All Terms Flashcards
Investment
An investment is that it is deferred consumption. Any net outlay of cash made with the prospect of receiving future benefits might be considered an investment.
Traditional Investments
Traditional investments include publicly traded equities, fixed-income securities, and cash.
Real assets
Real assets are investments in which the underlying assets involve direct ownership of nonfinancial assets rather than ownership through financial assets, such as the securities of manufacturing or service enterprises.
Farmland
Farmland consists of land cultivated for row crops (e.g., vegetables and grains) and permanent crops (e.g., orchards and vineyards).
Financial Asset
A financial asset is not a real asset; it is a claim on cash flows, such as a share of stock or a bond.
Infrastructure Investments
Infrastructure investments are claims on the income of toll roads, regulated utilities, ports, airports, and other real assets that are traditionally held and controlled by the public sector (i.e., various levels of government).
Hedge Fund
A hedge fund is a privately organized investment vehicle that uses its less regulated nature to generate investment opportunities that are substantially distinct from those offered by traditional investment vehicles, which are subject to regulations such as those restricting their use of derivatives and leverage.
Private equity
The term private equity is used in the CAIA curriculum to include both equity and debt positions that, among other things, are not publicly traded.
Distressed Debt
Distressed debt refers to the debt of companies that have filed or are likely to file in the near future for bankruptcy protection.
Mezzanine Debt
Mezzanine debt derives its name from its position in the capital structure of a firm: between the senior secured debt and equity.
Structured Products
Structured products are instruments created to exhibit particular return, risk, taxation, or other attributes.
Absolute return products
Absolute return products are investment products viewed as having little or no return correlation with traditional assets, and have investment performance that is often analyzed on an absolute basis rather than relative to the performance of traditional investments.
Diversifier
A diversifier is an investment with a primary purpose of contributing diversification benefits to its owner.
Illiquidity
Illiquidity means that the investment trades infrequently or with low volume (i.e., thinly).
Lumpy Assets
Lumpy assets are assets that can be bought and sold only in specific quantities, such as a large real estate project.
Efficiency
Efficiency refers to the tendency of market prices to reflect all available information.
Inefficiency
Inefficiency refers to the deviation of actual prices from valuations that would be anticipated in an efficient market.
Compensation Structure
Compensation structure refers to the ways that organizational issues, especially compensation schemes, influence particular investments.
Structuring
Structuring refers to the partitioning of claims to cash flows through leverage and securitization.
Regulatory
Regulatory factors in the context of investing refer to the role of government, including both regulation and taxation, in influencing the nature of an investment.
Trading Strategies
Trading strategies refer to the role of an investment vehicle’s investment managers in developing and implementing trading strategies that alter the nature of an investment.
Institutional Factors
Institutional factors refer to the financial markets (and their policies, such as restrictions on short selling, leverage, and trading) and financial institutions related to a particular investment, such as whether the investment is publicly traded.
Incomplete markets
Incomplete markets refer to markets with insufficient distinct investment opportunities.
Information asymmetries
Information asymmetries refer to the extent to which market participants possess different data and knowledge.
Moral Hazard
Moral hazard is risk that the behavior of one or more parties will change after entering into a contract.
Active Management
Active management refers to efforts of buying and selling securities in pursuit of superior combinations of risk and return.
Passive Investing
Passive investing tends to focus on buying and holding securities in an effort to match the risk and return of a target, such as a highly diversified index.
Innovation
Innovation is the application of creativity.
Active Return
Active return is the difference between the return of a portfolio and its benchmark that is due to active management.
Active Risk
Active risk is that risk that causes a portfolio’s return to deviate from the return of a benchmark due to active management.
Benchmark
A benchmark is a performance standard for a portfolio that reflects the preferences of an investor with regard to risk and return.
Benchmark Return
A benchmark return is the return of the benchmark index or benchmark portfolio.
Absolute return standard
An absolute return standard means that returns are to be evaluated relative to zero, a fixed rate, or relative to the riskless rate, and therefore independently of performance in equity markets, debt markets, or any other markets.
Relative return standard
A relative return standard means that returns are to be evaluated relative to a benchmark.
Pure arbitrage
Pure arbitrage is the attempt to earn risk-free profits through the simultaneous purchase and sale of identical positions trading at different prices in different markets.
Return diversifier
If the primary objective of including the product is the reduction in the portfolio’s risk that it is believed to offer through its lack of correlation with the portfolio’s other assets, then that product is often referred to as a return diversifier.
Return Enhancer
If the primary objective of including an investment product in a portfolio is the superior average returns that it is believed to offer, then that product is often referred to as a return enhancer.
Buy side
Buy side refers to the institutions and entities that buy large quantities of securities for the portfolios they manage.
Plan sponsor
A plan sponsor is a designated party, such as a company or an employer, that establishes a health care or retirement plan (pension) that has special legal or taxation status, such as a 401(k) retirement plan in the United States for employees.
Endowment
An endowment is a fund bestowed on an individual or institution (e.g., a museum, university, hospital, or foundation) to be used by that entity for specific purposes and with principal preservation in mind.
Family office
A family office is a group of investors joined by familial or other ties who manage their personal investments as a single entity, usually hiring professionals to manage money for members of the office.
Foundation
A foundation is a not-for-profit organization that donates funds and support to other organizations for its own charitable purposes.
Private limited partnerships
Private limited partnerships are a form of business organization that potentially offers the benefit of limited liability to the organization’s limited partners (similar to that enjoyed by shareholders of corporations) but not to its general partner.
Sovereign wealth funds
Sovereign wealth funds are state-owned investment funds held by that state’s central bank for the purpose of future generations and/or to stabilize the state currency.
Separately managed accounts
Separately managed accounts (SMAs) are individual investment accounts offered by a brokerage firm and managed by independent investment management firms.
‘40 Act funds
Mutual funds, or ‘40 Act funds, are registered investment pools offering their shareholders pro rata claims on the fund’s portfolio of assets.
Master limited partnerships (MLPs)
Master limited partnerships (MLPs) are publicly traded investment pools that are structured as limited partnerships and that offer their owners pro rata claims.
Mutual funds
Mutual funds, or ‘40 Act funds, are registered investment pools offering their shareholders pro rata claims on the fund’s portfolio of assets.
Sell side
Sell-side institutions, such as large dealer banks, act as agents for investors when they trade securities.
Large dealer banks
Large dealer banks are major financial institutions, such as Goldman Sachs, Deutsche Bank, and the Barclays Group, that deal in securities and derivatives.
Proprietary trading
Proprietary trading occurs when a firm trades securities with its own money in order to make a profit.
Back office operations
Back office operations play a supportive role in the maintenance of accounts and information systems used to transmit important market and trader information in all trading transactions, as well as in the clearance and settlement of the trades.
Front office operations
Front office operations involve investment decision-making and, in the case of brokerage firms, contact with clients.
Middle office operations
Middle office operations form the interface between the front office and the back office, with a focus on risk management.
Prime broker
The prime broker has the following primary functions: clearing and financing trades for its client, providing research, arranging financing, and producing portfolio accounting.
Fund administrator
The fund administrator maintains a general ledger account, marks the fund’s books, maintains its records, carries out monthly accounting, supplies its monthly profit and loss (P&L) statements, calculates its returns, verifies asset existence, independently calculates fees, and provides an unbiased, third-party resource for price confirmation on security positions.
Financial data providers
Financial data providers supply funds primarily with raw financial market data, including security prices, trading information, and indices.
Financial platforms
Financial platforms are systems that provide access to financial markets, portfolio management systems, accounting and reporting systems, and risk management systems.
Financial software
Financial software may consist of prepackaged software programs and computer languages tailored to the needs of financial organizations. Some funds use open-source software, and others pay licensing fees for proprietary software.
Hedge fund infrastructure
The hedge fund infrastructure may have three main financial components: (1) platforms, (2) software, and (3) data providers.
Consulting conflicts of interest
Consulting conflicts of interest can emerge when consultants are compensated by money managers because this form of payment can detract from the ability to offer independent advice to clients and encourage the consultant to favor the money managers offering compensation.
Commercial bank
A commercial bank focuses on the business of accepting deposits and making loans, with modest investment-related services.
Custodians
Depositories and custodians are very similar entities that are responsible for holding their clients’ cash and securities and settling clients’ trades, both of which maintain the integrity of clients’ assets while ensuring that trades are settled quickly.
Depositories
Depositories and custodians are very similar entities that are responsible for holding their clients’ cash and securities and settling clients’ trades, both of which maintain the integrity of clients’ assets while ensuring that trades are settled quickly.
Depository Trust Company (DTC)
The Depository Trust Company (DTC) is the principal holding body of securities for traders all over the world and is part of the Depository Trust and Clearing Corporation (DTCC), which provides clearing, settlement, and information services
Investment bank
An investment bank focuses on providing sophisticated investment services, including underwriting and raising capital, as well as other activities such as brokerage services, mergers, and acquisitions.
Universal banking
Germany uses universal banking, which means that German banks can engage in both commercial and investment banking.
Limited liability
Limited liability is the protection of investors from losses that exceed their investment.
Passive investments
In the context of limiting liability, passive investments are positions in entities (such as operating firms or investment firms) over which the owner of the position does not exert substantial control and therefore may receive reduced liability exposures and/or passive investment tax treatments.
Probity
Probity is the quality of exercising strong principles such as honesty, decency, and integrity.
Limited liability company (LLC)
A limited liability company (LLC) is a distinct entity: (1) designed to offer its investors (“members”) protection from losses exceeding their investments absent fraud or other activities that could “pierce the veil” between the member’s ownership interest in the LLC and the member’s other holdings, and (2) that does not require that distributions and any other advantages of ownership be made in proportion to each member’s capital contribution to the firm.
Special purpose vehicle (SPV)
A special purpose vehicle (SPV) is a legal entity at the heart of a CDO structure that is established to accomplish a specific transaction, such as holding the collateral portfolio.
Feeder fund
A feeder fund is a legal structure through which investors have access to the investment performance of the master trust.
Master trust
The master trust is the legal structure used to invest the assets of both onshore investors and offshore investors in a consistent if not identical manner, so that both funds share the benefit of the fund manager’s insights.
Special purpose entity (SPE)
A special purpose vehicle (SPV) or special purpose entity (SPE) is a legal entity such as an LLC that serves a specific function (such as holding assets),often with the goal of being bankruptcy remote.
Master-feeder funds
Master-feeder funds are designed to provide efficient access to investors who are subject to different taxation but wish to invest in the same portfolio.
Management company operating agreement
A management company operating agreement is an agreement between members related to a limited liability company and the conduct of its business as it pertains to the law.
Partnership agreement
A partnership agreement is a formal written contract creating a partnership.
Private-placement memoranda
Private-placement memoranda (a.k.a. offering documents) are formal descriptions of an investment opportunity that comply with federal securities regulations.
Subscription agreement
A subscription agreement is an application submitted by an investor who desires to join a limited partnership.
Adverse selection
Adverse selection takes place before a transaction is completed, when the decisions made by one party cause less desirable parties to be attracted to the transaction.
Limited partnership agreement (LPA)
The limited partnership agreement (LPA) defines its legal framework and its terms and conditions.
Qualified majority
A qualified majority is generally more than 75% of LPs in contrast to the over 50% required for a simple majority.
Limited partner advisory committee (LPAC)
The LP advisory committee (LPAC)’s responsibilities are defined in the LPA and normally relate to dealing with conflicts of interest, reviewing valuation methods, and any other consents predefined in the LPA.
Primary market
A primary market refers to the methods, institutions, and mechanisms involved in the placement of new securities to investors.
Secondary market
A secondary market facilitates trading among investors of previously existing securities.
Limit orders
In major markets, limit orders can be placed by market participants to buy securities at specified maximum prices or sell securities at specified minimum prices.
Securitization
Securitization involves bundling assets, especially unlisted assets, and issuing claims on the bundled assets.
Bid-ask spread
The price difference between the highest bid price (the best bid price) and the lowest offer (the best ask price) is the bid-ask spread.
Market making
Market making is a practice whereby an investment bank or another market participant deals securities by regularly offering to buy securities and sell securities.
Market orders
Market participants that wish to have transactions executed without delay may place market orders, which cause immediate execution at the best available price.
Market takers
Participants that place market orders are market takers, which buy at ask prices and sell at bid prices, generally paying the bid-ask spread for taking liquidity.
Third markets
Third markets are regional exchanges where stocks listed in primary secondary markets can also be traded. In the United States, third markets allow brokers and dealers to set up trades away from an exchange by listing their prices on the NASDAQ Intermarket.
Systemic risk
Systemic risk is the potential for economy-wide losses attributable to failures or concerns over potential failures in financial markets, financial institutions, or major participants.
Fourth markets
Fourth markets are electronic exchanges that allow traders to quickly buy and sell exchange-listed stocks via the electronic.
Liquid alternative
Liquid alternatives are investment vehicles that offer alternative strategies in a form that provides investors with liquidity through opportunities to sell their positions in a market.
Hedge fund replication
Hedge fund replication is the attempt to mimic the returns of an illiquid or highly sophisticated hedge fund strategy using liquid assets and simplified trading rules.
Closed-end mutual fund
Closed-end mutual fund structures provide investors with relatively liquid access to the returns of underlying assets even when the underlying assets are illiquid.
Progressive taxation
Progressive taxation places higher-percentage taxation on individuals and corporations with higher incomes.
Section 1256 contracts
Section 1256 contracts include many futures and options contracts; have potentially enormous tax advantages in the United States. including having their income treated as 60% long-term capital gain and 40% short-term capital gain regardless of holding period.
Short selling
Short selling financial assets is the process of borrowing securities from a securities lender, selling the securities at their market price, and eventually purchasing identical securities in the market to extinguish the loan from the securities lender.
Street name
Street name refers to the brokerage practice of having the direct legal ownership of customer securities held in the name of the brokerage firm on behalf of the customers rather than having the legal ownership of the shares reside directly with the economic owners of the securities (i.e., the customers of the brokerage firm).
Rebate
A rebate is a payment of interest to the securities’ borrower on the collateral posted.
Substitute dividends
Substitute dividends are cash flows paid by share borrowers to share lenders to compensate the lenders for the distributions paid by the corporation while the loan of stock is outstanding.
Dividend irrelevancy
Dividend irrelevancy is the proposition that, in the absence of imperfections such as income taxation that penalized dividends, the distribution of corporate dividends does not alter shareholder wealth.
Special stock
A special stock is a stock for which higher net fees are demanded when it is borrowed.
General collateral stocks
General collateral stocks, which are stocks not facing heavy borrowing demand, may earn a 2% rebate when Treasury bill rates are at 2%, whereas stocks on special may earn zero rebates or even negative rebates, wherein borrowers must pay the lenders money in addition to the interest that the lender is earning on the collateral.
Bought in
When the inventory of stock available to borrowers becomes extremely tight, short sellers may find their position bought in, meaning the broker revokes the borrowing privilege for that specific stock and requires the trader to cover the short position.
Short squeeze
A short squeeze occurs when holders of short positions are compelled to purchase shares at increasing prices to cover their positions due to limited liquidity.
Continuous compounding
Continuous compounding assumes that earnings can be instantaneously reinvested to generate additional earnings.
Discrete compounding
Discrete compounding includes any compounding interval other than continuous compounding such as daily, monthly, or annual.
Simple interest
Simple interest is an interest rate computation approach that does not incorporate compounding.
Log return
A log return is a continuously compounded return that can be formed by taking the natural logarithm of a wealth ratio: Rm = ∞ = ln(1 + R) where ln( ) is the natural logarithm function, Rm = ∞ is the log return, or continuously compounded return, and m is the number of compounding intervals per year.
Return computation interval
The return computation interval for a particular analysis is the smallest time interval for which returns are calculated, such as daily, monthly, or even annually.
Notional principal
Notional principal or notional value of a contract is the value of the asset underlying, or used as a reference to, the contract or derivative position.
return on notional principal
The return on notional principal divides economic gain or loss by the notional principal of the contract.
Fully collateralized
Fully collateralized means that a position (such as a forward contract) is assumed to be paired with a quantity of capital equal in value to the notional principal of the contract.
Partially collateralized
A partially collateralized position has collateral lower in value than the notional value.
Internal rate of return (IRR)
The internal rate of return (IRR) can be defined as the discount rate that equates the present value of the costs (cash outflows) of an investment with the present value of the benefits (cash inflows) from the investment.
Interim IRR
The interim IRR is a computation of IRR based on realized cash flows from an investment and its current estimated residual value.
Lifetime IRR
A lifetime IRR contains all of the cash flows, realized or anticipated, occurring over the investment’s entire life, from period 0 to period T.
Since-inception IRR
A since-inception IRR is commonly used as a measure of fund performance rather than the performance of an individual investment.
Borrowing type cash flow pattern
A borrowing type cash flow pattern begins with one or more cash inflows and is followed only by cash outflows.
Complex cash flow pattern
A complex cash flow pattern is an investment involving either borrowing or multiple sign changes.
Multiple sign change cash flow pattern
A multiple sign change cash flow pattern is an investment where the cash flows switch over time from inflows to outflows, or from outflows to inflows, more than once.
Scale differences
Scale differences are when investments have unequal sizes and/or timing of their cash flows.
Aggregation of IRRs
Aggregation of IRRs refers to the relationship between the IRRs of individual investments and the IRR of the combined cash flows of the investments.
Modified IRR
The modified IRR approach discounts all cash outflows into a present value using a financing rate, compounds all cash inflows into a future value using an assumed reinvestment rate, and calculates the modified IRR as the discount rate that sets the absolute values of the future value and the present value equal to each other.
Reinvestment rate assumption
The reinvestment rate assumption refers to the assumption of the rate at which any cash flows not invested in a particular investment or received during the investment’s life can be reinvested during the investment’s lifetime.
Dollar-weighted returns
Dollar-weighted returns are averaged returns that are adjusted for and therefore reflect when cash has been contributed or withdrawn during the averaging period.
Time-weighted returns
Time-weighted returns are averaged returns that assume that no cash was contributed or withdrawn during the averaging period, meaning after the initial investment.
Distribution to paid-in (DPI) ratio
The distribution to paid-in (DPI) ratio, or realized return, is the ratio of the cumulative distribution to investors to the total capital drawn from investors, and can loosely viewed as a non-annualized measure of income (actually, distributions) in the numerator to total investment in the denominator.
Total value to paid-in (DPI) ratio
The total value to paid-in (TVPI) ratio, or total return, is a measure of the cumulative distribution to investors plus the total value of the unrealized investments relative to the total capital drawn from investors, and is the sum of the income (DPI) and capital gain or loss (RVPI).
Residual value to paid-in (DPI) ratio
The residual value to paid-in (RVPI) ratio, or unrealized return, at time T is the ratio of the total value of the unrealized investments at time T to the total capital drawn from investors during the previous time periods, and can be loosely viewed as a measure of capital gain or loss, with a ratio of one indicating that, ignoring prior distributions, the investment has neither gained or lost value relative to the total contributions.
Public Market Equivalent (PME) Method
The Public Market Equivalent (PME) method uses a publicly traded securities index that is believed to have a similar risk exposure to private equity as a return target and requires or finds the corresponding premium over public equity (e.g., 300 to 500 basis points) for a private equity investment using the investment’s cash contributions (calls), distributions, and terminal value.
Accounting convention of conservatism
The accounting convention of conservatism holds that it is prudent to recognize potential expenses and liabilities as soon as possible but not to similarly anticipate potential revenues or gains, often resulting in an understatement of income and assets in the short run.
J-curve
The J-curve is the classic illustration of the early losses and later likely profitability of venture capital.
Financial Accounting Standard (FAS) 157
Financial Accounting Standard (FAS) 157, which was introduced in 2006, seeks to require asset managers to regularly value their investments at fair value, even when the valuation is not immediately observable from market prices.
Waterfall
The waterfall is a provision of the limited partnership agreement that specifies how distributions from a fund will be split and how the payouts will be prioritized.
Carried interest
Carried interest is synonymous with an incentive fee or a performance-based fee and is the portion of the profit paid to the GPs as compensation for their services, above and beyond management fees.
Catch-up provision
A catch-up provision permits the fund manager to receive a large share of profits once the hurdle rate of return has been achieved and passed.
Hurdle rate
A hurdle rate specifies a return level that LPs must receive before GPs begin to receive incentive fees.
Incentive fee
Carried interest is synonymous with an incentive fee or a performance-based fee and is the portion of the profit paid to the GPs as compensation for their services, above and beyond management fees.
Performance-based fee
Carried interest is synonymous with an incentive fee or a performance-based fee and is the portion of the profit paid to the GPs as compensation for their services, above and beyond management fees.
Preferred return
The term preferred return is often used synonymously with hurdle rate–a return level that LPs must receive before GPs begin to receive incentive fees.
Vesting
Vesting is the process of granting full ownership of conferred rights, such as incentive fees.
Clawback
A clawback clause, clawback provision, or clawback option is designed to return incentive fees to LPs when early profits are followed by subsequent losses.
Compensation scheme
The compensation scheme is the set of provisions and procedures governing management fees, general partner investment in the fund, carried-interest allocations, vesting, and distribution.
Catch-up rate
A catch-up provision contains a catch-up rate, which is the percentage of the profits used to catch up the incentive fee once the hurdle is met.
Management fees
Management fees are regular fees that are paid from the fund to the fund managers based on the size of the fund rather than the profitability of the fund.
Management fee offsets
Management fee offsets occur when all fees earned by general partners would reduce the management fee owed to the GP by the LPs.
Deal-by-deal carried interest
Deal-by-deal carried interest is when incentive fees are awarded separately based on the performance of each individual investment.
Fund-as-a-whole carried interest
Carried interest can be fund-as-a-whole carried interest, which is carried interest based on aggregated profits and losses across all the investments, or can be structured as deal-by-deal carried interest.
Hard hurdle rate
A hard hurdle rate limits incentive fees to profits in excess of the hurdle rate.
Soft hurdle rate
A soft hurdle rate allows fund managers to earn an incentive fee on all profits, given that the hurdle rate has been achieved.
Ex ante returns
Future possible returns and their probabilities are referred to as expectational or ex ante returns.
Ex post returns
Ex post returns are realized outcomes rather than anticipated outcomes.
Normal distribution
The normal distribution is the familiar bell-shaped distribution, also known as the Gaussian distribution.
Central limit theorem
The formal statistical explanation for the idea that a variable will tend toward a normal distribution as the number of independent influences becomes larger is known as the central limit theorem.
Lognormal distribution
A variable has a lognormal distribution if the distribution of the logarithm of the variable is normally distributed.
Mean
The most common raw moment is the first raw moment and is known as the mean, or expected value, and is an indication of the central tendency of the variable.
Variance
The variance is the second central moment and is the expected value of the deviations squared.
Skewness
The skewness is equal to the third central moment divided by the standard deviation of the variable cubed and serves as a measure of asymmetry.
Kurtosis
Kurtosis serves as an indicator of the peaks and tails of a distribution.
Excess kurtosis
Excess kurtosis provides a more intuitive measure of kurtosis relative to the normal distribution because it has a value of zero in the case of the normal distribution.
Leptokurtosis
If a return distribution has positive excess kurtosis, meaning it has more kurtosis than the normal distribution, it is said to be leptokurtic, leptokurtotic, or fat tailed, and to exhibit leptokurtosis.
Mesokurtosis
If a return distribution has no excess kurtosis, meaning it has the same kurtosis as the normal distribution, it is said to be mesokurtic, mesokurtotic, or normal tailed, and to exhibit mesokurtosis.
Platykurtosis
If a return distribution has negative excess kurtosis, meaning less kurtosis than the normal distribution, it is said to be platykurtic, platykurtotic, or thin tailed, and to exhibit platykurtosis.
Covariance
The covariance of the return of two assets is a measure of the degree or tendency of two variables to move in relationship with each other.
Correlation coefficient
The correlation coefficient (also called the Pearson correlation coefficient) measures the degree of association between two variables, but unlike the covariance, the correlation coefficient can be easily interpreted.
perfect linear negative correlation
A correlation coefficient of −1 indicates that the two assets move in the exact opposite direction and in the same proportion, a result known as perfect linear negative correlation.
Perfect linear positive correlation
A correlation coefficient of +1 indicates that the two assets move in the exact same direction and in the same proportion, a result known as perfect linear positive correlation.
Spearman rank correlation
The Spearman rank correlation is a correlation designed to adjust for outliers by measuring the relationship between variable ranks rather than variable values.
Beta
The beta of an asset is defined as the covariance between the asset’s returns and a return such as the market index, divided by the variance of the index’s return, or, equivalently, as the correlation coefficient multiplied by the ratio of the asset volatility to market volatility.
Autocorrelation
The autocorrelation of a time series of returns from an investment refers to the possible correlation of the returns with one another through time.
First-order autocorrelation
First-order autocorrelation refers to the correlation between the return in time period t and the return in the immediately previous time period, t−1.
Partial autocorrelation coefficient
A partial autocorrelation coefficient adjusts autocorrelation coefficients to iso- late the portion of the correlation in a time series attributable directly to a particular higher-order relation.
Jarque-Bera test
The Jarque-Bera test involves a statistic that is a function of the skewness and excess kurtosis of the sample: JB = (n/6)[S2 + (K2/4)] where JB is the Jarque-Bera test statistic, n is the number of observations, S is the skewness of the sample, and K is the excess kurtosis of the sample.
GARCH
GARCH (generalized autoregressive conditional heteroskedasticity) is an example of a time-series method that adjusts for varying volatility.
Heteroskedascity
Heteroskedasticity is when the variance of a variable changes with respect to a variable, such as itself or time.
Homoskedasticity
Homoskedasticity is when the variance of a variable is constant.
ARCH
ARCH (autoregressive conditional heteroscedasticity) is a special case of GARCH that allows future variances to rely only on past disturbances, whereas GARCH allows future variances to depend on past covariances as well.
Autoregressive
Autoregressive refers to when subsequent values to a variable are explained by past values of the same variable.
Conditionally heteroskedastic
Conditionally heteroskedastic financial market prices have different levels of return variation even when specified conditions are similar (e.g., when they are viewed at similar price levels).
Informational market efficiency
Informational market efficiency refers to the extent to which asset prices reflect available information.
Semistrong form informational market efficiency
The concept of semistrong form informational market efficiency (or semistrong level) refers to market prices reflecting all publicly available information (including not only past prices and volumes but also any publicly available information such as financial statements and other underlying economic data).
Strong form informational market efficiency
The concept of strong form informational market efficiency (or strong level) refers to market prices reflecting all publicly and privately available information.
Weak form informational market efficiency
Weak form informational market efficiency (or weak level) refers to market prices reflecting available data on past prices and volumes.
Inflation
Inflation is the decline in the value of money relative to the value of a general bundle of goods and services.
Term structure of interest rates
Sometimes the term structure of interest rates is distinguished from the yield curve because the yield curve plots yields to maturity of coupon bonds, whereas the term structure of interest rates plots actual or hypothetical yields of zero-coupon bonds.
Anticipated inflation rate
The anticipated inflation rate (π) is generally defined as a measure of the expected rate of change in the value of a currency measured through changes in overall price levels.
Real interest rate
The real interest rate is the annualized rate earned on default-free fixed-income investments, after adjusting the nominal rate downward for the effect of inflation.
Modified Fisher equation
The modified Fisher equation expresses the nominal interest rate as the combination of the after- tax real interest rate, r, and the anticipated rate of inflation (π), with an adjustment for the income tax rate, T.
Fisher effect or Fisher equation
The Fisher effect (or Fisher equation) states that the nominal interest rate (i) is equal to the sum of the real interest rate (r) and the expected inflation rate (π), when interest rates are expressed as continuously compounded rates.
Nominal interest rate
A nominal interest rate is the rate of return measured in terms of a given currency without a downward adjustment for the potential effects of positive inflation.
Yield to maturity
The yield to maturity of a fixed income instrument is the rate that discounts all of the promised cash flows of the instrument into a summed present value that equals the instrument’s market price.
Unbiased expectations theory
The unbiased expectations theory hypothesizes that all fixed-income securities offer the same expected return over the same time interval (i.e., there are no risk premiums), therefore serving as a useful tool in risk-neutral modeling in which all interest rates are formed purely on interest rate expectations.
Liquidity preference theory
The liquidity preference theory hypothesizes that longer-term fixed-income securities offer higher expected returns over the same time interval as shorter-term bonds, that risk premiums are positive and increasing in the bond’s longevity, that all interest rates are formed based on both interest rate expectations and risk premiums, and that fixed-income management reflects a trade-off between risk and return.
Market segmentation theory
The market segmentation theory hypothesizes that the preferred habitats of borrowers and lenders influence the expected returns of each maturity range, resulting in varying risk premiums and varying expected returns across maturity ranges that form humps and other non-monotonic shapes that are not eliminated by arbitrageurs (because the market is segmented).
Implied forward rate
An implied forward rate, F(t, T), is the annual return between time t and T (with T > t) inferred from the term structure of interest rates.
Arbitrage
Arbitrage is the attempt to earn riskless profits (in excess of the risk-free rate) by identifying and trading relatively mispriced assets.
Term structure of implied forward rates
The term structure of implied forward rates is the relationship between implied forward rates and the starting point of each rate and is often superimposed on the term structure of spot rates.
Arbitrage-free model
An arbitrage-free model is a financial model with relationships derived by the assumption that arbitrage opportunities do not exist, or at least do not persist.
Relative pricing model
A relative pricing model prescribes the relationship between two prices.
Key externality of arbitrage activities
A key externality of arbitrage activities is that they tend to drive similar assets toward similar prices which, in turn, improves global economic decisions.
Absolute pricing model
An absolute pricing model attempts to describe a price level based on its underlying economic factors.
Cash market
The spot market or cash market is any market in which transactions involve immediate payment and delivery: The buyer immediately pays the price, and the seller immediately delivers the product.
Spot market
The spot market or cash market is any market in which transactions involve immediate payment and delivery: The buyer immediately pays the price, and the seller immediately delivers the product.
Binomial tree
A binomial tree projects possible outcomes in a variable such as a security price or interest rate by modeling uncertainty as two movements: an upward movement and a downward movement.
Recombining binomial tree
A recombining binomial tree has n + 1 possible final outcomes for an n period tree, rather than 2n outcomes.
Risk-neutral model
A risk-neutral model is a framework for valuing financial derivatives in which risk preferences and probabilities of price changes do not alter the solution and are therefore irrelevant, and in which the analyst selects risk-neutrality as the model’s underlying assumption with regard to risk preferences.
Duration
The general definition of duration is the elasticity of a bond price with respect to a shift in its yield (or a uniform shift in the spot rates, corresponding to each prospective cash flow).
Interest rate immunization
Interest rate immunization is the process of eliminating all interest rate risk exposures.
Duration of a fixed coupon bond
The duration of a fixed-coupon bond is the weighted average of the longevities of the cash flows to a coupon bond where the weight of each of the bond’s cash flows is the proportion of the bond’s total value attributable to that cash flow.
Asset pricing model
An asset pricing model is a framework for specifying the return or price of an asset based on its risk, as well as future cash flows and payoffs.
Capital asset pricing model (CAPM)
The capital asset pricing model (CAPM) provides one of the easiest and most widely understood examples of single-factor asset pricing by demonstrating that the risk of the overall market index is the only risk that offers a risk premium.
Market portfolio
The market portfolio is a hypothetical portfolio containing all tradable assets in the world.
Market weight
The market weight of an asset is the proportion of the total value of that asset to the total value of all assets in the market portfolio.
Single-factor asset pricing model
A single-factor asset pricing model explains returns and systematic risk using a single risk factor.
Ex ante models
Ex ante models, such as ex ante asset pricing models, explain expected relationships, such as expected returns. Ex ante means “from before.”
Idiosyncratic return
Idiosyncratic return is the portion of an asset’s return that is unique to an investment and not driven by a common association.
Idiosyncratic risk
Idiosyncratic risk is the dispersion in economic outcomes caused by investment-specific effects. This section focuses on realized returns and the modeling of risk.
Systematic return
Systematic return is the portion of an asset’s return driven by a common association.
Systematic risk
Systematic risk is the dispersion in economic outcomes caused by variation in systematic return.
Ex post model
An ex post model describes realized returns and provides an understanding of risk and how it relates to the deviations of realized returns from expected returns.
Excess return
The excess return of an asset refers to the excess or deficiency of the asset’s return relative to the periodic risk-free rate.
Forward contract
A forward contract is simply an agreement calling for deferred delivery of an asset or a payoff.
Reference rate
A reference rate is a market rate specified in contracts such as a forward contract that fluctuates with market conditions and drives the magnitude and direction of cash settlements.
Forward rate agreement (FRA)
A forward rate agreement (FRA) is a cash-settled contract in which one party agrees to offer a specified or fixed rate (the FRA rate), such as an interest rate on a specified principal amount and over a specified time in the future (or a currency exchange rate at a specified time in the future) while the other party agrees to provide that rate.
Swap
A swap is a string of forward contracts grouped together that vary by time to settlement.
Financed positions
Financed positions enable economic ownership of an asset without the posting of the purchase price.
Carrying cost
The carrying cost is the cost of maintaining a position through time and includes direct costs, such as storage or custody costs, as well as opportunity costs, such as forgone cash flows.
Cost-of-carry model
A cost-of-carry model specifies a relationship between two positions that must exist if the only difference between the positions involves the expense of maintaining the positions.
Cost of carry
In the context of futures and forward contracts, a cost of carry (or carrying cost) is any financial difference between maintaining a position in the cash market and maintaining a position in the forward market.
Convenience yield
Convenience yield, y, is the economic benefit that the holder of an inventory in the commodity receives from directly holding the inventory rather than having a long position in a forward contract on the commodity.
Storage costs
Storage costs of physical commodities involve such expenditures as warehouse fees, insurance, transportation, and spoilage.
Marginal market participant
The marginal market participant to a derivative contract is any entity with individual costs and benefits that make the entity indifferent between physical positions and synthetic positions.
Open interest
The outstanding quantity of unclosed contracts is known as open interest.
Marked-to-market
The term marked-to-market means that the side of a futures contract that benefits from a price change receives cash from the other side of the contract (and vice versa) throughout the contract’s life.
Crisis at maturity
A crisis at maturity is when the party owing a payment is forced at the last moment to reveal that it cannot afford to make the payment or when the party obligated to deliver the asset at the original price is forced to reveal that it cannot deliver the asset.
Initial margin
The collateral deposit made at the initiation of a long or short futures position is called the initial margin.
Maintenance margin requirement
A maintenance margin requirement is a minimum collateral requirement imposed on an ongoing basis until a position is closed.
Margin call
A margin call is a demand for the posting of additional collateral to meet the initial margin requirement.
Rolling contracts
Rolling contracts refers to the process of closing positions in short-term futures contracts and simultaneously replacing the exposure by establishing similar positions with longer terms.
Distant contracts
Contracts with longer times to settlement are often called distant contracts, deferred contracts, or back contracts.
Front month contract
On an exchange, the futures contract with the shortest time to settlement is often referred to as the front month contract.
Naked option
A short option position that is unhedged is often referred to as a naked option.
Covered call
A covered call combines being long an asset with being short a call option on the same asset.
Protective put
A protective put combines being long an asset with a long position in a put option on the same asset.
Bear spread
An option combination in which the long option position is at the higher of two strike prices is a bear spread, which offers bearish exposure to the underlying asset that begins at the higher strike price and ends at the lower strike price.
Bull spread
An option combination in which the long option position is at the lower of two strike prices is a bull spread, which offers bullish exposure to the underlying asset that begins at the lower strike price and ends at the higher strike price.
Option spread
An option spread (1) contains either call options or put options (not both), and (2) contains both long and short positions in options with the same underlying asset.
Option combination
An option combination contains both calls and puts on the same underlying asset.
Option straddle
An option straddle is a position in a call and put with the same sign (i.e., long or short), the same underlying asset, the same expiration date, and the same strike price.
Option strangle
An option strangle is a position in a call and put with the same sign, the same underlying asset, the same expiration date, but different strike prices.
Ratio spreads
Spread positions termed ratio spreads can be formed in which the number of options in each position differ.
Option collar
An option collar generally refers only to the long position in a put and a short position in a call.
Risk reversal
A long out-of-the-money call combined with a short out-of- the-money put on the same asset and with the same expiration date is termed a risk reversal.
Put-call parity
Put-call parity is an arbitrage-free relationship among the values of an asset, a riskless bond, a call option, and a put option.
Black-Scholes call option formula
Black-Scholes call option formula expresses the price of a call option as a function of five variables: the price of the underlying asset, the strike price, the return volatility of the underlying asset, the time to the option’s expiration, and the riskless rate.
Rho
Rho is the sensitivity of an option price with respect to changes in the riskless interest rate.
Standard deviation
The square root of the variance is an extremely popular and useful measure of dispersion known as the standard deviation.
Volatility
In investment terminology, volatility is a popular term that is used synonymously with the standard deviation of returns.
Elasticity
An elasticity is the percentage change in a value with respect to a percentage change in another value.
Omicron
Omicron is the partial derivative of an option or a position containing an option to a change in the credit spread and is useful for analyzing option positions on credit-risky assets.
Lambda
Lambda or omega for a call option is the elasticity of an option price with respect to the price of the underlying asset and is equal to delta multiplied times the quantity (S/c).
Omega
Lambda or omega for a call option is the elasticity of an option price with respect to the price of the underlying asset and is equal to delta multiplied times the quantity (S/c).
Semivariance
The semivariance uses a formula otherwise identical to the variance formula except that it considers only the negative deviations. Semivariance is therefore expressed as: Semivariance = 1/Σ[Rt E(R)]2 For all Rt < E(R) where T is the number of negative deviations.
Semistandard deviation
Semistandard deviation, sometimes called semideviation, is the square root of semivariance.
Semivolatility
Semivolatility is similar to semistandard deviation except that it is unambiguously based on only the number of observations below the mean or threshold (T*) and it subtracts 0.5, rather than 1.0, from that number.
Shortfall risk
Shortfall risk is simply the probability that the return will be less than the investor’s target rate of return.
Target semistandard deviation
Target semistandard deviation (TSSD) is simply the square root of the target semivariance.
Target semivariance
Target semivariance is similar to semivariance except that target semivariance substitutes the investor’s target rate of return in place of the mean return.
Tracking error
Tracking error indicates the dispersion of the returns of an investment relative to a benchmark return, where a benchmark return is the contemporaneous realized return on an index or peer group of comparable risk.
Drawdown
Drawdown is defined as the maximum loss in the value of an asset over a specified time interval and is usually expressed in percentage-return form rather than currency.
Maximum drawdown
Maximum drawdown is defined as the largest decline over any time interval within the entire observation period.
Value at risk
Value at risk (VaR) is the loss figure associated with a particular percentile of a cumulative loss function.
Conditional value-at-risk
Conditional value-at-risk (CVaR), also known as expected tail loss, is the expected loss of the investor given that the Var has been equaled or exceeded.
Parametric VaR
A VaR computation assuming normality and using the statistics of the normal distribution is known as parametric VaR.
Monte Carlo analysis
Monte Carlo analysis is a type of simulation in which many potential paths of the future are projected using an assumed model, the results of which are analyzed as an approximation to the future probability distributions.
Benchmarking
Benchmarking, often referred to as performance benchmarking, is the process of selecting an investment index, an investment portfolio, or any other source of return as a standard (or benchmark) for comparison during performance analysis.
Peer group
The peer group is typically a group of funds with similar objectives, strategies, or portfolio holdings.
Performance attribution
Performance attribution, also known as return attribution, is the process of identifying the components of an asset’s return or performance.
Return attribution
Performance attribution, also known as return attribution, is the process of identifying the components of an asset’s return or performance.
Sharpe ratio
The Sharpe ratio has excess return as its numerator and volatility as its denominator: SR = [E(Rp) − Rf]/σp where SR is the Sharpe ratio for portfolio p,E (Rp) is the expected return for portfolio p, Rf is the riskless rate, and σp is the standard deviation of the returns of portfolio p.
Well-diversified portfolio
In the field of investments, the term well-diversified portfolio is traditionally interpreted as any portfolio containing only trivial amounts of diversifiable risk.
Treynor ratio
The Treynor ratio has excess return as its numerator and beta as the measure of risk as its denominator: TR = [E(Rp) − Rf]/βp where TR is the Treynor ratio for portfolio p; E(Rp) is the expected return, or mean return, for portfolio p; Rf is the riskless rate; and βp is the beta of the returns of portfolio p.
Sortino ratio
The Sortino ratio subtracts a benchmark return, rather than the riskless rate, from the asset’s return in its numerator and uses downside standard deviation as the measure of risk in its denominator: Sortino Ratio = [E(Rp) − RTarget ]/TSSD where E(Rp) is the expected return, or mean return in practice, for portfolio p; RTarget is the user’s target rate of return; and TSSD is the target semistandard deviation (or downside deviation).
Information ratio
The information ratio has a numerator formed by the difference between the average return of a portfolio (or other asset) and its benchmark, and a denominator equal to its tracking error: Information Ratio = [E(Rp) − RBenchmark]/TEp where E(Rp) is the expected or mean return for portfolio p, RBenchmark is the expected or mean return of the benchmark, and TEp is the tracking error of the portfolio relative to its benchmark return.
Return on VaR (RoVaR)
Return on VaR (RoVaR) is simply the expected or average return of an asset divided by a specified VaR (expressing VaR as a positive number): RoVaR = E(Rp)/VaR.
Jensen’s alpha
Jensen’s alpha may be expressed as the difference between its expected return and the expected return of efficiently priced assets of similar risk.
M^2 approach
The M^2 approach, or M-squared approach, expresses the excess return of an investment after its risk has been normalized to equal the risk of the market portfolio.
Average tracking error
Average tracking error refers to the excess of an investment’s return relative to its benchmark. In other words, it is the numerator of the information ratio.
Alpha
Alpha refers to any excess or deficient investment return after the return has been adjusted for the time value of money (the risk-free rate) and for the effects of bearing systematic risk (beta).
Ex ante alpha
Ex ante alpha is the expected superior return if positive (or inferior return if negative) offered by an investment on a forward-looking basis after adjusting for the riskless rate and for the effects of systematic risks(beta) on expected returns.
Ex post alpha
Ex post alpha is the return, observed or estimated in retrospect, of an investment above or below the risk- free rate and after adjusting for the effects of beta (systematic risks).
Dependent variable
The dependent variable is the variable supplied by the researcher that is the focus of the analysis and is determined at least in part by other (independent or explanatory) variables.
Independent variable
Independent variables are those explanatory variables that are inputs to the regression and are viewed as causing the observed values of the dependent variable.
Simple linear regression
A simple linear regression is a linear regression in which the model has only one independent variable.
Regression
A regression is a statistical analysis of the relationship that explains the values of a dependent variable as a function of the values of one or more independent variables based on a specified model.
Intercept
The intercept is the value of the dependent variable when all independent variables are zero.
Residuals
The residuals of the regression, eit, reflect the regression’s estimate of the idiosyncratic portion of asset i’s realized returns above or below its mean idiosyncratic return (i.e., the regression’s estimates of the error term).
Slope coefficient
The slope coefficient is a measure of the change in a dependent variable with respect to a change in an independent variable.
Goodness of fit
The goodness of fit of a regression is the extent to which the model appears to explain the variation in the dependent variable.
R-squared
The r-squared value of the regression, which is also called the coefficient of determination, is often used to assess goodness of fit, especially when comparing models. In a simple linear regression, the r-squared is simply the squared value of the estimated correlation coefficient between the dependent variable and the independent variable.
T-statistic
The t-statistic of a parameter is formed by taking the estimated absolute value of the parameter and dividing by its standard error.
T-test
A t-test is a statistical test that rejects or fails to reject a hypothesis by comparing a t-statistic to a critical value.
Model misspecification
Model misspecification is any error in the identification of the variables in a model or any error in identification of the relationships between the variables.
Omitted (more misidentified) systematic return factors
Omitted (or misidentified) systematic return factors is the failure to include relevant factors in an analysis of returns such as momentum or size.
Misestimated betas
Misestimated betas is estimation error due to randomness or econometric errors such as failure to correct for heteroskedasticity.
Nonlinear risk-return relation error
Nonlinear risk-return relation error is the failure to model nonlinearity such as quadratic or cubic effects.
Beta creep
Beta creep is when hedge fund strategies pick up more systematic market risk over time.
Beta expansion
Beta expansion is the perceived tendency of the systematic risk exposures of a fund or asset to increase due to changes in general economic conditions.
Beta nonstationarity
Beta nonstationarity is a general term that refers to the tendency of the systematic risk of a security, strategy, or fund to shift through time.
Full market cycle
A full market cycle is a period of time containing a large representation of market conditions, especially up (bull) markets and down (bear) markets.
Abnormal return persistence
Abnormal return persistence is the tendency of idiosyncratic performance in one time period to be correlated with idiosyncratic performance in a subsequent time period.
Return driver
The term return driver represents the investments, the investment products, the investment strategies, or the underlying factors that generate the risk and return of a portfolio.
Alpha driver
An investment that seeks high returns independent of the market is an alpha driver.
Beta driver
An investment that moves in tandem with the overall market or a particular risk factor is a beta driver.
Equity risk premium
The equity risk premium (ERP) is the expected return of the equity market in excess of the risk-free rate.
Equity risk premium puzzle
The equity risk premium puzzle is the enigma that equities have historically performed much better than can be explained purely by risk aversion, yet many investors continue to invest heavily in low-risk assets.
Linear risk exposure
A linear risk exposure means that when the returns to such a strategy are graphed against the returns of the market index or another appropriate standard, the result tends to be a straight line.
Asset gatherers
Asset gatherers are managers striving to deliver beta as cheaply and efficiently as possible, and include the large- scale index trackers that produce passive products tied to well-recognized financial market benchmarks.
Passive beta driver
A passive beta driver strategy generates returns that follow the up-and-down movement of the market on a one-to-one basis.
Process drivers
Process drivers are beta drivers that focus on providing beta that is fine-tuned or differentiated.
Product innovators
At one end of the spectrum are product innovators, which are alpha drivers that seek new investment strategies offering superior rates of risk-adjusted return.
Hypotheses
Hypotheses are propositions that underlie the analysis of an issue.
Alternative hypothesis
The alternative hypothesis is the behavior that the analyst assumes would be true if the null hypothesis were rejected.
Null hypothesis
The null hypothesis is usually a statement that the analyst is attempting to reject, typically that a particular variable has no effect or that a parameter’s true value is equal to zero.
Confidence interval
A confidence interval is a range of values within which a parameter estimate is expected to lie with a given probability.
P-value
The p-value is a result generated by the statistical test that indicates the probability of obtaining a test statistic by chance that is equal to or more extreme than the one that was actually observed (under the condition that the null hypothesis is true).
Significance level
The term significance level is used in hypothesis testing to denote a small number, such as 1%, 5%, or 10%, that reflects the probability that a researcher will tolerate of the null hypothesis being rejected when in fact it is true.
Test statistic
The test statistic is the variable that is analyzed to make an inference with regard to rejecting or failing to reject a null hypothesis.
Economic significance
Economic significance describes the extent to which a variable in an economic model has a meaningful impact on another variable in a practical sense.
Type I error
A type I error, also known as a false positive, is when an analyst makes the mistake of falsely rejecting a true null hypothesis.
Type II error
A type II error, also known as a false negative, is failing to reject the null hypothesis when it is false.
Selection bias
Selection bias is a distortion in relevant sample characteristics from the characteristics of the population, caused by the sampling method of selection or inclusion.
Self-selection bias
If the selection bias originates from the decision of fund managers to report or not to report their returns, then the bias is referred to as a self-selection bias.
Survivorship bias
Survivorship bias is a common problem in investment databases in which the sample is limited to those observations that continue to exist through the end of the period of study.
Data dredging
Data dredging, or data snooping, refers to the overuse and misuse of statistical tests to identify historical patterns.
Data mining
Data mining typically refers to the vigorous use of data to uncover valid relationships.
Backfill bias
Backfill bias, or instant history bias, is when the funds, returns, and strategies being added to a data set are not representative of the universe of fund managers, fund returns, and fund strategies.
Backfilling
Backfilling typically refers to the insertion of an actual trading record of an investment into a database when that trading record predates the entry of the investment into the database.
Backtesting
Backtesting is the use of historical data to test a strategy that was developed subsequent to the observation of the data.
Overfitting
Overfitting is using too many parameters to fit a model very closely to data over some past time frame.
Cherry-picking
Cherry-picking is the concept of extracting or publicizing only those results that support a particular viewpoint.
Chumming
Chumming is a fishing term used to describe scattering pieces of cheap fish into the water as bait to attract larger fish to catch. In investments, we apply this term to the practice of unscrupulous investment managers broadcasting a variety of predictions in the hope that some of them will turn out to be correct and thus be viewed as an indication of skill.
Outlier
An outlier is an observation that is markedly further from the mean than almost all other observations.
Causality
The difference between true correlation and causality is that causality reflects when one variable’s correlation with another variable is determined by or due to the value or change in value of the other variable.
Spurious correlation
The difference between spurious correlation and true correlation is that spurious correlation is idiosyncratic in nature, coincidental, and limited to a specific set of observations.
Natural resources
Natural resources are real assets that have received no or almost no human alteration.
Split estate
A split estate is when surface rights and mineral rights are separately owned.
Pure play
A pure play on an investment is an investment vehicle that offers direct exposure to the risks and returns of a specific type of investment without the inclusion of other exposures.
Exchange option
An exchange option is an option to exchange one risky asset for another rather than to buy or sell one asset at a fixed exercise or strike price.
Perpetual option
A perpetual option is an option with no expiration date.
Low-hanging-fruit principle
The low-hanging-fruit principle states that the first action that should be taken is the one that reaps the highest benefits over costs.
Intrinsic option value
An intrinsic option value is the greater of $0 and the value of an option if exercised immediately.
Time value of an option
The time value of an option is the excess of an option’s price above its intrinsic value.
Land banking
Land banking is the practice of buying vacant lots for the purpose of development or disposition at a future date.
Blue top lots
Blue top lots are at an interim stage of lot completion. In this case, the owner has completed the rough grading of the property and the lots, including the undercutting of the street section, interim drainage, and erosion control facilities, and has paid all applicable fees required.
Finished lots
Finished lots are fully completed and ready for home construction and occupancy.
Paper lots
Paper lots refers to sites that are vacant and approved for development by the local zoning authority but for which construction on streets, utilities, and other infrastructure has not yet commenced.
Binomial option pricing
Binomial option pricing is a technique for pricing options that assumes that the price of the underlying asset can experience only a specified upward movement or downward movement during each period.
Risk-neutral probability
A risk-neutral probability is a probability that values assets correctly if, everything else being equal, all market participants were risk neutral.
Negative survivorship bias
A negative survivorship bias is a downward bias caused by excluding the positive returns of the properties or other assets that successfully left the database.
Timberland investment management organizations (TIMOs)
Timberland investment management organizations (TIMOs) provide management services to timberland owned by institutional investors, such as pension plans, endowments, foundations, and insurance companies.
Rotation
Rotation is the length of time from the start of the timber (typically the planting) until the harvest of the timber.
Reduced integration in the forest products industry
Reduced integration in the forest products industry refers to the increased separation of ownership of trees, pulp mills, and sawmills and is a key reason for changes in timberland ownership.
Cap rate
In real estate, the cap rate (capitalization rate) or yield is a common term for the return on assets (7.33% in this example).
Agency risk
Agency risk is the economic dispersion resulting from the consequences of having another party (the agent) making decisions contrary to the preferences of the owner (the principal).
Political risk
Political risk is economic uncertainty caused by changes in government policy that may affect returns, perhaps dramatically.
Row cropland
Row cropland is annual cropland that produces row crops, such as corn, cotton, carrots, or potatoes from annual seeds.
Permanent cropland
Permanent cropland refers to land with long-term vines or trees that produce crops, such as grapes, cocoa, nuts, or fruit.
Agronomy
Agronomy is the science of soil management, cultivation, crop production, and crop utilization.
Smoothing
Smoothing is reduction in the reported dispersion in a price or return series.
Favorable mark
A favorable mark is a biased indication of the value of a position that is intentionally provided by a subjective source.
Managed returns
Managed returns are returns based on values that are reported with an element of managerial discretion.
Model manipulation
Model manipulation is the process of altering model assumptions and inputs to generate desired values and returns.
Selective appraisals
Selective appraisals refers to the opportunity for investment managers to choose how many, and which, illiquid assets should have their values appraised during a given quarter or some other reporting period.
Market manipulation
Market manipulation refers to engaging in trading activity designed to cause the markets to produce favorable prices for thinly traded listed securities.
Stale prices
Stale prices are indications of value derived from data that no longer represent current market conditions.
Contagion
Contagion is the general term used in finance to indicate any tendency of major market movements–especially declines in prices or increases in volatility–to be transmitted from one financial market to other financial markets.
Hotelling’s theory
Hotelling’s theory states that prices of exhaustible commodities, such as various forms of energy and metals, should increase by the prevailing nominal interest rate–perhaps with a risk premium.
Commodity-linked note
A commodity-linked note (CLN) is an intermediate-term debt instrument whose value at maturity is a function of the value of an underlying commodity or basket of commodities.
Spoilage cost
Spoilage cost is the loss of value that may naturally occur through time during storage due to physical deterioration.
inventory shrinkage
Inventory shrinkage is loss of inventory through time due to theft, decline in moisture content, and so forth.
Perfectly elastic supply
With regard to supply, on one end of the spectrum is a perfectly elastic supply, in which any quantity demanded of a commodity can be instantaneously and limitlessly supplied without changes in the market price.
Inelastic supply
Inelastic supply is when supplies change slowly in response to market prices or when large changes in market prices are necessary to effect supply changes.
Backwardation
When the slope of the term structure of forward prices is negative, the market is in backwardation, or is backwardated.
Contango
When the term structure of forward prices is upward sloping (i.e., when more distant forward contracts have higher prices than contracts that are nearby), the market is said to be in contango.
Inelastic demand
Inelastic demand is a market condition in which the demand for a good does not increase or decrease substantially due to changes in price and therefore is a potential cause of higher price volatility and higher convenience yield.
Basis
The basis in a forward contract is the difference between the spot (or cash) price of the referenced asset, S, and the price (F) of a forward contract with delivery T.
Basis risk
Basis risk is the dispersion in economic returns associated with changes in the relationship between spot prices and futures prices.
Calendar spread
A calendar spread can be viewed as the difference between futures or forward prices on the same underlying asset but with different settlement dates.
Excess return of a futures contract
The return generated exclusively from changes in futures prices is known as the excess return of a futures contract.
Fully collateralized position
A fully collateralized position is a position in which the cash necessary to settle the contract has been posted in the form of short-term, riskless bonds.
Collateral yield
Collateral yield, is the interest earned from the riskless bonds or other money market assets used to collateralize the futures contract.
Roll return
Roll yield or roll return is properly defined as the portion of the return of a futures position from the change in the contract’s basis through time.
Roll yield
Roll yield or roll return is properly defined as the portion of the return of a futures position from the change in the contract’s basis through time.
Spot return
Spot return is the return on the underlying asset in the spot market.
Heterogeneous
A heterogeneous value differs across one or more dimensions.
Normal backwardation
In normal backwardation, the forward price is believed to be below the expected spot price.
Normal contango
In normal contango, the forward price is believed to be above the expected spot price.
Stock-out
Stock-out occurs when storage effectively drops to zero, resulting in consumption being entirely dependent on production and transportation networks, and typically occurs in markets with peak seasonal demand, such as natural gas or heating oil, or with annual crop cycles, such as grains.
Working curve
The theory of storage as illustrated in the Working curve positively relates the slope of the forward curve to current levels of inventory such that low inventory levels tend to be associated with a negative and nonlinear forward curve slope.
Humped curve
The crude oil futures market has often exhibited a humped curve, which in the typical case of commodity futures means that the market is in contango in the short term, but gives way to backwardation for longer-maturity contracts.
Nominal price
A nominal price refers to the stated price of an asset measured using the contemporaneous values of a currency.
Real price
A real price refers to the price of an asset that is adjusted for inflation through being expressed in the value of currency from a different time period.
Volatility asymmetry
A volatility asymmetry is a difference in values between two analogous volatilities, such as is the case with commodities, in which volatility tends to be higher when prices are rising than when they are falling.
Inflation risk
Inflation risk is the dispersion in economic outcomes caused by uncertainty regarding the value of a currency.
Investable index
An investable index has returns that an investor can match in practice by maintaining the same positions that constitute the index.
Production-weighted index
A production-weighted index weights each underlying commodity using estimates of the quantity of each commodity produced.
Standard & Poor’s GSCI (S&P GSCI)
The Standard & Poor’s GSCI (S&P GSCI) is a long only index of physical commodity futures.
Bloomberg Commodity Index (BCOM)
The Bloomberg Commodity Index (BCOM), formerly the Dow Jones-UBS Commodity Index, is a long-only index composed of futures contracts on 22 physical commodities.
Thomson Reuters ore Commodity Research Bureau (CRB) index
The Thomson Reuters Core Commodity Research Bureau (CRB) Index is the oldest major commodity index and is currently made up of 19 commodities traded on various exchanges.
Downstream operations
Downstream operations focus on refining, distributing, and marketing the oil and gas.
Upstream operations
Upstream operations focus on exploration and production; midstream operations focus on storing and transporting the oil and gas.
Midstream operations
Midstream operations and midstream MLPs—the largest of the three segments—process, store, and transport energy and tend to have little or no commodity price risk.
