Equity Flashcards
Abnormal Return
The difference between the return on a stock (or entire portfolio) and the performance of an index, such as the S&P 500. The abnormal return is equal to the market return - the normal return. For example, a stock that provided a return of 10% over the same period of time in which an index provided a 6% return would have an abnormal return of 10% - 6% = 4%. If the abnormal return is negative then it has underperformed the index.
72 Rule
The estimation of doubling time on an investment, for which the compounded annual rate of return times the number of years must equal roughly 72 for the investment to double in value.
For example, an investment earning roughly 7% per year will double in value in 10 years – specifically, 72 divided by 7 is approximately 10.
Above Par
A term used to describe the price of a security when it is trading above its face value. A security usually trades at above par when its income distributions are higher than those of other instruments currently available in the market.
If an investor purchases a security above face value, he or she will incur a capital loss at maturity when it is redeemed for face value.
Investopedia explains ‘Above Par’
For example, a 5-year bond with $1,000 face value that pays a coupon of 10% annually may trade closer to $1,168 if similar bond rates decline to 6%. This is because investors are willing to pay more for a higher coupon; thus, it is said to be trading above par.
In order to make its yield equal current market rates, the bond should trade at its present value.
Absolute Priority Rule
The idea that creditors’ claims take precedence over shareholders’ claims in the event of a liquidation or reorganization. Shareholders are compensated only after creditors have been fully paid off.
Absolute Return
The return that an asset achieves over a certain period of time. This measure looks at the appreciation or depreciation (expressed as a percentage) that an asset - usually a stock or a mutual fund - achieves over a given period of time.
Absolute return differs from relative return because it is concerned with the return of a particular asset and does not compare it to any other measure or benchmark.
In general, a mutual fund seeks to produce returns that are better that its peers, its fund category, and/or the market as a whole. This type of fund management is referred to as a relative return approach to fund investing. As an investment vehicle, an absolute return fund seeks to make positive returns by employing investment management techniques that differ from traditional mutual funds.
Absolute return investment techniques include using short selling, futures, options, derivatives, arbitrage, leverage and unconventional assets.
Alfred Winslow Jones is credited with forming the first absolute return fund in New York in 1949. In recent years, this so-called absolute return approach to fund investing has become one of the fastest growing investment products in the world and is more commonly referred to as a hedge fund.
Absolute Return Index
A stock index designed to measure absolute returns. The absolute return index is actually a composite index made up of five other indexes. This index is used to compare the absolute returns posted by the hedge fund market as a whole against individual hedge funds.
The hedge fund absolute return index (HFRX) measures the comprehensive overall returns of hedge funds. Since hedge funds explore unique investment strategies and seek to obtain absolute returns rather than focus on beating the benchmark, the HFRX is representative of all hedge fund strategies.
Accelerated Bookbuild
A form of offering in the equity capital markets. It involves offering shares in a short time period, with little to no marketing. The bookbuild of the offering is done vey quickly in one or two days. Underwriters may sometimes guarantee a minimum price and proceeds to the firm.
An accelerated bookbuild is often used when a company is in immediate need of financing and debt financing is out of the question. This can be the case when a firm is looking to make an offer to acquire another firm.
For example, BetandWin.com used an accelerated bookbuild to raise between 200 and 300 million euros to help fund the acquisition of Ongame E-Solutions, the operator of pokerroom.com, one of the most popular poker websites.
Accidental High Yielder
Stocks that have an unusual high dividend yield for a specific company. The stock was not expected or intended to pay such a high dividend but will be a common occurrence in a bear market when stock prices are declining.
Accommodation Trading
A tax-avoidance technique whereby two traders agree to make a non-competitive stock trade that allows one trader to claim an investment loss when filing taxes. For example, Tim agrees to purchase shares that Joe bought for $50 at a price of $40; thereby, Joe can claim a loss of $10 per share. Once taxes are filed, Tim sells the shares back to Joe at a price of $40.
This trade, also known as a wash sale, allows Joe to cheat the tax system, while never actually losing any value on the stock.
Acid-Test Ratio
A stringent indicator that determines whether a firm has enough short-term assets to cover its immediate liabilities without selling inventory.
The ratio of current assets less inventories to total current liabilities. This ratio is the most stringent measure of how well the company is covering its short-term obligations, since the ratio only considers that part of current assets which can be turned into cash immediately (thus the exclusion of inventories). The ratio tells creditors how much of the company’s short term debt can be met by selling all the company’s liquid assets at very short notice.
The acid-test ratio is far more strenuous than the working capital ratio, primarily because the working capital ratio allows for the inclusion of inventory assets.
Calculated by: Cash + Accounts Receivables + Short term Investments / Current Liabilities
Companies with ratios of less than 1 cannot pay their current liabilities and should be looked at with extreme caution. Furthermore, if the acid-test ratio is much lower than the working capital ratio, it means current assets are highly dependent on inventory. Retail stores are examples of this type of business.
The term comes from the way gold miners would test whether their findings were real gold nuggets. Unlike other metals, gold does not corrode in acid; if the nugget didn’t dissolve when submerged in acid, it was said to have passed the acid test. If a company’s financial statements pass the figurative acid test, this indicates its financial integrity.
Across the Board
Applying to all items in a group in approximately the same way, such as when nearly all stocks move in the same direction on a given day.
Active Portfolio Strategy
An investment approach in which an investor uses a variety of forecasting and assumption techniques to determine which securities to purchase in order to achieve a high return. Unlike the buy and hold strategy, an adherent to an active portfolio strategy is more likely to buy and sell securities with greater frequencies as the investor seeks to move available capital into more profitable stocks.
Activist Investor
A stockholder whose purpose for holding the stock is to influence corporate decision-making. The investor may be motivated by self-centered or ethical intentions. A significant shareholder can influence decisions such as company pay scales, environmental impacts, product releases, and more.
Adding to a Loser
Investing in a declining equity, in the hopes that through dollar cost averaging the stock will be better poised to return to profitability.
The action of a trader/investor increasing a position in an asset when its price is heading in the direction that’s opposite to what the investor/trader desires.
This is generally not a wise investment decision because unless the asset begins to move in the desired direction, the investor’s losses will increase.
An investor might add to a losing position instead of closing it because he or she gets emotionally attached to the asset and has a hard time accepting that it was a bad investment. Once the trade moves substantially in the wrong direction, however, it may be time to consider closing out or re-evaluating the reason for having the position rather than putting more money at risk.
All Weather Fund
A diversified portfolio with a combination of various counterbalancing asset classes, designed to perform well in both up and down markets. Hedging strategies such as short selling and options trading may also be used to maintain profitability.
