Series 66 Portfolios
Which risks are unique to mortgage backed securities?
1. Contraction risk or call risk. (The certificates pay off much earlier than expected as the expected maturity shortens. 2. Extension risk. (If market interest rates have risen after a mortgage pool is created, the homeowners sit tight and don't move. Thus, the anticipated rate of prepayments built into the security slows down and the maturity extends. The certificate holder winds up earning a lower than market rate of interest for much longer than he or she ever expected!)
Buy and Hold - Bond Portfolio
A buy and hold bond portfolio is completely passively managed. Bonds are purchased and simply held to maturity. There is no periodic rebalancing. To do this correctly, only non-callable bonds of the highest credit quality should be purchased. Otherwise, bonds can be called, forcing the investor to make new bond purchases over the investment time horizon. Since the investments will be held for a long time without change, deteriorating credit quality is an issue and only the highest quality issues should be purchased.
Alpha
A measure of a stock's price movement relative to the stocks in its industry, and independent of general market movements. A stock with a high "alpha" moves faster than the average of the stocks in its grouping. A stock with a low "alpha" moves slower than the average of the stocks in its grouping.
Tracking Error
A passive fund manager attempts to allocate investments so that the fund's return matches ("tracks") the appropriate index. (to "mirror" a designated index) If the fund manager under-performs (or over-performs) relative to the designated index, this is known as the "tracking error."
Standard Deviation
A statistical measure of the variability of returns from an investment. The higher the standard deviation, the greater the range of potential returns from an investment over a fixed time frame. For example, returns from U.S. Government securities have a very low standard deviation; returns from small capitalization stock investments have a very high standard deviation.
Principal Transaction
A trade where a member firm acts as a dealer in the transaction, selling the security to the customer out of the firm's inventory; or buying the security into the firm's inventory from the customer. When effecting a principal transaction, the dealer earns a mark-up when the security is sold to a customer; and a mark-down when the security is bought from a customer. Also, a member firm can be a principal in an underwriting when it takes financial liability for the issue, as in a firm commitment underwriting.
Agency Transaction
A trade where the executing member acted as a middleman or broker, finding the person in the market with the lowest price for a customer who wishes to buy; or the person in the market with the highest price for a customer who wishes to sell. In agency transactions, the executing member earns a commission for finding the "best market" for the customer. Also, a member firm may be an agent in an underwriting when it does not take financial liability for the issue, such as in a "best efforts" underwriting.
Current Liabilities
Accounts Payable. Wages Payable. Taxes Payable . Interest Payable.
The risk adjusted rate of return of an investment is most closely correlated to the investment's:
Alpha coefficient. "Alpha" measures the portion of an investment's return arising from "stock specific" risk - that is, the portion of the return that is not variable with the market as a whole. Thus, market risk is taken out of the equation. "Alpha" compares the "excess return" (return in excess of the risk-free rate of return) of the specific investment or portfolio to the "excess return" of the benchmark index, with the benchmark index "beta-adjusted" to match the beta of that investment.
Systematic Risk
Also called market risk, the risk that a decline in the overall market will adversely affect the value of a portfolio. Diversification does not protect against this type of risk.
Keynesian Theory
An economic theory postulated by John Maynard Keynes that the level of economic growth is determined by the level of fiscal stimulus provided by the government.
Monetarist Theory
An economic theory postulated by Milton Friedman that the level of economic growth is determined by monetary policy, that is, the actions the Federal Reserve Board.
Supply-Side Theory
An economic theory, popularly known as Reaganomics since it came into use during the Reagan administration, that is a mirror image of Keynesian theory. It postulates that reducing fiscal stimulus (reduction of government spending) and reducing taxes will give entrepreneurial individuals the incentive to form businesses, resulting in an expanding economy.
Capital in Excess of Par, Capital Surplus, and Additional Paid In Capital all refer the same account.
Any monies that are paid by shareholders that are in excess of the stated par value are credited to this account.
Risk associated with Bonds with LOW coupons and LONG maturities:
Are most affected by: 1. Interest rate risk. 2. Purchasing power risk (risk of inflation). If market interest rates rise (due to Fed policy actions or rising rates of inflation), then this bond's price would drop sharply. This is the major risk for a long term zero coupon obligation.
Buy and Hold - Fund Investments
Because fund investments are "managed" by an investment adviser, either actively or passively, there is no need for portfolio rebalancing. These are the classic "buy and hold" investments.
Current Assets
Cash. Accounts Receivable. Inventory.
Dark Pools
Dark pools are private trading platforms, usually run by broker-dealers for institutions that wish to avoid attempting to have very large orders filled on public exchanges. The exchanges' electronic order books are designed to handle a large volume of smaller orders. Very large orders (e.g., over 1,000,000 shares for market orders) cannot be entered into these systems. If very large orders are routed to a single exchange, it can result in an inferior fill when it electronically "sweeps" the order book - at ever higher prices for market orders to buy or ever lower prices for market orders to sell. To avoid this risk, institutions can use dark pools run by broker-dealers, where their large orders are kept "hidden" from view. The user of the system (another institution) does not know the order size or the identity of the institution that placed the order in the dark pool - orders are hidden from view, hence the name "dark pool." Thus, the institution that placed the order in the system is not showing its hand (the fact that it either wants to buy or sell a large block). This lack of transparency is attractive to institutions because if they were to place a large order to sell in a public market, that alone could force prices down; and it could force prices up if it were a large buy order. Once an order is filled in a dark pool, it is reported to the tape like any other trade.
Inflation-Adjusted Return
Inflation-Adjusted return deducts the rate of inflation from the investment return, to approximate the "real rate of return." If an investment yields 6% when the inflation rate of 2%, the inflation adjusted rate of return is 4%.
Dividend Discount Model
Is a way of finding the theoretical price of common stock. It takes the anticipated future dividends to be paid by the company and discounts them to present value. Instead of having to discount each year's anticipated dividend payment, the formula can be reduced to one similar to that for a perpetuity.
P/E Ratio
Is the Price to Earnings Ratio. It measures the stock's price relative to its earnings per share. A high P/E ratio means that the market is giving the stock a high valuation; a low P/E ratio means that the market is giving the stock a low valuation.
Total Return
Is the total of income from the investment and capital gains or capital losses on the investment. It is relevant for any security that generates income and that is subject to market risk. The formula for Total Return is: INCOME+GROWTH/AMOUNT INVESTED
CAPM - Capital Asset Pricing Model
Is to used to find the "expected return of an investment". CAPM formula: Expected Return of An Investment =Risk-Free Rate of Return + Risk Premium* *Risk Premium is: Beta x (Expected Market Return- Risk-Free Rate of Return)
Current Ratio
It is a measure of liquidity, because it looks at whether the company can pay its current bills as they come due. Formula: Current Assets / Current Liabilities Cash, Accounts Receivable and Inventory are the primary "Current Assets." Accounts Payable, Wages Payable, Taxes Payable and Interest Payable are the primary "Current Liabilities."
Quick Ratio
Measure of the corporation's LIQUIDITY; and is a more stringent test than the Current Ratio. Formula: Current Assets-Inventory & Pre-paid Expense/Current Liabilities. The Quick Ratio should be about 1, showing that there are sufficient "quick" current assets to pay current liabilities.
Dollar Weighted Average Return
Most often used by mutual fund investors, it is the rate of return achieved by the investor, taking into the account the timing of investor's cash inflows into the fund and cash withdrawals from the fund.
Non-Systematic Risk
Non-Systematic risk is "stock-specific" risk. Can be diversified away.
Price/Book Value ratio
Price is market value per share Book Value is best described as: Net Accounting Value
4 Business Cycles in Economic & Investment
Recovery: Technology, Transportation Expansion: Basic Materials, Capital Goods Peak: Consumer Staples, Energy Recession: Utilities Financials
Retained Earnings
Represents accumulated earnings of a corporation that have not been paid out as dividends
Arithmetic Mean
Standard deviation of investment returns is computed by comparing all of the investment returns against the "average" investment return. The more broadly dispersed the investment returns are as compared to the arithmetic mean (which is simply the average of all investment returns), then the greater the standard deviation.
Strategic Asset Allocation
Strategic asset management is the setting of the strategy for an asset allocation scheme - that is setting the percentage of asset to be allocated to each asset class and investment vehicles within that asset class, based on the customer's, age, investment objectives, financial situation and needs, investment time horizon, risk tolerance, etc. Example: The selected asset classes are 75% Equities and 25% Debt for a young single investor. The allocations to investment vehicles within each asset class under strategic asset management might be: 50%Aggressive Growth Equities 25%International Stocks 20%Corporate Bonds 5%Treasury Bills
Strategic vs. Tactical Asset Allocation
Strategic asset management is the setting of the strategy for an asset allocation scheme - that is setting the percentage of assets to be allocated to each investment vehicle within an asset class, based on the customer's investment objective, financial situation and needs, age, investment time horizon, risk tolerance, etc. Tactical asset management is the permitted variation that the manager is allowed from the fixed percentage allocations strategically assigned to each investment vehicle within an asset class. If a certain sector is undervalued, the manager can tactically overweight this asset class by the permitted variation; if a certain sector is overvalued, the manager can underweight this asset class by the permitted variation.
A TIPS is issued with a 3.5% coupon rate and a 5 year maturity. If inflation runs at 4% per year for the 5-year life of the bond, the redemption value of the bond at maturity will be approximately: A. $1,000 B. $1,051 C. $1,219 D. $1,445
TIPS are Treasury Inflation Protection Securities. The bonds are issued at par with a lower interest rate than conventional Treasury bonds. In return, the principal amount is adjusted upwards for inflation, with the inflated principal amount paid at maturity. The inflation adjustment is made semi-annually when the interest payment is made. Thus, if inflation runs at 4% annually for the 5-year life of the bond, the principal amount will have been adjusted upwards 10 times, at a 2% increase per adjustment. After the 1st year, the bond's value is $1,000 x 1.02 x 1.02 = $1,040.40 After the 2nd year, the bond's value is $1,040.40 x 1.02 x 1.02 = $1,082.43 After the 3rd year, the bond's value is $1,082.43 x 1.02 x 1.02 = $1,126.16 After the 4th year, the bond's value is $1,126.16 x 1.02 x 1.02 = $1,171.66After the 5th year, the bond's value is $1,171.66 x 1.02 x 1.02 = $1,218.99
Tactical Asset Allocation
Tactical asset management is the permitted variation that the manager is allowed from the fixed percentage allocations strategically assigned to each asset class Example: The selected investment vehicles within asset classes and percentage allocations decided under strategic asset management for a young single investor might be: 50%Aggressive Growth Equities 20%International Stocks20%Corporate Bonds 10%Treasury Bills However, assume the manager is permitted to vary these percentages by + or - 10%. If the manager believes that international stocks will do exceptionally well, the manager can tactically increase the international stock allocation to 30%; and, say, reduce the T-Bill allocation to 0%.
Net Present Value
Takes the expected annual cash flows from an investment over the years and discounts them, using the market rate of interest compounded over time, to today's "present value." This is basically the opposite of future value.
Real Rate of Return
The "real" rate of return excludes the effect of inflation on the return. It is the actual rate of return achieved on the investment minus the inflation rate: Real Rate of Return = Nominal Rate - Inflation Rate
Debt/Equity Ratio
The Debt/Equity Ratio measures of proportion of a company's capitalization that comes from the sale of long-term debt. The higher the ratio, the more highly-leveraged the company is and the greater the risk that it could default on its fixed debt interest payments. The Debt/Equity Ratio is: Long Term Debt / Stockholder's Equity
Required Rate of Return (Hurdle" Rate of Return)
The RRR (Required Rate of Return) is the minimum return that an investment must offer in order for someone to decide to buy it. Assume that the RRR is 10%. If the security actually offers a return of 12% (the Internal Rate of Return, which is the same as the yield to maturity offered by the investment) then the purchase should be made because the IRR (actual return) returns the RRR (minimum required return). Assume that the RRR is 10%. If the security actually offers a return of 8% (the Internal Rate of Return, which is the same as the yield to maturity offered by the investment) then the purchase should not be made because the RRR (minimum required return) exceeds the IRR (actual return). Another name for the Required Rate of Return is the "Hurdle" Rate of Return".
Sharpe Ratio
The Sharpe Ratio measures the reward-to-volatility ratio by looking at the ratio of portfolio excess return to standard deviation. Formula: Risk Adjusted Rate of Return/Standard Deviation of Returns
Which of the following will equal the face value of a bond? A. The present value of the payments to be received from the issuer discounted by the bond coupon rate B. The present value of the payments to be received from the issuer discounted by the market rate of interest C. The future value of the payments to be received from the issuer discounted by the bond coupon rate D. The future value of the payments to be received from the issuer discounted by the market rate of interest
The best answer is A. If the annual interest payments and final principal repayment to be received from a bond are discounted back to present value using the coupon rate, the present value of those payments will be $1,000 = the face value of the bond.
One of the key assumptions of the Capital Asset Pricing Model is that: A. Investors are risk averse B. Investors are emotional C. Investors consider taxes when making investment decisions D. Some investors have access to better market information than other investors
The best answer is A. Key assumptions backing the Capital Asset Pricing Model are: 1. Investors are risk averse and are rational, seeking a higher return for taking on greater risk 2. Investors do not consider taxes when making investment decisions 3. All investors hold securities for the same time period There are no transaction costs 4. All investors have access to the same market information Thus, CAPM does not reflect the real world, but it can give an approximation of the rate of return required to make an investment, based on the requirement that the investor earn the risk free rate of return plus a risk premium.
An example of a passive long term bond investment strategy is: A. buy and hold B. a barbell C. a ladder D. interest rate anticipation
The best answer is A. Since long term bonds are more volatile than short term bonds as market interest rates move, a long term bond investor should be a "buy and hold" investor. As long as the bond is held to maturity, the bondholder will not experience a market value loss due to an interest rate rise. This is a "passive" strategy because it does not require a manager to decide when to change the portfolio composition. When constructing a bond portfolio, "laddering" the portfolio means that the portfolio is structured with short-term; intermediate term; and long-term investments. As the short-term bonds mature, the proceeds are reinvested either in new short-term, intermediate-term or long-term bonds, depending on anticipated movements in interest rates (if rates are expected to rise, then the proceeds are invested in short-term bonds, which will fall the least from a market interest rate rise; if rates are expected to fall, then the proceeds are invested in long term bonds, which will rise the most from a market interest rate fall; if rates are expected to be stable, then the proceeds are invested in intermediate term bonds). Thus, there is active portfolio rebalancing going on as interest rates move - so this is an example of an interest rate anticipation strategy. A barbell strategy is a similar strategy, using only short term and long term bonds (the 2 ends of the barbell). Thus, a barbell, a ladder, and interest rate anticipation, are all "active" strategies.
When the market price of ABCD stock is at $48, a customer places a buy stop limit order at $50. The next trades in the stock occur in sequence at: 51...52....53....49....48 The first trade where execution could occur is: A. 48 B. 49 C. 52 D. 53
The best answer is B. A buy stop limit order is triggered in a rising market. It is most often used to stop a loss on an existing short stock position. Once the market trades up to 50 or higher, the order is triggered and becomes a limit order to buy at $50, meaning buy at $50 or lower. The very first reported trade of $51 elects the order because the market moved from $48 to $51 and went right through the stop price of $50. The order now becomes a limit order to buy at $50, meaning that the customer does not want to pay more than $50 to buy. The next trade of $52 is too high; the following trade of $53 is too high; and the next trade of $49 is the first one that meets the customer's limit (buy at $50 or lower). This is the first trade where the order could be filled.
A corporation that has been in business for 40 years has consistently paid a 3% annual dividend. The corporation has no debt and its stock trades at a multiple of 7. The common stock of this company would be termed a: A. growth stock B. value stock C. capital stock D. speculative stock
The best answer is B. Stock of a mature company that sells at a low "multiple" of earnings and that pays a good dividend is considered a good "value" - hence the name "value" stock. Capital stock is a term for the original capitalization of the company - the stock sold to the public from which the company received its initial capital injection to start business.
A Debt/Equity Ratio of 1 means that: A. the company will be able to pay all of its debts in the upcoming year B. shareholders and creditors have an equal stake in the company's assets C. the company has not used any leverage in its capital base D. the company's interest payments to bondholders equals the company's dividend payments to shareholders
The best answer is B. The Debt/Equity ratio measures a company's leverage - the use of borrowed funds in the company's capital base. Companies borrow long-term funds for capital expenditures when it is cheaper to do so, meaning interest rates are low. Furthermore, the company can deduct the interest payments. The risk is a business decline, where the company might not be able to cover its fixed interest expense. If a company has borrowed $10,000,000 and it has $10,000,000 of stockholders' equity, it has long term capital of $20,000,000. Its Debt/Equity Ratio is $10,000,000 Debt / $10,000,000 Equity = 1. This means that both creditors and shareholders have an equal stake in the company. Notice that the ratio has nothing to do with interest payments or dividend payments made.
A customer buys a 3-year maturity, 6% coupon bond at par. If market interest rates rise to 8%, then the bond's price will fall by: A. 2% B. 5% C. 10% D. 25%
The best answer is B. The customer bought this 3-year bond at par with a coupon rate of 6%. If market interest rates rise to 8%, then the present value of the bond's cash flows will fall as follows: Year 1:$60 / 1.08 = $55.55Year 2:$60 / (1.08)2 = $51.44Year 3:$1,060 / (1.08)3 = $841.46 Total Present Value = $55.55 + $51.44 + $841.46 = $948.45 The bond will fall in price by $51.55 from $1,000 par, for a fall of 5.155%.
A passively managed index fund, to compensate for a negative tracking error, would: A. rebalance its portfolio B. actively manage a portion of its portfolio C. terminate its portfolio manager and hire a more experienced individual D. implement a new strategic asset allocation plan
The best answer is B. The deviation between a portfolio's return and the benchmark return is known as the "tracking error" (this can be either positive or negative). Here is an example of how tracking error occurs and can be managed. Index fund managers, who seek to match the performance of a benchmark index, must, in reality, do better than the benchmark index results to cover the costs of operating the fund (e.g., brokerage costs, administrative costs, etc.). They cannot be completely passive in their approach because then they will always underperform the index (the "tracking error"). Therefore, in order to boost their yield up to cover these expenses, they must employ a bit of active asset management - in essence, making disproportionately large bets on stocks in the index that they think will outperform the index - in order to juice up their returns enough to cover fund expenses. The idea is that the positive tracking error from the actively managed positions will more than offset the negative tracking error built into the passively managed positions.
An investment portfolio indexed to the S&P 500 Index produced a return for the year of 12% with a beta of +1. Investment Manager "A" has an actively managed stock portfolio that produced at return for the year of 14.8% with a beta of 1.4. The "alpha" produced by Investment Manager "A" is: A + 2% B - 2% C +2.80% D -2.80%
The best answer is B. Investment Manager "A" produced a 14.8% return by assuming 40% more "risk" as measured by beta than if the portfolio was invested in a benchmark stock index with a beta of 1. To compare "apples with apples," a portfolio with a beta of 1.4 should return 1.4 times the benchmark index return of 12% = 1.4 x 12% = 16.80%. This manager produced a return of 14.8%, so the "alpha" (value of the active manager's expertise over investing in an index fund) is actually negative. This manager did worse, producing a negative alpha of -2%.
Diversification among multiple asset classes reduces the: I market risk of the portfolioII marketability risk of the portfolioIII standard deviation of portfolio returns A. I only B. II and III C. I and III D. I, II, III
The best answer is C. Diversification of a portfolio reduces market risk; and also reduces the variability of investment returns. It does not affect marketability risk - that is, how difficult is it to liquidate given position in the portfolio.
The Specialist (Designated Market Maker) on the floor of a stock exchange does all of the following EXCEPT: A. act as an auctioneer in the designated security when necessary to maintain an orderly market B. act as the buyer of last resort when no one else wants to buy on the floor and as the seller of last resort when no one else wants to sell C. provide general market commentary during the trading day for the designated security D. match orders of buyers and sellers that are routed to the exchange floor
The best answer is C. The Specialist is the Designated Market Maker on the NYSE trading floor. Though most trading is now done through automated matching, the Specialist has the "positive obligation" of standing ready to buy if there are no other buyers in the market; and standing ready to sell if there are no other sellers in the market - thus, buyers and sellers who place market orders are always assured of getting their orders filled. The Specialist also maintains the book of open orders and fills the orders as the market moves. Finally, the Specialist has the "negative obligation" of taking him- or herself out of trading and acting as an auctioneer, conducting an orderly auction between floor brokers who want to buy and those who want to sell, if the market becomes too "crazy."
A customer places an order on the NYSE to sell bonds. The order reads "Sell 5M ABC 9s M '42 @ 90 GTC." At which of the following prices may the order be executed?I 89II 90III 91IV 92 A. I and II only B. III and IV only C. II, III, IV D. I, II, III, IV
The best answer is C. The customer places a limit order to sell 5M - or 5 $1,000 par bonds at 90% of par value or more, if possible. The order must be executed at 90% or more, so selling at 90, 91 and 92 are OK. Selling at 89 is not high enough to satisfy the customer's limit.
A trade confirmation for an Over-The-Counter Bulletin Board stock shows the following: "We sold to you 100 shares of XXXX @ $7 Net" In this transaction, the member firm acted as a(n): A. agent, and charges a commission in addition to the Net price B. agent, and charges a commission included in the Net price C. dealer, and charges a mark-up in addition to the Net price D. dealer, and charges a mark-up included in the Net price
The best answer is D. In an over-the-counter principal transaction, the member firm sells a security out of its inventory to a customer who wishes to buy; or buys a security into its inventory from a customer who wishes to sell. In this transaction, the firm acts as a dealer, and marks-up the stock to the customer who wishes to buy; or marks-down the stock from the customer that wishes to sell.
TIPS are Treasury Inflation Protection Securities.
The bonds are issued at par with a lower interest rate than conventional Treasury bonds. In return, the principal amount is adjusted upwards for inflation, with the inflated principal amount paid at maturity. The inflation adjustment is made semi-annually when the interest payment is made.
Asset Class
The categorization of investments into groupings with similar risk and return characteristics. The commonly recognized asset classes are: Equities, Fixed Income Securities, Cash Equivalents, Real Estate, Commodities.
Risk Adjusted Rate of Return
The excess return that can be achieved by investing in a chosen asset class, over and above that can be achieved by investing in an asset class that has no risk, such as Treasury Bills.
Risk Premium
The excess return that can be achieved by investing in specific securities, as compared to a benchmark portfolio.
Internal Rate of Return
The internal rate of return on a bond is the interest rate that will discount the bond's cash flows to the purchase price of the bond. It is the same as the bond's yield to maturity. In a direct participation program (DPP) offering, the computation of the real investment yield considering the time value of money; calculated by finding the implicit interest rate that discounts that program's projected annual cash flows to a present value of "0."
Future Value
The original principal amount of an investment plus any interest accrued during a specific time period. The Future Value is dependent upon the amount of time the investment is held and the interest rate earned over the investment's life. (Also known as Compound value)
Compound Value
The original principal amount of an investment plus any interest accrued during a specific time period. The compound value is dependent upon the amount of time the investment is held and the interest rate earned over the investment's life. (also known as Future value)
Return on Investment (ROI)
The percentage return given by an investment, computed by taking the annual cash flows generated by the investment, averaging them, and then dividing the average annual cash flow by the initial investment amount. The annual compounded investment return necessary to increase the value of an asset to a specified future amount. This considers the time value of money, and is the same as internal rate of return.
Active Asset Management
The pursuit of investment returns in excess of the specific benchmark return. Active asset managers believe that undervalued stocks exist in the marketplace, and that by investing in them, they can surpass the performance of a similar index fund.
Opportunity Cost
The rate of return forgone, as compared to investing in an alternative security. For example, an investor that is currently earning 5% on a given security; and who could earn 7% on another comparable security in the same risk class; is incurring an opportunity cost of 2%.
Time Weighted Average Return
The rate of return required to be shown in mutual fund performance charts, time weighted average return shows the growth over time of a fixed investment amount, ignoring the timing of cash deposits into the fund and cash outflows from the fund (these can greatly impact an individual's actual return)
Expected Rate of Return
The rate of return that an investment is "expected" to return. It is computed by assigning probabilities to various scenarios for that investment's potential returns. CAPM is to used to find the "expected return of an investment". CAPM formula: Expected Return of An Investment =Risk-Free Rate of Return + Risk Premium* *Risk Premium is: Beta x (Expected Market Return- Risk-Free Rate of Return)
Beta (Also called Beta Coefficient)
The relative volatility of a particular stock relative to the overall market as measured by the Standard & Poor's 500 index. If a stock's Beta coefficient is +1, this means that its price rises and falls in direct relationship to the movement of the index. A Beta that is LESS than +1 indicates a stock is less volatile than the overall market; while a Beta of GREATER than +1 indicates that a stock is more volatile. A - Beta indicates that the stock's price moves in the opposite direction to the market as a whole.
Annualized Rate of Return
The return achieved by an investment over a period that is shorter than 1 year is "annualized" to make a valid comparison with the return provided by alternative investments. For example, an investment yielding 2% over a 6-month time frame has an annualized rate of return of 4%.
Risk Free Rate of Return
The return that can be achieved by investing in an asset class that has no risk, such as Treasury Bills.
Current Yield
The return that the dividend on a stock, or the interest on a bond, provides relative to the security's current market price. The formula for computing the current yield for a stock is the annual dividend amount divided by the stock's current market price. For a bond, the current yield is the annual interest amount divided by the bond's current market price.
Portfolio Rebalancing - Active/Passive
The terms "active" and "passive" are most often used when looking at the management of a stock portfolio. An actively managed portfolio has its investments selected by a professional manager; whereas a passive portfolio has a composition that is matched to a market index. However, "active" and "passive" can also be used to refer to the frequency of portfolio rebalancing. A portfolio that is rebalanced once annually is said to be "passive;" a portfolio that is rebalanced more frequently or as market conditions move is said to be "active." These terms can be combined to describe both the frequency of rebalancing (active or passive) and the underlying investment style (active or passive). Therefore, a portfolio that is: Rebalanced monthly and actively managed is called: "Active/Active;" Rebalanced annually and actively managed is called: "Passive/Active;" Rebalanced monthly and invested in index funds is called: "Active/Passive;" and Rebalanced annually and invested in index funds is called: "Passive/Passive."
Efficient Market Theory
The theory that all information about an issuer is available to all participants in the market at the same time and that the prices of securities directly reflect investor expectations based on this information. Therefore, attempting to profit from buying undervalued stocks or selling short overvalued stocks is futile. Most accepted is the "semi-strong" version of this theory, which states that market valuations reflect all "publicly known" information about an issuer; but do not reflect information known only by "insiders" - the officers and directors of that company.
The closest approximation of the internal rate of return on a bond is the bond's:
Yield to maturity. The internal rate of return on a bond is the interest rate that will discount the bond's cash flows to the purchase price of the bond. It is the same as the bond's yield to maturity.
Passive Asset Management
the pursuit of investment returns to match, but not exceed, the specific benchmark return. Passive asset managers believe that undervalued stocks do not exist in the marketplace, and that they can only match the performance of a similar index fund.
