Finance Terms

Preferred Stock

A class of ownership in a corporation that has a higher claim on the assets and earnings than common stock. Preferred stock generally has a dividend that must be paid out before dividends to common stockholders and the shares usually do not have voting rights. The precise details as to the structure of preferred stock is specific to each corporation. However, the best way to think of preferred stock is as a financial instrument that has characteristics of both debt (fixed dividends) and equity (potential appreciation). Also known as "preferred shares".

Tier 1 Capital Ratio

A comparison between a banking firm's core equity capital and total risk-weighted assets. A firm's core equity capital is known as its Tier 1 capital and is the measure of a bank's financial strength based on the sum of its equity capital and disclosed reserves, and sometimes non-redeemable, non-cumulative preferred stock. A firm's risk-weighted assets include all assets that the firm holds that are systematically weighted for credit risk. Central banks typically develop the weighting scale for different asset classes, such as cash and coins, which have zero risk, versus a letter or credit, which carries more risk.

Municipal Bond "Muni"

A debt security issued by a state, municipality or county to finance its capital expenditures. Municipal bonds are exempt from federal taxes and from most state and local taxes, especially if you live in the state in which the bond is issued.

Options

A financial derivative that represents a contract sold by one party (option writer) to another party (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). Call options give the option to buy at certain price, so the buyer would want the stock to go up. Put options give the option to sell at a certain price, so the buyer would want the stock to go down.

Bear Market

A market condition in which the prices of securities are falling, and widespread pessimism causes the negative sentiment to be self-sustaining. As investors anticipate losses in a _______ and selling continues, pessimism only grows. Although figures can vary, for many, a downturn of 20\% or more in multiple broad market indexes, such as the Dow Jones Industrial Average (DJIA) or Standard & Poor's 500 Index (S&P 500), over at least a two-month period, is considered an entry into a ________.

T-Bonds

A marketable, fixed-interest U.S. government debt security with a maturity of more than 10 years. ____ _______ make interest payments semi-annually and the income that holders receive is only taxed at the federal level.

Alpha

A measure of performance on a risk-adjusted basis. Alpha takes the volatility (price risk) of a mutual fund and compares its risk-adjusted performance to a benchmark index. The excess return of the fund relative to the return of the benchmark index is a fund's alpha.

CPI

A measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. The CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them; the goods are weighted according to their importance. Changes in CPI are used to assess price changes associated with the cost of living. Sometimes referred to as "headline inflation."

Exchange-Traded Fund (ETF)

A security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange. _____ experience price changes throughout the day as they are bought and sold. Because it trades like a stock, an ______ does not have its net asset value (NAV) calculated every day like a mutual fund does. By owning an _____, you get the diversification of an index fund as well as the ability to sell short, buy on margin and purchase as little as one share. Another advantage is that the expense ratios for most _____s are lower than those of the average mutual fund. When buying and selling ______s, you have to pay the same commission to your broker that you'd pay on any regular order. One of the most widely known ______s is called the Spider (SPDR), which tracks the S&P 500 index and trades under the symbol SPY.

Derivative

A security whose price is dependent upon or derived from one or more underlying assets. The _______ itself is merely a contract between two or more parties. 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. Most ________ are characterized by high leverage.

Defensive Stock

A stock that provides a constant dividend and stable earnings regardless of the state of the overall stock market. However, during an expansion phase it performs below the market. Betas of defensive stocks are less than one. Also known as a "non-cyclical stock" because it is not highly correlated with the business cycle.

130-30 Strategy

A strategy that uses financial leverage by shorting poor performing stocks and purchasing shares that are expected to have high returns. A 130-30 ratio implies shorting stocks up to 30% of the portfolio value and then using the funds to take a long position in the stocks the investor feels will outperform the market. Often, investors will mimic an index such as the S&P 500 when choosing stocks for this strategy.

Fixed Income

A type of investing or budgeting style for which real return rates or periodic income is received at regular intervals at reasonably predictable levels. Fixed-income budgeters and investors are often one and the same - typically retired individuals who rely on their investments to provide a regular, stable income stream. This demographic tends to invest heavily in fixed-income investments because of the reliable returns they offer. The most common type of fixed-income security is the bond; bonds are issued by federal governments, local municipalities or major corporations.

Long/Short Equity

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.

Mutual Fund

An investment vehicle that is 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. __________ 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 __________'s portfolio is structured and maintained to match the investment objectives stated in its prospectus. One of the main advantages of __________ is that they give small investors access to professionally managed, diversified portfolios of equities, bonds and other securities, which would be quite difficult (if not impossible) to create with a small amount of capital.

Stop Order

An order to buy or sell a security when its price surpasses a particular point, thus ensuring a greater probability of achieving a predetermined entry or exit price, limiting the investor's loss (on shorted securities) or locking in his or her profit (on . Once the price surpasses the predefined entry/exit point, the stop order becomes a market order. Also referred to as a "stop" and/or "stop-loss order."

Hedge

Making an investment to reduce the risk of adverse price movements in an asset. Normally, a hedge consists of taking an offsetting position in a related security, such as a futures contract.

Liquidity

The degree to which an asset or security can be bought or sold in the market without affecting the asset's price. ____ is characterized by a high level of trading activity. Assets that can be easily bought or sold are known as ____ assets. It is safer to invest in ____ assets than illiquid ones because it is easier for an investor to get his/her money out of the investment. Examples of assets that are easily converted into cash include blue chip and money market securities.

Short Selling

The sale of a security that is not owned by the seller, or that the seller has borrowed. ______ ______ is motivated by the belief that a security's price will decline, enabling it to be bought back at a lower price to make a profit. ______ ______ may be prompted by speculation, or by the desire to hedge the downside risk of a long position in the same security or a related one. Since the risk of loss on a short sale is theoretically infinite, ______ ______ should only be used by experienced traders who are familiar with its risks.

Leverage

The use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment.

Equity

The value of an asset after all debt and liabilities have been paid.

Parity Bond

Two or more bond issues with equal rights to one another. In other words, a parity bond is an issued bond with equal rights to a claim as other bonds already issued. For example, unsecured bonds have equal rights in that coupons can be claimed without any one bond having priority over another. Therefore, unsecured bonds would be referred to as parity bonds.