Investments Tenth Edition

Tracking Portfolio

- the returns on such a portfolio track the evolution of particular sources of macroeconomic risk but are uncorrelated with other sources of risk.

Factor Portfolio

-A well-diversified portfolio constructed to have a beta of 1 on one of the factors and a beta of zero on any other factor

Homogeneous Expectations

-identical estimates of the probability distribution

Capital Market Segments

1) Longer Term Bond Markets, 2) Equity Markets, 3) Derivative Markets for Options, and 4) Derivative Markets for Futures.

Multifactor Model

1. determine risk profile of index: duration, key rate duration, PVD of cash flows, sector and quality weights, et

Blocks

A block refers to a large order of the same security to be bought or sold by institutional or other large investors. There is no official size designation constituting a block of securities, but a commonly used threshold is more than 10,000 equity shares, or a total market value of more than $200,000. Blocks of securities are traded in block trades, facilitating trades involving institutional investors or other large investors requiring such bulk trades to meet their needs.

Capital Market Line

A capital allocation line provided by the market index portfolio

Closed-End Fund

A closed-end fund is organized as a publicly traded investment company by the Securities and Exchange Commission (SEC). Like a mutual fund, a closed-end fund is a pooled investment fund with a manager overseeing the portfolio; it raises a fixed amount of capital through an initial public offering (IPO). The fund is then structured, listed and traded like a stock on a stock exchange.

Investment Company

A corporation or trust engaged in the business of investing the pooled capital of investors in financial securities. This is most often done either through a closed-end fund or an open-end fund (also referred to as a mutual fund). In the U.S., most investment companies are registered with and regulated by the Securities & Exchange Commission under the Investment Company Act of 1940.

Scatter Diagram

A correlation chart that uses a regression line to explain or to predict how the change in an independent variable will change a dependent variable.

Indifference Curve

A curve connecting all portfolios with the same utility according to their means and standard deviations.

Dealer Markets

A financial market mechanism wherein multiple dealers post prices at which they will buy or sell a specific security of instrument. In a dealer market, a dealer - who is designated as a "market maker" - provides liquidity and transparency by electronically displaying the prices at which it is willing to make a market in a security, indicating both the price at which it will buy the security (the "bid" price) and the price at which it will sell the security (the "offer" price). Bonds and foreign exchange trade primarily in dealer markets, while stock trading on the Nasdaq is a prime example of an equity dealer market.

Dividend Yield

A financial ratio that indicates how much a company pays out in dividends each year relative to its share price. Dividend yield is represented as a percentage and can be calculated by dividing the dollar value of dividends paid in a given year per share of stock held by the dollar value of one share of stock.

Regression Equation

A formula for a line that models a linear relationship between two quantitative variables.

NASDAQ Stock Market

A global electronic marketplace for buying and selling securities, as well as the benchmark index for U.S. technology stocks. Nasdaq was created by the National Association of Securities Dealers (NASD) to enable investors to trade securities on a computerized, speedy and transparent system, and commenced operations on February 8, 1971. The term "Nasdaq" is also used to refer to the Nasdaq Composite, an index of more than 3,000 stocks listed on the Nasdaq exchange that includes the world's foremost technology and biotech giants such as Apple, Google, Microsoft, Oracle, Amazon, Intel and Amgen.

Capital Allocation Line

A graph showing all feasible risk-return combinations of a risky and risk-free asset.

Limit Order

A limit order is a take-profit order placed with a bank or brokerage to buy or sell a set amount of a financial instrument at a specified price or better; because a limit order is not a market order, it may not be executed if the price set by the investor cannot be met during the period of time in which the order is left open. Limit orders also allow an investor to limit the length of time an order can be outstanding before being canceled.

Secondary Market

A market for reselling financial assets

Market Portfolio

A portfolio consisting of all stocks.

Well-Diversified Portfolio

A portfolio sufficiently diversified that nonsystematic risk is negligible.

Security Market Line (SML)

A positively sloped straight line displaying the relationship between expected return and beta

Agency Problem

A potential conflict of interest between outside shareholders (owners) and managers who make decisions about how to operate the firm.

Real Interest Rate

A real interest rate is an interest rate that has been adjusted to remove the effects of inflation to reflect the real cost of funds to the borrower and the real yield to the lender or to an investor. The real interest rate of an investment is calculated as the amount by which the nominal interest rate is higher than the inflation rate

Risk Averse

A risk averse investor will consider risky portfolios only if they provide compensation for risk via a risk premium.

Risk Premium

A risk premium is the return in excess of the risk-free rate of return an investment is expected to yield; an asset's risk premium is a form of compensation for investors who tolerate the extra risk, compared to that of a risk-free asset, in a given investment. For example, high-quality corporate bonds issued by established corporations earning large profits have very little risk of default. Therefore, such bonds pay a lower interest rate, or yield, than bonds issued by less-established companies with uncertain profitability and relatively higher default risk.

Short Sale

A short sale is a transaction in which an investor sells borrowed securities in anticipation of a price decline and is required to return an equal number of shares at some point in the future. A short seller makes money if the stock goes down in price, while a long position makes money when the stock goes up. In real estate, short sale means selling a house for less than the mortgage owed with the lender's approval.

Specialist

A specialist is a member of a stock exchange who acts as the market maker to facilitate the trading of a given stock. The specialist holds an inventory of the stock, posts the bid and ask prices, manages limit orders and executes trades. If there is a large shift in demand on the buy or sell side, the specialist steps in and sells off his own inventory as a way to manage large movements and to meet the demand until the gap between supply and demand narrows.

Stop Orders

A stop order is 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 or locking in his or her profit. Once the price surpasses the predefined entry/exit point, the stop order becomes a market order.

Certificate of Deposit

A time deposit within a bank. Time deposits may not be withdrawn on demand. The bank pays interest and principal to the depositor only at the the end of the fixed term of the CD.

Unit Investment Trust

A unit investment trust (UIT) is an investment company that offers a fixed portfolio, generally of stocks and bonds, as redeemable units to investors for a specific period of time. It is designed to provide capital appreciation and/or dividend income. Unit investment trusts, along with mutual funds and closed-end funds, are defined as investment companies.

Algorithmic Trading

Algorithmic trading is an investment strategy that utilizes an algorithm, or a procedure written in computer code for the purpose of processing data and identifying trends in the market.

Alpha

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.

Futures Contract

An agreement to buy or sell a specific commodity or currency at a set price on a set date in the future

Annual Percentage Rate (APR)

An annual percentage rate (APR) is the annual rate charged for borrowing or earned through an investment, and is expressed as a percentage that represents the actual yearly cost of funds over the term of a loan. This includes any fees or additional costs associated with the transaction but does not take compounding into account. As loans or credit agreements can vary in terms of interest-rate structure, transaction fees, late penalties and other factors, a standardized computation such as the APR provides borrowers with a bottom-line number they can easily compare to rates charged by other lenders.

Arbitrage Pricing Theory

An asset pricing theory that is derived from a factor model, using diversification and arbitrage arguments. The theory describes the relationship between expected returns on securities, given that there are no opportunities to create wealth through risk-free arbitrage investment.s

Risk-Free Asset

An asset with a certain rate of return, often taken to be short-term T bills

Auction Market

An auction market is a market in which buyers enter competitive bids, and sellers enter competitive offers at the same time. The price at which a stock is traded represents the highest price that a buyer is willing to pay and the lowest price that a seller is willing to sell. Matching bids and offers are then paired together, and the orders are executed. The New York Stock Exchange (NYSE) is an example of an auction market.

Price-Weighted Average

An average computed by adding the prices of the stocks and dividing by a "divisor."

Electronic Communication Networks (ECNs)

An electronic communication network (ECN) is an automated system that matches buy and sell orders for securities. It connects major brokerages and individual traders so they can trade directly between themselves without going through a middleman and make it possible for investors in different geographic locations to quickly and easily trade with each other. The U.S. Securities and Exchange Commission (SEC) requires ECNs to register as broker-dealers.

Market-Value-Weighted Index

An index of a group of securities computed by calculating a weighted average of the returns of each security in the index, with weights proportional to outstanding market value

Fair Game

An investment prospect that has a zero risk premium.

Asset Allocation

An investment strategy that aims to balance risk and reward by apportioning a portfolio's assets according to an individual's goals, risk tolerance and investment horizon.

Open-End Fund

An open-end fund is a type of mutual fund that does not have restrictions on the amount of shares the fund can issue. The majority of mutual funds are open-end, providing investors with a useful and convenient investing vehicle. When a fund's investment manager(s) determine that a fund's total assets have become too large to effectively execute its stated objective, the fund will be closed to new investors, and in extreme cases, will be closed to new investment by existing fund investors.

Banker's Acceptance

An order to a bank by a customer to pay a sum of money at a future date.

12b-1 Fees

Annual fees charged by a mutual fund to pay for marketing and distribution costs.

Real Assets

Assets used to produce goods and services, not financial

Risk-Return Trade-Off

Assets with higher expected returns entail greater risk.

Active Management

Attempts to achieve portfolio returns higher than commensurate with risk, whether by forecasting broad markets or by identifying mispriced securities

Liquidity

Availability of resources to meet short-term cash requirements.

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.

Systemic Risk

Breakdowns in an entire system, as opposed to breakdowns in individual parts or components

Investment Bankers

Brokers and agents who help investors negotiate a deal between investors and lenders for a fee based on the size and complexity of the deal.

Passive Management

Buying and holding a diversified portfolio without attempting to identify mispriced securities. Typically follows an index.

Treasury Notes

Certificates issued by the US Treasury in exchange for minimum amounts of $1,000 and maturing in 1 to 10 years

Equivalent Taxable Yield

Comparison of the taxable yield on a corporate or government bond and the tax-free yield on a municipal bond. Depending on the tax bracket, an investor's after-tax return may be greater with a municipal bond than with a corporate or government bond offering a higher interest rate.

Dark Pools

Dark pools are an ominous-sounding term for private exchanges or forums for trading securities; unlike stock exchanges, dark pools are not accessible by the investing public. Also known as "dark pools of liquidity," they are so named for their complete lack of transparency. Dark pools came about primarily to facilitate block trading by institutional investors, who did not wish to impact the markets with their large orders and consequently obtain adverse prices for their trades. While dark pools have been cast in a very unfavorable light in Michael Lewis' bestseller "Flash Boys: A Wall Street Revolt," the reality is that they do serve a purpose. However, their lack of transparency makes them vulnerable to potential conflicts of interest by their owners and predatory trading practices by some high-frequency traders. (See also "How IEX is Combating Predatory Types of High-Frequency Trades.")

Event Tree

Depicts all possible sequence of events.

Eurodollars

Dollar-denominated deposits at foreign banks or foreign branches of American banks

Separation Property

Every investor will hold the same portfolio of risky assets but they can combine it with risk free however they want.

Sortino Ratio

Excess return divided by lower partial standard deviation.

Excess Return

Excess returns are investment returns from a security or portfolio that exceed the riskless rate on a security generally perceived to be risk free, such as a certificate of deposit or a government-issued bond. Additionally, the concept of excess returns may also be applied to returns that exceed a particular benchmark or index with a similar level of risk.

Exchange-Traded Funds

Exchange-traded funds (ETFs) can be a valuable component for any investor's portfolio, from the most sophisticated institutional money managers to a novice investor who is just getting started. Some investors use ETFs as the sole focus of their portfolios, and are able to build a well-diversified portfolio with just a few ETFs. Others use ETFs to complement their existing portfolios, and rely on ETFs to implement sophisticated investment strategies. But, as with any other investment vehicle, in order to truly benefit from ETFs, investors have to understand and use them appropriately.

Conditional Tail Expectation (CTE)

Expectation of a random variable conditional on its falling below some threshold value. Often used as a measure of down side risk.

Equities

Financial rights to the assets of a business

Illiquidity

Illiquidity - state of an asset that cannot be sold or exchanged without a significant loss in value.

Expected Return-Beta (or mean-beta) relationship

Implication of the CAPM that security risk premiums (expected excess returns) will be proportional to beta.

Factor Loading

In factor analysis, the correlation of a particular measure with a particular factor

Over-The-Counter (OTC) Market

In the over-the-counter (OTC) market, of which the Nasdaq is a large part, the market makers are analogous to the specialists at the exchanges. The market maker creates the bid and ask prices for an OTC security. This person or firm generally maintains inventory and stands ready to buy and sell the security at the quoted price to maintain an orderly market. Just like a specialist on an exchange, the market maker can act as a principal or as an agent.

Capital Markets

Include Longer term and riskier securities. Much more diverse than money Market.

Money Market

Include short-term, marketable, liquid, low-risk debt securities. Sometimes called Cash Equivalents or Cash for short.

Underwriters

Investment firms that act as intermediaries between a company selling securities and the investing public

Security Analysis

Involves the valuation of particular securities that might be included in the portfolio

Commercial Paper

Large, well-known companies often issue their own short-term unsecured debt notes rather than borrow directly from banks. Very often, commercial paper is backed by a bank line of credit. Maturities range up to 270 days. Maturities typically less than 1 or 2 months. Issued in multiples of $100,000.

Input List

List of parameters such as expected returns, variances, and covariances necessary to determine the optimal risky portfolio.

Margin

Margin is the difference between a product or service's selling price and its cost of production or to the ratio between a company's revenues and expenses. It also refers to the amount of equity contributed by an investor as a percentage of the current market value of securities held in a margin account. Margin is the portion of the interest rate on an adjustable-rate mortgage added to the adjustment-index rate.

Value at Risk (VAR)

Measure of downside risk. The loss that will be incurred in the event of an extreme adverse price change with some given, typically low, probability.

Skew

Measure of the asymmetry of a probability distribution.

Kurtosis

Measures of the fatness of the tails of a probability distribution. Indicates probability of observing extreme high or low values.

Index Funds

Mutual funds that mirror the composition of a particular market or index

Funds of Funds

Mutual funds that primarily invest in shares of other mutual funds.

Net Asset Value (NAV)

Net asset value (NAV) is value per share of a mutual fund or an exchange-traded fund (ETF) on a specific date or time. With both security types, the per-share dollar amount of the fund is based on the total value of all the securities in its portfolio, any liabilities the fund has and the number of fund shares outstanding.

Nominal Interest Rate

Nominal interest rate refers to the interest rate before taking inflation into account. Nominal can also refer to the advertised or stated interest rate on a loan, without taking into account any fees or compounding of interest. Finally, the federal funds rate, the interest rate set by the Federal Reserve, can also be referred to as a nominal rate.

Security Characteristic Line

Plot of the excess return of the security on the excess return of the market

Information Ratio

Ratio of alpha to the standard deviation of diversifiable risk

Reward-To-Volatility Ratio

Ratio of excess return to portfolio standard deviation.

Market Price of Risk

Required rate of return on the market portfolio minus the risk free rate

Unique Risk

Risk attributable to firm-specific risk, or nonmarket risk.

Systematic Risk

Risk factors common to the whole economy, nondiversifiable risk, also called market risk.

Risk Neutral

Risk neutral investor finds the level of risk irrelevant and considers only the expected return of risk prospects.

Repurchase Agreements

Sale of a security with a simultaneous agreement by the seller to buy the same security back from the purchaser at an agreed-upon price and future dat

Derivative Assets

Securities providing payoffs that depend on or are contingent on the values of other assets such as commodity prices, bond and stock prices or market-index values. (ie: futures, options)

Derivative Securities

Securities whose value is derived from the value of other assets

Diversification

Spreading a portfolio over many investments to avoid excessive exposure to any one source of risk.

Lower Partial Standard Deviation (LPSD)

Standard deviation computed using only the portion of the probability distribution below the mean of the variable.

Mutual Fund Theorem

States that all investors desire the same portfolio of risky assets and can be satisfied by a single mutual fund composed of that portfolio

Preferred Stock

Stock that gives its owners preference in the payment of dividends and an earlier claim on assets than common stockholders if the company is forced out of business and its assets sold. No voting rights.

Ask Price

The Price you would have to pay to buy a T-Bill from a security dealer

Optimal Risky Portfolio

The best combination of risky assets to be mixed with safe assets to form the complete portfolio.

Certainty Equivalent Rate

The certain return providing the same utility as a risky portfolio.

Bid-Ask Spread

The difference between the bid and ask prices.

Effective Annual Rate (EAR)

The effective annual interest rate is the interest rate that is actually earned or paid on an investment, loan or other financial product due to the result of compounding over a given time period. It is also called the effective interest rate, the effective rate or the annual equivalent rate

Complete Portfolio

The entire portfolio, including risky and risk-free assets.

Expected Shortfall (ES)

The expected loss on a security conditional on returns being in the left tail of the probability distribution.

Portfolio Opportunity Set

The expected return-standard deviation pairs of all portfolios that can be constructed from a given set of assets.

Initial Public Offerings (IPOs)

The first time a corporation issues stock to the public

London Interbank Offered Rate (LIBOR)

The interest rate at which major international banks in London lend to each other. (LIBID is London interbank bid rate; LIMEAN is mean of bid and offered rate.) the London Interbank Offered Rate (Libor), which is a Eurodollar rate—plus a spread. The spread varies depending on the borrower's credit-worthiness

Federal Funds Rate

The interest rate that member banks charge each other to borrow money overnight from the funds they keep in the Federal Reserve Accounts

Insurance Principle

The law of averages. The average outcome for many independent trials of an experiment will approach the expected value of the experiment.

Lognormal Distribution

The log of the variable has a normal (bell-shaped) distribution.

Utility

The measure of the welfare or satisfaction of an investor

Zero-Beta Portfolio

The minimum variance portfolio uncorrelated with a chosen efficient portfolio.

Nominal Distribution

The normal distribution, also known as the Gaussian or standard normal distribution, is the probability distribution that plots all of its values in a symmetrical fashion, and most of the results are situated around the probability's mean. Values are equally likely to plot either above or below the mean. Grouping takes place at values close to the mean and then tails off symmetrically away from the mean.

Minimum-Variance Portfolio

The portfolio of risky assets with lowest variance.

Arbitrage

The process of buying a good in one market at a low price and selling it in another market at a higher price

Securitization

The process of transforming loans or other financial assets into securities

Residual Claim

The right of a common stockholder to corporate assets in the event that the corporation ceases to exist. A common stockholder may claim assets only after the claims of all creditors and other security holders have been satisfied.

Risk-Free Rate

The risk-free rate of return is the theoretical rate of return of an investment with zero risk. The risk-free rate represents the interest an investor would expect from an absolutely risk-free investment over a specified period of time. In theory, the risk-free rate is the minimum return an investor expects for any investment because he will not accept additional risk unless the potential rate of return is greater than the risk-free rate. In practice, however, the risk-free rate does not exist because even the safest investments carry a very small amount of risk. Thus, the interest rate on a three-month U.S. Treasury bill is often used as the risk-free rate for U.S.-based investors.

Mean-Variance (M-V) Criterion

The selection of portfolios based on the means and variances of their returns. The choice of the higher expected return portfolio for a given level of variance or the lower variance portfolio for a given expected return.

Single-Index Model

The single-index model compares all securities to a single benchmark. By observing how two independent securities behave relative to a third value, we learn something about how the securities are likely to behave relative to each other.

Bid Price

The slightly lower price you would receive if you wanted to sell a bill to a dealer

Risk Aversion

The tendency to make decisions that avoid risk.

Latency

The time delay between the moment something is initiated and the moment it becomes detectable

Soft Dollars

The value of research services that brokerage houses provide "free of charge" in exchange for the investment manager's business.

Risk Arbitrage

Traders called arbitrageurs attempt to profit from TAKEOVERS by cashing in on the expected rise in the price of the target company's shares and drop in the price of the acquirer's shares. Risk arbitrage differs from market arbitrage, which entails profiting from the differences in the prices of two securities trading on different exchanges.

Turnover

Turnover is an accounting term that calculates how quickly a business collects cash from accounts receivable or how fast the company sells its inventory. In the investment industry, turnover represents the percentage of a portfolio that is sold in a particular month or year. A quick turnover rate generates more commissions for trades placed by a broker.

Risk Lover

Willing to accept lower expected returns on prospects with higher amounts of risk.

Minimum-Variance Frontier

a graph of the expected return/variance combinations for all minimum-variance portfolios

Load

a sales fee that you pay when you invest in a mutual fund

Risk Sharing

a service the financial system provides that allows savers to spread and transfer risk

High-Frequency Trading

a subset of algorithmic trading that relies on computer programs to make very rapid trading decisions

Efficient Frontier of Risky Assets

above the global minimum variance point on the minimum variance frontier

Hedge Fund

an aggressively managed portfolio of investments that uses advanced investment strategies such as leveraged, long, short and derivative positions in both domestic and international markets with the goal of generating high returns

Capital Gains

are profits made from the sale of capital assets such as stocks and bonds

Municipal Bonds

bonds issued by local and state governments, often to fund internal improvements; low interest rate, but interest is TAX-FREE

Security Selection

choice of specific securities within each asset class

Financial Assets

claims on real assets or the income generated by them

Prospectus

document issued to possible buyers of a stocks and bonds outlining the financial condition of the company issuing those securities

Investment Companies

financial intermediaries that invest the funds of individual investors in securities or other assets

Financial Intermediaries

institution that helps channel funds from savers to borrowers

Treasury Bonds

long term in nature and mature in 10 to 30 years. they provide direct interest and trade in units of $1,000 and higher. no risk of default, U.S. gov't securities provide lower returns than other forms of credit obligations

Primary Market

market for selling financial assets that can only be redeemed by the original holder

Price-Earnings Ratio

market price per common share / earnings per share

Stock Exchanges

marketplaces where stocks are bought and sold

Inside Information

nonpublic knowledge about a corporation possessed by corporate officers, major owners, or other individuals with privileged access to information about the firm

Private Placement

occurs when stock and other corporate securities are sold directly to insurance companies, pension funds, or large institutional investors

Risk Pooling

organizing people into a group to collectively absorb the risk faced by each individual

Private Equity

ownership assets that aren't publicly traded; includes venture capital

Strike Price

price at which the stock is bought and sold if the option is exercised

Sharpe Ratio

reward-to-volatility ratio; ratio of portfolio excess return to standard deviation

Fixed-Income Securities

securities such as bonds, notes, and preferred stocks that offer purchasers fixed periodic income

Investment

the act of redirecting resources from being consumed today so that they may create benefits in the future; the use of assets to earn income or profit

Residuals

the difference between an observed value of the response variable and the value predicted by the regression line

Yield to Maturity

the interest rate that equates the present value of payments received from a credit market instrument with its value today

Law of One Price

the notion that a good should sell for the same price in all markets

Call Option

the option to buy shares of stock at a specified time in the future

Put Option

the option to sell shares of stock at a specified time in the future