivatives have a variety of functions and applications as well, based on the type of derivative. Certain kinds of derivatives can be used for hedging, or insuring against risk on an asset. Derivatives can also be used for speculation in betting on the future price of an asset or in circumventing exchange rate issues. For example, a European investor purchasing shares of an American company off of an American exchange (using U.S. dollars to do so) would be exposed to exchange-rate risk while holding that stock. To hedge this risk, the investor could purchase currency futures to lock in a specified exchange rate for the future stock sale and currency conversion back into Euros. Additionally, many derivatives are characterized by high leverage. Common Forms of 'Derivative' Futures contracts are one of the most common types of derivatives. A futures contract (or simply futures, colloquially) is an agreement between two parties for the sale of an asset at an agreed upon price. One would generally use a futures contract to hedge against risk during a particular period of time. For example, suppose that on July 31, 2014 Diana owned ten thousand shares of Wal-Mart (WMT) stock, which were then valued at $73.58 per share. Fearing that the value of her shares would decline, Diana decided that she wanted to arrange a futures contract to protect the value of her stock. Jerry, a speculator predicting a rise in the value of Wal-Mart stock, agrees to a futures contract with Diana, dictating that in one year's time Jerry will buy Diana's ten thousand Wal-Mart shares at their current value of $73.58. The futures contract may in part be considered to be something like a bet between the two parties. If the value of Diana's stock declines, her investment is protected because Jerry has agreed to buy them at their July 2014 value, and if the value of the stock increases, Jerry earns greater value on the stock, as he is paying July 2014 prices for stock in July 2015. A year later, July 31 rolls around and Wal-Mart is valued at $71.98 per share. Diana, then, has benefited from the futures contract, making $1.60 more per share than she would have if she had simply waited until July 2015 to sell her stock. While this might not seem like much, this difference of $1.60 per share translates to a difference of $16,000 when considering the ten thousand shares that Diana sold. Jerry, on the other hand, has speculated poorly and lost a sizeable sum. Forward contracts are another important kind of derivative similar to futures contracts, the key difference being that unlike futures, forward contracts (or "forwards") are not traded on exchange, but rather are only traded over-the-counter. Options are another common form of derivative. An option is similar to a futures contract in that it is an agreement between two parties granting one the opportunity to buy or sell a security from or to the other party at a predetermined future date. Yet, the key difference between options and futures is that with an option the buyer or seller is not obligated to make the transaction if he or she decides not to, hence the name "option." The exchange itself is, ultimately, optional. Like with futures, options may be used to hedge the seller's stock against a price drop and to provide the buyer with an opportunity for financial gain through speculation. An option can be short or long, as well as a call or put. Another form of derivative is a mortgage-backed security, which is a broad category of derivative simply defined by the fact that the assets underlying the derivative are mortgages.

Multiple

What is a 'Multiple' A multiple measures some aspect of a company's financial well-being, determined by dividing one metric by another metric. The metric in the numerator is typically larger than the one in the denominator. For example, a multiple can be used to show how much investors are willing to pay per dollar of earnings, as computed by the price-to-earnings (P/E) ratio. Assume you are analyzing a stock with $2 of earnings per share (EPS) that is trading at $20. This stock has a P/E ratio of 10. This means investors are willing to pay a multiple of 10 times the current EPS for the stock.

SIFI (50 billion plus)

What is a 'Systemically Important Financial Institution - SIFI' Any firm as designated by the U.S. Federal Reserve, whose collapse would pose a serious risk to the economy. Systematically important financial institutions became the target of legislation and regulatory reform by the Obama Administration, due to issues concerning their consolidated supervision and regulation, following the financial crisis of 2008. Economic risks can arise from the banking sector, but also from other financial organizations such as investment banks and insurance firms. New regulations under the Dodd-Frank legislation, mandate that financial institutions that fit SIFI qualifications, will have to meet higher capital standards and develop contingency plans for potential future failures.

Put Option

A put option is an option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time. This is the opposite of a call option, which gives the holder the right to buy shares. BREAKING DOWN 'Put Option' A put option becomes more valuable as the price of the underlying stock depreciates relative to the strike price. Conversely, a put option loses its value as the underlying stock increases and the time to expiration approaches.

Simple Moving Average

A simple moving average (SMA) is an arithmetic moving average calculated by adding the closing price of the security for a number of time periods and then dividing this total by the number of time periods. A simple moving average is customizable in that it can be calculated for a different number of time periods, simply by adding the closing price of the security for a number of time periods and then dividing this total by the number of time periods, which gives the average price of the security over the time period. A simple moving average smoothes out volatility, and makes it easier to view the price trend of a security. If the simple moving average points up, this means that the security's price is increasing. If it is pointing down it means that the security's price is decreasing. The longer the timeframe for the moving average, the smoother the simple moving average. A shorter-term moving average is more volatile, but its reading is closer to the source data. Analytical Significance Moving averages are an important analytical tool used to identify current price trends and the potential for a change in an established trend. The simplest form of using a simple moving average in analysis is using it to quickly identify if a security is in an uptrend or downtrend. Another popular, albeit slightly more complex analytical tool, is to compare a pair of simple moving averages with each covering different time frames. If a shorter-term simple moving average is above a longer-term average, an uptrend is expected. On the other hand, a long-term average above a shorter-term average signals a downward movement in the trend. Popular Trading Patterns Two popular trading patterns that use simple moving averages include the death cross and a golden cross. A death cross occurs when the 50-day simple moving average crosses below the 200-day moving average. This is considered a bearish signal, that further losses are in store. The golden cross occurs when a short-term moving average breaks above a long-term moving average. Reinforced by high trading volumes, this can signal further gains are in store.

Adam Smith

Adam Smith was an 18th-century philosopher renowned as the father of modern economics, and a major proponent of laissez-faire economic policies. In his first book, "The Theory of Moral Sentiments," Smith proposed the idea of the invisible hand—the tendency of free markets to regulate themselves by means of competition, supply and demand, and self-interest. Smith is also known for his theory of compensating wage differentials, meaning that dangerous or undesirable jobs tend to pay higher wages to attract workers to these positions, but he is most famous for his 1776 book: "An Inquiry into the Nature and Causes of the Wealth of Nations." Read on to learn about how this Scottish philosopher argued against mercantilism to become the father of modern free trade and the creator of the concept now known as GDP.

Alternative Investment

An alternative investment is an asset that is not one of the conventional investment types, such as stocks, bonds and cash. Most alternative investment assets are held by institutional investors or accredited, high-net-worth individuals because of the complex natures and limited regulations of the investments. Alternative investments include private equity, hedge funds, managed futures, real estate, commodities and derivatives contracts.

Arbitrage

Arbitrage is the simultaneous purchase and sale of an asset to profit from a difference in the price. It is a trade that profits by exploiting the price differences of identical or similar financial instruments on different markets or in different forms. Arbitrage exists as a result of market inefficiencies. As a simple example of arbitrage, consider the following. The stock of Company X is trading at $20 on the New York Stock Exchange (NYSE) while, at the same moment, it is trading for $20.05 on the London Stock Exchange (LSE). A trader can buy the stock on the NYSE and immediately sell the same shares on the LSE, earning a profit of 5 cents per share. The trader could continue to exploit this arbitrage until the specialists on the NYSE run out of inventory of Company X's stock, or until the specialists on the NYSE or LSE adjust their prices to wipe out the opportunity.

Book Value

Book value of an asset is the value at which the asset is carried on a balance sheet and calculated by taking the cost of an asset minus the accumulated depreciation. Book value is also the net asset value of a company, calculated as total assets minus intangible assets (patents, goodwill) and liabilities. For the initial outlay of an investment, book value may be net or gross of expenses such as trading costs, sales taxes, service charges and so on.

Oil Benchmarks

Brent Blend - Roughly two-thirds of all crude contracts around the world reference Brent Blend, making it the most widely used marker of all. These days, "Brent" actually refers to oil from four different fields in the North Sea: Brent, Forties, Oseberg and Ekofisk. Crude from this region is light and sweet, making them ideal for the refining of diesel fuel, gasoline and other high-demand products. And because the supply is water-borne, it's easy to transport to distant locations. West Texas Intermediate (WTI) - WTI refers to oil extracted from wells in the U.S. and sent via pipeline to Cushing, Oklahoma. The fact that supplies are land-locked is one of the drawbacks to West Texas crude - it's relatively expensive to ship to certain parts of the globe. The product itself is very light and very sweet, making it ideal for gasoline refining, in particular. WTI continues to be the main benchmark for oil consumed in the United States.

Capital Markets

Capital markets are markets for buying and selling equity and debt instruments. Capital markets channel savings and investment between suppliers of capital such as retail investors and institutional investors, and users of capital like businesses, government and individuals. Capital markets are vital to the functioning of an economy, since capital is a critical component for generating economic output. Capital markets include primary markets, where new stock and bond issues are sold to investors, and secondary markets, which trade existing securities.

Exchange-Traded Fund (ETF)

DEFINITION of 'Exchange-Traded Fund (ETF)' An ETF, or exchange traded fund, is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund. Unlike mutual funds, an ETF trades like a common stock on a stock exchange. ETFs experience price changes throughout the day as they are bought and sold. ETFs typically have higher daily liquidity and lower fees than mutual fund shares, making them an attractive alternative for individual investors. Because it trades like a stock, an ETF does not have its net asset value (NAV) calculated once at the end of every day like a mutual fund does.

Fixed-Income Arbitrage

DEFINITION of 'Fixed-Income Arbitrage' An investment strategy that attempts to profit from arbitrage opportunities in interest rate securities. When using a fixed-income arbitrage strategy, the investor assumes opposing positions in the market to take advantage of small price discrepancies while limiting interest rate risk.

Michigan Consumer Sentiment Index - MCSI

DEFINITION of 'Michigan Consumer Sentiment Index - MCSI' A survey of consumer confidence conducted by the University of Michigan. The Michigan Consumer Sentiment Index (MCSI) uses telephone surveys to gather information on consumer expectations regarding the overall economy. BREAKING DOWN 'Michigan Consumer Sentiment Index - MCSI' The preliminary report, which includes about 60% of total survey results, is released around the 10th of each month. A final report for the prior month is released on the first of the month. The index is becoming more and more useful for investors because it gives a snapshot of whether consumers feel like spending money.

P/E 30 Ratio

DEFINITION of 'P/E 30 Ratio' The price-to-earnings (P/E) ratio is the valuation ratio of a company's market value per share divided by a company's earnings per share (EPS). A P/E ratio of 30 means that a company's stock price is trading at 30 times the company's earnings per share. BREAKING DOWN 'P/E 30 Ratio' A P/E of 30 is high by historical stock market standards. This type of valuation is usually placed on only the fastest-growing companies by investors in the company's early stages of growth. Once a company becomes more mature, it will grow more slowly and the P/E tends to decline.

Stock Market Crash of 1987

DEFINITION of 'Stock Market Crash Of 1987' A rapid and severe downturn in stock prices that occurred in late October of 1987. After five days of intensifying stock market declines, selling pressure hit a peak on October 19, known as Black Monday. The Dow Jones Industrial Average (DJIA) fell a record 22% on that day alone, with many stocks halted during the day as order imbalances prevented true price discovery.

Tequila Effect

DEFINITION of 'Tequila Effect' Informal name given to the impact of the 1994 Mexican economic crisis on the South American economy. The Tequila Effect occurred because of a sudden devaluation in the Mexican peso, which then caused other currencies in the region (the Southern Cone and Brazil) to decline. The falling peso was propped up by US$50 billion loan granted by then U.S. president Bill Clinton. Also referred to as the "Mexican Shock". BREAKING DOWN 'Tequila Effect' Immediately after the Mexican peso was devalued in the early days of the Presidency of Ernesto Zedillo, South American countries suffered rapid currency depreciation. It was a known fact that the peso was overvalued, but the extent of Mexico's economic vulnerability was not well known. Since governments and businesses in the area had high levels of U.S. dollar-denominated debt, the devaluation meant that it would be increasingly difficult to pay back the debts.

An Introduction to Stock Market Indices

The Dow The Dow Jones Industrial Average (DJIA) is one of the oldest, most well-known and most frequently used indices in the world. It includes the stocks of 30 of the largest and most influential companies in the United States. The DJIA represents about a quarter of the value of the entire U.S. stock market, A change in the Dow represents changes in investors' expectations of the earnings and risks of the large companies included in the average. Because the general attitude toward large-cap stocks often differs from the attitude toward small-cap stocks, international stocks or technology stocks, the Dow should not be used to represent sentiment in other areas of the marketplace. On the other hand, because the Dow is made up of some of the most well-known companies in the U.S., large swings in this index generally correspond to the movement of the entire market, although not necessarily on the same scale. The S&P 500 Standard & Poor's 500 Index (known commonly as the S&P 500) is a larger and more diverse index than the DJIA. Made up of 500 of the most widely traded stocks in the U.S., it represents about 80% of the total value of U.S. stock markets. In general, the S&P 500 index gives a good indication of movement in the U.S. marketplace as a whole. The S&P 500 index includes companies in a variety of sectors, including energy, industrials, information technology, healthcare, financials and consumer staples. The Nasdaq Composite Index Most investors know that the Nasdaq is the exchange on which technology stocks are traded. The Nasdaq Composite Index is a market-capitalization-weighted index of all stocks traded on the Nasdaq stock exchange. This index includes some companies that are not based in the U.S. Although this index is known for its large portion of technology stocks, the Nasdaq Composite also includes stocks from financial, industrial, insurance and transportation industries, among others. The Nasdaq Composite includes large and small firms but, unlike the Dow and the S&P 500, it also includes many speculative companies with small market capitalizations. Consequently, its movement generally indicates the performance of the technology industry as well as investors' attitudes toward more speculative stocks. The Russell 2000 The Russell 2000 is a market-capitalization-weighted index of the 2,000 smallest stocks in the Russell 3000, an index of the 3,000 largest publicly-traded companies, based on market cap, in the U.S. stock market. The Russell 2000 index gained popularity during the 1990s when small-cap stocks soared, and investors moved more money to the sector. The Russell 2000 is the best-known indicator of the daily performance of small companies in the market; it is not dominated by a single industry.

Bonds, commodities, currencies and equities

The market is a big, confusing beast. With multiple indexes, stock types and categories, it can be overwhelming for the eager investor. But by understanding how the different markets interact with each other, the bigger picture can become much clearer. Observing the relationship between commodities, bond prices, stocks and currencies can also lead to smarter trades. In most cycles, there is a general order in which these four markets move. By watching all of them, we are better able to assess the direction in which a market is shifting. All four markets work together. Some move with each other, and some against. Read on to find out how the cycle works and how you can make it work for you. The Market Push and Pull Let's take a look at how commodities, bonds, stocks and currencies interact. As commodity prices rise, the cost of goods is pushed up. This increasing price action is inflationary, and interest rates also rise to reflect the inflation. Since the relationship between interest rates and bond prices is inverse, bond prices fall as interest rates rise. Bond prices and stocks are generally correlated. When bond prices begin to fall, stocks will eventually follow suit and head down as well. As borrowing becomes more expensive and the cost of doing business rises due to inflation, it is reasonable to assume that companies (stocks) will not do as well. Once again, we will see a lag between bond prices falling and the resulting stock market decline. The currency markets have an impact on all markets, but the main one to focus on is commodity prices. Commodity prices affect bonds and, subsequently, stocks. The U.S. dollar and commodity prices generally trend in opposite directions. As the dollar declines relative to other currencies, the reaction can be seen in commodity prices (which are based in U.S. dollars).

Fundamentals

What does 'Fundamentals' mean The fundamentals include the qualitative and quantitative information that contributes to the economic well-being and the subsequent financial valuation of a company, security or currency. Analysts and investors analyze these fundamentals to develop an estimate as to whether the underlying asset is considered a worthwhile investment. For businesses, information such as revenue, earnings, assets, liabilities and growth are considered some of the fundamentals. BREAKING DOWN 'Fundamentals' In business and economics, the fundamentals represent the basic qualities and reported information needed to analyze the health and stability of business or asset in question. This can include topics within both the macroeconomic and microeconomic disciplines that are considered standards for determining the financial values attributed to the assets. Macroeconomics and Microeconomics Macroeconomic fundamentals include topics that affect an economy at large. This can include statistics regarding unemployment, supply and demand, growth, and inflation, as well as considerations for monetary or fiscal policy and international trade. These categories can be applied to analysis of a large-scale economy as a whole or can be related to individual business activity to make changes based on macroeconomic influences. Microeconomic fundamentals focus on the activities within smaller segments of the economy, such as a particular market or sector. This can include issues of supply and demand within the specified segment, as well as the theory of firms, theory of consumers and labor issues as related to a particular industry.

Alpha

What is 'Alpha' Alpha is used in finance to represent two things: 1. A measure of performance on a risk-adjusted basis. Alpha, often considered the active return on an investment, gauges the performance of an investment against a market index used as a benchmark, since they are often considered to represent the market's movement as a whole. The excess returns of a fund relative to the return of a benchmark index is the fund's alpha. Alpha is most often used for mutual funds and other similar investment types. It is often represented as a single number (like 3 or -5), but this refers to a percentage measuring how the portfolio or fund performed compared to the benchmark index (i.e. 3% better or 5% worse). Alpha is often used with beta, which measures volatility or risk, and is also often referred to as "excess return" or "abnormal rate of return."

Beta

What is 'Beta' Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. Beta is used in the capital asset pricing model (CAPM), which calculates the expected return of an asset based on its beta and expected market returns. Beta is also known as the beta coefficient. BREAKING DOWN 'Beta' Beta is calculated using regression analysis. Beta represents the tendency of a security's returns to respond to swings in the market. A security's beta is calculated by dividing the covariance the security's returns and the benchmark's returns by the variance of the benchmark's returns over a specified period. Using Beta Beta Interpretation A beta of 1 indicates that the security's price moves with the market. A beta of less than 1 means that the security is theoretically less volatile than the market. A beta of greater than 1 indicates that the security's price is theoretically more volatile than the market. For example, if a stock's beta is 1.2, it's theoretically 20% more volatile than the market. Conversely, if an ETF's beta is 0.65, it is theoretically 35% less volatile than the market. Therefore, the fund's excess return is expected to underperform the benchmark by 35% in up markets and outperform by 35% during down markets. Many utilities stocks have a beta of less than 1. Conversely, most high-tech, Nasdaq-based stocks have a beta of greater than 1, offering the possibility of a higher rate of return, but also posing more risk. For example, as of May 31, 2016, the PowerShares QQQ, an ETF tracking the Nasdaq-100 Index, has a trailing 15-year beta of 1.27 when measured against the S&P 500 Index, which is a commonly used equity market benchmark.

Commercial Paper

What is 'Commercial Paper' Commercial paper is an unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories and meeting short-term liabilities. Maturities on commercial paper rarely range any longer than 270 days. Commercial paper is usually issued at a discount from face value and reflects prevailing market interest rates. BREAKING DOWN 'Commercial Paper' Commercial paper is not usually backed by any form of collateral, making it a form of unsecured debt. As a result, only firms with high-quality debt ratings will easily find buyers without having to offer a substantial discount (higher cost) for the debt issue. Because commercial paper is issued by large institutions, the denominations of the commercial paper offerings are substantial, usually $100,000 or more. Other corporations, financial institutions, wealthy individuals and money market funds are usually buyers of commercial paper.

Correlation

What is 'Correlation' Correlation, in the finance and investment industries, is a statistic that measures the degree to which two securities move in relation to each other. Correlations are used in advanced portfolio management. Correlation is computed into what is known as the correlation coefficient, which has value that must fall between -1 and 1. BREAKING DOWN 'Correlation' A perfect positive correlation means that the correlation coefficient is exactly 1. This implies that as one security moves, either up or down, the other security moves in lockstep, in the same direction. A perfect negative correlation means that two assets move in opposite directions, while a zero correlation implies no relationship at all. For example, large-cap mutual funds generally have a high positive correlation to the Standard and Poor's (S&P) 500 Index, very close to 1. Small-cap stocks have a positive correlation to that same index also, but it is not as high, generally around 0.8. However, put option prices and underlying stock prices tend to have a negative correlation. As the stock price increases, the put option prices go down. This is a direct and high-magnitude negative correlation.

Depression

What is 'Depression' Depression is a severe and prolonged downturn in economic activity. In economics, a depression is commonly defined as an extreme recession that lasts two or more years. A depression is characterized by economic factors such as substantial increases in unemployment, a drop in available credit, diminishing output, bankruptcies and sovereign debt defaults, reduced trade and commerce, and sustained volatility in currency values. In times of depression, consumer confidence and investments decrease, causing the economy to shut down.

Dry Powder

What is 'Dry Powder' Dry powder is a slang term referring to marketable securities that are highly liquid and considered cash-like. Dry powder can also refer to cash reserves kept on hand by a company, venture capital firm or person to cover future obligations, purchase assets or make acquisitions. Securities considered to be dry powder could be Treasuries, or other fixed income investments, and can be liquidated on short notice, in order to provide emergency funding or allow an investor to purchase assets.

EBITDA - Earnings Before Interest, Taxes, Depreciation and Amortization

What is 'EBITDA - Earnings Before Interest, Taxes, Depreciation and Amortization' EBITDA stands for earnings before interest, taxes, depreciation and amortization. EBITDA is one indicator of a company's financial performance and is used as a proxy for the earning potential of a business, although doing so has its drawbacks. Further, EBITDA strips out the cost of debt capital and its tax effects by adding back interest and taxes to earnings. BREAKING DOWN 'EBITDA - Earnings Before Interest, Taxes, Depreciation and Amortization' In its simplest form, EBITDA is calculated in the following manner: EBITDA = Operating Profit + Depreciation Expense + Amortization Expense The more literal formula for EBITDA is: EBITDA = Net Profit + Interest +Taxes + Depreciation + Amortization EBITDA is essentially net income with interest, taxes, depreciation and amortization added back to it. EBITDA can be used to analyze and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions. EBITDA is often used in valuation ratios and compared to enterprise value and revenue. Example of EBITDA A retail company generates $100 million in revenue and incurs $40 million in product cost and $20 million in operating expenses. Depreciation and amortization expense amounts to $10 million, yielding an operating profit of $30 million. The interest expense is $5 million, leading to earnings before taxes of $25 million. With a 20% tax rate, net income equals $20 million after $5 million in taxes are subtracted from pretax income. Using the EBITDA formula, we add operating profit to depreciation and amortization expense to get EBITDA of $40 million ($30 million + $10 million). The Drawbacks of EBITDA EBITDA is a non-GAAP measure that allows a greater amount of discretion as to what is and what is not included in the calculation. This also means that companies often change the items included in their EBITDA calculation from one reporting period to the next.

Leverage

What is 'Leverage' Leverage is the investment strategy of using borrowed money: specifically, the use of various financial instruments or borrowed capital to increase the potential return of an investment. Leverage can also refer to the amount of debt used to finance assets. When one refers to something (a company, a property or an investment) as "highly leveraged," it means that item has more debt than equity.

Long/Short Equity

What is 'Long/Short Equity' Long/short equity is an investing strategy of taking long positions in stocks that are expected to appreciate and short positions in stocks that are expected to decline. A long/short equity strategy seeks to minimize market exposure, while profiting from stock gains in the long positions and price declines in the short positions. Although this may not always be the case, the strategy would be profitable on a net basis as long as the long positions generate more profit than the short positions, or the other way around. The long/short equity strategy is popular with hedge funds, many of which employ a market-neutral strategy where the dollar amounts of the long and short positions are equal.

Merger Arbitrage

What is 'Merger Arbitrage' Merger arbitrage involves simultaneously purchasing and selling the stocks of two merging companies to create "riskless" profits and is often considered a hedge fund strategy. A merger arbitrageur looks at the risk the merger deal will not close on time, or at all. Because of this slight uncertainty, the target company's stock typically sells at a discount to the price of the combined company when the merger is closed; this discrepancy is the arbitrageur's profit.

Smart Beta

What is 'Smart Beta' Smart beta defines a set of investment strategies that emphasize the use of alternative index construction rules to traditional market capitalization based indices. Smart beta emphasizes capturing investment factors or market inefficiencies in a rules-based and transparent way. The increased popularity of smart beta is linked to a desire for portfolio risk management and diversification along factor dimensions as well as seeking to enhance risk-adjusted returns above cap-weighted indices. BREAKING DOWN 'Smart Beta' Investment managers that follow a smart beta investment strategy seek to passively follow indices, while also taking into account alternative weighting schemes such as volatility. That's because smart beta strategies are implemented like a typical index strategies in that the index rules are set and transparent. Smart Beta strategies will differ from standard indices, such as the S&P 500 or the Barclays Aggregate, in that the indices focus on areas of the market that offer an opportunity for exploitation.

Standard Deviation

What is 'Standard Deviation' Standard deviation is a measure of the dispersion of a set of data from its mean. It is calculated as the square root of variance by determining the variation between each data point relative to the mean. If the data points are further from the mean, there is higher deviation within the data set. In finance, standard deviation is a statistical measurement; when applied to the annual rate of return of an investment, it sheds light on the historical volatility of that investment. The greater the standard deviation of a security, the greater the variance between each price and the mean, indicating a larger price range. For example, a volatile stock has a high standard deviation, while the deviation of a stable blue-chip stock is usually rather low. BREAKING DOWN 'Standard Deviation' In the financial services industry, standard deviation is one of the key fundamental risk measures that analysts, portfolio managers, wealth management advisors and financial planners use. Investment firms report the standard deviation of their mutual funds and other products. A large dispersion indicates how much the return on the fund is deviating from the expected normal returns. Because it is easy to understand, this statistic is often reported to the end clients and investors on a regular basis.

Technical Analysis

What is 'Technical Analysis' Technical analysis is a trading tool employed to evaluate securities and attempt to forecast their future movement by analyzing statistics gathered from trading activity, such as price movement and volume. Unlike fundamental analysts who attempt to evaluate a security's intrinsic value, technical analysts focus on charts of price movement and various analytical tools to evaluate a security's strength or weakness and forecast future price changes. BREAKING DOWN 'Technical Analysis' Technical analysts believe past trading activity and price changes of a security are better indicators of the security's likely future price movements than the intrinsic value of the security. Technical analysis was formed out of basic concepts gleaned from Dow Theory, a theory about trading market movements that came from the early writings of Charles Dow. Two basic assumptions of Dow Theory that underlie all of technical analysis are 1) market price discounts every factor that may influence a security's price and 2) market price movements are not purely random but move in identifiable patterns and trends that repeat over time. How Technical Analysis Is Used Technical analysis is used to attempt to forecast the price movement of virtually any tradable instrument that is generally subject to forces of supply and demand, including stocks, bonds, futures and currency pairs. In fact, technical analysis can be viewed as simply the study of supply and demand forces as reflected in the market price movements of a security. It is most commonly applied to price changes, but some analysts may additionally track numbers other than just price, such as trading volume or open interest figures. Over the years, numerous technical indicators have been developed by analysts in attempts to accurately forecast future price movements. Some indicators are focused primarily on identifying the current market trend, including support and resistance areas, while others are focused on determining the strength of a trend and the likelihood of its continuation. Commonly used technical indicators include trendlines, moving averages and momentum indicators such as the moving average convergence divergence (MACD) indicator.

10-K

What is a '10-K' A 10-K is a comprehensive summary report of a company's performance that must be submitted annually to the Securities and Exchange Commission. Typically, the 10-K contains much more detail than the annual report. It includes information such as company history, organizational structure, equity, holdings, earnings per share, subsidiaries, etc. BREAKING DOWN '10-K' The 10-K must be filed within 60 days (it used to be 90 days) after the end of the fiscal year. 10-K = Yearly 10-Q = Quarterly

Bear Market

What is a 'Bear Market' A bear market is a condition in which securities prices fall and widespread pessimism causes the stock market's downward spiral to be self-sustaining. Investors anticipate losses as pessimism and selling increases. Although figures vary, a downturn of 20% or more from a peak in multiple broad market indexes, such as the Dow Jones Industrial Average (DJIA) or Standard & Poor's 500 Index (S&P 500), over a two-month period is considered an entry into a bear market. BREAKING DOWN 'Bear Market' A bear market should not be confused with a correction, which is a short-term trend that has a duration of fewer than two months. While corrections offer a good time for value investors to find an entry point into stock markets, bear markets rarely provide suitable points of entry. This is because it is almost impossible to determine a bear market's bottom. Trying to recoup losses can be an uphill battle, unless investors are short sellers or use other strategies to make gains in falling markets. Between 1900 and 2015 there were 32 bear markets, averaging one every 3.5 years. The last bear market coincided with the global financial crisis, occurring between October 2007 and March 2009; the DJIA declined 54% during the period. Short Selling in Bear Markets Investors can make gains in a bear market by short selling. This technique involves selling borrowed shares and buying them back at lower prices. A short seller must borrow the shares from a broker before a short-sell order is placed. The short seller's profit and loss amount is the difference between the price at which the shares were sold and the price at which they were bought back, referred to as "covered." For example, an investor shorts 100 shares of a stock at $94.00. The price falls and the shares are covered at $84.00. The investor pockets a profit of $10 x 100 = $1,000. Put Options and Inverse ETFs in Bear Markets A put option gives the owner the right, but not the obligation to sell a stock at a specific price on, or before, a certain date. Put options can be used to speculate on falling stock prices, and to hedge against falling prices to protect long-only portfolios. Investors must have options privileges in their accounts to make such trades. Inverse ETFs are designed to change values in the opposite direction of the index they are tracking. For example, the inverse ETF for the S&P 500 would increase by 1% if the S&P 500 index decreased by 1%. There are many leveraged inverse ETFs that magnify the returns of the index they track by two and three times. Like options, inverse ETFs can be used to speculate or protect portfolios.

Bubble

What is a 'Bubble' A bubble is an economic cycle characterized by rapid escalation of asset prices followed by a contraction. It is created by a surge in asset prices unwarranted by the fundamentals of the asset and driven by exuberant market behavior. When no more investors are willing to buy at the elevated price, a massive selloff occurs, causing the bubble to deflate.

Bull Market

What is a 'Bull Market' A bull market is a financial market of a group of securities in which prices are rising or are expected to rise. The term "bull market" is most often used to refer to the stock market but can be applied to anything that is traded, such as bonds, currencies and commodities. BREAKING DOWN 'Bull Market' Bull markets are characterized by optimism, investor confidence and expectations that strong results should continue. It is difficult to predict consistently when the trends in the market might change. Part of the difficulty is that psychological effects and speculation may sometimes play a large role in the markets. Bull vs. Bear Markets The opposite of a bull market is a bear market, which is characterized by falling prices and typically shrouded in pessimism. The use of "bull" and "bear" to describe markets comes from the way the animals attack their opponents. A bull thrusts its horns up into the air, while a bear swipes its paws downward. These actions are metaphors for the movement of a market. If the trend is up, it's a bull market. If the trend is down, it's a bear market. Bull markets and bear markets often coincide with the economic cycle, which consists of four phases: expansion, peak, contraction and trough. The onset of a bull market is often a leading indicator of economic expansion. Because public sentiment about future economic conditions drives stock prices, the market frequently rises even before broader economic measures, such as gross domestic product (GDP) growth, begin to tick up. Likewise, bear markets usually set in before economic contraction takes hold. A look back at a typical U.S. recession reveals a falling stock market several months ahead of GDP decline. Bull Market Example The most prolific bull market in modern American history started at the end of the stagflation era in 1982 and concluded during the dotcom bust in 2000. During this secular bull market - a term that denotes a bull market lasting many years - the Dow Jones Industrial Average (DJIA) averaged 16.8% annual returns. The NASDAQ, a tech-heavy exchange, increased its value fivefold between 1995 and 2000, rising from 1,000 to over 5,000. A protracted bear market followed the 1982-2000 bull market. From 2000 to 2009, the market struggled to establish footing and delivered average annual returns of -6.2%.

Call Option

What is a 'Call Option' A call option is an agreement that gives an investor the right, but not the obligation, to buy a stock, bond, commodity or other instrument at a specified price within a specific time period. It may help you to remember that a call option gives you the right to call in, or buy, an asset. You profit on a call when the underlying asset increases in price. BREAKING DOWN 'Call Option' Call options are typically used by investors for three primary purposes. These are tax management, income generation and speculation. How Options Work An options contract gives the holder the right to buy 100 shares of the underlying security at a specific price, known as the strike price, up until a specified date, known as the expiration date. For example, a single call option contract may give a holder the right to buy 100 shares of Apple stock at a price of $100 until Dec. 31, 2017. As the value of Apple stock goes up, the price of the options contract goes up, and vice versa. Options contract holders can hold the contract until the expiration date, at which point they can take delivery of the 100 shares of stock or sell the options contract at any point before the expiration date at the market price of the contract at the time.

Hedge Fund

What is a 'Hedge Fund' Hedge funds are alternative investments using pooled funds that employ numerous different strategies to earn active return, or alpha, for their investors. Hedge funds may be aggressively managed or make use of derivatives and leverage in both domestic and international markets with the goal of generating high returns (either in an absolute sense or over a specified market benchmark). It is important to note that hedge funds are generally only accessible to accredited investors as they require less SEC regulations than other funds. One aspect that has set the hedge fund industry apart is the fact that hedge funds face less regulation than mutual funds and other investment vehicles.

Mutual Fund

What is a 'Mutual Fund' A mutual fund is an investment vehicle made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. Mutual funds are operated by money managers, who invest the fund's capital and attempt to produce capital gains and income for the fund's investors. A mutual fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus.

Recession

What is a 'Recession' A recession is a significant decline in activity across the economy, lasting longer than a few months. It is visible in industrial production, employment, real income and wholesale-retail trade. The technical indicator of a recession is two consecutive quarters of negative economic growth as measured by a country's gross domestic product (GDP), although the National Bureau of Economic Research (NBER) does not necessarily need to see this occur to call a recession. Perhaps the most common leading indicator is contraction in the stock market. Declines in broad stock indices, such as the Dow Jones Industrial Average (DJIA) and Standard & Poor's (S&P) 500 index, often appear several months before a recession takes shape. This was the case in 2007, when the market began declining in August, four months ahead of the official recession in December 2007.

Trendline

What is a 'Trendline' A trendline is a line drawn over pivot highs or under pivot lows to show the prevailing direction of price. Trendlines are a visual representation of support and resistance in any timeframe. Trendlines are used to show direction and speed of price, and also describe patterns during periods of price contraction. BREAKING DOWN 'Trendline' There are two branches of analysis in stock research: fundamental analysis and technical analysis. Fundamental analysis is used to determine what to buy, while technical analysis is used to determine when to buy it. One of the most important tools used by technical analysts is the trendline. Fundamental vs. Technical Analysis The bottom line for companies is profit. A company with growth in earnings and revenues is also likely to have an increase in stock price, which is what fundamental analysts count on. This is because the market likes to assign a value to earnings. This value is represented by the market price, which is what technical analysts and chartists use to analyze the market. Instead of looking at past business performance, technical analysts look for trends in price action. At the foundation of identifying trends is a tool called the trendline. A trendline helps technical analysts determine the current direction in market prices. Technical analysts believe the trend is your friend, and identifying this trend is the first step in the process of making a good trade.

Value Stock

What is a 'Value Stock' A value stock is a stock that tends to trade at a lower price relative to its fundamentals (e.g., dividends, earnings and sales) and thus considered undervalued by a value investor. Common characteristics of such stocks include a high dividend yield, low price-to-book ratio and/or low price-to-earnings ratio. An easy way to attempt to find value stocks is to use the "Dogs of the Dow" investing strategy by purchasing the 10 highest dividend-yielding stocks on the Dow Jones at the beginning of each year and adjusting the portfolio every year thereafter. Two Approaches to Selecting Stocks The two basic approaches for equity investing relate to purchasing growth stock or value stock. Growth stocks are equities of companies with strong anticipated growth potential. Value stock emphasis equities that are currently undervalued. A balanced diversified portfolio will have both value stock and growth stock. These portfolios may be referred to as a blended portfolio. How to Spot Value Stocks A value stock will have bargain-price as the company is seen as unfavorable in the marketplace. A value stock will have an equity price lower than stock prices of companies in the same industry. Negative publicity relating to unsatisfactory earnings reports or legal problems are indicators of a value stock as the market will negatively view the company's long-term prospects. A value stock will most likely come from a mature company with a stable dividend issuance that is temporarily experiencing negative events. However, companies that have recently issued equities have high value potential as many investors may be unaware of the entity. Risk and Return of Value Stocks A value stock is considered riskier than a growth stock. This is because of the skeptical attitude the market has towards the value stock. For a value stock to turn profitable, the market must alter its perception of the company, which is considered riskier than a growth entity developing. For this reason, a value stock is typically more likely to have a higher long-term return than a growth stock because of the underlying risk. The investing duration must be taken into consideration a value stock may need some time to emerge from its undervalued position. The true risk in investing in a value stock is that this emergence may never materialize.

Index Fund

What is an 'Index Fund' An index fund is a type of mutual fund with a portfolio constructed to match or track the components of a market index, such as the Standard & Poor's 500 Index (S&P 500). An index mutual fund is said to provide broad market exposure, low operating expenses and low portfolio turnover. These funds adhere to specific rules or standards (e.g. efficient tax management or reducing tracking errors) that stay in place no matter the state of the markets.

Institutional Investor

What is an 'Institutional Investor' An institutional investor is a nonbank person or organization that trades securities in large enough share quantities or dollar amounts that it qualifies for preferential treatment and lower commissions. Institutional investors face fewer protective regulations because it is assumed they are more knowledgeable and better able to protect themselves. Examples of institutional investors include pension funds and life insurance companies. BREAKING DOWN 'Institutional Investor' An institutional investor is an organization that invests on behalf of its members. Examples include endowment funds, commercial banks, mutual funds and hedge funds.

Option

What is an 'Option' An option is a financial derivative that represents a contract sold by one party (the option writer) to another party (the option holder). The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price (the strike price) during a certain period of time or on a specific date (exercise date). BREAKING DOWN 'Option' Options are extremely versatile securities. Traders use options to speculate, which is a relatively risky practice, while hedgers use options to reduce the risk of holding an asset. In terms of speculation, option buyers and writers have conflicting views regarding the outlook on the performance of an underlying security. Call Option Call options give the option to buy at a certain price, so the buyer would want the stock to go up. Conversely, the option writer needs to provide the underlying shares in the event that the stock's market price exceeds the strike due to the contractual obligation. An option writer who sells a call option believes that the underlying stock's price will drop relative to the option's strike price during the life of the option, as that is how he will reap maximum profit. This is exactly the opposite outlook of the option buyer. The buyer believes that the underlying stock will rise; if this happens, the buyer will be able to acquire the stock for a lower price and then sell it for a profit. However, if the underlying stock does not close above the strike price on the expiration date, the option buyer would lose the premium paid for the call option. Put Option Put options give the option to sell at a certain price, so the buyer would want the stock to go down. The opposite is true for put option writers. For example, a put option buyer is bearish on the underlying stock and believes its market price will fall below the specified strike price on or before a specified date. On the other hand, an option writer who shorts a put option believes the underlying stock's price will increase about a specified price on or before the expiration date. If the underlying stock's price closes above the specified strike price on the expiration date, the put option writer's maximum profit is achieved. Conversely, a put option holder would only benefit from a fall in the underlying stock's price below the strike price. If the underlying stock's price falls below the strike price, the put option writer is obligated to purchase shares of the underlying stock at the strike price.

Asian Financial Crisis (1997)

What is the 'Asian Financial Crisis' The Asian financial crisis, also called the "Asian Contagion," was a series of currency devaluations and other events that spread through many Asian markets beginning in the summer of 1997. The currency markets first failed in Thailand as the result of the government's decision to no longer peg the local currency to the U.S. dollar (USD). Currency declines spread rapidly throughout South Asia, in turn causing stock market declines, reduced import revenues and government upheaval.

Black Scholes Model

What is the 'Black Scholes Model' The Black Scholes model, also known as the Black-Scholes-Merton model, is a model of price variation over time of financial instruments such as stocks that can, among other things, be used to determine the price of a European call option. The model assumes the price of heavily traded assets follows a geometric Brownian motion with constant drift and volatility. When applied to a stock option, the model incorporates the constant price variation of the stock, the time value of money, the option's strike price and the time to the option's expiry. BREAKING DOWN 'Black Scholes Model' The Black Scholes Model is one of the most important concepts in modern financial theory. It was developed in 1973 by Fisher Black, Robert Merton and Myron Scholes and is still widely used in 2016. It is regarded as one of the best ways of determining fair prices of options. The Black Scholes model requires five input variables: the strike price of an option, the current stock price, the time to expiration, the risk-free rate and the volatility. Additionally, the model assumes stock prices follow a lognormal distribution because asset prices cannot be negative. Moreover, the model assumes there are no transaction costs or taxes; the risk-free interest rate is constant for all maturities; short selling of securities with use of proceeds is permitted; and there are no riskless arbitrage opportunities. Black-Scholes Formula The Black Scholes call option formula is calculated by multiplying the stock price by the cumulative standard normal probability distribution function. Thereafter, the net present value (NPV) of the strike price multiplied by the cumulative standard normal distribution is subtracted from the resulting value of the previous calculation.

Dow Theory

What is the 'Dow Theory' The Dow theory is an approach to trading developed by Charles H. Dow, who with Edward Jones and Charles Bergstresser founded Dow Jones & Company Inc. and developed the Dow Jones Industrial Average. BREAKING DOWN 'Dow Theory' There are six main components to the Dow theory. They are summarized briefly here; for a more in-depth look read Chad Langager and Casey Murphy's tutorial. 1. The market discounts everything. The Dow theory operates on the efficient markets hypothesis, which states that asset prices incorporate all available information. 2. There are three kinds of market trends. Markets experience primary trends which last a year or more, such as a bull or bear market. Within these broader trends, they experience secondary trends, often working against the primary trend, such as a pullback within a bull market or a rally within a bear market; these secondary trends last from three weeks to three months. Finally, there minor trends lasting less than three weeks, which are largely noise. 3. Primary trends have three phases. A primary trend will pass through three phases, according to the Dow theory. In a bull market, these are the accumulation phase, the public participation (or big move) phase and the excess phase. In a bear market, they are called the distribution phase, the public participation phase and the panic (or despair) phase. 4. Indices must confirm each other. In order for a trend to be established, Dow postulated that indices or market averages must confirm each other. Dow used the two indices he and his partners invented, the Dow Jones Industrial (DJIA) and Rail (now Transportation) Averages, on the assumption that if business conditions were in fact healthy - as a rise in the DJIA might suggest - the railroads would be profiting from moving the freight this business activity required. If asset prices were rising but the railroads were suffering, the trend would likely not be sustainable. The converse also applies: if railroads are profiting but the market is in a downturn, there is no clear trend. 5. Volume must confirm the trend. Volume should increase if price is moving in the direction of the primary trend, and decrease if it is moving against it. Low volume signals a weakness in the trend. For example, in a bull market, volume should increase as the price is rising, and fall during secondary pullbacks. If, in this example, volume picks up during a pullback, it could be a sign that the trend is reversing as more market participants turn bearish. 6. Trends persist until a clear reversal occurs. Reversals in primary trends can be confused with secondary trends. Determining whether an upswing in a bear market is a reversal - the beginning of a bull market - or a short-lived rally to be followed by lower lows is difficult, and the Dow theory advocates caution, insisting that reversal be confirmed.

Efficient Market Hypothesis - EMH

What is the 'Efficient Market Hypothesis - EMH' The efficient market hypothesis (EMH) is an investment theory that states it is impossible to "beat the market" because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. According to the EMH, stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. As such, it should be impossible to outperform the overall market through expert stock selection or market timing, and the only way an investor can possibly obtain higher returns is by purchasing riskier investments. BREAKING DOWN 'Efficient Market Hypothesis - EMH' Although it is a cornerstone of modern financial theory, the EMH is highly controversial and often disputed. Believers argue it is pointless to search for undervalued stocks or to try to predict trends in the market through either fundamental or technical analysis. While academics point to a large body of evidence in support of EMH, an equal amount of dissension also exists. For example, investors such as Warren Buffett have consistently beaten the market over long periods of time, which by definition is impossible according to the EMH. Detractors of the EMH also point to events such as the 1987 stock market crash, when the Dow Jones Industrial Average (DJIA) fell by over 20% in a single day, as evidence that stock prices can seriously deviate from their fair values.

Enterprise Value (EV)

What is the 'Enterprise Value (EV)' Enterprise Value, or EV for short, is a measure of a company's total value, often used as a more comprehensive alternative to equity market capitalization. The market capitalization of a company is simply its share price multiplied by the number of shares a company has outstanding. Enterprise value is calculated as the market capitalization plus debt, minority interest and preferred shares, minus total cash and cash equivalents. Often times, the minority interest and preferred equity is effectively zero, although this need not be the case. EV = market value of common stock + market value of preferred equity + market value of debt + minority interest - cash and investments.

Expected Value

What is the 'Expected Value' The expected value (EV) is an anticipated value for a given investment. In statistics and probability analysis, the EV is calculated by multiplying each of the possible outcomes by the likelihood each outcome will occur, and summing all of those values. By calculating expected values, investors can choose the scenario most likely to give them their desired outcome. BREAKING DOWN 'Expected Value' Scenario analysis is one technique for calculating the EV of an investment opportunity. It uses estimated probabilities with multivariate models, to examine possible outcomes for a proposed investment. Scenario analysis also helps investors determine whether they are taking on an appropriate level of risk, given the likely outcome of the investment. The EV of a random variable gives a measure of the center of the distribution of the variable. Essentially, the EV is the long-term average value of the variable. Because of the law of large numbers, the average value of the variable converges to the EV as the number of repetitions approaches infinity. The EV is also known as expectation, the mean or the first moment. EV can be calculated for single discreet variables, single continuous variables, multiple discreet variables and multiple continuous variables. For continuous variable situations, integrals must be used. Basic Expected Value Example To calculate the EV for a single discreet random variable, you must multiply the value of the variable by the probability of that value occurring. Take, for example, a normal six-sided die. Once you roll the die, it has an equal one-sixth chance of landing on one, two, three, four, five or six. Given this information, the calculation is straightforward: (1/6 * 1) + (1/6 * 2) + (1/6 * 3) + (1/6 * 4) + (1/6 * 5) + (1/6 * 6) = 3.5 If you were to roll a six-sided die an infinite amount of times, you see the average value equals 3.5. A More Complicated Expected Value Example The logic of EV can be used to find solutions to more complicated problems. Assume the following situation: you have a six-sided die and want to roll the highest number possible. You can roll the die once and if you dislike the result, roll the die one more time. But if you roll the die a second time, you must accept the value of the second roll. Half of the time, the value of the first roll will be below the EV of 3.5, or a one, two or three, and half the time, it will be above 3.5, or a four, five or six. When the first roll is below 3.5, you should roll again, otherwise you should stick with the first roll. Thus, half the time you keep a four, five or six, the first roll, and half the time you have an EV of 3.5, the second roll. The expected value of this scenario is: (50% * ((4 + 5+ 6) / 3)) + (50% * 3.5) = 2.5 + 1.75 = 4.25

Laffer Curve

What is the 'Laffer Curve' The Laffer Curve is a theory developed by supply-side economist Arthur Laffer to show the relationship between tax rates and the amount of tax revenue collected by governments. The curve is used to illustrate Laffer's main premise that the more an activity such as production is taxed, the less of it is generated. Likewise, the less an activity is taxed, the more of it is generated. BREAKING DOWN 'Laffer Curve' Laffer Curve The Laffer Curve suggests that, as taxes increase from low levels, tax revenue collected by the government also increases. It also shows that tax rates increasing after a certain point (T*) would cause people not to work as hard or not at all, thereby reducing tax revenue. Eventually, if tax rates reached 100%, shown as the far right on his curve, all people would choose not to work because everything they earned would go to the government. Governments would like to be at point T*, because it is the point at which the government collects maximum amount of tax revenue while people continue to work hard. The Laffer Curve Explained The first presentation of the Laffer Curve was performed on a paper napkin back in 1974, when its author was speaking with senior staff members of President Gerald Ford's administration about the state of economic malaise that had engulfed the country. At the time, most economists were espousing a Keynesian approach to solving the problem, which advocated more government spending to stimulate demand for products. Laffer countered that the problem isn't too little demand. Rather, it was the burden of heavy taxes and regulations that created impediments to production, which impacts government revenue. Laffer argues that the more money taken from a business in the form of taxes, the less money it has to invest in the business. A business is more likely to find ways to protect its capital from taxation, or to relocate all or a part of its operations overseas. Investors are less likely to risk their own capital if a larger percentage of their profits are taken. When workers see increasing portion of their paychecks taken due to increased efforts on their part, they will lose the incentive to work harder. For every type of tax, there is a threshold rate above which the incentive to produce more diminishes, thereby reducing the amount of revenue the government receives. The theory later became a cornerstone of President Ronald Reagan's economic policy, which resulted in one of the biggest tax cuts in history. During his time in office, tax revenues received by the government increased from $517 billion in 1980 to $909 billion in 1988.

Moving Average Convergence Divergence

What is the 'Moving Average Convergence Divergence - MACD' Moving average convergence divergence (MACD) is a trend-following momentum indicator that shows the relationship between two moving averages of prices. The MACD is calculated by subtracting the 26-day exponential moving average (EMA) from the 12-day EMA. A nine-day EMA of the MACD, called the "signal line", is then plotted on top of the MACD, functioning as a trigger for buy and sell signals. BREAKING DOWN 'Moving Average Convergence Divergence - MACD' There are three common methods used to interpret the MACD: 1. Crossovers - As shown in the chart above, when the MACD falls below the signal line, it is a bearish signal, which indicates that it may be time to sell. Conversely, when the MACD rises above the signal line, the indicator gives a bullish signal, which suggests that the price of the asset is likely to experience upward momentum. Many traders wait for a confirmed cross above the signal line before entering into a position to avoid getting getting "faked out" or entering into a position too early, as shown by the first arrow. 2. Divergence - When the security price diverges from the MACD. It signals the end of the current trend. 3. Dramatic rise - When the MACD rises dramatically - that is, the shorter moving average pulls away from the longer-term moving average - it is a signal that the security is overbought and will soon return to normal levels. Traders also watch for a move above or below the zero line because this signals the position of the short-term average relative to the long-term average. When the MACD is above zero, the short-term average is above the long-term average, which signals upward momentum. The opposite is true when the MACD is below zero. As you can see from the chart above, the zero line often acts as an area of support and resistance for the indicator.

Phillips Curve

What is the 'Phillips Curve' The Phillips curve is an economic concept developed by A. W. Phillips showing that inflation and unemployment have a stable and inverse relationship. The theory states that with economic growth comes inflation, which in turn should lead to more jobs and less unemployment. However, the original concept has been somewhat disproven empirically due to the occurrence of stagflation in the 1970s, when there were high levels of both inflation and unemployment. Stagflation Stagflation occurs when an economy experiences stagnant economic growth, high unemployment and high price inflation. This scenario, of course, directly contracts the theory behind the Philips curve. Stagflation was never experienced in the United States until the 1970s, when rising unemployment did not coincide with declining inflation.

Price-Earnings Ratio P/E Ratio

What is the 'Price-Earnings Ratio - P/E Ratio' The price-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings. The price-earnings ratio is also sometimes known as the price multiple or the earnings multiple. The P/E ratio can be calculated as: Market Value per Share / Earnings per Share For example, suppose that a company is currently trading at $43 a share and its earnings over the last 12 months were $1.95 per share. The P/E ratio for the stock could then be calculated as 43/1.95, or 22.05. EPS is most often derived from the last four quarters. This form of the price-earnings ratio is called trailing P/E, which may be calculated by subtracting a company's share value at the beginning of the 12-month period from its value at the period's end, adjusting for stock splits if there have been any. Sometimes, price-earnings can also be taken from analysts' estimates of earnings expected during the next four quarters. This form of price-earnings is also called projected or forward P/E. A third, less common variation uses the sum of the last two actual quarters and the estimates of the next two quarters. BREAKING DOWN 'Price-Earnings Ratio - P/E Ratio' In essence, the price-earnings ratio indicates the dollar amount an investor can expect to invest in a company in order to receive one dollar of that company's earnings. This is why the P/E is sometimes referred to as the multiple because it shows how much investors are willing to pay per dollar of earnings. If a company were currently trading at a multiple (P/E) of 20, the interpretation is that an investor is willing to pay $20 for $1 of current earnings. In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E. A low P/E can indicate either that a company may currently be undervalued or that the company is doing exceptionally well relative to its past trends. When a company has no earnings or is posting losses, in both cases P/E will be expressed as "N/A." Though it is possible to calculate a negative P/E, this is not the common convention. The price-earnings ratio can also be seen as a means of standardizing the value of one dollar of earnings throughout the stock market. In theory, by taking the median of P/E ratios over a period of several years, one could formulate something of a standardized P/E ratio, which could then be seen as a benchmark and used to indicate whether or not a stock is worth buying. Limitations of 'Price-Earnings Ratio - P/E Ratio' Like any other metric designed to inform investors as to whether or not a stock is worth buying, the price-earnings ratio comes with a few important limitations that are important to take into account, as investors may often be led to believe that there is one single metric that will provide complete insight into an investment decision, which is virtually never the case. One primary limitation of using P/E ratios emerges when comparing P/E ratios of different companies. Valuations and growth rates of companies may often vary wildly between sectors due both to the differing ways companies earn money and to the differing timelines during which companies earn that money. As such, one should only use P/E as a comparative tool when considering companies within the same sector, as this kind of comparison is the only kind that will yield productive insight. Comparing the P/E ratios of a telecommunications company and an energy company, for example, may lead one to believe that one is clearly the superior investment, but this is not a reliable assumption. An individual company's P/E ratio is much more meaningful when taken alongside P/E ratios of other companies within the same sector. For example, an energy company may have a high P/E ratio, but this may reflect a trend within the sector rather than one merely within the individual company. An individual company's high P/E ratio, for example, would be less cause for concern when the entire sector has high P/E ratios. Moreover, because a company's debt can affect both the prices of shares and the company's earnings, leverage can skew P/E ratios as well. For example, suppose there are two similar companies that differ primarily in the amount of debt they take on. The one with more debt will likely have a lower P/E value than the one with less debt. However, if business is good, the one with more debt stands to see higher earnings because of the risks it has taken. Another important limitation of price-earnings ratios is one that lies within the formula for calculating P/E itself. Accurate and unbiased presentations of P/E ratios rely on accurate inputs of the market value of shares and of accurate earnings per share estimates. While the market determines the value of shares and, as such, that information is available from a wide variety of reliable sources, this is less so for earnings, which are often reported by companies themselves and thus are more easily manipulated. Since earnings are an important input in calculating P/E, adjusting them can affect P/E as well. Things to Remember Generally a high P/E ratio means that investors are anticipating higher growth in the future. The average market P/E ratio is 20-25 times earnings. The P/E ratio can use estimated earnings to get the forward looking P/E ratio. Companies that are losing money do not have a P/E ratio.

Purchasing Managers Index

What is the 'Purchasing Managers' Index - PMI' The Purchasing Managers' Index (PMI) is an indicator of the economic health of the manufacturing sector. The PMI is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment. The purpose of the PMI is to provide information about current business conditions to company decision makers, analysts and purchasing managers. BREAKING DOWN 'Purchasing Managers' Index - PMI' The information to produce the PMI is gathered using monthly surveys sent to purchasing executives at approximately 300 companies. A PMI of more than 50 represents expansion of the manufacturing sector when compared to the previous month. A PMI reading under 50 represents a contraction, and a reading at 50 indicates no change. The Institute of Supply Management (ISM) generates the PMI each month. Although the ISM publishes several indexes, the PMI is the most widely followed and is sometimes referred to as the ISM index. How PMI Impacts Management Decisions PMI is a critical decision-making tool for managers in a variety of roles. An automobile manufacturer, for example, makes production decisions based on the new orders it expects from customers in future months. Those new orders drive management's purchase decisions about dozens of component parts and raw materials, such as steel and plastic. Existing inventory balances also drive the amount of production the manufacturer needs to complete to fill new orders and to keep some inventory on hand at the end of the month. Suppliers also make decisions based on PMI. A parts supplier for a manufacturer follows PMI to estimate the amount of future demand for its products. The supplier also wants to know how much inventory its customers have on hand, which also impacts the amount of production its clients must generate. PMI information about supply and demand affects the prices that suppliers can charge. If the manufacturer's new orders are growing, for example, it may raise customer prices and accept price increases from its suppliers. On the other hand, when new orders are declining, the manufacturer may have to lower its prices and demand a lower cost for the parts it purchases. A company uses all of this PMI information to plan its annual budget, staffing levels and to forecast cash flow. Factoring in Imports and Exports PMI also provides information on imports and exports, which are important statistics for businesses that operate overseas. Assume, for example, that the automobile manufacturer purchases steel in the United States and from China. If imports are increasing, that trend will have a negative impact on U.S. firms that sell the same product. On the other hand, if exports by parts manufacturers are increasing, a parts supplier may demand higher prices from U.S. companies that need to purchase its products.

Stock Market Capitalization To GDP Ratio

What is the 'Stock Market Capitalization To GDP Ratio' The stock market capitalization to GDP ratio is a ratio used to determine whether an overall market is undervalued or overvalued. The ratio can be used to focus on specific markets, such as the U.S. market, or it can be applied to the world market depending on what values are used in the calculation. Market Capitalization to GDP = Stock Market Capitalization/Market GDP X 100

Theory of the Firm

What is the 'Theory Of The Firm' The theory of the firm is the microeconomic concept founded in neoclassical economics that states that firms (including businesses and corporations) exist and make decisions to maximize profits. Firms interact with the market to determine pricing and demand and then allocate resources according to models that look to maximize net profits.

Dotcom Bubble (1990's)

What was the 'Dotcom Bubble' The dotcom bubble occurred in the late 1990s and was characterized by a rapid rise in equity markets fueled by investments in Internet-based companies. During the dotcom bubble, the value of equity markets grew exponentially, with the technology-dominated NASDAQ index rising from under 1,000 to more than 5,000 between 1995 and 2000.

Great Depression (1929)

What was the 'Great Depression' The Great Depression was the greatest and longest economic recession of the 20th century and, by some accounts, modern world history. By most contemporary accounts, it began with the U.S. stock market crash of 1929, and didn't completely end until after World War II, in 1946. Economists and historians often cite the Great Depression as the most critical economic event of the 20th century.

The Florida Real Estate Craze (1926)

When: 1926 Where: Florida The amount the market declined from peak to bottom: Land that could be bought for $800,000 could, within a year, be resold for $4 million before crashing back down to pre-boom levels. The prices were so inflated that to buy a condo-style property in 1926, you would've had to pay the same as you would now have to pay for a luxury home in the guard-gated communities in Miami ($4,500,000) - without adjusting for inflation! Synopsis: In the 1920s, the United States of America was chugging along like the British Empire of the 1700s, and it was only natural that people were beginning to believe such prosperity was infinite. But it wasn't the stock market that was the recipient of a bubble. It was the real estate market. In 1920, Florida became the popular U.S. destination/residence for people who don't like the cold. The population was growing steadily and housing couldn't match the demand, causing prices to double and triple in some cases, which was not exactly unjustified at this point. But, news of anything doubling and tripling in price always attracts speculators. So, once people began pumping huge amounts of money into the real estate market it took off. Soon everyone in Florida was either a real estate investor or a real estate agent.

Housing Bubble and Credit Crisis (2007-2009)

When: 2007-2009 Where: Housing centered in the United States and Britain; Credit crisis occurred around the world The amount the market declined from peak to bottom: The S&P 500 declined 57% from its high in October 2007 of 1576 to its low in March 2009 of 676; many indicators of credit risk such as the "Ted Spread" or the option adjusted spread (OAS) on corporate bonds reached record highs

John Maynard Keynes

Who was 'John Maynard Keynes' John Maynard Keynes was a 19th-century British philosopher and economist who spent his working years with the East India Company and is known as the father of Keynesian economics. He is specifically known for his theories of Keynesian economics that addressed, among other things, the causes of long-term unemployment. In a paper titled "The General Theory of Employment, Interest and Money," Keynes became an outspoken proponent of full employment and government intervention as a way to stop economic recession. Principles of Keynesian Economics The most basic principle of Keynesian economics is that if an economy's investment exceeds its savings, it will cause inflation. Conversely, if an economy's saving is higher than its investment, it will cause a recession. This was the basis of Keynes belief that an increase in spending would, in fact, decrease unemployment and help economic recovery. Keynesian economics also advocates that it's actually demand that drives production and not supply. In Keynes time, the opposite was believed to be true. With this in mind, Keynesian economics argues that economies are boosted when there is a healthy amount of output driven by sufficient amounts of economic expenditures. Keynes believed that unemployment was caused by a lack of expenditures within an economy, which decreased aggregate demand. Continuous decreases in spending during a recession result in further decreases in demand, which in turn incites higher unemployment rates, which results in even less spending as the amount of unemployed people increases. Keynes advocated that the best way to pull an economy out of a recession is for the government to borrow money and increase demand by infusing the economy with capital to spend. This means that Keynesian economics is a sharp contrast to laissez-faire in that it believes in government intervention.

Floating Exchange Rate

A floating exchange rate is a regime where the currency price is set by the forex market based on supply and demand compared with other currencies. This is in contrast to a fixed exchange rate, in which the government entirely or predominantly determines the rate. The currencies of most of the world's major economies were allowed to float freely following the collapse of the Bretton Woods system in 1971.

John Templeton John Templeton was born in Tennessee, being the first of his town to go to college, he still managed to graduate from Yale University with an economics degree. Mr. Templeton began his investments career at the Wall Street firm Fenner and Beane, where he discovered the power of value investing by always looking for bargain prices. John Templeton has proven to be a successful investor using a fundamental analysis approach, quadrupling his money within the first four years of investing, creating a well know reputation in Wall Street.

"If you want to have a better performance than the crowd, you must do things differently from the crowd." "Invest at the point of maximum pessimism." "The four most dangerous words in investing are 'This time it's different.'" "If we become increasingly humble about how little we know, we may be more eager to search." "Bull markets are born on pessimism, grown on scepticism, mature on optimism and die on euphoria"

Return On Investment (ROI)

A performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments. ROI measures the amount of return on an investment relative to the investment's cost. To calculate ROI, the benefit (or return) of an investment is divided by the cost of the investment, and the result is expressed as a percentage or a ratio.

Financial Statements

Financial statements for businesses usually include income statements, balance sheets, statements of retained earnings and cash flows. It is standard practice for businesses to present financial statements that adhere to generally accepted accounting principles (GAAP) to maintain continuity of information and presentation across international borders. Financial statements are often audited by government agencies, accountants, firms, etc. to ensure accuracy and for tax, financing or investing purposes.

Free Cash Flow

Free cash flow (FCF) is a measure of a company's financial performance, calculated as operating cash flow minus capital expenditures. FCF represents the cash that a company is able to generate after spending the money required to maintain or expand its asset base. FCF is important because it allows a company to pursue opportunities that enhance shareholder value.

Interest

Interest is the charge for the privilege of borrowing money, typically expressed as annual percentage rate. Interest can also refer to the amount of ownership a stockholder has in a company, usually expressed as a percentage. There are two main types of interest that can be applied to loans: simple and compound. Simple interest is a set rate on the principle originally lent to the borrower that the borrower has to pay for the ability to use the money. Compound interest is interest on both the principle and the compounding interest paid on that loan. The latter of the two types of interest is the most common.

Liquidity

Liquidity describes the degree to which an asset or security can be quickly bought or sold in the market without affecting the asset's price.

Porter's 5 Forces

What are 'Porter's 5 Forces' Porter's Five Forces model, named after Michael E. Porter, identifies and analyzes five competitive forces that shape every industry, and helps determine an industry's weaknesses and strengths. These forces are: 1. Competition in the industry; 2. Potential of new entrants into the industry; 3. Power of suppliers; 4. Power of customers; 5. Threat of substitute products. Frequently used to identify an industry's structure to determine corporate strategy, Porter's model can be applied to any segment of the economy to search for profitability and attractiveness.

Animal Spirits

human emotion that drives consumer confidence, animal spirits also generate human trust

Death Cross

A death cross is a crossover resulting from a security's long-term moving average breaking above its short-term moving average or support level. It is so named due to the shape created when charting the activity and its association with a downward market trend. As long-term indicators carry more weight, this trend indicates a bear market on the horizon and is reinforced by high trading volumes. Additionally, the long-term moving average becomes the new resistance level in the rising market. BREAKING DOWN 'Death Cross' The death cross can occur in individual stocks, within various funds, and when examining indices and averages. Considered a bearish signal within the market, a death cross occurs when the short-term, 50-day moving average, also called a price trend, crosses below the long-term, 200-day moving average. It is named a death cross due to the X shape it makes when the trend is charted and is often considered a sign of further losses for a particular stock. The death cross is seen as a decline in short-term momentum and can result in further losses as investors move away from the particular investment vehicle involved. However, it is not a guarantee of further losses as other market forces can override the fears relating to the trend. Further, a death cross is generally seen as temporary when examined in the long term. Understanding Moving Averages Moving averages relate to the change measured within a data set over time. In financial terms, the moving average monitors the change in a particular asset's value from day to day, focusing on the mean between two particular consecutive data points, to chart a course. This demonstrates the asset's current momentum within the marketplace. Death Crosses and Market Averages A death cross can be formed when charting an index fund as well as individual stocks. During times when all four major averages, the NASDAQ, Dow Jones Industrial Average, the S&P 500 and the Russell 2000, fall into a death cross simultaneously, they are generally referred to as the "four horsemen of the apocalypse" due to the negative connotations surrounding the event. Significance of a Death Cross Generally, the significance of a death cross is related to recent changes in trading volume. The higher the trading volume, the more meaningful the death cross is said to be, and vice versa. While some consider this movement as a foreshadowing of changing market trends, others believe it better represents trend changes that have already occurred and may not be indicative of future potential. The Golden Cross The opposite of the death cross is the golden cross. This marks a time when the short-term, 50-day moving average moves above the long-term, 200-day average. This tends to be associated with positive momentum and is seen as bullish in nature.

Fixed-Income Security

A fixed-income security is an investment that provides a return in the form of fixed periodic payments and the eventual return of principal at maturity. Unlike a variable-income security, where payments change based on some underlying measure such as short-term interest rates, the payments of a fixed-income security are known in advance. BREAKING DOWN 'Fixed-Income Security' A fixed-income security, commonly referred to as a bond or money market security, is a loan made by an investor to a government or corporate borrower. The borrower, or issuer, promises to pay a set amount of interest, called the coupon, on a predetermined basis until a set date. The issuer returns the principal amount, also called the face or par value, to the investor on the maturity date.

Forward Contract

A forward contract is a customized contract between two parties to buy or sell an asset at a specified price on a future date. A forward contract can be used for hedging or speculation, although its non-standardized nature makes it particularly apt for hedging. Unlike standard futures contracts, a forward contract can be customized to any commodity, amount and delivery date. A forward contract settlement can occur on a cash or delivery basis. Forward contracts do not trade on a centralized exchange and are therefore regarded as over-the-counter (OTC) instruments. While their OTC nature makes it easier to customize terms, the lack of a centralized clearinghouse also gives rise to a higher degree of default risk. As a result, forward contracts are not as easily available to the retail investor as futures contracts.

Solvency Ratio

A key metric used to measure an enterprise's ability to meet its debt and other obligations. The solvency ratio indicates whether a company's cash flow is sufficient to meet its short-term and long-term liabilities. The lower a company's solvency ratio, the greater the probability that it will default on its debt obligations.

Preferred Stock

A preferred stock is a class of ownership in a corporation that has a higher claim on its assets and earnings than common stock. Preferred shares generally have a dividend that must be paid out before dividends to common shareholders, and the shares usually do not carry voting rights.

Price Target

A price target is the projected price level of a financial security stated by an investment analyst or advisor. It represents a security's price that, if achieved, results in a trader recognizing the best possible outcome for his investment. This is the price at which the trader or investor wants to exit his existing position so he can realize the most reward.

Tax Liability

A tax liability is the amount of taxation that a business or an individual incurs based on current tax laws. A taxable event triggers a tax liability calculation, which is the tax base of the event multiplied by a tax rate. Tax liabilities are incurred due to earning income, a gain on the sale of an asset or other taxable events.

Tender Offer

A tender offer is an offer to purchase some or all of shareholders' shares in a corporation. The price offered is usually at a premium to the market price. Securities and Exchange Commission laws require any corporation or individual acquiring 5% of a company to disclose information to the SEC, the target company and the exchange.

Write-Down

A write-down is the reducing of the book value of an asset because it is overvalued compared to the market value. A write-down typically occurs on a company's financial statement, when the carrying value of the asset can no longer be justified as fair value and the likelihood of receiving the cost, or book value, is questionable at best.

Accruals

Accruals are earned revenues and incurred expenses that have an overall impact on an income statement. They also affect the balance sheet, which represents liabilities and non-cash-based assets used in accrual-based accounting. These accounts include, among many others, accounts payable, accounts receivable, goodwill, future tax liability and future interest expense.

Impaired Asset

An impaired asset is a company's asset that has a market price less than the value listed on the company's balance sheet. Accounts that are likely to be written down are the company's goodwill, accounts receivable and long-term assets because the carrying value has a longer span of time for impairment. Upon adjusting an impaired asset's carrying value, the loss is recognized on the company's income statement.

Stop Loss Order

An order placed with a broker to sell a security when it reaches a certain price. A stop-loss order is designed to limit an investor's loss on a position in a security. Although most investors associate a stop-loss order only with a long position, it can also be used for a short position, in which case the security would be bought if it trades above a defined price. A stop-loss order takes the emotion out of trading decisions and can be especially handy when one is on vacation or cannot watch his/her position. However, execution is not guaranteed, particularly in situations where trading in the stock is halted or gaps down (or up) in price. Also known as a "stop order" or "stop-market order."

Contango

Contango is a situation where the futures price of a commodity is above the expected future spot price. Contango refers to a situation where the future spot price is below the current price, and people are willing to pay more for a commodity at some point in the future than the actual expected price of the commodity. This may be due to people's desire to pay a premium to have the commodity in the future rather than paying the costs of storage and the carry costs of buying the commodity today.

Convexity

Convexity is a measure of the curvature in the relationship between bond prices and bond yields that demonstrates how the duration of a bond changes as the interest rate changes. As convexity increases, the systemic risk to which the portfolio is exposed increases. As convexity decreases, the exposure to market interest rates decreases and the bond portfolio can be considered hedged. In general, the higher the coupon rate, the lower the convexity (or market risk) of a bond. This is because market rates would have to increase greatly to surpass the coupon on the bond, meaning there is less risk to the investor. If a bond's duration increases as yields increase, the bond is said to have negative convexity. In other words, the shape of the bond is said to be concave. Therefore, if a bond has negative convexity, its price would increase in value as interest rates rise, and the opposite is true. Some examples of bonds that exhibit negative convexity are bonds with a traditional call provision, preferred bonds and most mortgage-backed securities (MBS). If a bond's duration rises and yields fall, the bond is said to have positive convexity. If a bond has positive convexity, it would typically experience larger price increases if yields fall, in relation to price decreases when yields increase. The typical types of bonds with positive convexity are bonds with make-whole call provisions and non-callable bonds.

Gross Margin

Gross margin is a company's total sales revenue minus its cost of goods sold (COGS), divided by total sales revenue, expressed as a percentage. The gross margin represents the percent of total sales revenue that the company retains after incurring the direct costs associated with producing the goods and services it sells. The higher the percentage, the more the company retains on each dollar of sales, to service its other costs and debt obligations.

Duration

Duration is a measure of the sensitivity of the price of a bond or other debt instrument to a change in interest rates. The Macaulay duration is the weighted average time until all the bond's cash flows are paid. Modified duration measures the expected change in a bond's price to a 1% change in interest rates.

Fiduciary Rule

Fiduciary rule requires retirement advisors to put their clients' needs and best interests before their own. This rule is regulated by the Department of Labor (DOL), and it was enacted to prevent financial advisors from taking advantage of their clients by giving them bad retirement advice. This bad advice tends to result in the financial firm benefiting from hidden fees that are granted through fine print.

Albert Einstein

If you can't explain it simply, you don't understand it well enough.

Regression

If you've ever wondered how two or more things relate to each other, or if you've ever had your boss ask you to create a forecast or analyze relationships between variables, then learning regression would be worth your time. In this article, you'll learn the basics of simple linear regression - a tool commonly used in forecasting and financial analysis. We will begin by learning the core principles of regression, first learning about covariance and correlation, and then moving on to building and interpreting a regression output. A lot of software such as Microsoft Excel can do all the regression calculations and outputs for you, but it is still important to learn the underlying mechanics. Variables At the center of regression is the relationship between two variables called the dependent and independent variables. For instance, suppose you want to forecast sales for your company and you've concluded that your company's sales go up and down depending on changes in GDP. The sales you are forecasting would be the dependent variable because their value "depends" on the value of GDP and the GDP would be the independent variable. You would then need to determine the strength of the relationship between these two variables in order to forecast sales. If GDP increases/decreases by 1%, how much will your sales increase or decrease? Covariance The formula to calculate the relationship between two variables is called covariance. This calculation shows you the direction of the relationship as well as its relative strength. If one variable increases and the other variable tends to also increase, the covariance would be positive. If one variable goes up and the other tends to go down, then the covariance would be negative. The actual number you get from calculating this can be hard to interpret because it isn't standardized. A covariance of five, for instance, can be interpreted as a positive relationship, but the strength of the relationship can only be said to be stronger than if the number was four or weaker than if the number was six. Correlation Coefficient We need to standardize the covariance in order to allow us to better interpret and use it in forecasting, and the result is the correlation calculation. The correlation calculation simply takes the covariance and divides it by the product of the standard deviation of the two variables. This will bound the correlation between a value of -1 and +1. A correlation of +1 can be interpreted to suggest that both variables move perfectly positively with each other and a -1 implies they are perfectly negatively correlated. In our previous example, if the correlation is +1 and the GDP increases by 1%, then sales would increase by 1%. If the correlation is -1, a 1% increase in GDP would result in a 1% decrease in sales - the exact opposite.

Bond Prices, Yields and Interest Rates

Interest rates rise: yields go up and prices go down Interest rates fall: yields fall and prices rise

Net Profit Margin

Net profit margin is the ratio of net profits to revenues for a company or business segment . Typically expressed as a percentage, net profit margins show how much of each dollar collected by a company as revenue translates into profit. The equation to calculate net profit margin is: net margin = net profit / revenue.

R*

Neutral interest rate that is neither accommodative or restrictive

Quantitative Easing

Quantitative easing is an unconventional monetary policy in which a central bank purchases government securities or other securities from the market in order to lower interest rates and increase the money supply. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity. Quantitative easing is considered when short-term interest rates are at or approaching zero, and does not involve the printing of new banknotes.

80-20 Rule

The 80-20 rule is a rule of thumb that states that 80% of outcomes can be attributed to 20% of all causes for a given event. In business, the 80-20 is often used to point out that 80% of a company's revenue is generated by 20% of its total customers. Therefore, the rule is used to help managers identify and determine which operating factors are most important and should receive the most attention, based on an efficient use of resources.

Stock Market Indices

The Dow Jones Industrial Average (DJIA) Standard & Poor's 500 Index (known commonly as the S&P 500) The Wilshire 5000 The Nasdaq Composite Index

SEC Form 13

The SEC Form 13F is a filing with the Securities and Exchange Commission (SEC) also known as the Information Required of Institutional Investment Managers Form. It is a quarterly filing required of institutional investment managers with over $100 million in qualifying assets. Companies required to file SEC Form 13F may include insurance companies, banks, pension funds, investment advisers and broker-dealers.

10-Q

The SEC form 10-Q is a comprehensive report of a company's performance that must be submitted quarterly by all public companies to the Securities and Exchange Commission. In the 10-Q, firms are required to disclose relevant information regarding their financial position. There is no filing after the fourth quarter, because that is when the 10-K is filed.

Taylor Rule

The Taylor Rule is an interest rate forecasting model invented and perfected by famed economist John Taylor in 1992 and outlined in his landmark 1993 study "Discretion Vs. Policy Rules in Practice". 00:06 01:42 The Taylor Rule is an interest rate forecasting model invented and perfected by famed economist John Taylor in 1992 and outlined in his landmark 1993 study "Discretion Vs. Policy Rules in Practice". Taylor operated in the early 1990s with credible assumptions that the Federal Reserve determined future interest rates based on the rational expectations theory of macroeconomics. This is a backward-looking model that assumes that if workers, consumers and firms have positive expectations for the future of the economy, interest rates don't need an adjustment. The problem with this model is not only that it is backward looking, but also that it doesn't take into account long-term economic prospects. The Phillips curve was the last of discredited rational expectations theory models that attempted to forecast the tradeoff between inflation and employment. The problem again was that while short-term expectation may have been correct, long-term assumptions based on these models are difficult, and how can adjustments be made to an economy if the interest rate action taken was wrong? Here, monetary policy was based more on discretion than concrete rules. What economists found was that they couldn't imply monetary expectations based on rational expectation theories any longer, particularly when an economy didn't grow or stagflation was the result of recent interest rate change. This situation brought rise to the Taylor rule. (See also: The Impact of a Fed Interest Rate Hike.) Calculations The formula used for the Taylor rule looks like this: i= r* + pi + 0.5 (pi-pi*) + 0.5 ( y-y*). Where: i = nominal fed funds rate r* = real federal funds rate (usually 2%) pi = rate of inflation p* = target inflation rate Y = logarithm of real output y* = logarithm of potential output What this equation says is that the difference between a nominal and real interest rate is inflation. Real interest rates are factored for inflation while nominal rates are not. Here we are looking at possible targets of interest rates, but this can't be accomplished in isolation without looking at inflation. To compare rates of inflation or non-inflation, one must look at the total picture of an economy in terms of prices. Prices and inflation are driven by three factors: the Consumer Price Index, producer prices and the Employment Index. Most nations in the modern day look at the Consumer Price Index as a whole rather than look at core CPI. Taylor recommends this method, as core CPI excludes food and energy prices. This method allows an observer to look at the total picture of an economy in terms of prices and inflation. Rising prices means higher inflation, so Taylor recommends factoring the rate of inflation over one year (or four quarters) for a comprehensive picture. Taylor recommends the real interest rate should be 1.5 times the inflation rate. This is based on the assumption of an equilibrium rate that factors the real inflation rate against the expected inflation rate. Taylor calls this the equilibrium, a 2% steady state, equal to a rate of about 2%. The product of the Taylor Rule is three numbers: an interest rate, an inflation rate and a GDP rate all based on an equilibrium rate to gauge exactly the proper balance for an interest rate forecast by monetary authorities. The rule for policymakers is this: The Federal Reserve should raise rates when inflation is above target or when GDP growth is too high and above potential. The Fed should lower rates when inflation is below the target level or when GDP growth is too slow and below potential. When inflation is on target and GDP is growing at its potential, rates are said to be neutral. This model aims to stabilize the economy in the short term and to stabilize inflation over the long term. The Bottom Line The Taylor Rule has held many central banks around the world in good stead since its inception in 1993. It has served not only as a gauge of interest rates, inflation and output levels, but also as a guide to gauge proper levels of the money supply, since money supply levels and inflation meld together to form a perfect economy. It allows us to understand money vs. prices to determine a proper balance because inflation can erode the purchasing power of the dollar if it's not leveled properly.

Acid-Test Ratio

The acid-test ratio is a strong indicator of whether a firm has sufficient short-term assets to cover its immediate liabilities. Commonly known as the quick ratio, this metric is more robust than the current ratio, also known as the working capital ratio, since it ignores illiquid assets such as inventory.

The VIX

The gist is that the VIX -- what some people refer to as a fear gauge -- is nothing but a backward-looking measure that historically just tracks realized volatility. The below chart shows pretty convincingly that the VIX simply reflects what we've already seen in the market, and tells us little about what investors see going forward.

Wage-Price Spiral

The wage-price spiral is a macroeconomic theory used to explain the cause-and-effect relationship between rising wages and rising prices, or inflation. The wage-price spiral suggests that rising wages increases disposable income, thus raising the demand for goods and causing prices to rise. Rising prices cause demand for higher wages, which leads to higher production costs and further upward pressure on prices, creating a conceptual spiral.

Venture Capital

Venture capital is financing that investors provide to startup companies and small businesses that are believed to have long-term growth potential. For startups without access to capital markets, venture capital is an essential source of money. Risk is typically high for investors, but the downside for the startup is that these venture capitalists usually get a say in company decisions.

Futures

What are 'Futures' Futures are financial contracts obligating the buyer to purchase an asset or the seller to sell an asset, such as a physical commodity or a financial instrument, at a predetermined future date and price. Futures contracts detail the quality and quantity of the underlying asset; they are standardized to facilitate trading on a futures exchange. Some futures contracts may call for physical delivery of the asset, while others are settled in cash. BREAKING DOWN 'Futures' The futures markets are characterized by the ability to use very high leverage relative to stock markets. Futures can be used to hedge or speculate on the price movement of the underlying asset. For example, a producer of corn could use futures to lock in a certain price and reduce risk, or anybody could speculate on the price movement of corn by going long or short using futures. The primary difference between options and futures is that options give the holder the right to buy or sell the underlying asset at expiration, while the holder of a futures contract is obligated to fulfill the terms of his contract. In real life, the actual delivery rate of the underlying goods specified in futures contracts is very low as the hedging or speculating benefits of the contracts can be had largely without actually holding the contract until expiry and delivering the good. For example, if you were long in a futures contract, you could go short in the same type of contract to offset your position. This serves to exit your position, much like selling a stock in the equity markets closes a trade.

Expansion

What does 'Expansion' mean Expansion is the phase of the business cycle when the economy moves from a trough to a peak. It is a period when the level of business activity surges and gross domestic product (GDP) expands until it reaches a peak. A period of expansion is also known as an economic recovery.

Variability

What is 'Variability' Variability is the extent to which data points in a statistical distribution or data set diverge from the average, or mean, value as well as the extent to which these data points differ from each other. There are four commonly used measures of variability: range, mean, variance and standard deviation. BREAKING DOWN 'Variability' The risk perception of an asset class is directly proportional to the variability of its returns. As a result, the risk premium that investors demand to invest in assets, such as stocks and commodities, is higher than the risk premium for assets such as Treasury bills, which have a much lower return variability. Variability refers to the difference being exhibited by data points within a dataset, as related to each other or as related to the mean. This can be expressed through the range, variance or standard deviation of a dataset. Largest and Smallest Value The range refers to the difference between the largest and smallest value assigned to the variable being examined. In statistical analysis, the range is represented by a single number. The variance is the square of the standard deviation based on a list of data points, while the standard deviation is representative of the spread existing between data points. Variance With Regards to the Mean The mean, or average, value of a dataset represents a midpoint of the values expressed within the data. This is separate from the median, which refers to the exact value of the data point that falls at the center of the data points should they be listed in ascending or descending order based on numerical value. While the median must be represented by the precise value of the midvalued data point, the mean may or may not be actually reflected as a figure within the dataset. While the range only focuses on the most extreme data points, the variance considers the placement of each data point and is used as a source of information regarding overall data distribution. Variability in Investing Variability is used to standardize the returns obtained on an investment and provides a point of comparison for additional analysis. One measure of reward-to-variability is the Sharpe ratio, which measures the excess return or risk premium per unit of risk for an asset. In essence, the Sharpe ratio provides a metric to compare the amount of compensation an investor receives with regard to the overall risk being assumed by holding said investment. The excess return is based on the amount of return experienced beyond investments that are considered free of risk. All else being equal, the asset with the higher Sharpe ratio delivers more return for the same amount of risk.

Credit Spread

What is a 'Credit Spread' A credit spread is the difference in yield between a U.S. Treasury bond and a debt security with the same maturity but of lesser quality. A credit spread can also refer to an options strategy where a high premium option is sold and a low premium option is bought on the same underlying security. Credit spreads between U.S. Treasuries and other bond issuances are measured in basis points, with a 1% difference in yield equal to a spread of 100 basis points. BREAKING DOWN 'Credit Spread' To illustrate, if a 10-year Treasury note has a yield of 2.54% while a 10-year corporate bond has a yield of 4.60%, then the corporate bond offers a spread of 206 basis points over the Treasury note. Credit spreads vary from one security to another based on the credit rating of the issuer of the bond. Debt issued by the United States Treasury is used as the benchmark in the financial industry due to its risk-free status, being backed by the full faith and credit of the U.S. government. As the default risk of the issuer increases, its spread widens. Credit spreads also fluctuate due to changes in expected inflation and changes in the supply of credit and demand for investment within particular markets. For instance, in an economic atmosphere of uncertainty, investors tend to favor safer U.S. Treasury markets, causing Treasury prices to rise and current yields to drop, thereby widening the credit spreads of other issuances of debt.

Line Of Credit

What is a 'Line Of Credit - LOC' A line of credit, abbreviated as LOC, is an arrangement between a financial institution, usually a bank, and a customer that establishes a maximum loan balance that the lender permits the borrower to access or maintain. The borrower can access funds from the line of credit at any time, as long as he does not exceed the maximum amount set in the agreement and as long as he meets any other requirements set by the financial institution, such as making timely minimum payments. BREAKING DOWN 'Line Of Credit - LOC' The main advantage of a line of credit is its built-in flexibility. Borrowers can request a certain amount, but they do not have to use it all. Rather, borrowers can tailor what they spend to their needs, and they only have to pay interest on the amount they spend, not on the entire credit line. In addition, consumers can also adjust their repayment amounts as needed, based on their budget or cash flow. For example, borrowers can repay the entire outstanding balance at once, or they can opt to just make the minimum monthly payments. Revolving Accounts A line of credit is a type of revolving account. This means that the borrower can spend the money, repay it and spend it again, in a virtually never-ending, revolving cycle. Revolving accounts such as lines of credit and credit cards exist in contrast to installment loans such as mortgages, car loans and signature loans. With installment loans, consumers borrow a set amount of money, and they repay it in equal monthly installments until the loan is paid off. Once an installment loan has been paid off, the consumer cannot spend the funds again unless he applies for a new loan. Unsecured LOCs Versus Secured LOCs In most cases, lines of credit are unsecured loans. This means that there is no collateral backing them. However, there is one notable exception, which is a home equity lines of credit (HELOC). This line of credit is secured by the equity in the borrower's home, but it works exactly like any other line of credit.

Probability Distribution

What is a 'Probability Distribution' A probability distribution is a statistical function that describes all the possible values and likelihoods that a random variable can take within a given range. This range will be between the minimum and maximum statistically possible values, but where the possible value is likely to be plotted on the probability distribution depends on a number of factors. These factors include the distribution's mean, standard deviation, skewness and kurtosis. BREAKING DOWN 'Probability Distribution' Academics and fund managers alike may determine a particular stock's probability distribution to determine the possible returns that the stock may yield in the future. The stock's history of returns, which can be measured on any time interval, will likely be comprised of only a fraction of the stock's returns, which will subject the analysis to sampling error. By increasing the sample size, this error can be dramatically reduced. Types of Probability Distributions There are many different classifications of probability distributions. Some of them include the normal distribution, chi square distribution, binomial distribution, and Poisson distribution. The different probability distributions serve different purposes. The binomial distribution, for example, evaluates the probability of an event occurring several times over a given number of trials and given the event's probability in each trial. The usual example would use a fair coin and figuring the probability of that coin coming up heads in ten straight flips. The most commonly used distribution is the normal distribution and it is used frequently in finance, investing, science, and engineering. The normal distribution is fully characterized by its mean and standard deviation, meaning the distribution is not skewed and does exhibit kurtosis. This makes the distribution symmetric and it is depicted as a bell-shaped curve when plotted. Probability Distributions Used in Investing Stock returns are often assumed to be normally distributed but in reality, they exhibit kurtosis with large negative and positive returns seeming to occur more than would be predicted by a normal distribution. This shows up on a plot of stock returns with the tails of the distribution having greater thickness. Probability distributions are often used in risk management as well to evaluate the probability and amount of losses that an investment portfolio would incur based on a distribution of historical returns. One popular risk management metric used in investing is value-at-risk (VaR). VaR yields the minimum loss that can occur given a probability and timeframe for a portfolio. Alternatively, an investor can get a probability of loss for an amount of loss and time frame using VaR. Misuse and over-reliance on VaR has been implicated as one of the major causes of the Financial Crisis.

Investment Grade

What is an 'Investment Grade' An investment grade is a rating that indicates that a municipal or corporate bond has a relatively low risk of default. Bond rating firms, such as Standard & Poor's and Moody's, use different designations consisting of upper- and lower-case letters 'A' and 'B' to identify a bond's credit quality rating. 'AAA' and 'AA' (high credit quality) and 'A' and 'BBB' (medium credit quality) are considered investment grade. Credit ratings for bonds below these designations ('BB', 'B', 'CCC', etc.) are considered low credit quality, and are commonly referred to as "junk bonds". BREAKING DOWN 'Investment Grade' Credit ratings are important because they communicate the risk associated with buying a certain bond. An investment grade credit rating indicates a low risk of a credit default, making it an attractive investment vehicle. Investors should note that government bonds, or Treasuries, are not subject to credit quality ratings, and these securities are considered to be of the very highest credit quality. In the case of municipal and corporate bond funds, the fund company literature, such as the fund prospectus and independent investment research reports, will report an "average credit quality" for the fund's portfolio as a whole. Credit Rating Details Investment grade issuer credit ratings are those that are above BBB- or Baa. The exact ratings depend on the credit rating agency. For Standard & Poor's, investment grade credit ratings include. AAA, AA+, AA, and AA-. Companies that have credit ratings in this category have a very high capacity to repay their loans, with AAA rated companies having the highest capacity to repay. The next category down includes companies with A+, A, and A- ratings, these are companies that have a strong capacity to repay. These companies are currently stable and easily able to repay their debts, but could face challenges if economic conditions deteriorate. The bottom tier of investment grade credit ratings include BBB+, BBB, and BBB-. These companies are vulnerable to changing economic conditions and could face big challenges if economic conditions decline. When rated, however, these companies have demonstrated both the capacity and capability to meet their debt payment obligations

Zero Sum Game

Zero-sum is a situation in game theory in which one person's gain is equivalent to another's loss, so the net change in wealth or benefit is zero. A zero-sum game may have as few as two players, or millions of participants. Zero-sum games are found in game theory, but are less common than non-zero sum games. Poker and gambling are popular examples of zero-sum games since the sum of the amounts won by some players equals the combined losses of the others. Games like chess and tennis, where there is one winner and one loser, are also zero-sum games. In the financial markets, options and futures are examples of zero-sum games, excluding transaction costs. For every person who gains on a contract, there is a counter-party who loses.

Hurdle Rate

A hurdle rate is the minimum rate of return on a project or investment required by a manager or investor. The hurdle rate denotes appropriate compensation for the level of risk present; riskier projects generally have higher hurdle rates than those that are deemed to be less risky.

Profit and Loss Statement (P&L)

A profit and loss statement (P&L) is a financial statement that summarizes the revenues, costs and expenses incurred during a specific period of time, usually a fiscal quarter or year.

Convertible Arbitrage

DEFINITION of 'Convertible Arbitrage' A trading strategy that typically involves taking a long strategy in a convertible security and a short position in the underlying common stock, in order to capitalize on pricing inefficiencies between the convertible and the stock. Convertible arbitrage is a long-short strategy that is favored by hedge funds and big traders.

Risk/Reward Ratio

Many investors use a risk/reward ratio to compare the expected returns of an investment to the amount of risk undertaken to capture these returns. This ratio is calculated mathematically by dividing the amount the trader stands to lose if the price moves in the unexpected direction (the risk) by the amount of profit the trader expects to have made when the position is closed (the reward). BREAKING DOWN 'Risk/Reward Ratio' The risk/reward ratio is most often used as a measure for trading individual stocks. The optimal risk/reward ratio differs widely among trading strategies. Some trial and error is usually required to determine which ratio is best for a given trading strategy, and many investors have a specified risk/reward ratio for their investments. In many cases, market strategists find the ideal risk/reward ratio for their investments to be 1:3. Investors can manage risk/reward more directly through the use of stop-loss orders and derivatives. Investing With a Risk/Reward Focus Investors often use stop-loss orders when trading individual stocks to help minimize losses and directly manage their investments with a risk/reward focus. A stop-loss order is a trading trigger placed on a stock that automates the selling of the stock from a portfolio if the stock reaches a specified low. Investors can automatically set stop-loss orders through brokerage accounts and typically do not require exorbitant additional trading costs. Consider this example. A trader purchases 100 shares of XYZ Company at $20 and places a stop-loss order at $15 to ensure that losses will not exceed $500. Also assume that this trader believes that the price of XYZ will reach $30 in the next few months. In this case, the trader is willing to risk $5 per share to make an expected return of $10 per share after closing the position. Since the trader stands to make double the amount that she has risked, she would be said to have a 1:2 risk/reward ratio on that particular trade. Using the Risk/Reward Ratio to Your Advantage Investing with a risk/reward focus for individual stocks using stop-loss orders can significantly help investors to manage the overall risk on their investments. Stop-loss orders allow investors to place a sell trigger on their investments at essentially only the trading cost of the block trade. With this trading mechanism in place, investors can manipulate risk/reward ratios to their benefit by setting a specified risk/reward ratio of their choosing per investment. For example, if a conservative investor seeks a 1:5 risk/reward ratio for a specified investment, then he can use the stop-loss order to adjust the risk/reward ratio to his investing specification. In this case, in the trading example noted above, if an investor has a 1:5 risk/reward ratio required for his investment, he would set the stop-loss order at $18.

Dow Theory: Three Trend Market

Primary Trend In Dow theory, the primary trend is the major trend of the market, which makes it the most important one to determine. This is because the overriding trend is the one that affects the movements in stock prices. The primary trend will also impact the secondary and minor trends within the market. Secondary, or Intermediate, Trend In Dow theory, a primary trend is the main direction in which the market is moving. Conversely, a secondary trend moves in the opposite direction of the primary trend, or as a correction to the primary trend. Minor Trend The last of the three trend types in Dow theory is the minor trend, which is defined as a market movement lasting less than three weeks. The minor trend is generally the corrective moves within a secondary move, or those moves that go against the direction of the secondary trend.

Private Equity

Private equity is a source of investment capital from high net worth individuals and institutions for the purpose of investing and acquiring equity ownership in companies. Partners at private-equity firms raise funds and manage these monies to yield favorable returns for their shareholder clients, typically with an investment horizon between four and seven years. These funds can be used in purchasing shares of private companies, or in public companies that eventually become delisted from public stock exchanges under go-private deals. The minimum amount of capital required for investors can vary depending on the firm and fund raised. Some funds have a $250,000 minimum investment requirement; others can require millions of dollars.

STAR METHOD

Situation: Describe the situation that you were in or the task that you needed to accomplish. You must describe a specific event or situation, not a generalized description of what you have done in the past. Be sure to give enough detail for the interviewer to understand. This situation can be from a previous job, from a volunteer experience, or any relevant event. Task: What goal were you working toward? Action: Describe the actions you took to address the situation with an appropriate amount of detail and keep the focus on YOU. What specific steps did you take and what was your particular contribution? Be careful that you don't describe what the team or group did when talking about a project, but what you actually did. Use the word "I," not "we" when describing actions. Result: Describe the outcome of your actions and don't be shy about taking credit for your behavior. What happened? How did the event end? What did you accomplish? What did you learn? Make sure your answer contains multiple positive results.

EMH

The efficient market hypothesis (EMH) is an investment theory that states it is impossible to "beat the market" because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. According to the EMH, stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. As such, it should be impossible to outperform the overall market through expert stock selection or market timing, and the only way an investor can possibly obtain higher returns is by purchasing riskier investments.

Par Value

The face value of a bond. Par value for a share refers to the stock value stated in the corporate charter. Par value is important for a bond or fixed-income instrument because it determines its maturity value as well as the dollar value of coupon payments. Par value for a bond is typically $1,000 or $100. Shares usually have no par value or very low par value, such as 1 cent per share. The market price of a bond may be above or below par, depending on factors such as the level of interest rates and the bond's credit status. In the case of equity, par value has very little relation to the shares' market price. BREAKING DOWN 'Par Value' For example, a bond with par value of $1,000 and a coupon rate of 4% will have annual coupon payments of $40. A bond with par value of $100 and a coupon rate of 4% will have annual coupon payments of $4. One of the main factors that causes bonds to trade above or below par value is the level of interest rates in the economy, as compared to the bonds' coupon rates. A bond with a 4% coupon will trade below par if interest rates are at 5%. This is because in such a scenario, investors have a choice of buying similar-rated bonds that have a 5% coupon. The price of a lower-coupon bond therefore must decline to offer the same 5% yield to investors. Likewise, a bond with a 4% coupon will trade above par if interest rates are at 3%. A bond that is trading above par is said to be trading at a premium, while a bond trading below par is regarded as trading at a discount. During periods when interest rates are low or have been trending lower, a larger proportion of bonds will trade above par or at a premium. When interest rates are high, a larger proportion of bonds will trade at a discount.

Golden Cross

The golden cross is a bullish breakout pattern formed from a crossover involving a security's short-term moving average (such as the 15-day moving average) breaking above its long-term moving average (such as 50-day moving average) or resistance level. As long-term indicators carry more weight, the golden cross indicates a bull market on the horizon and is reinforced by high trading volumes. BREAKING DOWN 'Golden Cross' There are three stages to a golden cross. The first stage requires that a downtrend eventually bottoms out as selling is depleted. In the second stage, the shorter moving average forms a crossover up through the larger moving average to trigger a breakout and confirmation of trend reversal. The last stage is the continuing uptrend for the follow through to higher prices. The moving averages act as support levels on pullbacks, until they crossover back down at which point a death cross may form. The death cross is the opposite of the golden cross as the shorter moving average forms a crossover down through the longer moving average. Applications of the Golden Cross The most commonly used moving averages are the 50-period and the 200-period moving average. The period represents a specific time increment. Generally, larger time periods tend to form stronger lasting breakouts. For example, the daily 50-day moving average crossover up through the 200-day moving average on an index like the S&P 500 is one of the most popular bullish market signals. With a bell weather index, the motto "A rising tide lifts all boats" applies when a golden cross forms as the buying resonates throughout the index components and sectors. Day traders commonly use smaller time periods like the 5-period and 15-period moving averages to trade intra-day golden cross breakouts. The time interval of the charts can also be adjusted from 1 minute to weeks or months. Just as larger periods make for stronger signals, the same applies for chart time periods as well. The larger the chart time frame, the stronger and lasting the golden cross breakout tends to be. For example, a monthly 50-period and 200-period moving average golden cross is significantly stronger and longer lasting than the same 50.200- period moving average crossover on a 15-minute chart. Golden cross breakout signals can be utilized with various momentum oscillators like stochastic, moving average convergence divergence (MACD) and relative strength index (RSI) to track when the uptrend is overbought and oversold. This helps to spot ideal entries and exits.

Two and Twenty

Two and twenty is a type of compensation structure that hedge fund managers typically employ in which part of compensation is performance-based. This phrase refers to how hedge fund managers charge a flat 2% of total asset value as a management fee and an additional 20% of any profits earned.

Working Capital

Working capital is a measure of both a company's efficiency and its short-term financial health. Working capital is calculated as: Working Capital = Current Assets - Current Liabilities The working capital ratio (Current Assets/Current Liabilities) indicates whether a company has enough short term assets to cover its short term debt. Anything below 1 indicates negative W/C (working capital). While anything over 2 means that the company is not investing excess assets. Most believe that a ratio between 1.2 and 2.0 is sufficient. Also known as "net working capital".