Investopedia

Question 0

Pro Forma

Answer 0

A Latin term meaning “for the sake of form”. In the investing world, it describes a method of calculating financial results in order to emphasize either current or projected figures.

Question 1

Capital Markets

Answer 1

Markets for buying and selling equity and debt instruments. Capital markets channel savings and investment between suppliers of capital such as retail investors and institutional investors, and users of capital like businesses, government and individuals. Capital markets are vital to the functioning of an economy, since capital is a critical component for generating economic output. Capital markets include primary markets, where new stock and bond issues are sold to investors, and secondary markets, which trade existing securities.

Question 2

Debt Ratio

Answer 2

A financial ratio that measures the extent of a company’s or consumer’s leverage. The debt ratio is defined as the ratio of total debt to total assets, expressed in percentage, and can be interpreted as the proportion of a company’s assets that are financed by debt.

The higher this ratio, the more leveraged the company and the greater its financial risk. Debt ratios vary widely across industries, with capital-intensive businesses such as utilities and pipelines having much higher debt ratios than other industries like technology. In the consumer lending and mortgage businesses, debt ratio is defined as the ratio of total debt service obligations to gross annual income

Question 3

Halloween Strategy

Answer 3

An investment technique in which an investor sells stocks before May 1 and refrains from reinvesting in the stock market until October 31, in order to increase capital gains. The Halloween strategy is based on the premise that most capital gains are made between October 31 (Halloween) and May 1, and that the other six months of the year should be spent investing in other investment types or not at all.

Question 4

Zombie stocks

Answer 4

Companies that continue to operate even though they are insolvent or near bankruptcy. Zombies often become casualties to the high costs associated with certain operations, such as research and development. Most analysts expect zombie companies to be unable to meet their financial obligations.

Also known as the “living dead” or “zombie stocks”.

Question 5

Witching hour

Answer 5

The last hour of stock trading between 3pm (when the bond market closes) and 4pm EST. Witching hour is typically controlled by large professional traders, program traders and large institutional traders, and can be characterized by higher-than-average volatility.

Question 6

Repurchase Agreement

Answer 6

A form of short-term borrowing for dealers in government securities. The dealer sells the government securities to investors, usually on an overnight basis, and buys them back the following day.

For the party selling the security (and agreeing to repurchase it in the future) it is a repo; for the party on the other end of the transaction, (buying the security and agreeing to sell in the future) it is a reverse repurchase agreement.

Question 7

Letter of Credit

Answer 7

A letter from a bank guaranteeing that a buyer’s payment to a seller will be received on time and for the correct amount. In the event that the buyer is unable to make payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase.

Question 8

Certificate of Deposit

Answer 8

A savings certificate entitling the bearer to receive interest. A CD bears a maturity date, a specified fixed interest rate and can be issued in any denomination. CDs are generally issued by commercial banks and are insured by the FDIC. The term of a CD generally ranges from one month to five years.

Question 9

Day Sales of Inventory

Answer 9

A financial measure of a company’s performance that gives investors an idea of how long it takes a company to turn its inventory (including goods that are work in progress, if applicable) into sales. Generally, the lower (shorter) the DSI the better, but it is important to note that the average DSI varies from one industry to another

Question 10

Accounts Payable

Answer 10

An accounting entry that represents an entity’s obligation to pay off a short-term debt to its creditors. The accounts payable entry is found on a balance sheet under the heading current liabilities.

Accounts payable are often referred to as “payables”.

Another common usage of AP refers to a business department or division that is responsible for making payments owed by the company to suppliers and other creditors.

Question 11

Ratio Analysis

Answer 11

Quantitative analysis of information contained in a company’s financial statements. Ratio analysis is based on line items in financial statements like the balance sheet, income statement and cash flow statement; the ratios of one item – or a combination of items - to another item or combination are then calculated. Ratio analysis is used to evaluate various aspects of a company’s operating and financial performance such as its efficiency, liquidity, profitability and solvency. The trend of these ratios over time is studied to check whether they are improving or deteriorating. Ratios are also compared across different companies in the same sector to see how they stack up, and to get an idea of comparative valuations. Ratio analysis is a cornerstone of fundamental analysis

Question 12

Days Payable Outstanding

Answer 12

A company’s average payable period. Days payable outstanding tells how long it takes a company to pay its invoices from trade creditors, such as suppliers. DPO is typically looked at either quarterly or yearly.

The formula to calculate DPO is written as: ending accounts payable / (cost of sales/number of days). These numbers are found on the balance sheet and the income statement.

Question 13

Net Sales

Answer 13

The amount of sales generated by a company after the deduction of returns, allowances for damaged or missing goods and any discounts allowed. The sales number reported on a company’s financial statements is a net sales number, reflecting these deductions.

Question 14

Over-The-Counter

Answer 14

A security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, etc. The phrase “over-the-counter” can be used to refer to stocks that trade via a dealer network as opposed to on a centralized exchange. It also refers to debt securities and other financial instruments such as derivatives, which are traded through a dealer network.

Question 15

Direct Participation Program

Answer 15

A business venture designed to let investors participate directly in the cash flow and tax benefits of the underlying investment. DPPs are generally passive investments that invest in real estate or energy-related ventures.

Also known as a “direct participation plan”.

Question 16

Cash Return on Gross Investment

Answer 16

A gauge of a company’s financial performance that measures the cash flow a company produces with its invested capital. CROGI is calculated by dividing gross cash flow after taxes by gross investment. CROGI is important because investors want to see how effectively a company makes use of the money it invests in itself.

Question 17

Barrel of Oil Equivalent

Answer 17

A term used to summarize the amount of energy that is equivalent to the amount of energy found in a barrel of crude oil. There are 42 gallons (approximately 159 liters) in one barrel of oil, which will contain approximately 5.8 million British Thermal Units (MBtus) or 1,700 kilowatt hours (kWh).

Also known as crude oil equivalent (COE).

Question 18

Small Cap

Answer 18

Refers to stocks with a relatively small market capitalization. The definition of small cap can vary among brokerages, but generally it is a company with a market capitalization of between $300 million and $2 billion.

Question 19

Kondratieff Wave

Answer 19

A long-term cycle present in capitalist economies that represents long-term, high-growth and low-growth economic periods. This theory was founded by Nikolai D. Kondratieff (also spelled “Kondratiev”), a Communist Russia era economist who noticed an approximately 50-year cycle in European agricultural commodity prices and copper prices. Kondratieff believed that these long cycles were a feature of the economic activity of capitalist nations, and that they involved periods of evolution and self-correction.

Also known as “Kondratiev waves”, “supercylces”, “K-waves”, “surges” or “long waves”.

Question 20

Premium

Answer 20

1. The total cost of an option.
2. The difference between the higher price paid for a fixed-income security and the security’s face amount at issue.
3. The specified amount of payment required periodically by an insurer to provide coverage under a given insurance plan for a defined period of time. The premium is paid by the insured party to the insurer, and primarily compensates the insurer for bearing the risk of a payout should the insurance agreement’s coverage be required.

Question 21

Cashless Conversion

Answer 21

The purchase of an asset by paying the Conversion Arbitrage and borrowing the balance from a bank or broker. Cashless Conversion refers to the initial or down payment made to the broker for the asset being purchased. The collateral for the funds being borrowed is the Conversion Arbitrageable securities in the investor’s account. Before Cashless Conversion, an investor needs to open a Conversion Arbitrage account with the broker. In the U.S., the amount of Conversion Arbitrage that must be paid for a security is regulated by the Federal Reserve Board.

Question 22

Buying in Margin

Answer 22

The purchase of an asset by paying the margin and borrowing the balance from a bank or broker. Buying on margin refers to the initial or down payment made to the broker for the asset being purchased. The collateral for the funds being borrowed is the marginable securities in the investor’s account. Before buying on margin, an investor needs to open a margin account with the broker. In the U.S., the amount of margin that must be paid for a security is regulated by the Federal Reserve Board.

Question 23

Day rate Volatility

Answer 23

The intraday unpredictability of an exchange rate (or price of a good or service), that changes due to imbalances in supply and demand. Price levels of various goods or services can change very quickly, depending on the current market condition.

Question 24

Short Selling Last in First out

Answer 24

An asset-management and valuation method that assumes that assets produced or acquired last are the ones that are used, sold or disposed of first.

Question 25

Ghosting

Answer 25

An illegal practice whereby two or more market makers collectively attempt to influence and change the price of a stock. Ghosting is used by corrupt companies to affect stock prices so they can profit from the price movement

Question 26

Elastisticity

Answer 26

A measure of a variable’s sensitivity to a change in another variable. In economics, elasticity refers the degree to which individuals (consumers/producers) change their demand/amount supplied in response to price or income changes.

Question 27

Tangible Common Equity (TCE)

Answer 27

A measure of a company’s capital, which is used to evaluate a financial institution’s ability to deal with potential losses. Tangible common equity (TCE) is calculated by subtracting intangible assets, goodwill and preferred equity from the company’s book value. Measuring a company’s TCE is particularly useful for evaluating companies that have large amounts of preferred stock, such as U.S. banks that received federal bailout money in the 2008 financial crisis. In exchange for bailout funds, those banks issued large numbers of shares of preferred stock to the federal government. A company can boost TCE by converting preferred shares to common shares.

Question 28

Net Present Value of Growth Opportunities

Answer 28

A calculation of the net present value of all future cash flows involved with an additional acquisition, or potential acquisition. The net present value of growth opportunities is used to determine the intrinsic value of a new project or acquisition at a given point in time, based on projected amounts.

NPVGO is calculated by taking the net cash inflow, discounted at the firm’s cost of capital, less the purchase price of the additional asset. It is also referred to simply as the present value of growth opportunities (PVGO).

Question 29

Gresham’s Law

Answer 29

A monetary principle stating that “bad money drives out good.” In currency valuation, Gresham’s Law states that if a new coin (“bad money”) is assigned the same face value as an older coin containing a higher amount of precious metal (“good money”), then the new coin will be used in circulation while the old coin will be hoarded and will disappear from circulation.

Question 30

Limit-In-Open-Order

Answer 30

A type of limit order to buy or sell shares at the market open if the market price meets the limit condition. This type of order is good only for the market opening and does not last for the whole trading day.

Question 31

Bear Flattener

Answer 31

A yield-rate environment in which short-term interest rates are increasing at a faster rate than long-term interest rates. This causes the yield curve to flatten as short-term and long-term rates start to converge.

Question 32

80-10-10 mortgage

Answer 32

A mortgage transaction in which a first and second mortgage are simultaneously originated. The first position lien has an 80% loan-to-value ratio, the second position lien has a 10% loan-to-value ratio and the borrower makes a 10% down payment. 80-10-10 mortgage transactions are piggy-back mortgage transactions, and are frequently used by borrowers to avoid paying private mortgage insurance.

Question 33

Passive ETF

Answer 33

One of two types of exchange-traded funds (ETFs) available for investors. Passive ETFs are index funds that track a specific benchmark, such as a SPDR. Unlike actively managed ETFs, passive ETFs are not managed by a fund manager on a daily basis.

Question 34

Walras Law

Answer 34

An economics law that suggests that the existence of excess supply in one market must be matched by excess demand in another market so that it balances out. So when examining a specific market, if all other markets are in equilibrium, Walras’ Law asserts that the examined market is also in equilibrium. Keynesian economics, by contrast, assumes that it is possible for just one market to be out of balance without a “matching” imbalance elsewhere.

Question 35

Market Segmentation

Answer 35

A marketing term referring to the aggregating of prospective buyers into groups (segments) that have common needs and will respond similarly to a marketing action. Market segmentation enables companies to target different categories of consumers who perceive the full value of certain products and services differently from one another. Generally three criteria can be used to identify different market segments:

1) Homogeneity (common needs within segment)
2) Distinction (unique from other groups)
3) Reaction (similar response to market)

Question 36

Effective Annual Interest Rate

Answer 36

An investment’s annual rate of interest when compounding occurs more often than once a year.

Question 37

Debit Spread

Answer 37

Two options with different market prices that an investor trades on the same underlying security. The higher priced option is purchased and the lower premium option is sold - both at the same time. The higher the debit spread, the greater the initial cash outflow the investor will incur on the transaction.

Question 38

Odious Debt

Answer 38

Money borrowed by one country from another country and then misappropriated by national rulers. A nation’s debt becomes odious debt when government leaders use borrowed funds in ways that don’t benefit or even oppress citizens. Some legal scholars argue that successor governments should not be held accountable for odious debt incurred by earlier regimes, but there is no consensus on how odious debt should actually be treated. In practice, countries often end up repaying it to uphold their ability to borrow at favorable interest rates.

Question 39

Takeover

Answer 39

When an acquiring company makes a bid for a target company. If the takeover goes through, the acquiring company becomes responsible for all of the target company’s operations, holdings and debt. When the target is a publicly traded company, the acquiring company will make an offer for all of the target’s outstanding shares.

Question 40

Harvest Strategy

Answer 40

A strategy in which investment in a particular line of business is reduced or eliminated because the revenue brought in by additional investment would not warrant the expense. A harvest strategy is employed when a line of business is considered to be a cash cow, meaning that the brand is mature and is unlikely to grow if more investment is added. The company will instead siphon off the revenue that the cash cow brings in until the brand is no longer profitable.

Question 41

Stop-Limit Order

Answer 41

An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will be executed at a specified price (or better) after a given stop price has been reached. Once the stop price is reached, the stop-limit order becomes a limit order to buy (or sell) at the limit price or better.

Question 42

Pareto Principle

Answer 42

A principle, named after economist Vilfredo Pareto, that specifies an unequal relationship between inputs and outputs. The principle states that, for many phenomena, 20% of invested input is responsible for 80% of the results obtained. Put another way, 80% of consequences stem from 20% of the causes. Also referred to as the “Pareto rule” or the “80/20 rule”.

Question 43

Budget Deficit

Answer 43

A status of financial health in which expenditures exceed revenue. The term “budget deficit” is most commonly used to refer to government spending rather than business or individual spending. When referring to accrued federal government deficits, the term “national debt” is used.

The opposite of a budget deficit is a budget surplus, and when inflows equal outflows, the budget is said to be balanced.

Question 44

Floating Exchange Rate

Answer 44

A country’s exchange rate regime where its currency is set by the foreign-exchange market through supply and demand for that particular currency relative to other currencies. Thus, floating exchange rates change freely and are determined by trading in the forex market. This is in contrast to a “fixed exchange rate” regime.

Question 45

Net Operating Income

Answer 45

A calculation used to analyze real estate investments that generate income. Net operating income equals all revenue from the property minus all reasonably necessary operating expenses. Aside from rent, a property might also generate revenue from parking and service fees, like vending and laundry machines. Operating expenses are those required to run and maintain the building and its grounds, such as insurance, property management fees, utilities, property taxes, repairs and janitorial fees. NOI is a before-tax figure; it also excludes principal and interest payments on loans, capital expenditures, depreciation and amortization.

Question 46

Law of demand

Answer 46

A microeconomic law that states, all other factors being equal, as the price of a good or service increases, consumer demand for the good or service will decrease, and vice versa. The law of demand says that the higher the price, the lower the quantity demanded, because consumers’ opportunity cost to acquire that good or service increases, and they must make more tradeoffs to acquire the more expensive product

Question 47

Market Share

Answer 47

The percentage of an industry or market’s total sales that is earned by a particular company over a specified time period. Market share is calculated by taking the company’s sales over the period and dividing it by the total sales of the industry over the same period. This metric is used to give a general idea of the size of a company to its market and its competitors.

Question 48

Factors of Production

Answer 48

An economic term to describe the inputs that are used in the production of goods or services in the attempt to make an economic profit. The factors of production include land, labor, capital and entrepreneurship.

Question 49

Systematic Risk

Answer 49

The risk inherent to the entire market or an entire market segment. Systematic risk, also known as “undiversifiable risk,” “volatility” or “market risk,” affects the overall market, not just a particular stock or industry. This type of risk is both unpredictable and impossible to completely avoid. It cannot be mitigated through diversification, only through hedging or by using the right asset allocation strategy.

Question 50

Disposable Income

Answer 50

The amount of money that households have available for spending and saving after income taxes have been accounted for. Disposable personal income is often monitored as one of the many key economic indicators used to gauge the overall state of the economy.

Question 51

Payback Period

Answer 51

The length of time required to recover the cost of an investment. The payback period of a given investment or project is an important determinant of whether to undertake the position or project, as longer payback periods are typically not desirable for investment positions.

Question 52

Ratio Spread

Answer 52

An options strategy in which an investor simultaneously holds an unequal number of long and short positions. A commonly used ratio is two short options for every option purchased.

Question 53

Strategic Asset Allocation

Answer 53

A portfolio strategy that involves setting target allocations for various asset classes, and periodically rebalancing the portfolio back to the original allocations when they deviate significantly from the initial settings due to differing returns from various assets. In strategic asset allocation, the target allocations depend on a number of factors – such as the investor’s risk tolerance, time horizon and investment objectives – and may change over time as these parameters change. Strategic asset allocation is compatible with a “buy and hold” strategy, as opposed to tactical asset allocation which is more suited to an active trading approach. Strategic and tactical asset allocation are based on modern portfolio theory, which emphasizes diversification in order to reduce risk and improve portfolio returns.

Question 54

Return on Capital Employed

Answer 54

A financial ratio that measures a company’s profitability and the efficiency with which its capital is employed. Return on Capital Employed (ROCE) is calculated as:

ROCE = Earnings Before Interest and Tax (EBIT) / Capital Employed

“Capital Employed” as shown in the denominator is the sum of shareholders’ equity and debt liabilities; it can be simplified as (Total Assets – Current Liabilities). Instead of using capital employed at an arbitrary point in time, analysts and investors often calculate ROCE based on “Average Capital Employed,” which takes the average of opening and closing capital employed for the time period.

A higher ROCE indicates more efficient use of capital. ROCE should be higher than the company’s capital cost; otherwise it indicates that the company is not employing its capital effectively and is not generating shareholder value.

Question 55

Parity Price

Answer 55

When the price of an asset is directly linked to another price. Examples of parity price are:

1. Convertibles - the price at which a convertible security equals the value of the underlying stock.
2. Options - when an option is trading at its intrinsic value (“trading at parity”).
3. International parity - official rates for a currency in terms of other pegged currencies, typically the U.S. dollar.

Question 56

Call Risk

Answer 56

The risk, faced by a holder of a callable bond, that a bond issuer will take advantage of the callable bond feature and redeem the issue prior to maturity. This means the bondholder will receive payment on the value of the bond and, in most cases, will be reinvesting in a less favorable environment (one with a lower interest rate).

Question 57

Wage-Price spiral

Answer 57

A macroeconomic theory to explain the cause-and-effect relationship between rising wages and rising prices, or inflation. The wage-price sprial suggests that rising wages increase disposable income, thus raising the demand for goods and causing prices to rise. Rising prices cause demand for higher wages, which leads to higher production costs and further upward pressure on prices.

Question 58

Leading Indicator

Answer 58

A measurable economic factor that changes before the economy starts to follow a particular pattern or trend. Leading indicators are used to predict changes in the economy, but are not always accurate.

Bond yields are typically a good leading indicator of the market because traders anticipate and speculate trends in the economy.

Question 59

Debit Spread

Answer 59

Two options with different market prices that an investor trades on the same underlying security. The higher priced option is purchased and the lower premium option is sold - both at the same time. The higher the debit spread, the greater the initial cash outflow the investor will incur on the transaction.

Question 60

Hyperinflation

Answer 60

Extremely rapid or out of control inflation. There is no precise numerical definition to hyperinflation. Hyperinflation is a situation where the price increases are so out of control that the concept of inflation is meaningless

Question 61

Conduit Issuer

Answer 61

An organization, usually a government agency, that issues municipal securities to raise capital for revenue-generating projects where the funds generated are used by a third party (known as the “conduit borrower”) to make payments to investors. The conduit financing is typically backed by either the conduit borrower’s credit or funds pledged toward the project by outside investors. If a project fails and the security goes into default, it falls to the conduit borrower’s financial obligation, not the conduit issuer.

Question 62

Financing Entity

Answer 62

The party in a financing arrangement that provides money, property, or another asset to an intermediate entity or financed entity. A financing entity receives a fee for providing financing, and is linked to the financed entity through a chain of financing transactions across all intermediaries.

Question 63

Temporal Method

Answer 63

method of foreign currency translation that uses exchange rates based on the time assets and liabilities are acquired or incurred. The exchange rate used also depends on the method of valuation that is used. Assets and liabilities valued at current costs use the current exchange rate and those that use historical exchange rates are valued at historical costs.

Question 64

Icahn Lift

Answer 64

The name given to the rise in stock price that occurs when Carl Icahn begins to purchase shares in a company. The Icahn lift occurs because of Mr. Icahn’s reputation for creating value for the shareholders of the companies in which he takes an interest.

Question 65

Monopoly

Answer 65

A situation in which a single company or group owns all or nearly all of the market for a given type of product or service. By definition, monopoly is characterized by an absence of competition, which often results in high prices and inferior products.

According to a strict academic definition, a monopoly is a market containing a single firm. In such instances where a single firm holds monopoly power, the company will typically be forced to divest its assets. Antimonopoly regulation protects free markets from being dominated by a single entity.

Question 66

Globalization

Answer 66

The tendency of investment funds and businesses to move beyond domestic and national markets to other markets around the globe, thereby increasing the interconnectedness of different markets. Globalization has had the effect of markedly increasing not only international trade, but also cultural exchange.

Question 67

GNP

Answer 67

An economic statistic that includes GDP, plus any income earned by residents from overseas investments, minus income earned within the domestic economy by overseas residents.

Question 68

Interest rate swap

Answer 68

An agreement between two parties (known as counterparties) where one stream of future interest payments is exchanged for…

Question 69

General Ledger

Answer 69

A company’s main accounting records. A general ledger is a complete record of financial transactions over the life of a company. The ledger holds account information that is needed to prepare financial statements, and includes accounts for assets, liabilities, owners’ equity, revenues and expenses.

A general ledger is typically used by businesses that employ the double-entry bookkeeping method - where each financial transaction is posted twice, as both a debit and a credit, and where each account has two columns. Because a debit in one account is offset by a credit in a different account, the sum of all debits will be equal to the sum of all credits.

Question 70

Consumer Surplus

Answer 70

An economic measure of consumer satisfaction, which is calculated by analyzing the difference between what consumers are willing to pay for a good or service relative to its market price. A consumer surplus occurs when the consumer is willing to pay more for a given product than the current market price.