CFA Level 1 Glossary Terms

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Capital allocation line

(CAL) A graph line that describes the combinations of expected return and standard deviation of return available to an investor from combining the optimal portfolio of risky assets with the risk-free asset.

Capital asset pricing model

(CAPM) An equation describing the expected return on any asset (or portfolio) as a linear function of its beta relative to the market portfolio.

Capital market line

(CML) The line with an intercept point equal to the risk-free rate that is tangent to the efficient frontier of risky assets; represents the efficient frontier when a risk-free asset is available for investment.

Coefficient of variation

(CV) The ratio of a set of observations' standard deviation to the observations' mean value.

Dividend discount model

(DDM) A present value model that estimates the intrinsic value of an equity share based on the present value of its expected future dividends.

Degree of financial leverage

(DFL) The ratio of the percentage change in net income to the percentage change in operating income; the sensitivity of the cash flows available to owners when operating income changes.

Degree of operating leverage

(DOL) The ratio of the percentage change in operating income to the percentage change in units sold; the sensitivity of operating income to changes in units sold.

Initial public offering

(IPO) The first issuance of common shares to the public by a formerly private corporation.

Investment policy statement

(IPS) A written planning document that describes a client's investment objectives and risk tolerance over a relevant time horizon, along with constraints that apply to the client's portfolio.

Internal rate of return

(IRR) The discount rate that makes net present value equal 0; the discount rate that makes the present value of an investment's costs (outflows) equal to the present value of the investment's benefits (inflows).

Leveraged buyout

(LBO) A transaction whereby the target company management team converts the target to a privately held company by using heavy borrowing to finance the purchase of the target company's outstanding shares.

Moving-average convergence/divergence oscillator

(MACD) A momentum oscillator that is constructed based on the difference between short-term and long-term moving averages of a security's price.

Management buyout

(MBO) An event in which a group of investors consisting primarily of the company's existing management purchase all of its outstanding shares and take the company private.

Modern portfolio theory

(MPT) The analysis of rational portfolio choices based on the efficient use of risk.

Net present value

(NPV) The present value of an investment's cash inflows (benefits) minus the present value of its cash outflows (costs).

Price to earnings ratio

(P/E ratio or P/E) The ratio of share price to earnings per share.

Separately managed account

(SMA) An investment portfolio managed exclusively for the benefit of an individual or institution.

Security market line

(SML) The graph of the capital asset pricing model.

Value at risk

(VaR) A money measure of the minimum value of losses expected during a specified time period at a given level of probability.

Statement of changes in equity

(statement of owners' equity) A financial statement that reconciles the beginning-of-period and end-of-period balance sheet values of shareholders' equity; provides information about all factors affecting shareholders' equity. Also called statement of owners' equity.

Broker

1) An agent who executes orders to buy or sell securities on behalf of a client in exchange for a commission. 2) Seefutures commission merchants.

Arbitrage

1) The simultaneous purchase of an undervalued asset or portfolio and sale of an overvalued but equivalent asset or portfolio, in order to obtain a riskless profit on the price differential. Taking advantage of a market inefficiency in a risk-free manner. 2) The condition in a financial market in which equivalent assets or combinations of assets sell for two different prices, creating an opportunity to profit at no risk with no commitment of money. In a well-functioning financial market, few arbitrage opportunities are possible. 3) A risk-free operation that earns an expected positive net profit but requires no net investment of money.

Kondratieff wave

A 54-year long economic cycle postulated by Nikolai Kondratieff.

Single price auction

A Dutch auction variation, also involving a single price, is used in selling US Treasury securities.

Asian call option

A European-style option with a value at maturity equal to the difference between the stock price at maturity and the average stock price during the life of the option, or $0, whichever is greater.

American depository receipt

A US dollar-denominated security that trades like a common share on US exchanges.

Deferred tax assets

A balance sheet asset that arises when an excess amount is paid for income taxes relative to accounting profit. The taxable income is higher than accounting profit and income tax payable exceeds tax expense. The company expects to recover the difference during the course of future operations when tax expense exceeds income tax payable.

Deferred tax liabilities

A balance sheet liability that arises when a deficit amount is paid for income taxes relative to accounting profit. The taxable income is less than the accounting profit and income tax payable is less than tax expense. The company expects to eliminate the liability over the course of future operations when income tax payable exceeds tax expense.

Classified balance sheet

A balance sheet organized so as to group together the various assets and liabilities into subcategories (e.g., current and noncurrent).

Unclassified balance sheet

A balance sheet that does not show subtotals for current assets and current liabilities.

Committed lines of credit

A bank commitment to extend credit up to a pre-specified amount; the commitment is considered a short-term liability and is usually in effect for 364 days (one day short of a full year).

Depository bank

A bank that raises funds from depositors and other investors and lends it to borrowers.

Target independent

A bank's ability to determine the definition of inflation that they target, the rate of inflation that they target, and the horizon over which the target is to be achieved.

Operational independence

A bank's ability to execute monetary policy and set interest rates in the way it thought would best meet the inflation target.

Histogram

A bar chart of data that have been grouped into a frequency distribution.

Look-ahead bias

A bias caused by using information that was unavailable on the test date.

Callable bond

A bond containing an embedded call option that gives the issuer the right to buy the bond back from the investor at specified prices on pre-determined dates.

Restricted payments

A bond covenant meant to protect creditors by limiting how much cash can be paid out to shareholders over time.

Syndicated offering

A bond issue that is underwritten by a group of investment banks.

Non-sovereign bonds

A bond issued by a government below the national level, such as a province, region, state, or city.

Non-sovereign government bonds

A bond issued by a government below the national level, such as a province, region, state, or city.

Sovereign bonds

A bond issued by a national government.

Sovereigns

A bond issued by a national government.

Supranational bonds

A bond issued by a supranational agency such as the World Bank.

Quasi-government bonds

A bond issued by an entity that is either owned or sponsored by a national government. Also called agency bond.

Treasury Inflation-Protected Securities

A bond issued by the United States Treasury Department that is designed to protect the investor from inflation by adjusting the principal of the bond for changes in inflation.

Duration gap

A bond's Macaulay duration minus the investment horizon.

Extreme value theory

A branch of statistics that focuses primarily on extreme outcomes.

Aging schedule

A breakdown of accounts into categories of days outstanding.

Personal income

A broad measure of household income that includes all income received by households, whether earned or unearned; measures the ability of consumers to make purchases.

Block brokers

A broker (agent) that provides brokerage services for large-size trades.

Sell-side firm

A broker or dealer that sells securities to and provides independent investment research and recommendations to investment management companies.

Passive investment

A buy and hold approach in which an investor does not make portfolio changes based on short-term expectations of changing market or security performance.

Marketable limit order

A buy limit order in which the limit price is placed above the best offer, or a sell limit order in which the limit price is placed below the best bid. Such orders generally will partially or completely fill right away.

Bond equivalent yield

A calculation of yield that is annualized using the ratio of 365 to the number of days to maturity. Bond equivalent yield allows for the restatement and comparison of securities with different compounding periods.

Capital rationing

A capital rationing environment assumes that the company has a fixed amount of funds to invest.

Margin bond

A cash deposit required by the clearinghouse from the participants to a contract to provide a credit guarantee. Also called a performance bond.

Subordinated debt

A class of unsecured debt that ranks below a firm's senior unsecured obligations.

Support tranche

A class or tranche in a CMO that protects the PAC tranche from prepayment risk.

Fiduciary call

A combination of a European call and a risk-free bond that matures on the option expiration day and has a face value equal to the exercise price of the call.

Statutory voting

A common method of voting where each share represents one vote.

Factor

A common or underlying element with which several variables are correlated.

Global registered share

A common share that is traded on different stock exchanges around the world in different currencies.

Multinational corporation

A company operating in more than one country or having subsidiary firms in more than one country.

Comparable company

A company that has similar business risk; usually in the same industry and preferably with a single line of business.

Non-cyclical

A company whose performance is largely independent of the business cycle.

Target capital structure

A company's chosen proportions of debt and equity.

Competitive strategy

A company's plans for responding to the threats and opportunities presented by the external environment.

Operating profit

A company's profits on its usual business activities before deducting taxes. Also called operating income.

Payout policy

A company's set of principles guiding payouts.

Relative strength analysis

A comparison of the performance of one asset with the performance of another asset or a benchmark based on changes in the ratio of the securities' respective prices over time.

Benchmark

A comparison portfolio; a point of reference or comparison.

Simulation trial

A complete pass through the steps of a simulation.

Current account

A component of the balance of payments account that measures the flow of goods and services.

Capital account

A component of the balance of payments account that measures transfers of capital.

Financial account

A component of the balance of payments account that records investment flows.

Index of Leading Economic Indicators

A composite of economic variables used by analysts to predict future economic conditions.

Locked limit

A condition in the futures markets in which a transaction cannot take place because the price would be beyond the limits.

Liquidity trap

A condition in which the demand for money becomes infinitely elastic (horizontal demand curve) so that injections of money into the economy will not lower interest rates or affect real activity.

Excess supply

A condition in which the quantity ready to be supplied is greater than the quantity demanded.

Equilibrium condition

A condition necessary for the forces within a system to be in balance.

Budget constraint

A constraint on spending or investment imposed by wealth or income.

Normal distribution

A continuous, symmetric probability distribution that is completely described by its mean and its variance.

Credit derivatives

A contract in which one party has the right to claim a payment from another party in the event that a specific credit event occurs over the life of the contract.

Long-term contract

A contract that spans a number of accounting periods.

Conventional cash flow

A conventional cash flow pattern is one with an initial outflow followed by a series of inflows.

Medium-term note

A corporate bond offered continuously to investors by an agent of the issuer, designed to fill the funding gap between commercial paper and long-term bonds.

Menu costs

A cost of inflation in which businesses constantly have to incur the costs of changing the advertised prices of their goods and services.

Sunk cost

A cost that has already been incurred.

Quasi-fixed cost

A cost that stays the same over a range of production but can change to another constant level when production moves outside of that range.

Automatic stabilizer

A countercyclical factor that automatically comes into play as an economy slows and unemployment rises.

Small country

A country that is a price taker in the world market for a product and cannot influence the world market price.

Absolute advantage

A country's ability to produce a good or service at a lower absolute cost than its trading partner.

Comparative advantage

A country's ability to produce a good or service at a lower relative cost, or opportunity cost, than its trading partner.

Change of control put

A covenant giving bondholders the right to require the issuer to buy back their debt, often at par or at some small premium to par value, in the event that the borrower is acquired.

Effective convexity

A curve convexity statistic that measures the secondary effect of a change in a benchmark yield curve on a bond's price.

Marginal value curve

A curve describing the highest price consumers are willing to pay for each additional unit of a good.

Long-run industry supply curve

A curve describing the relationship between quantity supplied and output prices when no costs are considered fixed.

Indifference curve

A curve representing all the combinations of two goods or attributes such that the consumer is entirely indifferent among them.

Credit curve

A curve showing the relationship between time to maturity and yield spread for an issuer with comparable bonds of various maturities outstanding, usually upward sloping.

Experience curve

A curve that shows the direct cost per unit of good or service produced or delivered as a typically declining function of cumulative output.

Over-the-counter (OTC) markets

A decentralized market where buy and sell orders initiated from various locations are matched through a communications network.

Global depository receipt

A depository receipt that is issued outside of the company's home country and outside of the United States.

Straight-line method

A depreciation method that allocates evenly the cost of a long-lived asset less its estimated residual value over the estimated useful life of the asset.

Units-of-production method

A depreciation method that allocates the cost of a long-lived asset based on actual usage during the period.

Parameter

A descriptive measure computed from or used to describe a population of data, conventionally represented by Greek letters.

Tree diagram

A diagram with branches emanating from nodes representing either mutually exclusive chance events or mutually exclusive decisions.

Dividend

A distribution paid to shareholders based on the number of shares owned.

Univariate distribution

A distribution that specifies the probabilities for a single random variable.

Probability distribution

A distribution that specifies the probabilities of a random variable's possible outcomes.

Extra dividend

A dividend paid by a company that does not pay dividends on a regular schedule, or a dividend that supplements regular cash dividends with an extra payment.

Special dividend

A dividend paid by a company that does not pay dividends on a regular schedule, or a dividend that supplements regular cash dividends with an extra payment.

Liquidating dividend

A dividend that is a return of capital rather than a distribution from earnings or retained earnings.

Balance of payments

A double-entry bookkeeping system that summarizes a country's economic transactions with the rest of the world for a particular period of time, typically a calendar quarter or year.

Maturity structure

A factor explaining the differences in yields on similar bonds; also called term structure.

Management fee

A fee based on assets under management or committed capital, as applicable. Also called base fee.

Behavioral finance

A field of finance that examines the psychological variables that affect and often distort the investment decision making of investors, analysts, and portfolio managers.

Intermarket analysis

A field within technical analysis that combines analysis of major categories of securities—namely, equities, bonds, currencies, and commodities—to identify market trends and possible inflections in a trend.

Debt incurrence test

A financial covenant made in conjunction with existing debt that restricts a company's ability to incur additional debt at the same seniority based on one or more financial tests or conditions.

Option

A financial instrument that gives one party the right, but not the obligation, to buy or sell an underlying asset from or to another party at a fixed price over a specific period of time. Also referred to as contingent claim or option contract.

Derivatives

A financial instrument whose value depends on the value of some underlying asset or factor (e.g., a stock price, an interest rate, or exchange rate).

Broker-dealer

A financial intermediary (often a company) that may function as a principal (dealer) or as an agent (broker) depending on the type of trade.

Dealers

A financial intermediary that acts as a principal in trades.

Cash conversion cycle

A financial metric that measures the length of time required for a company to convert cash invested in its operations to cash received as a result of its operations; equal to days of inventory on hand + days of sales outstanding - number of days of payables. Also called net operating cycle.

Profit and loss (P&L) statement

A financial statement that provides information about a company's profitability over a stated period of time.

Statement of operations

A financial statement that provides information about a company's profitability over a stated period of time.

Income statement

A financial statement that provides information about a company's profitability over a stated period of time. Also called statement of operations or profit and loss statement.

Statement of cash flows

A financial statement that reconciles beginning-of-period and end-of-period balance sheet values of cash; provides information about an entity's cash inflows and cash outflows as they pertain to operating, investing, and financing activities. Also called cash flow statement.

Statement of retained earnings

A financial statement that reconciles beginning-of-period and end-of-period balance sheet values of retained income; shows the linkage between the balance sheet and income statement.

Statement of owners' equity

A financial statement that reconciles the beginning of-period and end-of-period balance sheet values of shareholders' equity; provides information about all factors affecting shareholders' equity. Also called statement of changes in shareholders' equity.

Annuity

A finite set of level sequential cash flows.

Underwriter

A firm, usually an investment bank, that takes the risk of buying the newly issued securities from the issuer, and then reselling them to investors or to dealers, thus guaranteeing the sale of the securities at the offering price negotiated with the issuer.

Contractionary fiscal policy

A fiscal policy that has the objective to make the real economy contract.

Arms index

A flow of funds indicator applied to a broad stock market index to measure the relative extent to which money is moving into or out of rising and declining stocks.

TRIN

A flow of funds indicator applied to a broad stock market index to measure the relative extent to which money is moving into or out of rising and declining stocks.

Laddering strategy

A form of active strategy which entails scheduling maturities on a systematic basis within the investment portfolio such that investments are spread out equally over the term of the ladder.

Repo

A form of collateralized loan involving the sale of a security with a simultaneous agreement by the seller to buy the same security back from the purchaser at an agreed-on price and future date. The party who sells the security at the inception of the repurchase agreement and buys it back at maturity is borrowing money from the other party, and the security sold and subsequently repurchased represents the collateral.

Repurchase agreement

Intergenerational data mining

A form of data mining that applies information developed by previous researchers using a dataset to guide current research using the same or a related dataset.

Technical analysis

A form of security analysis that uses price and volume data, which is often displayed graphically, in decision making.

Forward rate agreements

A forward contract calling for one party to make a fixed interest payment and the other to make an interest payment at a rate to be determined at the contract expiration.

Joint probability function

A function giving the probability of joint occurrences of values of stated random variables.

Cumulative distribution function

A function giving the probability that a random variable is less than or equal to a specified value.

Probability function

A function that specifies the probability that the random variable takes on a specific value.

Probability density function

A function with non-negative values such that probability can be described by areas under the curve graphing the function.

Venture capital fund

A fund for private equity investors that provides financing for development-stage companies.

Buyout fund

A fund that buys all the shares of a public company so that, in effect, the company becomes private.

GDP deflator

A gauge of prices and inflation that measures the aggregate changes in prices across the overall economy.

Implicit price deflator for GDP

A gauge of prices and inflation that measures the aggregate changes in prices across the overall economy.

Money

A generally accepted medium of exchange and unit of account.

Veblen good

A good that increases in desirability with price.

Normal good

A good that is consumed in greater quantities as income increases.

Giffen good

A good that is consumed more as the price of the good rises.

Inferior goods

A good whose consumption decreases as income increases.

Frequency polygon

A graph of a frequency distribution obtained by drawing straight lines joining successive points representing the class frequencies.

Constant-yield price trajectory

A graph that illustrates the change in the price of a fixed-income bond over time assuming no change in yield-to-maturity. The trajectory shows the "pull to par" effect on the price of a bond trading at a premium or a discount to par value.

Investment opportunity schedule

A graphical depiction of a company's investment opportunities ordered from highest to lowest expected return. A company's optimal capital budget is found where the investment opportunity schedule intersects with the company's marginal cost of capital.

Momentum oscillators

A graphical representation of market sentiment that is constructed from price data and calculated so that it oscillates either between a high and a low or around some number.

Asset class

A group of assets that have similar characteristics, attributes, and risk/return relationships.

Peer group

A group of companies engaged in similar business activities whose economics and valuation are influenced by closely related factors.

Industry

A group of companies offering similar products and/or services.

Neo-Keynesians

A group of dynamic general equilibrium models that assume slow-to-adjust prices and wages.

New Keynesians

A group of dynamic general equilibrium models that assume slow-to-adjust prices and wages.

Sector

A group of related industries.

Indifference curve map

A group or family of indifference curves, representing a consumer's entire utility function.

t-Test

A hypothesis test using a statistic (t-statistic) that follows at-distribution.

Hedge portfolio

A hypothetical combination of the derivative and its underlying that eliminates risk.

Synthetic lease

A lease that is structured to provide a company with the tax benefits of ownership while not requiring the asset to be reflected on the company's financial statements.

Precautionary stocks

A level of inventory beyond anticipated needs that provides a cushion in the event that it takes longer to replenish inventory than expected or in the case of greater than expected demand.

Safety stock

A level of inventory beyond anticipated needs that provides a cushion in the event that it takes longer to replenish inventory than expected or in the case of greater than expected demand.

Deferred income

A liability account for money that has been collected for goods or services that have not yet been delivered; payment received in advance of providing a good or service.

Deferred revenue

A liability account for money that has been collected for goods or services that have not yet been delivered; payment received in advance of providing a good or service.

Unearned revenue

A liability account for money that has been collected for goods or services that have not yet been delivered; payment received in advance of providing a good or service. Also called deferred revenue or deferred income.

Limit up

A limit move in the futures market in which the price at which a transaction would be made is at or above the upper limit.

Limit down

A limit move in the futures market in which the price at which a transaction would be made is at or below the lower limit.

Standing limit orders

A limit order at a price below market and which therefore is waiting to trade.

Current ratio

A liquidity ratio calculated as current assets divided by current liabilities.

Defensive interval ratio

A liquidity ratio that estimates the number of days that an entity could meet cash needs from liquid assets; calculated as (cash + short-term marketable investments + receivables) divided by daily cash expenditures.

Chart of accounts

A list of accounts used in an entity's accounting system.

Combination

A listing in which the order of the listed items does not matter.

Bilateral loan

A loan from a single lender to a single borrower.

Interest-only mortgage

A loan in which no scheduled principal repayment is specified for a certain number of years.

Mortgage loan

A loan secured by the collateral of some specified real estate property that obliges the borrower to make a predetermined series of payments to the lender.

Asset-based loan

A loan that is secured with company assets.

Trend

A long-term pattern of movement in a particular direction.

Order-driven markets

A market (generally an auction market) that uses rules to arrange trades based on the orders that traders submit; in their pure form, such markets do not make use of dealers.

Oversold

A market condition in which market sentiment is thought to be unsustainably bearish.

Overbought

A market condition in which market sentiment is thought to be unsustainably bullish.

Efficient market

A market in which asset prices reflect new information quickly and rationally.

Informationally efficient market

A market in which asset prices reflect new information quickly and rationally.

Brokered market

A market in which brokers arrange trades among their clients.

Quote-driven market

A market in which dealers acting as principals facilitate trading.

Strong-form efficient market

A market in which security prices reflect all public and private information.

Semi-strong-form efficient market

A market in which security prices reflect all publicly known and available information.

Continuous trading market

A market in which trades can be arranged and executed any time the market is open.

Call market

A market in which trades occur only at a particular time and place (i.e., when the market is called).

Imperfect competition

A market structure in which an individual firm has enough share of the market (or can control a certain segment of the market) such that it is able to exert some influence over price.

Perfect competition

A market structure in which the individual firm has virtually no impact on market price, because it is assumed to be a very small seller among a very large number of firms selling essentially identical products.

Utility function

A mathematical representation of the satisfaction derived from a consumption basket.

Covariance matrix

A matrix or square array whose entries are covariances; also known as a variance-covariance matrix.

Winsorized mean

A mean computed after assigning a stated percent of the lowest values equal to one specified low value, and a stated percent of the highest values equal to one specified high value.

Trimmed mean

A mean computed after excluding a stated small percentage of the lowest and highest observations.

Market

A means of bringing buyers and sellers together to exchange goods and services.

Enterprise value

A measure of a company's total market value from which the value of cash and short-term investments have been subtracted.

Geometric mean

A measure of central tendency computed by taking the nth root of the product of n non-negative values.

Spearman rank correlation coefficient

A measure of correlation applied to ranked data.

Population standard deviation

A measure of dispersion relating to a population in the same unit of measurement as the observations, calculated as the positive square root of the population variance.

Population variance

A measure of dispersion relating to a population, calculated as the mean of the squared deviations around the population mean.

Financial leverage ratio

A measure of financial leverage calculated as average total assets divided by average total equity.

CBOE Volatility Index

A measure of near-term market volatility as conveyed by S&P 500 stock index option prices.

Treynor ratio

A measure of risk-adjusted performance that relates a portfolio's excess returns to the portfolio's beta.

Duration

A measure of the approximate sensitivity of a security to a change in interest rates (i.e., a measure of interest rate risk).

Covariance

A measure of the co-movement (linear association) between two random variables.

Modified duration

A measure of the percentage price change of a bond given a change in its yield-to-maturity.

Money duration

A measure of the price change in units of the currency in which the bond is denominated given a change in its yield-to-maturity.

Income elasticity of demand

A measure of the responsiveness of demand to changes in income, defined as the percentage change in quantity demanded divided by the percentage change in income.

Beta

A measure of the sensitivity of a given investment or portfolio to movements in the overall market.

Vega

A measure of the sensitivity of an option's price to changes in the underlying's volatility.

Elasticity of supply

A measure of the sensitivity of quantity supplied to a change in price.

Operating cycle

A measure of the time needed to convert raw materials into cash from a sale; it consists of the number of days of inventory and the number of days of receivables.

Capital consumption allowance

A measure of the wear and tear (depreciation) of the capital stock that occurs in the production of goods and services.

A measure of what a portfolio would have returned if it had taken on the same total risk as the market index.

Weighted average life

A measure that gives investors an indication of how long they can expect to hold the MBS before it is paid off; the convention-based average time to receipt of all principal repayments. Also called average life.

Nominal scale

A measurement scale that categorizes data but does not rank them.

Ratio scales

A measurement scale that has all the characteristics of interval measurement scales as well as a true zero point as the origin.

Interval scale

A measurement scale that not only ranks data but also gives assurance that the differences between scale values are equal.

Ordinal scale

A measurement scale that sorts data into categories that are ordered (ranked) with respect to some characteristic.

Vote by proxy

A mechanism that allows a designated party—such as another shareholder, a shareholder representative, or management—to vote on the shareholder's behalf.

If-converted method

A method for accounting for the effect of convertible securities on earnings per share (EPS) that specifies what EPS would have been if the convertible securities had been converted at the beginning of the period, taking account of the effects of conversion on net income and the weighted average number of shares outstanding.

Treasury stock method

A method for accounting for the effect of options (and warrants) on earnings per share (EPS) that specifies what EPS would have been if the options and warrants had been exercised and the company had used the proceeds to repurchase common stock.

Debt-rating approach

A method for estimating a company's before-tax cost of debt based upon the yield on comparably rated bonds for maturities that closely match that of the company's existing debt.

Pure-play method

A method for estimating the beta for a company or project; it requires using a comparable company's beta and adjusting it for financial leverage differences.

Acquisition method

A method of accounting for a business combination where the acquirer is required to measure each identifiable asset and liability at fair value. This method was the result of a joint project of the IASB and FASB aiming at convergence in standards for the accounting of business combinations.

Key rate duration

A method of measuring the interest rate sensitivities of a fixed-income instrument or portfolio to shifts in key points along the yield curve.

Completed contract

A method of revenue recognition in which the company does not recognize any revenue until the contract is completed; used particularly in long-term construction contracts.

Cost recovery method

A method of revenue recognition in which the seller does not report any profit until the cash amounts paid by the buyer—including principal and interest on any financing from the seller—are greater than all the seller's costs for the merchandise sold.

Percentage-of-completion

A method of revenue recognition in which, in each accounting period, the company estimates what percentage of the contract is complete and then reports that percentage of the total contract revenue in its income statement.

Target balance

A minimum level of cash to be held available—estimated in advance and adjusted for known funds transfers, seasonality, or other factors.

Price floor

A minimum price for a good or service, typically imposed by government action and typically above the equilibrium price.

Binomial model

A model for pricing options in which the underlying price can move to only one of two possible new prices.

Return-generating model

A model that can provide an estimate of the expected return of a security given certain parameters and estimates of the values of the independent variables in the model.

Multi-factor model

A model that explains a variable in terms of the values of a set of factors.

Change in quantity supplied

A movement along a given supply curve.

Closed-end fund

A mutual fund in which no new investment money is accepted. New investors invest by buying existing shares, and investors in the fund liquidate by selling their shares to other investors.

No-load fund

A mutual fund in which there is no fee for investing in the fund or for redeeming fund shares, although there is an annual fee based on a percentage of the fund's net asset value.

Load fund

A mutual fund in which, in addition to the annual fee, a percentage fee is charged to invest in the fund and/or for redemptions from the fund.

Open-end fund

A mutual fund that accepts new investment money and issues additional shares at a value equal to the net asset value of the fund at the time of investment.

Negative externality

A negative effect (e.g., pollution) of a market transaction that is borne by parties other than those who transacted; a spillover cost.

Deadweight loss

A net loss of total (consumer and producer) surplus.

Convenience yield

A non-monetary advantage of holding an asset.

Special purpose entity

A non-operating entity created to carry out a specified purpose, such as leasing assets or securitizing receivables; can be a corporation, partnership, trust, limited liability, or partnership formed to facilitate a specific type of business activity. Also called special purpose vehicle or variable interest entity.

Prepaid expense

A normal operating expense that has been paid in advance of when it is due.

Floating-rate notes

A note on which interest payments are not fixed, but instead vary from period to period depending on the current level of a reference interest rate.

Divisor

A number (denominator) used to determine the value of a price return index. It is initially chosen at the inception of an index and subsequently adjusted by the index provider, as necessary, to avoid changes in the index value that are unrelated to changes in the prices of its constituent securities.

Probability

A number between 0 and 1 describing the chance that a stated event will occur.

Correlation

A number between −1 and +1 that measures the comovement (linear association) between two random variables.

Correlation coefficient

A number between −1 and +1 that measures the consistency or tendency for two investments to act in a similar way. It is used to determine the effect on portfolio risk when two assets are combined.

Gamma

A numerical measure of how sensitive an option's delta (the sensitivity of the derivative's price) is to a change in the value of the underlying.

Parallel shift

A parallel yield curve shift implies that all rates change by the same amount in the same direction.

Lockbox system

A payment system in which customer payments are mailed to a post office box and the banking institution retrieves and deposits these payments several times a day, enabling the company to have use of the fund sooner than in a centralized system in which customer payments are sent to the company.

Defined-benefit plan

A pension plan that specifies the plan sponsor's obligations in terms of the benefit to plan participants.

Defined-contribution plan

A pension plan that specifies the sponsor's obligations in terms of contributions to the pension fund rather than benefits to plan participants.

Recession

A period during which real GDP decreases (i.e., negative growth) for at least two successive quarters, or a period of significant decline in total output, income, employment, and sales usually lasting from six months to a year.

Perpetuity

A perpetual annuity, or a set of never-ending level sequential cash flows, with the first cash flow occurring one period from now. A bond that does not mature.

Household

A person or a group of people living in the same residence, taken as a basic unit in economic analysis.

Voluntarily unemployed

A person voluntarily outside the labor force, such as a jobless worker refusing an available vacancy.

Underemployed

A person who has a job but has the qualifications to work a significantly higher-paying job.

Discouraged worker

A person who has stopped looking for a job or has given up seeking employment.

Security characteristic line

A plot of the excess return of a security on the excess return of the market.

Security market index

A portfolio of securities representing a given security market, market segment, or asset class.

Short position

A position in an asset or contract in which one has sold an asset one does not own, or in which a right under a contract can be exercised against oneself.

Long position

A position in an asset or contract in which one owns the asset or has an exercisable right under the contract.

Positive externality

A positive effect (e.g., improved literacy) of a market transaction that is borne by parties other than those who transacted; a spillover benefit.

Outcome

A possible value of a random variable.

Double coincidence of wants

A prerequisite to barter trades, in particular that both economic agents in the transaction want what the other is selling.

Candlestick chart

A price chart with four bits of data for each time interval. A candle indicates the opening and closing price for the interval. The body of the candle is shaded if the opening price was higher than the closing price, and the body is clear if the opening price was lower than the closing price. Vertical lines known as wicks or shadows extend from the top and bottom of the candle to indicate the high and the low prices for the interval.

Bar chart

A price chart with four bits of data for each time interval—the high, low, opening, and closing prices. A vertical line connects the high and low. A cross-hatch left indicates the opening price and a cross-hatch right indicates the close.

Laspeyres index

A price index created by holding the composition of the consumption basket constant.

Bollinger Bands

A price-based technical analysis indicator consisting of a moving average plus a higher line representing the moving average plus a set number of standard deviations from average price (for the same number of periods as used to calculate the moving average) and a lower line that is a moving average minus the same number of standard deviations.

Derivative pricing rule

A pricing rule used by crossing networks in which a price is taken (derived) from the price that is current in the asset's primary market.

Discriminatory pricing rule

A pricing rule used in continuous markets in which the limit price of the order or quote that first arrived determines the trade price.

Addition rule for probabilities

A principle stating that the probability that A or B occurs (both occur) equals the probability that A occurs, plus the probability that B occurs, minus the probability that both Aand B occur.

A priori probability

A probability based on logical analysis rather than on observation or personal judgment.

Multivariate normal distribution

A probability distribution for a group of random variables that is completely defined by the means and variances of the variables plus all the correlations between pairs of the variables.

Multivariate distribution

A probability distribution that specifies the probabilities for a group of related random variables.

Subjective probability

A probability drawing on personal or subjective judgment.

Discount interest

A procedure for determining the interest on a loan or bond in which the interest is deducted from the face value in advance.

Systematic sampling

A procedure of selecting every kth member until reaching a sample of the desired size. The sample that results from this procedure should be approximately random.

Securitization

A process that involves moving assets into a special legal entity, which then uses the assets as guarantees to secure a bond issue.

Mutual fund

A professionally managed investment pool in which investors in the fund typically each have a pro-rata claim on the income and value of the fund.

Return on total capital

A profitability ratio calculated as EBIT divided by the sum of short- and long-term debt and equity.

Pretax margin

A profitability ratio calculated as earnings before taxes divided by revenue.

Return on equity (ROE)

A profitability ratio calculated as net income divided by average shareholders' equity.

Return on assets (ROA)

A profitability ratio calculated as net income divided by average total assets; indicates a company's net profit generated per dollar invested in total assets.

Operating profit margin

A profitability ratio calculated as operating income (i.e., income before interest and taxes) divided by revenue. Also called operating margin.

Stackelberg model

A prominent model of strategic decisionmaking in which firms are assumed to make their decisions sequentially.

Skewness

A quantitative measure of skew (lack of symmetry); a synonym of skew.

Measures of location

A quantitative measure that describes the location or distribution of data; includes not only measures of central tendency but also other measures such as percentiles.

Measure of central tendency

A quantitative measure that specifies where data are centered.

Statistic

A quantity computed from or used to describe a sample of data.

Sample statistic

A quantity computed from or used to describe a sample.

Random variable

A quantity whose future outcomes are uncertain.

Stated annual interest rate

A quoted interest rate that does not account for compounding within the year. Also called quoted interest rate.

Quoted interest rate

A quoted interest rate that does not account for compounding within the year. Also called stated annual interest rate.

Bank discount basis

A quoting convention that annualizes, on a 360-day year, the discount as a percentage of face value.

Continuous random variable

A random variable for which the range of possible outcomes is the real line (all real numbers between −∞ and +∞ or some subset of the real line).

Bernoulli random variable

A random variable having the outcomes 0 and 1.

Discrete random variable

A random variable that can take on at most a countable number of possible values.

Nominal rate

A rate of interest based on the security's face value.

Interest rate

A rate of return that reflects the relationship between differently dated cash flows; a discount rate.

Price relative

A ratio of an ending price over a beginning price; it is equal to 1 plus the holding period return on the asset.

Price multiple

A ratio that compares the share price with some sort of monetary flow or value to allow evaluation of the relative worth of a company's stock.

Drawdown

A reduction in net asset value (NAV).

Reverse stock split

A reduction in the number of shares outstanding with a corresponding increase in share price, but no change to the company's underlying fundamentals.

Market model

A regression equation that specifies a linear relationship between the return on a security (or portfolio) and the return on a broad market index.

Demand function

A relationship that expresses the quantity demanded of a good or service as a function of own-price and possibly other variables.

Reverse repo

A repurchase agreement viewed from the perspective of the cash lending counterparty.

Reverse repurchase agreement

A repurchase agreement viewed from the perspective of the cash lending counterparty.

Margin call

A request for the short to deposit additional funds to bring their balance up to the initial margin.

Clawback

A requirement that the GP return any funds distributed as incentive fees until the LPs have received back their initial investment and a percentage of the total profit.

Valuation allowance

A reserve created against deferred tax assets, based on the likelihood of realizing the deferred tax assets in future accounting periods.

Inverse demand function

A restatement of the demand function in which price is stated as a function of quantity.

Dutch Book theorem

A result in probability theory stating that inconsistent probabilities create profit opportunities.

Statistically significant

A result indicating that the null hypothesis can be rejected; with reference to an estimated regression coefficient, frequently understood to mean a result indicating that the corresponding population regression coefficient is different from 0.

Total probability rule for expected value

A rule explaining the expected value of a random variable in terms of expected values of the random variable conditional on mutually exclusive and exhaustive scenarios.

Total probability rule

A rule explaining the unconditional probability of an event in terms of probabilities of the event conditional on mutually exclusive and exhaustive scenarios.

Sample skewness

A sample measure of degree of asymmetry of a distribution.

Sample excess kurtosis

A sample measure of the degree of a distribution's peakedness in excess of the normal distribution's peakedness.

Sample kurtosis

A sample measure of the degree of a distribution's peakedness.

Sample variance

A sample measure of the degree of dispersion of a distribution, calculated by dividing the sum of the squared deviations from the sample mean by the sample size minus 1.

Total factor productivity

A scale factor that reflects the portion of growth that is not accounted for by explicit factor inputs (e.g. capital and labor).

Linear scale

A scale in which equal distances correspond to equal absolute amounts. Also called arithmetic scale.

Logarithmic scale

A scale in which equal distances represent equal proportional changes in the underlying quantity.

Measurement scales

A scheme of measuring differences. The four types of measurement scales are nominal, ordinal, interval, and ratio.

Second lien

A secured interest in the pledged assets that ranks below first lien debt in both collateral protection and priority of payment.

Organized exchange

A securities marketplace where buyers and seller can meet to arrange their trades.

Collateralized mortgage obligation

A security created through the securitization of a pool of mortgage-related products (mortgage pass-through securities or pools of loans).

Mortgage pass-through security

A security created when one or more holders of mortgages form a pool of mortgages and sell shares or participation certificates in the pool.

Depository receipt

A security that trades like an ordinary share on a local exchange and represents an economic interest in a foreign company.

Spot rates

A sequence of market discount rates that correspond to the cash flow dates; yields-to-maturity on zero-coupon bonds maturing at the date of each cash flow.

Fibonacci sequence

A sequence of numbers starting with 0 and 1, and then each subsequent number in the sequence is the sum of the two preceding numbers. In Elliott Wave Theory, it is believed that market waves follow patterns that are the ratios of the numbers in the Fibonacci sequence.

Spot curve

A sequence of yields-to-maturity on zero-coupon bonds. Sometimes called zero or strip curve because coupon payments are "stripped" off of the bonds.

Par curve

A sequence of yields-to-maturity such that each bond is priced at par value. The bonds are assumed to have the same currency, credit risk, liquidity, tax status, and annual yields stated for the same periodicity.

Forward curve

A series of forward rates, each having the same timeframe.

Change in supply

A shift in the supply curve.

Commercial paper

A short-term, negotiable, unsecured promissory note that represents a debt obligation of the issuer.

Point estimate

A single numerical estimate of an unknown quantity, such as a population parameter.

Interest coverage

A solvency ratio calculated as EBIT divided by interest payments.

Debt-to-assets ratio

A solvency ratio calculated as total debt divided by total assets.

Debt-to-capital ratio

A solvency ratio calculated as total debt divided by total debt plus total shareholders' equity.

Debt-to-equity ratio

A solvency ratio calculated as total debt divided by total shareholders' equity.

Fixed charge coverage

A solvency ratio measuring the number of times interest and lease payments are covered by operating income, calculated as (EBIT + lease payments) divided by (interest payments + lease payments).

Consumption basket

A specific combination of the goods and services that a consumer wants to consume.

Consumption bundle

A specific combination of the goods and services that a consumer wants to consume.

Stress testing

A specific type of scenario analysis that estimates losses in rare and extremely unfavorable combinations of events or scenarios.

Order

A specification of what instrument to trade, how much to trade, and whether to buy or sell.

Trade credit

A spontaneous form of credit in which a purchaser of the goods or service is financing its purchase by delaying the date on which payment is made.

Measure of value

A standard for measuring value; a function of money.

Autarky

A state in which a country does not trade with other countries.

Credit scoring model

A statistical model used to classify borrowers according to creditworthiness.

Paired comparisons test

A statistical test for differences based on paired observations drawn from samples that are dependent on each other.

Acid-test ratio

A stringent measure of liquidity that indicates a company's ability to satisfy current liabilities with its most liquid assets, calculated as (cash + short-term marketable investments + receivables) divided by current liabilities.

Quick ratio

Credit tranching

A structure used to redistribute the credit risk associated with the collateral; a set of bond classes created to allow investors a choice in the amount of credit risk that they prefer to bear.

Collateralized bond obligations

A structured asset-backed security that is collateralized by a pool of bonds.

Collateralized loan obligations

A structured asset-backed security that is collateralized by a pool of loans.

Simple random sample

A subset of a larger population created in such a way that each element of the population has an equal probability of being selected to the subset.

Sample

A subset of a population.

Currency swap

A swap in which each party makes interest payments to the other in different currencies.

Total return swap

A swap in which one party agrees to pay the total return on a security. Often used as a credit derivative, in which the underlying is a bond.

Commodity swap

A swap in which the underlying is a commodity such as oil, gold, or an agricultural product.

Interest rate swap

A swap in which the underlying is an interest rate. Can be viewed as a currency swap in which both currencies are the same and can be created as a combination of currency swaps.

Equity swap

A swap transaction in which at least one cash flow is tied to the return to an equity portfolio position, often an equity index.

Frequency distribution

A tabular display of data summarized into a relatively small number of intervals.

Tax loss carry forward

A taxable loss in the current period that may be used to reduce future taxable income.

Point and figure chart

A technical analysis chart that is constructed with columns of X's alternating with columns of O's such that the horizontal axis represents only the number of changes in price without reference to time or volume.

Flags

A technical analysis continuation pattern formed by parallel trendlines, typically over a short period.

Pennants

A technical analysis continuation pattern formed by trendlines that converge to form a triangle, typically over a short period.

Put/call ratio

A technical analysis indicator that evaluates market sentiment based upon the volume of put options traded divided by the volume of call options traded for a particular financial instrument.

Relative strength index

A technical analysis momentum oscillator that compares a security's gains with its losses over a set period.

Dead cross

A technical analysis term that describes a situation where a short-term moving average crosses from above a longer-term moving average to below it; this movement is considered bearish.

Golden cross

A technical analysis term that describes a situation where a short-term moving average crosses from below a longer-term moving average to above it; this movement is considered bullish.

Elliott wave theory

A technical analysis theory that claims that the market follows regular, repeated waves or cycles.

Change in polarity principle

A tenet of technical analysis that once a support level is breached, it becomes a resistance level. The same holds true for resistance levels; once breached, they become support levels.

Growth cyclical

A term sometimes used to describe companies that are growing rapidly on a long-term basis but that still experience above-average fluctuation in their revenues and profits over the course of a business cycle.

Two-sided hypothesis test

A test in which the null hypothesis is rejected in favor of the alternative hypothesis if the evidence indicates that the population parameter is either smaller or larger than a hypothesized value.

Two-tailed hypothesis test

A test in which the null hypothesis is rejected in favor of the alternative hypothesis if the evidence indicates that the population parameter is either smaller or larger than a hypothesized value.

One-sided hypothesis test

A test in which the null hypothesis is rejected only if the evidence indicates that the population parameter is greater than (smaller than) θ0. The alternative hypothesis also has one side.

One-tailed hypothesis test

A test in which the null hypothesis is rejected only if the evidence indicates that the population parameter is greater than (smaller than) θ0. The alternative hypothesis also has one side.

Out-of-sample test

A test of a strategy or model using a sample outside the time period on which the strategy or model was developed.

Nonparametric test

A test that is not concerned with a parameter, or that makes minimal assumptions about the population from which a sample comes.

Planning horizon

A time period in which all factors of production are variable, including technology, physical capital, and plant size.

Voluntary export restraint

A trade barrier under which the exporting country agrees to limit its exports of the good to its trading partners to a specific number of units.

Pairs arbitrage trade

A trade in two closely related stocks involving the short sale of one and the purchase of the other.

Buyback

A transaction in which a company buys back its own shares. Unlike stock dividends and stock splits, share repurchases use corporate cash.

Share repurchase

A transaction in which a company buys back its own shares. Unlike stock dividends and stock splits, share repurchases use corporate cash.

Short selling

A transaction in which borrowed securities are sold with the intention to repurchase them at a lower price at a later date and return them to the lender.

Standardizing

A transformation that involves subtracting the mean and dividing the result by the standard deviation.

Asset-backed securities

A type of bond issued by a legal entity called a special purpose entity (SPE) on a collection of assets that the SPE owns. Also, securities backed by receivables and loans other than mortgages.

Auction

A type of bond issuing mechanism often used for sovereign bonds that involves bidding.

Refinancing rate

A type of central bank policy rate.

Credit default swap (CDS)

A type of credit derivative in which one party, the credit protection buyer who is seeking credit protection against a third party, makes a series of regularly scheduled payments to the other party, the credit protection seller. The seller makes no payments until a credit event occurs.

Backup lines of credit

A type of credit enhancement provided by a bank to an issuer of commercial paper to ensure that the issuer will have access to sufficient liquidity to repay maturing commercial paper if issuing new paper is not a viable option.

CFA Level 1 Glossary Terms

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