glossary Flashcards
Activism
Active engagement and intervention (by voting or otherwise) by investors with the companies in which they have holdings, in order to monitor or influence the management of such companies.
Actuarial risk
The risk of not being able to meet liabilities as they fall due (ie mismatching
assets and liabilities).
Alpha
A measure of a stock’s, or fund’s, outperformance, adjusted for the level of risk taken.
So, for a comparison with the market, alpha is given by:
(r - rf ) - b (rm - rf )
Where r is the stock’s/ fund’s rate of return, rf is the risk free rate and rm is the
market rate of return. The risk adjustment is the same as in the CAPM model.
Alpha fund
A label used by fund managers to describe funds that are more aggressive in trying to outperform the market.
American option
An option that can be exercised on any date before its expiry.
Amortisation
The writing-down of the value of intangible assets (such as goodwill, advertising and R and D) over time.
Anomaly switch
A technique used in the active management of a bond portfolio. Anomaly switching involves moving between stocks with similar volatility, thereby taking advantage of temporary anomalies in price.
Arbitrage
The simultaneous buying and selling of two economically equivalent but differently priced portfolios so as to make a risk-free profit.
Recall that derivative pricing is based on the assumption that markets are arbitrage-free and so there are no arbitrage opportunities.
Arithmetic index
An index constructed as the arithmetic average of the prices of the constituent investments. The prices are often weighted and the average is usually multiplied by a factor chosen to give a convenient starting value for the index. The factor is periodically altered so as to maintain a continuous index value when it is necessary to alter the constituents or the weights.
Recall from Chapter 14 that such indices cannot be used for valid performance measurement.
Backfill
To add an investment fund’s past history into a performance database. Since only successful funds will seek to be added to the database, this will tend to improve the reported returns (“backfill bias”).
Beta value
A measure of a stock’s volatility relative to movements in the whole market. Usually defined as the covariance of the return on the stock with the return on the market, divided by the variance of the market return.
Recall that beta measures the systematic risk of a security or a portfolio.
Chain-linking
Adjusting an investment index so that it reflects the investment performance of its constituents (and not injections or withdrawals of funds into or out of the market itself).
Close out
The process of establishing an equal and opposite derivative or asset position in order to neutralize or offset the risk of an existing position.
Collateral
Assets that are given as security for a loan as a fall-back measure to be used in the event of default. By taking collateral, the creditor has an additional source of repayment should its counterparty be unable to perform on its obligations.
Contingent liability
A liability dependent on other events.
Credit spread
A measure of the difference between the yield on a risky and a risk-free security. It is a measure of the risk premium a credit-risky corporate or sovereign entity must pay to attract capital. Credit spreads are used widely as references for credit derivatives.
Cyclical company
A company whose fortunes are very closely linked to the state of the economy. The share price, relative to the rest of the market, will therefore depend on the current state of the economy and any (discounted) expected future changes in the economy.
Defensive company
A company whose fortunes are reasonably immune to the state of the economy. Any security that exhibits less volatility than the market as a whole (ie its beta is less than 1.0), providing lower, but more stable, returns.
Deflators
Stochastic discount factors which can be applied to a series of cash flows under a set of realistic scenarios to produce market-consistent valuations of assets and liabilities. Sometimes referred to as “state-price deflators”.
Dividend cover
The number of times that the dividend payments are covered by earnings for the relevant period. Defined as:
earnings per share dividend per share
It is the inverse of the payout ratio. Care needs to be taken that the tax treatment of the earnings and dividend figures are consistent.
Downside risk
The risk that something bad will happen and a loss will occur. The risk of something going wrong. A risk whose outcome is adverse.
Economic good
A consumable item that is useful to people but is scarce in relation to its demand, so that human effort is required to obtain it.
Enterprise value
The combined total market capitalisation of a firm’s debt and equity. This may also be computed as the sum of expected future net cash flows, discounted at a firm-specific discount rate.
Equitable
Characterised by fairness. Thus an ownership interest in assets that is conveyed via title and which is considered fair and just by the courts, but which may not represent a strict legal right (eg the interests of a beneficiary in a trust) are of an equitable nature.
Eurobond
An international bond issued by a company or government, often in a currency other than the currency of the borrower. The bonds are traded internationally through banks, and not in the traditional bond markets.
Event risk
The risk of loss due to single events that are unlikely but may have serious consequences if they do occur. The events are either largely or entirely outside the control of the organisation. Such losses do not follow traditional stochastic processes.
Exchange traded funds
An exchange traded fund (ETF) is a collective investment vehicle that is traded on a securities exchange at a price that is closely related to its net asset value and is quoted in real time. It combines the valuation feature of a unit trust with the tradability of an investment trust. ETFs are generally managed as index- tracker funds and, not being shares, do not incur stamp duty on purchases.
Fiduciary
Proceeding from trust or confidence. Also, an individual, corporation or association to whom certain property is given to hold in trust. The property is to be utilised or invested for the benefit of the property owner, to the best ability of the fiduciary.
Floating rate note (FRN)
A Eurobond with a variable rate of interest. FRNs are usually medium-term bonds.
Forward Rate Agreement (FRA)
A forward contract where the parties agree that a certain interest rate will apply to a certain principal amount during a specified future time period.
Geometric index
A geometric index is based on the geometric mean of the ratio of the share prices.
Recall from Chapter 14 that such indices cannot be used for valid performance measurement.
Interest cover
A calculation made for loans issued by companies. The interest cover is the number of times that the profit of the company (before interest payable and tax) covers the interest on the loan (including the interest on prior ranking loans).
In-the-money
An option with a positive intrinsic value is in-the-money.
Infrastructure
The basic facilities, services and installations needed for the functioning of a community or society.
