CAIA Level 1 Glossary

management company operating agreement

A management company operating agreement is an agreement between members related to a limited liability company and the conduct of its business as it pertains to the law.

28 2.1.3 partnership agreement

A partnership agreement is a formal written contract creating a partnership.

23 2.1.1 plan sponsor

A plan sponsor is a designated party, such as a company or an employer, that establishes a health care or retirement plan (pension) that has special legal or taxation status, such as a 401(k) retirement plan in the United States for employees.

30 2.2 primary market

A primary market refers to the methods, institutions, and mechanisms involved in the placement of new securities to investors.

30 2.2 secondary market

A secondary market facilitates trading among investors of previously existing securities.

33 2.3.2 soft dollar arrangement

A soft dollar arrangement generally refers to an agreement or an understanding by which an investment adviser receives research services from a broker-dealer in exchange for a fee (such as a commission) paid out of the fund or client account.

28 2.1.3 subscription agreement

A subscription agreement is an application submitted by an investor who desires to join a limited partnership.

absolute return products

Absolute return products are investment products viewed as having little or no return correlation with traditional assets, and have investment performance that is often analyzed on an absolute basis rather than relative to the performance of traditional investments.

57 3.4.3 aggregation of IRRs

Aggregation of IRRs refers to the relationship between the IRRs of individual investments and the IRR of the combined cash flows of the investments.

endowment

An endowment is a fund bestowed on an individual or institution (e.g., a museum, university, hospital, or foundation) to be used by that entity for specific purposes and with principal preservation in mind.

investment bank

An investment bank focuses on providing sophisticated investment services, including underwriting and raising capital, as well as other activities such as brokerage services, mergers, and acquisitions.

61 3.5.1 carried interest

Carried interest is synonymous with an incentive fee or a performance-based fee and is the portion of the profit paid to the GPs as compensation for their services, above and beyond management fees.

closed-end mutual fund

Closed-end mutual fund structures provide investors with relatively liquid access to the returns of underlying assets even when the underlying assets are illiquid.

34 2.3.2 Regulation T margin rule

Federal Reserve Board leverage rules include the Regulation T margin rule, which currently requires a deposit of at least 50% of the purchase cost or short sale proceeds of a trade (margin).

financial data providers

Financial data providers supply funds primarily with raw financial market data, including security prices, trading information, and indices.

financial platforms

Financial platforms are systems that provide access to financial markets, portfolio management systems, accounting and reporting systems, and risk management systems.

financial software

Financial software may consist of prepackaged software programs and computer languages tailored to the needs of financial organizations. Some funds use open-source software, and others pay licensing fees for proprietary software.

fourth markets

Fourth markets are electronic exchanges that allow traders to quickly buy and sell exchange-listed stocks via the electronic communications systems offered by these markets.

front office operations

Front office operations involve investment decision-making and, in the case of brokerage firms, contact with clients.

30 2.1.3 universal banking

Germany uses universal banking, which means that German banks can engage in both commercial and investment banking.

hedge fund replication

Hedge fund replication is the attempt to mimic the returns of an illiquid or highly sophisticated hedge fund strategy using liquid assets and simplified trading rules.

return enhancer

If the primary objective of including an investment product in a portfolio is the superior average returns that it is believed to offer, then that product is often referred to as a return enhancer.

return diversifier

If the primary objective of including the product is the reduction in the portfolio's risk that it is believed to offer through its lack of correlation with the portfolio's other assets, then that product is often referred to as...

large dealer banks

Large dealer banks are major financial institutions, such as Goldman Sachs, Deutsche Bank, and the Barclays Group, that deal in securities and derivatives.

liquid alternatives

Liquid alternatives are investment vehicles that offer alternative strategies in a form that provides investors with liquidity through opportunities to sell their positions in a market.

market making

Market making is a practice whereby an investment bank or another market participant deals securities by regularly offering to buy securities and sell securities.

market orders

Market participants that wish to have transactions executed without delay may place market orders, which cause immediate execution at the best available price.

master limited partnerships (MLPs)

Master limited partnerships (MLPs) are publicly traded investment pools that are structured as limited partnerships and that offer their owners pro rata claims.

27 2.1.2 middle office operations

Middle office operations form the interface between the front office and the back office, with a focus on risk management.

25 2.1.1 mutual funds

Mutual funds, or '40 Act funds, are registered investment pools offering their shareholders pro rata claims on the fund's portfolio of assets.

market takers

Participants that place market orders are market takers, which buy at ask prices and sell at bid prices, generally paying the bid-ask spread for taking liquidity.

24 2.1.1 private limited partnerships

Private limited partnerships are a form of business organization that potentially offers the benefit of limited liability to the organization's limited partners (similar to that enjoyed by shareholders of corporations) but not to its general partner.

28 2.1.3 private-placement memoranda

Private-placement memoranda (a.k.a. offering documents) are formal descriptions of an investment opportunity that comply with federal securities regulations.

41 2.5.1 progressive taxation

Progressive taxation places higher-percentage taxation on individuals and corporations with higher incomes.

26 2.1.2 proprietary trading

Proprietary trading occurs when a firm trades securities with its own money in order to make a profit.

34 2.3.3 Undertakings for Collective Investment in Transferable Securities (UCITS)

Regulation of hedge funds in Europe centers on the concept of Undertakings for Collective Investment in Transferable Securities (UCITS). UCITS are carefully regulated European fund vehicles that allow retail access and marketing of hedgefund-like investment pools.

42 2.5.1 Section 1256 contracts

Section 1256 contracts include many futures and options contracts; have potentially enormous tax advantages in the United States. including having their income treated as 60% long-term capital gain and 40% short-term capital gain regardless of holding period.

31 2.2.1 securitization

Securitization involves bundling assets, especially unlisted assets, and issuing claims on the bundled assets.

25 2.1.2 sell side

Sell-side institutions, such as large dealer banks, act as agents for investors when they trade securities.

25 2.1.1 separately managed accounts

Separately managed accounts (SMAs) are individual investment accounts offered by a brokerage firm and managed by independent investment management firms.

24 2.1.1 sovereign wealth funds

Sovereign wealth funds are state-owned investment funds held by that state's central bank for the purpose of future generations and/or to stabilize the state currency.

32 2.3 systemic risk

Systemic risk is the potential for economy-wide losses attributable to failures or concerns over potential failures in financial markets, financial institutions, or major participants.

Markets in Financial Instruments Directive (MiFID)

The Markets in Financial Instruments Directive (MiFID) is an EU law that establishes uniform regulation for investment managers in the European Economic Area (the EU plus Iceland, Norway, and Liechtenstein).

fund administrator

The fund administrator maintains a general ledger account, marks the fund's books, maintains its records, carries out monthly accounting, supplies its monthly profit and loss (P&L) statements, calculates its returns, verifies asset existence, independently calculates fees, and provides an unbiased, third-party resource for price confirmation on security positions.

bid-ask spread

The price difference between the highest bid price (the best bid price) and the lowest offer (the best ask price)

27 2.1.3 prime broker

The prime broker has the following primary functions: clearing and financing trades for its client, providing research, arranging financing, and producing portfolio accounting.

private equity

The term used in the CAIA curriculum to include both equity and debt positions that, among other things, are not publicly traded.

infrastructure investments

are claims on the income of toll roads, regulated utilities, ports, airports, and other real assets that are traditionally held and controlled by the public sector (i.e., various levels of government).

commodities

are homogeneous goods available in large quantities, such as energy products, agricultural products, metals, and building materials.

alternative investments

are sometimes viewed as including any investment that is not simply a long position in traditional investments.

hedge fund

as a privately organized investment vehicle that uses its less regulated nature to generate investment opportunities that are substantially distinct from those offered by traditional investment vehicles, which are subject to regulations such as those restricting their use of derivatives and leverage.

lumpy assets

assets that can be bought and sold only in specific quantities, such as a large real estate project.

farmland

consists of land cultivated for row crops (e.g., vegetables and grains) and permanent crops (e.g., orchards and vineyards).

mezzanine debt

derives its name from its position in the capital structure of a firm: between the ceilings of senior secured debt and the floor of equity.

real estate

focuses on land and improvements that are permanently affixed, like buildings.

traditional investments

include publicly traded equities, fixed-income securities, and cash.

operationally focused real assets

include real estate, land, infrastructure, and intellectual property.

timberland

includes both the land and the timber of forests of tree species typically used in the forest products industry.

structured products

instruments created to exhibit particular return, risk, taxation, or other attributes.

real assets

investments in which the underlying assets involve direct ownership of nonfinancial assets rather than ownership through financial assets, such as the securities of manufacturing or service enterprises.

benchmark

is a performance standard for a portfolio that reflects the preferences of an investor with regard to risk and return.

diversifier

is an investment with a primary purpose of contributing diversification benefits to its owner.

financial asset

is not a real asset—it is a claim on cash flows, such as a share of stock or a bond.

investment

is that it is deferred consumption. Any net outlay of cash made with the prospect of receiving future benefits might be considered an investment.

active risk

is that risk that causes a portfolio's return to deviate from the return of a benchmark due to active management.

pure arbitrage

is the attempt to earn risk-free profits through the simultaneous purchase and sale of identical positions trading at different prices in different markets.

active return

is the difference between the return of a portfolio and its benchmark that is due to active management.

benchmark return

is the return of the benchmark index or benchmark portfolio.

institutional-quality investment

is the type of investment that financial institutions such as pension funds or endowments might include in their holdings because they are expected to deliver reasonable returns at an acceptable level of risk.

relative return standard

means that returns are to be evaluated relative to a benchmark.

illiquidity

means that the investment trades infrequently or with low volume (i.e., thinly).

back office operations

play a supportive role in the maintenance of accounts and information systems used to transmit important market and trader information in all trading transactions, as well as in the clearance and settlement of the trades.

incomplete markets

refer to markets with insufficient distinct investment opportunities.

information asymmetries

refer to the extent to which market participants possess different data and knowledge.

active management

refers to efforts of buying and selling securities in pursuit of superior combinations of risk and return.

distressed debt

refers to the debt of companies that have filed or are likely to file in the near future for bankruptcy protection.

inefficiency

refers to the deviation of actual prices from valuations that would be anticipated in an efficient market.

institutional structure

refers to the financial markets and financial institutions related to a particular investment, such as whether the investment is publicly traded.

buy side

refers to the institutions and entities that buy large quantities of securities for the portfolios they manage.

trading structure

refers to the role of an investment vehicle's investment managers in developing and implementing trading strategies.

regulatory structure

refers to the role of government, including both regulation and taxation, in influencing the nature of an investment.

securities structure

refers to the structuring of cash flows through leverage and securitization.

efficiency

refers to the tendency of market prices to reflect all available information.

compensation structure

refers to the ways that organizational issues, especially compensation schemes, influence particular investments.

40 Act funds

registered investment pools offering their shareholders pro rata claims on the fund's portfolio of assets. Mutual Funds

absolute return standard

returns are to be evaluated relative to zero, a fixed rate, or relative to the riskless rate, and therefore independently of performance in equity markets, debt markets, or any other markets.

moral hazard

risk that the behavior of one or more parties will change after entering into a contract.

passive investing

tends to focus on buying and holding securities in an effort to match the risk and return of a target, such as a highly diversified index.

land

variety of forms, including undeveloped land, timberland, and farmland.

54 3.4.1 borrowing type cash flow pattern

A borrowing type cash flow pattern begins with one or more cash inflows and is followed only by cash outflows.

61 3.5.1 catch-up rate

A catch-up provision contains a catch-up rate, which is the percentage of the profits used to catch up the incentive fee once the hurdle is met.

61 3.5.1 catch-up provision

A catch-up provision permits the fund manager to receive a large share of profits once the hurdle rate of return has been achieved and passed.

commercial bank

A commercial bank focuses on the business of accepting deposits and making loans, with modest investment-related services.

dark pool

A dark pool refers to non-exchange trading by large market participants that is hidden from the view of most market participants.

family office

A family office is a group of investors joined by familial or other ties who manage their personal investments as a single entity, usually hiring professionals to manage money for members of the office.

foundation

A foundation is a not-for-profit organization that donates funds and support to other organizations for its own charitable purposes.

custodians

Depositories and custodians are very similar entities that are responsible for holding their clients' cash and securities and settling clients' trades, both of which maintain the integrity of clients' assets while ensuring that trades are settled quickly.

depositories

Depositories and custodians are very similar entities that are responsible for holding their clients' cash and securities and settling clients' trades, both of which maintain the integrity of clients' assets while ensuring that trades are settled quickly.

Depository Trust Company (DTC)

The Depository Trust Company (DTC) is the principal holding body of securities for traders all over the world and is part of the Depository Trust and Clearing Corporation (DTCC), which provides clearing, settlement, and information services.

31 2.2.3 third markets

Third markets are regional exchanges where stocks listed in primary secondary markets can also be traded. In the United States, third markets allow brokers and dealers to set up trades away from an exchange by listing their prices on the NASDAQ Intermarket.