Glossary of Terms 1

Question 1

Actuarial Risk

Answer 1

The risk of not being able to meet liabilities as they fall due i.e. mismatching assets and liabilities.

Question 2

Alpha

Answer 2

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 give by (r - r_f) - beta * (r_m - r_f).

Where r is the stock’s/fund’s rate of return, r_f is the risk-free rate and r_m is the market rate of return. The risk adjustment is the same as in the CAPM model.

Question 3

Alpha Fund

Answer 3

A label used by fund managers to describe funds that are more aggressive in trying to outperform the market.

Question 4

American Option

Answer 4

An option that can be exercised on any date before its expiry.

Question 5

Amortisation

Answer 5

The writing-down of the value of intangible assets (such as goodwill, advertising and R&D) over time.

Question 6

Anomaly Switch

Answer 6

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.

Question 7

Arbitrage

Answer 7

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.

Question 8

Arithmetic Index

Answer 8

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.

Question 9

Backfill

Answer 9

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”).

Question 10

Beta Value

Answer 10

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.

Beta measures the systematic risk of a security or a portfolio.