vocab Flashcards
glossary
1
Q
absolute return products
A
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.
2
Q
absolute return standard
A
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.
3
Q
active management
A
Active management refers to efforts of buying and selling securities in pursuit of superior combinations of risk and return.
4
Q
active return
A
Active return is the difference between the return of a portfolio and its benchmark that is due to active management.
5
Q
active risk
A
Active risk is that risk that causes a portfolio’s return to deviate from the return of a benchmark due to active management.
6
Q
alternative investments
A
Alternative investments are sometimes viewed as including any investment that is not simply a long position in traditional investments.
7
Q
benchmark
A
A benchmark is a performance standard for a portfolio that reflects the preferences of an investor with regard to risk and return.
8
Q
benchmark return
A
A benchmark return is the return of the benchmark index or benchmark portfolio
9
Q
commodities
A
Commodities are homogeneous goods available in large quantities, such as energy products, agricultural products, metals, and building materials.
10
Q
compensation structure
A
Compensation structure refers to the ways that organizational issues, especially compensation schemes, influence particular investments.
11
Q
distressed debt
A
Distressed debt refers to the debt of companies that have filed or are likely to file in the near future for bankruptcy protection.
12
Q
diversifier
A
A diversifier is an investment with a primary purpose of contributing diversification benefits to its owner.
13
Q
efficiency
A
Efficiency refers to the tendency of market prices to reflect all available information.
14
Q
farmland
A
Farmland consists of land cultivated for row crops (e.g., vegetables and grains) and permanent crops (e.g., orchards and vineyards).
15
Q
financial asset
A
A financial asset is not a real asset—it is a claim on cash flows, such as a share of stock or a bond.
16
Q
hedge fund
A
A hedge fund as 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.
17
Q
illiquidity
A
Illiquidity means that the investment trades infrequently or with low volume (i.e., thinly).
18
Q
incomplete markets
A
Incomplete markets refer to markets with insufficient distinct investment opportunities
19
Q
inefficiency
A
Inefficiency refers to the deviation of actual prices from valuations that would be anticipated in an efficient market.
20
Q
information asymmetries
A
Information asymmetries refer to the extent to which market participants possess different data and knowledge.
21
Q
infrastructure investments
A
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).
22
Q
institutional structure
A
Institutional structure refers to the financial markets and financial institutions related to a particular investment, such as whether the investment is publicly traded.
23
Q
institutional-quality investment
A
An institutional-quality investment is the type of investment that financial institutions such as pension funds or endowments might include in their holdings because they are expected to deliver reasonable returns at an acceptable level of risk.
24
Q
investment
A
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.
25
land
Land comprises a variety of forms, including undeveloped land, timberland, and farmland.
26
lumpy assets
Lumpy assets are assets that can be bought and sold only in specific quantities, such as a large real estate project.
27
mezzanine debt
Mezzanine debt derives its name from its position in the capital structure of a firm: between the ceilings of senior secured debt and the floor of equity.
28
moral hazard
Moral hazard is risk that the behavior of one or more parties will change after entering into a contract.
29
operationally focused real assets
Operationally focused real assets include real estate, land, infrastructure, and intellectual property.
30
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.
31
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.
32
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.
33
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.
34
real estate
Real estate focuses on land and improvements that are permanently affixed, like buildings
35
regulatory structure
Regulatory structure refers to the role of government, including both regulation and taxation, in influencing the nature of an investment.
36
relative return standard
A relative return standard means that returns are to be evaluated relative to a benchmark.
37
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.
38
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.
39
securities structure
Securities structure refers to the structuring of cash flows through leverage and securitization.
40
structured products
Structured products are instruments created to exhibit particular return, risk, taxation, or other attributes.
41
timberland
Timberland includes both the land and the timber of forests of tree species typically used in the forest products industry.
42
trading structure
Trading structure refers to the role of an investment vehicle’s investment managers in developing and implementing trading strategies.
43
traditional investments
Traditional investments include publicly traded equities, fixed-income securities, and cash.
44
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.
45
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.
46
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.
47
buy side
Buy side refers to the institutions and entities that buy large quantities of securities for the portfolios they manage.
48
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.
49
commercial bank
A commercial bank focuses on the business of accepting deposits and making loans, with modest investment-related services.
50
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.
51
dark pool
A dark pool refers to non-exchange trading by large market participants that is hidden from the view of most market participants.
52
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.
53
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.
54
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.
55
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.
56
financial data providers
Financial data providers supply funds primarily with raw financial market data, including security prices, trading information, and indices.
57
financial platforms
Financial platforms are systems that provide access to financial markets, portfolio management systems, accounting and reporting systems, and risk management systems.
58
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.
59
foundation
A foundation is a not-for-profit organization that donates funds and support to other organizations for its own charitable purposes.
60
fourth markets
Fourth markets are electronic exchanges that allow traders to quickly buy and sell exchange-listed stocks via the electronic communications systems offered by these markets.
61
front office operations
Front office operations involve investment decision-making and, in the case of brokerage firms, contact with clients.
62
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.
63
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.
64
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.
65
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.
66
liquid alternatives
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.
67
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.
68
market making
market making
69
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.
70
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.
71
Markets in Financial Instruments Directive (MiFID)
The Markets in Financial Instruments Directive (MiFID) is an EU law that establishes uniform regulation for investment managers in the European Economic Area (the EU plus Iceland, Norway, and Liechtenstein).
72
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.
73
middle office operations
Middle office operations form the interface between the front office and the back office, with a focus on risk management.
74
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.
75
partnership agreement
A partnership agreement is a formal written contract creating a partnership.
76
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.
77
primary market
A primary market refers to the methods, institutions, and mechanisms involved in the placement of new securities to investors.
78
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.
79
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.
80
private-placement memoranda
Private-placement memoranda (a.k.a. offering documents) are formal descriptions of an investment opportunity that comply with federal securities regulations.
81
progressive taxation
Progressive taxation places higher-percentage taxation on individuals and corporations with higher incomes.
82
proprietary trading
Proprietary trading occurs when a firm trades securities with its own money in order to make a profit.
83
Regulation T margin rule
Federal Reserve Board leverage rules include the Regulation T margin rule, which currently requires a deposit of at least 50% of the purchase cost or short sale proceeds of a trade (margin).
84
secondary market
A secondary market facilitates trading among investors of previously existing securities.
85
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.
86
securitization
Securitization involves bundling assets, especially unlisted assets, and issuing claims on the bundled assets.
87
sell side
Sell-side institutions, such as large dealer banks, act as agents for investors when they trade securities.
88
separately managed accounts
Separately managed accounts (SMAs) are individual investment accounts offered by a brokerage firm and managed by independent investment management firms.
89
soft dollar arrangement
A soft dollar arrangement generally refers to an agreement or an understanding by which an investment adviser receives research services from a broker-dealer in exchange for a fee (such as a commission) paid out of the fund or client account.
90
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.
91
subscription agreement
A subscription agreement is an application submitted by an investor who desires to join a limited partnership.
92
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.
93
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.
94
Undertakings for Collective Investment in Transferable Securities (UCITS)
Regulation of hedge funds in Europe centers on the concept of
Undertakings for Collective Investment in Transferable Securities (UCITS). UCITS are carefully regulated European fund vehicles that allow retail access and marketing of hedge- fund-like investment pools.
95
universal banking
Germany uses universal banking, which means that German banks can engage in both commercial and investment banking.
96
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.
97
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.
98
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.
99
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.
100
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.
101
claw back
A claw back clause, claw back provision, or claw back option is designed to return incentive fees to LPs when early profits are followed by subsequent losses.
102
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.
103
complex cash flow pattern
A complex cash flow pattern is an investment involving either borrowing or multiple sign changes.
104
continuous compounding
Continuous compounding assumes that earnings can be instantaneously reinvested to generate additional earnings.
105
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.
106
discrete compounding
Discrete compounding includes any compounding interval other than continuous compounding such as daily, monthly, or annual.
107
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.
108
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.
109
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.
110
hard hurdle rate
A hard hurdle rate limits incentive fees to profits in excess of the hurdle rate.
111
hurdle rate
A hurdle rate specifies a return level that LPs must receive before GPs begin to receive incentive fees.
112
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.
113
interim IRR
The interim IRR is a computation of IRR based on realized cash flows from an investment and its current estimated residual value.
114
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.
115
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.
116
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.
117
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.
118
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.
119
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.
120
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.
121
partially collateralized
A partially collateralized position has collateral lower in value than the notional value.
122
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.
123
point-to-point IRR
A point-to-point IRR is a calculation of performance over part of an investment’s life.
124
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.
125
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.
126
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.
127
return on notional principal
The return on notional principal divides economic gain or loss by the notional principal of the contract.
128
scale differences
Scale differences are when investments have unequal sizes and/or timing of their cash flows.
129
simple interest
Simple interest is an interest rate computation approach that does not incorporate compounding.
130
since-inception IRR
A since-inception IRR is commonly used as a measure of fund performance rather than the performance of an individual investment.
131
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.
132
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.
133
vesting
Vesting is the process of granting full ownership of conferred rights, such as incentive fees.
134
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.
135
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 variances as well.
136
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.
137
autoregressive
Autoregressive refers to when subsequent values to a variable are explained by past values of the same variable.
138
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: βi = Cov(R m,R i)∕Var(R m) = σim∕σ2 where βi is the beta of the returns of asset i (Ri) with respect to a market index of returns, Rm.
139
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).
140
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.
141
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.
142
ex ante returns
Future possible returns and their probabilities are referred to as expectational or ex ante returns.
143
ex post returns
Ex post returns are realized outcomes rather than anticipated outcomes.
144
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: Excess Kurtosis = {E[(R − μ)4 ]∕σ4 } − 3
145
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.
146
GARCH
GARCH (generalized autoregressive conditional heteroskedasticity) is an example of a time-series method that adjusts for varying volatility.
147
heteroskedasticity
Heteroskedasticity is when the variance of a variable changes with respect to a variable, such as itself or time.
148
homoskedasticity
Homoskedasticity is when the variance of a variable is constant.
149
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.
150
kurtosis
Kurtosis serves as an indicator of the peaks and tails of a distribution. Kurtosis = E[(R − μ)4 ]∕σ4
151
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.
152
lognormal distribution
A variable has a lognormal distribution if the distribution of the logarithm of the variable is normally distributed.
153
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.
154
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.
155
normal distribution
The normal distribution is the familiar bell-shaped distribution, also known as the Gaussian distribution.
156
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.
157
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.
158
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.
159
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: Skewness = E[(R − μ)3 ]∕σ3
160
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.
161
standard deviation
The square root of the variance is an extremely popular and useful measure of dispersion known as the standard deviation: Standard Deviation = √σ2 = σ
162
variance
The variance is the second central moment and is the expected value of the deviations squared,
163
volatility
In investment terminology, volatility is a popular term that is used synonymously with the standard deviation of returns.
164
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.
165
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.
166
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.
167
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]∕TE where E(Rp) is the expected or mean return for portfolio p, RBenchmark is the expected or mean return of the benchmark, and TE is the tracking error of the portfolio relative to its benchmark return.
168
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.
169
M2 approach
The M2 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.
170
maximum drawdown
Maximum drawdown is defined as the largest decline over any time interval within the entire observation period.
171
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.
172
parametric V aR
A VaR computation assuming normality and using the statistics of the normal distribution is known as parametric VaR.
173
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.
174
semistandard deviation
Semistandard deviation, sometimes called semideviation, is the square root of semivariance.
175
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/∑[Rt E(R)]2 For all Rt< E(R) where T∗ is the number of negative deviations.
176
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.
177
shortfall risk
Shortfall risk is simply the probability that the return will be less than the investor’s target rate of return.
178
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).
```
179
target semistandard deviation
Target semistandard deviation (TSSD) is simply the square root of the target semivariance.
180
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.
181
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.
182
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 βpis the beta of the returns of portfolio p.
183
value at risk
Value at risk (VaR) is the loss figure associated with a particular percentile of a cumulative loss function.
184
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.
185
absolute pricing model
An absolute pricing model attempts to describe a price level based on its underlying economic factors.
186
arbitrage
Arbitrage is the attempt to earn riskless profits (in excess of the risk-free rate) by identifying and trading relatively mispriced assets.
187
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.
188
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.
189
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.
190
binomial tree model
A binomial tree model projects possible outcomes in a variable by modeling uncertainty as two movements: an upward movement and a downward movement.
191
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.
192
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.
193
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.
194
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.
195
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.
196
collar
A collar generally refers to a long position in an asset combined with a short call option and a long put option on that asset, in which the call option has a higher strike price than the put option.
197
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.
198
covered call
A covered call combines being long an asset with being short a call option on the same asset.
199
elasticity
An elasticity is the percentage change in a value with respect to a percentage change in another value.
200
empirical model
An empirical model is derived from observation. An example would be a model that recognizes that the returns of some traditional assets are correlated with their market-to-book ratios.
201
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.”
202
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.
203
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.
204
Fama-French model
The Fama-French model links the returns of assets to three factors: (1) the market portfolio, (2) a factor representing a value versus growth effect, and (3) a factor representing a small-cap versus large-cap effect.
205
Fama-French-Carhart model
The Fama-French-Carhart model adds a fourth factor to the Fama-French model: momentum.
206
financed positions
Financed positions enable economic ownership of an asset without the posting of the purchase price.
207
forward contract
A forward contract is simply an agreement calling for deferred delivery of an asset or a payoff.
208
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.
209
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.
210
informational market efficiency
Informational market efficiency refers to the extent to which asset prices reflect available information.
211
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).
212
market portfolio
The market portfolio is a hypothetical portfolio containing all tradable assets in the world.
213
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.
214
multifactor models
Multifactor models of asset pricing express systematic risk using multiple factors and are extremely popular throughout traditional and alternative investing.
215
naked option
A short option position that is unhedged is often referred to as a naked option.
216
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).
217
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.
218
option collar
An option collar generally refers only to the long position in a put and a short position in a call.
219
option combination
An option combination contains both calls and puts on the same underlying asset.
220
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.
221
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.
222
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.
223
protective put
A protective put combines being long an asset with a long position in a put option on the same asset.
224
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.
225
relative pricing model
relative pricing model
226
rho
Rho is the sensitivity of an option price with respect to changes in the riskless interest rate.
227
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.
228
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).
229
single-factor asset pricing model
A single-factor asset pricing model explains returns and systematic risk using a single risk factor.
230
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.
231
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.
232
systematic return
Systematic return is the portion of an asset’s return driven by a common association.
233
systematic risk
Systematic risk is the dispersion in economic outcomes caused by variation in systematic return
234
term structure of forward contracts
The term structure of forward contracts is the relationship between forward prices (or forward rates) and the time to delivery of the forward contract.
235
theoretical model
In a theoretical model, the factors are derived from reasoning based on known facts and relationships.
236
tradable asset
A tradable asset is a position that can be readily established and liquidated in the financial market, such as a stock position, a bond position, or a portfolio of liquid positions.
237
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.
238
abstract models
Abstract models, also called basic models, tend to have applicability only in solving real-world challenges of the future.
239
applied models
Applied models are designed to address immediate real- world challenges and opportunities.
240
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
241
cross-sectional models
Cross-sectional models analyze behavior at a single point in time across various subjects, such as investors or investments.
242
normative model
A normative model attempts to describe how people and prices ought to behave.
243
panel data sets
Panel data sets combine the two approaches by tracking multiple subjects through time and can also be referred to as longitudinal data sets and cross-sectional time-series data sets.
244
peer group
The peer group is typically a group of funds with similar objectives, strategies, or portfolio holdings.
245
performance attribution
Performance attribution, also known as return attribution, is the process of identifying the components of an asset’s return or performance.
246
positive model
A positive model attempts to describe how people and prices actually behave.
247
return attribution
Performance attribution, also known as return attribution, is the process of identifying the components of an asset’s return or performance.
248
time-series models
Time-series models analyze behavior of a single subject or a set of subjects through time.
249
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.
250
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).
251
alpha driver
An investment that seeks high returns independent of the market is an alpha driver.
252
alternative hypothesis
The alternative hypothesis is the behavior that the analyst assumes would be true if the null hypothesis were rejected.
253
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.
254
backfill bias
Backfill bias fun, 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.
255
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.
256
backtesting
Backtesting is the use of historical data to test a strategy that was developed subsequent to the observation of the data.
257
beta creep
Beta creep is when hedge fund strategies pick up more systematic market risk over time.
258
beta driver
An investment that moves in tandem with the overall market or a particular risk factor is a beta driver.
259
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.
260
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.
261
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.
262
cherry-picking
Cherry-picking is the concept of extracting or publicizing only those results that support a particular viewpoint.
263
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.
264
confidence interval
A confidence interval is a range of values within which a parameter estimate is expected to lie with a given probability.
265
data dredging
Data dredging, or data snooping, refers to the overuse and misuse of statistical tests to identify historical patterns.
266
data mining
Data mining typically refers to the vigorous use of data to uncover valid relationships.
267
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.
268
equity risk premium
The equity risk premium (ERP) is the expected return of the equity market in excess of the risk-free rate.
269
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.
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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.
271
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).
272
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.
273
hypotheses
Hypotheses are propositions that underlie the analysis of an issue.
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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.
275
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.
276
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.
277
outlier
An outlier is an observation that is markedly further from the mean than almost all other observations.
278
overfitting
Overfitting is using too many parameters to fit a model very closely to data over some past time frame.
279
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.
280
process drivers
Process drivers are beta drivers that focus on providing beta that is fine-tuned or differentiated.
281
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.
282
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).
283
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.
284
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.
285
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.
286
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.
287
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.
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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.
289
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.
290
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.
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type II error
A type II error, also known as a false negative, is failing to reject the null hypothesis when it is false.
292
conditional correlation
A conditional correlation is a correlation between two variables under specified circumstances.
293
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.
294
down market beta
The down market beta, bi,d, is the responsiveness of the fund’s return to the market return when the market return is less than the riskless rate (i.e., when the market’s excess return is negative, or down).
295
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.
296
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.
297
intercept
The intercept is the value of the dependent variable when all independent variables are zero.
298
look-back option
A look-back option has a payoff that is based on the value of the underlying asset over a reference period rather than simply the value of the underlying asset at the option’s expiration date.
299
multicollinearity
Multicollinearity is when two or more independent variables in a regression model have high correlation to each other.
300
multiple regression model
A multiple regression model is a regression model with more than one independent variable.
301
negative conditional correlation
When the correlation in the down sample is higher than the correlation in the up sample, it is termed negative conditional correlation.
302
nonlinear exposure
A nonlinear exposure of a position to a market factor is when the sensitivity of the position’s value varies based on the magnitude of the level of change in the market factor’s value.
303
nonstationary
The return distributions of hedge funds and hedge fund indices are nonstationary, meaning that return volatilities and correlations vary through time.
304
positive conditional correlation
Positive conditional correlation of investment returns to market returns is when the correlation in the up sample is higher than the correlation in the down sample. Investors prefer investment strategies with positive conditional correlation, since the strategies offer higher participation in profits during bull markets and lower participation in losses during bear markets.
305
principal components analysis
Principal components analysis is a statistical technique that groups the observations in a large data set into smaller sets of similar types based on commonalities in the data.
306
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.
307
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).
308
rolling window analysis
Rolling window analysis is a relatively advanced technique for analyzing statistical behavior over time, using overlapping subsamples that move evenly through time.
309
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.
310
serial correlation
Serial correlation is the same as autocorrelation: It is the correlation of a variable, such as return, in one time period (e.g., year) to the same variable in another time period.
311
simple linear regression
A simple linear regression is a linear regression in which the model has only one independent variable.
312
slope coefficient
The slope coefficient is a measure of the change in a dependent variable with respect to a change in an independent variable.
313
stepwise regression
Stepwise regression is an iterative technique in which variables are added or deleted from the regression equation based on their statistical significance.
314
style analysis
Style analysis is the process of understanding an investment strategy, especially using a statistical approach, based on grouping funds by their investment strategies or styles.
315
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.
316
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.
317
up market beta
The up market beta, bi,u, is the responsiveness of the fund’s return to the market return when the excess market return is positive, and is estimated as the sum of bi,d and bi,diff.
318
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).
319
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.
320
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.
321
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).
322
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.
323
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.
324
favorable mark
A favorable mark is a biased indication of the value of a position that is intentionally provided by a subjective source.
325
finished lots
Finished lots are fully completed and ready for home construction and occupancy.
326
intrinsic option value
An intrinsic option value is the greater of $0 and the value of an option if exercised immediately.
327
land banking
Land banking is the practice of buying vacant lots for the purpose of development or disposition at a future date.
328
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.
329
managed returns
Managed returns are returns based on values that are reported with an element of managerial discretion.
330
market manipulation
Market manipulation refers to engaging in trading activity designed to cause the markets to produce favorable prices for thinly traded listed securities.
331
model manipulation
Model manipulation is the process of altering model assumptions and inputs to generate desired values and returns.
332
natural resources
Natural resources are real assets that have received no or almost no human alteration.
333
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.
334
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.
335
perpetual option
A perpetual option is an option with no expiration date.
336
political risk
Political risk is economic uncertainty caused by changes in government policy that may affect returns, perhaps dramatically.
337
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.
338
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.
339
rotation
Rotation is the length of time from the start of the timber (typically the planting) until the harvest of the timber.
340
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.
341
smoothing
Smoothing is reduction in the reported dispersion in a price or return series.
342
split estate
A split estate is when surface rights and mineral rights are separately owned.
343
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.
344
time value of an option
The time value of an option is the excess of an option’s price above its intrinsic value.
345
backwardation
When the slope of the term structure of forward prices is negative, the market is in backwardation, or is backwardated.
346
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.
347
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.
348
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.
349
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.
350
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.
351
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.
352
distant contracts
Contracts with longer times to settlement are often called distant contracts, deferred contracts, or back contracts.
353
front month contract
On an exchange, the futures contract with the shortest time to settlement is often referred to as the front month contract.
354
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.
355
informationally inefficient term structure
An informationally inefficient term structure has pricing relationships that do not properly reflect available information.
356
initial margin
The collateral deposit made at the initiation of a long or short futures position is called the initial margin.
357
law of one price
The law of one price states that in the absence of trading restrictions, two identical assets will not persist in trading at different prices in different markets because arbitrageurs will buy the relatively underpriced asset and sell the relatively overpriced asset until the discrepancy disappears.
358
maintenance margin requirement
A maintenance margin requirement is a minimum collateral requirement imposed on an ongoing basis until a position is closed.
359
margin call
A margin call is a demand for the posting of additional collateral to meet the initial margin requirement.
360
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.
361
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.
362
normal backwardation
In normal backwardation, the forward price is believed to be below the expected spot price.
363
normal contango
In normal contango, the forward price is believed to be above the expected spot price.
364
open interest
The outstanding quantity of unclosed contracts is known as open interest.
365
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.
366
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.
367
storage costs
Storage costs of physical commodities involve such expenditures as warehouse fees, insurance, transportation, and spoilage.
368
swap
A swap is a string of forward contracts grouped together that vary by time to settlement.
369
basis risk
Basis risk is the dispersion in economic returns associated with changes in the relationship between spot prices and futures prices.
370
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.
371
collateral yield
Collateral yield, is the interest earned from the riskless bonds or other money market assets used to collateralize the futures contract.
372
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.
373
convergence at settlement
Convergence at settlement is the process of the futures price nearing the spot price as settlement approaches, and the two prices matching each other at settlement.
374
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.
375
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.
376
heterogeneous
A heterogeneous value differs across one or more dimensions.
377
inflation
Inflation is the decline in the value of money relative to the
value of a general bundle of goods and services.
378
inflation risk
Inflation risk is the dispersion in economic outcomes caused by uncertainty regarding the value of a currency.
379
investable index
An investable index has returns that an investor can match in practice by maintaining the same positions that constitute the index.
380
nominal price
A nominal price refers to the stated price of an asset measured using the contemporaneous values of a currency.
381
production-weighted index
A production-weighted index weights each underlying commodity using estimates of the quantity of each commodity produced.
382
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.
383
Reuters/Jefferies Commodity Research Bureau (CRB) Index
The Reuters/Jefferies Commodity Research Bureau (CRB) Index is the oldest major commodity index and is currently made up of 19 commodities traded on various exchanges.
384
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.
385
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.
386
spot return
Spot return is the return on the underlying asset in the spot market.
387
Standard & Poor's Goldman Sachs Commodity Index (S&P GSCI)
The Standard & Poor’s Goldman Sachs Commodity Index (S&P GSCI) is a longonly index of physical commodity futures.
388
brownfield project
Investable infrastructure can also be an existing project, or brownfield project, that has a history of operations and may have converted from a government asset into something privately investable.
389
double taxation
Double taxation is the application of income taxes twice: taxation of profits at the corporate income tax level and taxation of distributions at the individual income tax level.
390
downstream operations
Downstream operations focus on refining, distributing, and marketing the oil and gas.
391
evergreen funds
Unlisted open-end funds, also called evergreen funds, allow investors to subscribe to or redeem from these funds on a regular basis.
392
excludable good
An excludable good is a good others can be prevented from enjoying.
393
gates
Gates are fund restrictions on investor withdrawals.
394
greenfield project
Investable infrastructure can originate as a new, yet-to-be- constructed project, referred to as a greenfield project, which was designed to be investable.
395
intangible assets
Intangible assets are economic resources that do not have a physical form.
396
intellectual property
Intellectual property (IP) is an intangible asset that can be owned, such as copyrighted artwork.
397
investable infrastructure
Investable infrastructure is typically differentiated from other assets with seven primary characteristics: (1) public use, (2) monopolistic power, (3) government related, (4) essential, (5) cash generating, (6) conducive to privatization of control, and (7) capital intensive with long-term horizons.
398
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.
399
negative costs
Negative costs refer not to the sign of the values but to the fact that these are costs required to produce what was, in the predigital era, the film’s negative image.
400
present value of growth opportunities (PVGO)
In corporate finance, present value of growth opportunities (PVGO) describes a high value assigned to an investment based on the idea that the underlying assets offer exceptional future income.
401
privatization
When a governmental entity sells a public asset to a private operator, this is termed privatization.
402
public-private partnership
A public-private partnership (PPP) occurs when a private sector party is retained to design, build, operate, or maintain a public building (e.g., a hospital), often for a lease payment for a prespecified period of time.
403
regulatory risk
Regulatory risk is the economic dispersion to an investor from uncertainty regarding governmental regulatory actions.
404
unbundling
In recent years, there has been an increased interest in unbundling IP from corporations and permitting it to be purchased as a stand-alone investment.
405
upstream operations
Upstream operations focus on exploration and production; midstream operations focus on storing and transporting the oil and gas.
406
amortization
. Reduction in principal due to payments is known as amortization.
407
balloon payment
A balloon payment is a large scheduled future payment.
408
collateralized mortgage obligations (CMOs)
Collateralized mortgage obligations (CMOs) extend this MBS mechanism to create different security classes, called tranches, which have different priorities to receiving cash flows and therefore different risks.
409
commercial mortgage loans
Commercial mortgage loans are loans backed by commercial real estate (multifamily apartments, hotels, offices, retail and industrial properties) rather than owner-occupied residential properties.
410
commercial mortgage-backed securities
Commercial mortgage-backed securities (CMBS) are mortgage-backed securities with underlying collateral pools of commercial property loans.
411
conditional prepayment rate
The annualized percentage of a mortgage’s remaining principal value that is prepaid in a particular month is known as the conditional prepayment rate (CPR).
412
core real estate
Core real estate includes assets that achieve a relatively high percentage of their returns from income and are expected to have low volatility.
413
covenants
Covenants are promises made by the borrower to the lender, such as requirements that the borrower maintain the property in good repair and continue to meet specified financial conditions.
414
cross-collateral provision
In order to mitigate the risk to which they are exposed, lenders commonly use a cross-collateral provision, wherein the collateral for one loan is used as collateral for another loan.
415
debt service coverage ratio
A related measure is the debt service coverage ratio (DSCR), which is the ratio of the property’s net operating income to all loan payments, including the amortization of the loan.
416
equity REITs
Equity REITs invest predominantly in equity ownership within the private real estate market.
417
fixed charges ratio
The fixed charges ratio is the ratio of the property’s net operating income to all fixed charges that the borrower pays annually.
418
fixed-rate mortgage
A fixed-rate mortgage has interest charges and interest payments based on a single rate established at the initiation of the mortgage.
419
fully amortized
An asset is fully amortized when its principal is reduced to zero.
420
idiosyncratic prepayment factors
Factors affecting prepayment decisions other than interest rates or other systematic factors are known as idiosyncratic prepayment factors.
421
index rate
An index rate is a variable interest rate used in the determination of the mortgage’s stated interest rate.
422
interest coverage ratio
Lenders typically examine the interest coverage ratio, which can be defined as the property’s net operating income divided by the loan’s interest payments.
423
interest rate cap
An interest rate cap is a limit on interest rate adjustments used in mortgages and derivatives with variable interest rates.
424
loan-to-value ratio (LTV ratio)
The loan-to-value ratio (LTV ratio) is the ratio of the amount of the loan to the value (either market or appraised) of the property.
425
lumpiness
Lumpiness describes when assets cannot be easily and inexpensively bought and sold in sizes or quantities that meet the preferences of the buyers and sellers.
426
margin rate
A margin rate is the spread by which the stated mortgage rate is set above the index rate. (This should not be confused with the same term used to describe a rate associated with margin debt in a brokerage account.)
427
mortgage
A mortgage loan can be simply defined as a loan secured by property.
428
mortgage REITs
Mortgage REITs invest predominantly in real estate–based debt.
429
mortgage-backed securities (MBS)
Mortgage-backed securities (MBS) are a type of asset- backed security that is secured by a mortgage or pool of mortgages.
430
negative amortization
Negative amortization occurs when the interest owed is greater than the payments being made such that the deficit is added to the principal balance on the loan, causing the principal balance to increase through time.
431
opportunistic real estate
Opportunistic real estate properties are expected to derive most or all of their returns from property appreciation and may exhibit substantial volatility in value and returns.
432
option adjustable-rate mortgage (option ARM)
An option adjustable-rate mortgage (option ARM) is an adjustable-rate mortgage that provides borrowers with the flexibility to make one of several possible payments on their mortgage every month.
433
pass-through MBS
A pass-through MBS is perhaps the simplest MBS and consists of the issuance of a homogeneous class of securities with pro rata rights to the cash flows of the underlying pool of mortgage loans
434
prepayment option
The ability of the borrower to make or not make unscheduled principal payments is an option to the borrower: the borrower’s prepayment option.
435
PSA benchmark
The Public Securities Association (PSA) established the PSA benchmark, a benchmark of prepayment speed that is based on the CPR and that has become the standard approach used by market participants.
436
real estate investment trust (REIT)
A real estate investment trust (REIT) is an entity structured much like a traditional operating corporation, except that the assets of the entity are almost entirely real estate.
437
recourse
Recourse is the set of rights or means that an entity such as a lender has in order to protect its investment.
438
refinancing burnout
Reduced refinancing speeds due to high levels of previous refinancing activity is known as refinancing burnout.
439
residential mortgage loans
Residential mortgage loans are typically taken out by individual households on properties that generate no explicit rental income, since the houses are usually owner occupied.
440
residential mortgage-backed securities
The residential mortgage-backed securities (RMBS) market is backed by residential mortgage loans.
441
styles of real estate investing
Styles of real estate investing refer to the categorization of real estate property characteristics into core, value added, and opportunistic.
442
subprime mortgages
Uninsured mortgages with borrowers of relatively high credit risk are generally known as subprime mortgages.
443
unscheduled principal payments
If the borrower makes unscheduled principal payments, which are payments above and beyond the scheduled mortgage payments, the mortgage’s balance will decline more quickly than illustrated in Exhibit 14.1, and the mortgage will terminate early. In traditional mortgages, payments that exceed the required payment reduce the principal payment but do not lower required subsequent payments until the mortgage is paid off.
444
value-added real estate
Value-added real estate includes assets that exhibit one or more of the following characteristics: (1) achieving a substantial portion of their anticipated returns from appreciation in value, (2) exhibiting moderate volatility, and (3) not having the financial reliability of core properties.
445
variable-rate mortgage
A variable-rate mortgage has interest charges and interest payments based on a rate that is allowed to vary over the life of the mortgage based on terms established at the initiation of the mortgage.
446
after-tax discounting approach
In an after-tax discounting approach, the estimated after-tax cash flows (e.g., after-tax bond payments) are discounted using a rate that has been reduced to reflect the net rate received by an investor with a specified marginal tax rate.
447
appraisals
Appraisals are professional opinions with regard to the value of an asset, such as a real estate property.
448
backward induction
Backward induction is the process of solving a decision tree by working from the final nodes toward the first node, based on valuation analysis at each node.
449
closed-end real estate mutual fund
A closed-end real estate mutual fund is an investment pool that has real estate as its underlying asset and a relatively fixed number of outstanding shares.
450
commingled real state funds
Commingled real estate funds (CREFs) are a type of private equity real estate fund that is a pool of investment capital raised from private placements that are commingled to purchase commercial properties.
451
comparable sale prices approach
The comparable sale prices approach values real estate based on transaction values of similar real estate, with adjustments made for differences in characteristics.
452
data smoothing
Data smoothing occurs in a return series when the prices used in computing the return series have been dampened relative to the volatility of the true but unobservable underlying prices.
453
decision node
A decision node is a point in a decision tree at which the holder of the option must make a decision.
454
decision tree
A decision tree shows the various pathways that a decision maker can select as well as the points at which uncertainty is resolved.
455
depreciation
Depreciation is a noncash expense that is deducted from revenues in computing accounting income to indicate the decline of an asset’s value.
456
depreciation tax shield
A depreciation tax shield is a taxable entity’s ability to reduce taxes by deducting depreciation in the computation of taxable income.
457
discounted cash flow (DCF) method
The income approach is also known as the discounted cash flow (DCF) method when cash flows are discounted rather than accounting estimates of income.
458
effective gross income
The effective gross income is the potential gross income reduced for the vacancy loss rate
459
effective tax rate
The effective tax rate is the actual reduction in value that occurs in practice when other aspects of taxation are included in the analysis, such as exemptions, penalties, and timing of cash flows.
460
equity residual approach
An alternative approach, often termed the equity residual approach, focuses on the perspective of the equity investor by subtracting the interest expense and other cash outflows due to mortgage holders (in the numerator) and by discounting the remaining cash flows using an interest rate reflective of the required rate of return on the equity of a leveraged real estate investment (in the denominator).
461
exchange-traded funds (ETFs)
Exchange-traded funds (ETFs) represent a tradable investment vehicle that tracks a particular index or portfolio by holding its constituent assets or a subsample of them.
462
fixed expenses
Fixed expenses, examples of which are property taxes and property insurance, do not change directly with the level of occupancy of the property.
463
FTSE NAREIT US Real Estate Index Series
The FTSE NAREIT US Real Estate Index Series is a family of REIT-based performance indices that covers the different sectors of the U.S. commercial real estate space.
464
gearing
Gearing is the use of leverage.
465
hedonic price index
A hedonic price index estimates value changes based on an analysis of observed transaction prices that have been adjusted to reflect the differing characteristics of the assets underlying each transaction.
466
income approach
The income approach values real estate by projecting expected income or cash flows, discounting for time and risk, and summing them to form the total value.
467
information node
An information node denotes a point in a decision tree at which new information arrives.
468
NCREIF Property Index (NPI)
The NCREIF Property Index (NPI) is the primary example of an appraisal-based real estate index in the United States and is published by the National Council of Real Estate Investment Fiduciaries (NCREIF), a not-for-profit industry association that collects data regarding property values from its members.
469
net lease
In a net lease, the tenant is responsible for almost all of the operating expenses.
470
net operating income (NOI)
Net operating income (NOI) is a measure of periodic earnings that is calculated as the property’s rental income minus all expenses associated with maintaining and operating the property.
471
net sale proceeds
The net sale proceeds (NSP) is the expected selling price minus any expected selling expenses arising from the sale of the property at time T.
472
open-end real estate mutual funds
Open-end real estate mutual funds are public investments that offer a non-exchange traded means of obtaining access to the private real estate market.
473
operating expenses
Operating expenses are non-capital outlays that support rental of the property and can be classified as fixed or variable.
474
potential gross income
The potential gross income is the gross income that could potentially be received if all offices in the building were occupied.
475
pre-tax discounting approach
The pre-tax discounting approach is commonly used in finance, where pre-tax cash flows are used in the numerator of the present value analysis (as the cash flows to be received), and the pre-tax discount rate is used in the denominator.
476
private equity real estate funds
Private equity real estate funds are privately organized funds that are similar to other alternative investment funds, such as private equity funds and hedge funds, yet have real estate as their underlying asset.
477
profit approach
The profit approach to real estate valuation is typically used for properties with a value driven by the actual business use of the premises; it is effectively a valuation of the business rather than a valuation of the property itself.
478
real estate development projects
Real estate development projects can include one or more stages of creating or improving a real estate project, including the acquisition of raw land, the construction of improvements, and the renovation of existing facilities.
479
real estate joint ventures
Real estate joint ventures are private equity real estate funds that consist of the combination of two or more parties, typically represented by a small number of individual or institutional investors, embarking on a business enterprise such as the development of real estate properties.
480
real estate valuation
Real estate valuation is the process of estimating the market value of a property and should be reflective of the price at which informed investors would be willing to both buy and sell that property.
481
real option
A real option is an option on a real asset rather than a financial security.
482
risk premium approach
The risk premium approach to estimation of a discount rate for an investment uses the sum of a riskless interest rate and one or more expected rewards—expressed as rates—for bearing the risks of the investment.
483
stale pricing
The use of prices that lag changes in true market prices is known as stale pricing.
484
syndications
Syndications are private equity real estate funds formed by a group of investors who retain a real estate expert with the intention of undertaking a particular real estate project.
485
vacancy loss rate
The vacancy loss rate is the observed or anticipated rate at which potential gross income is reduced for space that is not generating rental income.
486
variable expenses
Variable expenses, examples of which are maintenance, repairs, utilities, garbage removal, and supplies, change as the level of occupancy of the property varies.
487
absolute return strategies
Absolute return strategies are hedge fund strategies that seek to minimize market risk and total risk.
488
annuity view of hedge fund fees
The annuity view of hedge fund fees represents the prospective stream of cash flows from fees available to a hedge fund manager.
489
asymmetric incentive fees
Asymmetric incentive fees, in which managers earn a portion of investment gains without compensating investors for investment losses, are generally prohibited for stock and bond funds offered as ’40 Act mutual funds in the United States.
490
at-the-money incentive fee approximation
The at-the-money incentive fee approximation expresses the value of a managerial incentive fee as the product of 40%, the fund’s NAV, the incentive fee percentage, and the volatility of the assets (σ1 ) over the option’s life.
491
capacity
Capacity is the limit on the quantity of capital that can be deployed without substantially diminished performance.
492
classification of hedge fund strategies
A classification of hedge fund strategies is an organized grouping and labeling of hedge fund strategies.
493
closet indexer
A closet indexer is a manager who attempts to generate returns that mimic an index while claiming to be an active manager.
494
consolidation
Consolidation is an increase in the proportion of a market represented by a relatively small number of participants (i.e., the industry concentration).
495
convergent strategies
Convergent strategies profit when relative value spreads move tighter, meaning that two securities move toward relative values that are perceived to be more appropriate.
496
diversified strategies
Diversified strategies are hedge fund strategies that seek to diversify across a number of different investment themes.
497
equity strategies
Equity strategies are hedge fund strategies that exhibit substantial market risk.
498
event-driven strategies
Event-driven strategies are hedge fund strategies that seek to earn returns by taking on event risk, such as failed mergers, that other investors are not willing or prepared to take.
499
excessive conservatism
Excessive conservatism is inappropriately high risk aversion by the manager, since the manager’s total income and total wealth may be highly sensitive to fund performance.
500
fee bias
Fee bias is when index returns overstate what a new investor can obtain in the hedge fund marketplace because the fees used to estimate index returns are lower than the typical fees that a new investor would pay.
501
fund mortality
Fund mortality, the liquidation or cessation of operations of funds, illustrates the risk of individual hedge funds and is an important issue in hedge fund analysis.
502
fund of funds
A fund of funds in this context is a hedge fund with underlying investments that are predominantly investments in other hedge funds.
503
headline risk
Headline risk is dispersion in economic value from events so important, unexpected, or controversial that they are the center of major news stories.
504
hedge fund program
A hedge fund program refers to the processes and procedures for the construction, monitoring, and maintenance of a portfolio of hedge funds.
505
high-water mark
The high-water mark (HWM) is the highest NAV of the fund on which an incentive fee has been paid.
506
incentive fee option value
The incentive fee option value is the risk-adjusted present value of the incentive fees to a manager that have been adjusted for its optionality.
507
instant history bias
Instant history bias or backfill bias occurs when an index contains histories of returns that predate the entry date of the corresponding funds into a database and thereby cause the index to disproportionately reflect the characteristics of funds that are added to a database.
508
investability
The investability of an index is the extent to which market participants can invest to actually achieve the returns of the index.
509
liquidation bias
Liquidation bias occurs when an index disproportionately reflects the characteristics of funds that are not near liquidation.
510
lock-in effect
The lock-in effect in this context refers to the pressure exerted on managers to avoid further risks once high profitability and a high incentive fee have been achieved.
511
managerial coinvesting
Managerial coinvesting in this context is an agreement between fund managers and fund investors that the managers will invest their own money in the fund.
512
managing returns
The terms managing returns and massaging returns refer to efforts by managers to alter reported investment returns toward preferred targets through accounting decisions or investment changes.
513
massaging returns
The terms managing returns and massaging returns refer to efforts by managers to alter reported investment returns toward preferred targets through accounting decisions or investment changes.
514
multistrategy fund
A multistrategy fund deploys its underlying investments with a variety of strategies and sub-managers, much as a corporation would use its divisions.
515
off-balance-sheet risk
Event risk is effectively an off-balance-sheet risk—that is, a risk exposure that is not explicitly reflected in the statement of financial positions.
516
opportunistic
An investment strategy is referred to as opportunistic when a major goal is to seek attractive returns through locating superior underlying investments.
517
optimal contracting
Optimal contracting between investors and hedge fund managers attempts to align the interests of both parties to the extent that the interests can be aligned cost-effectively, with marginal benefits that exceed marginal costs.
518
option view of incentive fees
The option view of incentive fees uses option theory to demonstrate the ability of managers to increase the present value of their fees by increasing the volatility of the fund’s assets.
519
participation bias
Participation bias may occur for a successful hedge fund manager who closes a fund and stops reporting results because the fund no longer needs to attract new capital.
520
perverse incentive
A perverse incentive is an incentive that motivates the receiver of the incentive to work in opposition to the interests of the provider of the incentive.
521
pure asset gatherer
A pure asset gatherer is a manager focused primarily on increasing the AUM of the fund. A pure asset gatherer is likely to take very little risk in a portfolio and, like mutual fund managers, become a closet indexer.
522
relative return product
A relative return product is an investment with returns that are substantially driven by broad market returns and that should therefore be evaluated on the basis of how the investment’s return compares with broad market returns.
523
relative value strategies
Relative value strategies are hedge fund strategies that seek to earn returns by taking risks regarding the convergence of values between securities.
524
representativeness
The representativeness of a sample is the extent to which the characteristics of that sample are similar to the characteristics of the universe.
525
safe harbor
In investments, a safe harbor denotes an area that is explicitly protected by one set of regulations from another set of regulations.
526
short volatility exposure
Short volatility exposure is any risk exposure that causes losses when underlying asset return volatilities increase.
527
single-manager hedge fund
A single-manager hedge fund, or single hedge fund, has underlying investments that are not allocations to other hedge funds.
528
strategy definitions
Strategy definitions, the method of grouping similar funds, raise two problems: (1) definitions of strategies can be very difficult for index providers to establish and specify, and (2) some funds can be difficult to classify in the process of applying the definition.
529
synthetic hedge funds
Synthetic hedge funds attempt to mimic hedge fund returns using listed securities and mathematical models.
530
black-box model trading
Systematic fund trading, often referred to as black-box model trading because the details are hidden in complex software, occurs when the ongoing trading decisions of the investment process are automatically generated by computer programs.
531
breakout strategies
Breakout strategies focus on identifying the commencement of a new trend by observing the range of recent market prices (e.g., looking back at the range of prices over a specific time period).
532
capacity risk
Capacity risk arises when a managed futures trader concentrates trades in a market that lacks sufficient depth (i.e., liquidity).
533
commodity pools
Commodity pools are investment funds that combine the money of several investors for the purpose of investing in the futures markets.
534
commodity trading advisers (CTAs)
Commodity trading advisers (CTAs) are professional money managers who specialize in the futures markets.
535
conditional correlation coefficient
A conditional correlation coefficient is a correlation coefficient calculated on a subset of observations that is selected using a condition.
536
counterparty risk
Counterparty risk is the uncertainty associated with the economic outcomes of one party to a contract due to potential failure of the other side of the contract to fulfill its obligations, presumably due to insolvency or illiquidity.
537
countertrend strategies
Countertrend strategies use various statistical measures, such as price oscillation or a relative strength index, to identify range-trading opportunities rather than price- trending opportunities.
538
degradation
Degradation is the tendency and process through time by which a trading rule or trading system declines in effectiveness.
539
discretionary fund trading
Discretionary fund trading occurs when the decisions of the investment process are made according to the judgment of human traders.
540
event risk
Event risk refers to sudden and unexpected changes in market conditions resulting from a specific event (e.g., Lehman Brothers bankruptcy).
541
exponential moving average
The exponential moving average is a geometrically declining moving average based on a weighted parameter, λ, with 0 < λ < 1.
542
fundamental analysis
Fundamental analysis uses underlying financial and economic information to ascertain intrinsic values based on economic modeling.
543
global macro funds
Global macro funds have the broadest investment universe: They are not limited by market segment, industry sector, geographic region, financial market, or currency, and therefore tend to offer high diversification.
544
in-sample data
In-sample data are those observations directly used in the backtesting process.
545
lack of trends risk
Lack of trends risk, which comes into play when the trader continues allocating capital to trendless markets, leading to substantial losses.
546
leverage
Leverage refers to the use of financing to acquire and maintain market positions larger than the assets under management (AUM) of the fund.
547
liquidity risk
Liquidity risk, is somewhat related to capacity risk in that it refers to how a large fund that is trading in a thinly traded market will affect the price should it decide to increase or decrease its allocation.
548
managed account
A managed account (or separately managed account) is created when money is placed directly with a CTA in an individual account rather than being pooled with other investors.
549
managed futures
The term managed futures refers to the active trading of futures and forward contracts on physical commodities, financial assets, and exchange rates.
550
market microstructure
Market microstructure is the study of how transactions take place, including the costs involved and the behavior of bid and ask prices.
551
market risk
Market risk refers to exposure to directional moves in general market price levels.
552
mean-reverting
Mean-reverting refers to the situation in which returns show negative autocorrelation—the opposite tendency of momentum or trending.
553
model risk
Model risk is economic dispersion caused by the failure of models to perform as intended.
554
momentum
Momentum is the extent to which a movement in a security price tends to be followed by subsequent movements of the same security price in the same direction.
555
Mount Lucas Management (MLM) Index
The Mount Lucas Management (MLM) Index is a passive, transparent, and investable index designed to capture the returns to active futures investing.
556
moving average
A moving average is a series of averages that is recalculated through time based on a window of observations.
557
natural hedger
A natural hedger is a market participant who seeks to hedge a risk that springs from its fundamental business activities.
558
out-of-sample data
Out-of-sample data are observations that were not directly used to develop a trading rule or even indirectly used as a basis for knowledge in the research.
559
pattern recognition system
A pattern recognition system looks to capture non-trend- based predictable abnormal market behavior in prices or volatilities.
560
private commodity pools
Private commodity pools are funds that invest in the futures markets and are sold privately to high-net-worth investors and institutional investors.
561
public commodity pools
Public commodity pools are open to the general public for investing in much the same way that a mutual fund sells its shares to the public.
562
random walk
A price series with changes in its prices that are independent from current and past prices is a random walk.
563
relative strength index (RSI)
The relative strength index (RSI), sometimes called the relative strength indicator, is a signal that examines average up and down price changes and is designed to identify trading signals such as the price level at which a trend reverses.
564
robustness
Robustness refers to the reliability with which a model or system developed for a particular application or with a particular data set can be successfully extended into other applications or data sets.
565
sideways market
A sideways market exhibits volatility without a persistent direction.
566
simple moving average
The most basic approach uses a simple moving average, a simple arithmetic average of previous prices.
567
slippage
Slippage is the unfavorable difference between assumed entry and exit prices and the entry and exit prices experienced in practice.
568
systematic fund trading
Systematic fund trading, often referred to as black-box model trading because the details are hidden in complex software, occurs when the ongoing trading decisions of the investment process are automatically generated by computer programs.
569
technical analysis
Technical analysis relies on data from trading activity, including past prices and volume data.
570
thematic investing
Thematic investing is a trading strategy that is not based on a particular instrument or market; rather, it is based on secular and long-term changes in some fundamental economic variables or relationships—for example, trends in population, the need for alternative sources of energy, or changes in a particular region of the world economy.
571
transparency
Transparency is the ability to understand the detail within an investment strategy or portfolio.
572
transparency risk
Transparency risk is dispersion in economic outcomes caused by the lack of detailed information regarding an investment portfolio or strategy.
573
trend-following strategies
Trend-following strategies are designed to identify and take advantage of momentum in price direction (i.e., trends in prices).
574
validation
Validation of a trading rule refers to the use of new data or new methodologies to test a trading rule developed on another set of data or with another methodology.
575
weighted moving average
A weighted moving average is usually formed as an unequal average, with weights arithmetically declining from most recent to most distant prices.
576
whipsawing
Whipsawing is when a trader alternates between establishing long positions immediately before price declines and establishing short positions immediately before price increases and, in so doing, experiences a sequence of losses. In trend following strategies, whipsawing results from a sideways market.
577
activist investment strategy
The activist investment strategy involves efforts by shareholders to use their rights, such as voting power or the threat of such power, to influence corporate governance to their financial benefit as shareholders.
578
agency costs
Agency costs are any costs, explicit (e.g., monitoring and auditing costs) or implicit (e.g., excessive corporate perks), resulting from inherent conflicts of interest between shareholders as principals and managers as agents.
579
agency theory
Agency theory studies the relationship between principals and agents.
580
agent compensation scheme
An agent compensation scheme is all agreements and procedures specifying payments to an agent for services, or any other treatment of an agent with regard to employment.
581
antitrust review
An antitrust review is a government analysis of whether a corporate merger or some other action is in violation of regulations through its potential to reduce competition.
582
bankruptcy process
The bankruptcy process is the series of actions taken from the filing for bankruptcy through its resolution.
583
bidding contest
A bidding contest or bidding war is when two or more firms compete to acquire the same target.
584
capital structure arbitrage
Capital structure arbitrage involves offsetting positions within a company’s capital structure with the goal of being long relatively underpriced securities, being short overpriced securities, and being hedged against risk.
585
corporate event risk
Corporate event risk is dispersion in economic outcomes due to uncertainty regarding corporate events.
586
corporate governance
Corporate governance describes the processes and people that control the decisions of a corporation.
587
distressed debt hedge funds
Distressed debt hedge funds invest in the securities of a corporation that is in bankruptcy or is likely to fall into bankruptcy.
588
event-driven
The event-driven category of hedge funds includes activist hedge funds, merger arbitrage funds, and distressed securities funds, as well as special situation funds and multistrategy funds that combine a variety of event-driven strategies.
589
event-driven multistrategy funds
Event-driven multistrategy funds diversify across a wide variety of event-driven strategies, participating in opportunities in both corporate debt and equity securities.
590
financial market segmentation
Financial market segmentation occurs when two or more markets use different valuations for similar assets due to the lack of participants who trade in both markets or who perform arbitrage between the markets.
591
financing risk
Financing risk is the economic dispersion caused by failure or potential failure of an entity, such as an acquiring firm, to secure the funding necessary to consummate a plan.
592
Form 13D
In the United States, Form 13D is required to be filed with the Securities and Exchange Commission (SEC) within 10 days, publicizing an activist’s stake in a firm once the activist owns more than 5% of the firm and has a strategic plan for the firm.
593
Form 13F
In the United States, Form 13F is a required quarterly filing of all long positions by all U.S. asset managers with over $100 million in assets under management, including hedge funds and mutual funds, among other investors.
594
Form 13G
In the United States, Form 13G is required of passive shareholders who buy a 5% stake in a firm, but this filing may be delayed until 45 days after year-end.
595
free rider
A free rider is a person or entity that allows others to pay initial costs and then benefits from those expenditures.
596
interlocking boards
Interlocking boards occur when board members from multiple firms—especially managers—simultaneously serve on each other’s boards and may lead to a reduced responsiveness to the interests of shareholders.
597
liquidation process
In a liquidation process (chapter 7 in U.S. bankruptcy laws), all of the assets of the firm are sold, and the cash proceeds are distributed to creditors.
598
long binary call option
A long binary call option makes one payout when the referenced price exceeds the strike price at expiration and a lower payout or no payout in all other cases.
599
long binary put option
A long binary put option makes one payout when the referenced price is lower than the strike price at expiration and a lower payout or no payout in all other cases.
600
merger arbitrage
Merger arbitrage attempts to benefit from merger activity with minimal risk and is perhaps the best-known event-driven strategy.
601
one-off transaction
A one-off transaction has one or more unique characteristics that cause the transaction to require specialized skill, knowledge, or effort.
602
principal-agent relationship
A principal-agent relationship is any relationship in which one person or group, the principal(s), hires another person or group, the agent(s), to perform decision-making tasks.
603
proxy battle
A proxy battle is a fight between the firm’s current management and one or more shareholder activists to obtain proxies (i.e., favorable votes) from shareholders.
604
recovery value
The recovery value of the firm and its securities is the value of each security in the firm and is based on the time it will take the firm to emerge from the bankruptcy process and the condition in which it will emerge.
605
reorganization process
In a reorganization process (chapter 11 in U.S. bankruptcy laws), the firm’s activities are preserved.
606
selling insurance
Selling insurance in this context refers to the economic process of earning relatively small returns for providing protection against risks, not the literal process of offering traditional insurance policies.
607
shareholder activism
Shareholder activism refers to efforts by one or more shareholders to influence the decisions of a firm in a direction contrary to the initial recommendations of the firm’s senior management.
608
special situation funds
Special situation funds also invest across a number of event styles are typically focused on equity securities, especially those with a spin-off or recent emergence from bankruptcy.
609
spin-off
A spin-off occurs when a publicly traded firm splits into two publicly traded firms, with shareholders in the original firm becoming shareholders in both firms.
610
split-off
A split-off occurs when investors have a choice to own Company A or B, as they are required to exchange their shares in the parent firm if they would like to own shares in the newly created firm.
611
staggered board seats
Staggered board seats exist when instead of having all members of a board elected at a single point in time, portions of the board are elected at regular intervals.
612
stock-for-stock mergers
Stock-for-stock mergers acquire stock in the target firm using the stock of the acquirer and typically generate large initial increases in the share price of the target firm.
613
toehold
A toehold is a stake in a potential merger target that is accumulated by a potential acquirer prior to the news of the merger attempt becoming widely known.
614
traditional merger arbitrage
Traditional merger arbitrage generally uses leverage to buy the stock of the firm that is to be acquired and to sell short the stock of the firm that is the acquirer.
615
wolf pack
A wolf pack is a group of investors who may take similar positions to benefit from an activists’ engagement with corporate management.
616
anticipated volatility
Anticipated volatility is the future level of volatility expected by a market participant.
617
asset-backed securities
Still another subset of fixed-income arbitrage trades is asset- backed securities (ABS), which are securitized products created from pools of underlying loans or other assets.
618
busted convertibles
Bonds with very high conversion premiums are often called busted convertibles, as the embedded stock options are far out-of-the-money.
619
carry trades
Carry trades attempt to earn profits from carrying or maintaining long positions in higher-yielding assets and short positions in lower-yielding assets without suffering from adverse price movements.
620
classic convertible bond arbitrage trade
The classic convertible bond arbitrage trade is to purchase a convertible bond that is believed to be undervalued and to hedge its risk using a short position in the underlying equity.
621
classic dispersion trade
The classic dispersion trade is a market-neutral short correlation trade, popular among volatility arbitrage practitioners, that typically takes long positions in options listed on the equities of single companies and short positions in a related index option.
622
classic relative value strategy trade
The classic relative value strategy trade is based on the premise that a particular relationship or spread between two prices or rates has reached an abnormal level and will therefore tend to return to its normal level.
623
complexity premium
A complexity premium is a higher expected return offered by a security to an investor to compensate for analyzing and managing a position that requires added time and expertise.
624
components of convertible arbitrage returns
The components of convertible arbitrage returns include interest, dividends, rebates, and capital gains and losses.
625
convergence
Convergence is the return of prices or rates to relative values that are deemed normal.
626
convertible bonds
Convertible bonds are hybrid corporate securities, mixing fixed-income and equity characteristics into one security.
627
correlation risk
Correlation risk is dispersion in economic outcomes attributable to changes in realized or anticipated levels of correlation between market prices or rates.
628
correlations go to one
The term correlations go to one means that during periods of enormous stress, stocks and bonds with credit risk decline simultaneously and with somewhat similar magnitudes.
629
delta
Delta is the change in the value of an option (or a security with an implicit option) with respect to a change in the value of the underlying asset (i.e., it measures the sensitivity of the option price to small changes in the price of its underlying asset).
630
delta-neutral
A delta-neutral position is a position in which the value- weighted sum of all deltas of all positions equals zero.
631
dilution
Dilution takes place when additional equity is issued at below- market values, and the per-share value of the holdings of existing shareholders is diminished.
632
duration
Duration is a measure of the sensitivity of a fixed-income security to a change in the general level of interest rates.
633
duration-neutral
A duration-neutral position is a portfolio in which the aggregated durations of the short positions equal the aggregated durations of the long positions weighted by value.
634
dynamic delta hedging
Dynamic delta hedging is the process of frequently adjusting positions in order to maintain a target exposure to delta, often delta neutrality.
635
effective duration
Effective duration is a measure of the interest rate sensitivity of a position that includes the effects of embedded option characteristics.
636
equity-like convertible
An equity-like convertible is a convertible bond that is far in- the-money and therefore has a price that tracks its underlying equity very closely.
637
fixed-income arbitrage
Fixed-income arbitrage involves simultaneous long and short positions in fixed income securities with the expectation that over the investment holding period, the security prices will converge toward a similar valuation standard.
638
gamma
Gamma is the second derivative of an option’s price with respect to the price of the underlying asset—or, equivalently, the first derivative of delta with respect to the price of the underlying asset.
639
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.
640
hybrid convertibles
Convertible bonds with moderately sized conversion ratios have stock options closer to being at-the-money and are called hybrid convertibles.
641
implied volatility
The implied volatility of an option or an option-like position— in this case, the implied volatility of a convertible bond—is the standard deviation of returns that is viewed as being consistent with an observed market price for the option.
642
intercurve arbitrage positions
There are also intercurve arbitrage positions, which means arbitrage (hedged positions) using securities related to different yield curves.
643
interest rate immunization
Interest rate immunization is the process of eliminating all interest rate risk exposures.
644
intracurve arbitrage positions
These are examples of intracurve arbitrage positions because they are based on hedged positions within the same yield curve.
645
marking-to-market
Marking-to-market refers to the use of current market prices to value instruments, positions, portfolios, and even the balance sheets of firms.
646
marking-to-model
Marking-to-model refers to valuation based on prices generated by pricing models. The pricing models generally involve two components.
647
modified duration
Modified duration is equal to traditional duration divided by the quantity [1 + (y/m)], where y is the stated annual yield, m is the number of compounding periods per year, and y/m is the periodic yield.
648
moneyness
Moneyness is the extent to which an option is in-the-money, at-the-money, or out-of-the-money.
649
mortgage-backed securities arbitrage
Mortgage-backed securities arbitrage attempts to generate low-risk profits through the relative mispricing among MBS or between MBS and other fixed-income securities.
650
net delta
The net delta of a position is the delta of long positions minus the delta of short positions.
651
option-adjusted spread
A key concept in pricing fixed income securities with embedded prepayment options is the option-adjusted spread (OAS), which is a measure of the excess of the return of a fixed-income security containing an option over the yield of an otherwise comparable fixed-income security without an option after the return of the fixed-income security containing the option has been adjusted to remove the effects of the option.
652
parallel shift
A parallel shift in the yield curve happens when yields of all maturities shift up or down by equal (additive) amounts.
653
portfolio insurance
Portfolio insurance is any financial method, arrangement, or program for limiting losses from large adverse price movements.
654
price transparency
Price transparency is information on the prices and quantities at which participants are offering to buy (bid) and sell (offer) an instrument.
655
pricing risk
Pricing risk is the economic uncertainty caused by actual or potential mispricing of positions.
656
realized volatility
Realized volatility is the actual observed volatility (i.e., the standard deviation of returns) experienced by an asset—in this case, the underlying stock.
657
rebate
A rebate is a payment of interest to the securities’ borrower on the collateral posted.
658
riding the yield curve
The process of holding a bond as its yield moves up or down the yield curve due to the passage of time is known as riding the yield curve.
659
rolling down
Rolling down the yield curve is the process of experiencing decreasing yields to maturity as an asset’s maturity declines through time in an upward-sloping yield curve environment.
660
short correlation
The classic dispersion trade is referred to as a short correlation trade because the trade generates profits from low levels of realized correlation and losses from high levels of realized correlation.
661
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.
662
sovereign debt
Sovereign debt is debt issued by national governments.
663
special stock
A special stock is a stock for which higher net fees are demanded when it is borrowed.
664
tail risk
Tail risk is the potential for very large loss exposures due to very unusual events, especially those associated with widespread market price declines.
665
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.
666
theta
Theta is the first derivative of an option’s price with respect to the time to expiration of the option.
667
variance notional value
The variance notional value of the contract simply scales the size of the cash flows in a variance swap.
668
variance swaps
Variance swaps are forward contracts in which one party agrees to make a cash payment to the other party based on the realized variance of a price or rate in exchange for receiving a predetermined cash flow.
669
vega
Vega is a measure of the risk of a position or an asset due to changes in the volatility of a price or rate that helps determine the value of that position or asset.
670
vega notional value
The vega notional value of a contract serves to scale the contract and determine the size of the payoff in a volatility swap.
671
vega risk
Vega risk is the economic dispersion caused by changes in the volatility of a price, return, or rate.
672
volatility arbitrage
Volatility arbitrage is any strategy that attempts to earn a superior and riskless profit based on prices that explicitly depend on volatility.
673
volatility risk
Volatility risk is dispersion in economic outcomes attributable to changes in realized or anticipated levels of volatility in a market price or rate.
674
volatility swap
A volatility swap mirrors a variance swap except that the payoff of the contract is linearly based on the standard deviation of a return series rather than the variance.
675
yield curve
A yield curve is the relationship between the yields of various securities, usually depicted on the vertical axis, and the term to maturity, usually depicted on the horizontal axis.
676
accounting accrual
An accounting accrual is the recognition of a value based on anticipation of a transaction.
677
asynchronous trading
Asynchronous trading is an example of market inefficiency in which news affecting more than one stock may be assimilated into the price of the stocks at different speeds.
678
breadth
The breadth of a strategy is the number of independent active bets placed into an active portfolio.
679
earnings momentum
Earnings momentum is the tendency of earnings changes to be positively correlated.
680
earnings surprise
Earnings surprise is the concept and measure of the unexpectedness of an earnings announcement.
681
equity long/short funds
Equity long/short funds tend to have net positive systematic risk exposure from taking a net long position, with the long positions beinglarger than the short positions.
682
equity market-neutral funds
Equity market-neutral funds attempt to balance short and long positions, ideally matching the beta exposure of the long and short positions and leaving the fund relatively insensitive to changes in the underlying stock market index.
683
Fundamental Law of Active Management (FLOAM)
Richard Grinold in 1989 proposed the Fundamental Law of Active Management (FLOAM), which identifies two key components of actively managed investment strategies: breadth and skill.
684
illegal insider trading
Illegal insider trading varies by jurisdiction but may involve using material nonpublic information, such as an impending merger, for trading without required disclosure.
685
information coefficient
The information coefficient (IC) measures managerial skill as the correlation between managerial return predictions and realized returns.
686
informationally efficient
Markets are said to be informationally efficient when security prices reflect available information.
687
issuance of new stock
Issuance of new stock is a firm’s creation of new shares of common stock in that firm and may occur as a result of a stock-for-stock merger transaction or through a secondary offering.
688
legal insider trading
Trading by insiders can be legal insider trading when it is performed subject to legal restrictions.
689
limits to arbitrage
The limits to arbitrage refer to the potential inability or unwillingness of speculators, such as equity hedge fund managers, to hold their positions without time constraints or to increase their positions without size constraints.
690
liquidity
Liquidity in this context is the extent to which transactions can be executed with minimal disruption to prices.
691
market anomalies
Investment strategies that can be identified based on available information and that offer higher expected returns after adjustment for risk are known as market anomalies, and they are violations of informational market efficiency.
692
market impact
Market impact is the degree of the short-term effect of trades on the sizes and levels of bid prices and offer prices.
693
market maker
A market maker is a market participant that offers liquidity, typically both on the buy side by placing bid orders and on the sell side by placing offer orders.
694
mean neutrality
Mean neutrality is when a fund is shown to have zero beta exposure or correlation to the underlying market index
695
multiple-factor scoring models
Multiple-factor scoring models combine the factor scores of a number of independent anomaly signals into a single trading signal.
696
net stock issuance
Net stock issuance is issuance of new stock minus share repurchases.
697
nonactive bets
Nonactive bets are positions held to reduce tracking error rather than to serve as return-enhancing active bets.
698
overreacting
Another potential source of abnormal profits for hedge funds is overreacting in which short-term price changes are too large relative to the value changes that should occur in a market
with perfect informational efficiency.
699
pairs trading
Pairs trading is a strategy of constructing a portfolio with matching stocks in terms of systematic risks but with a long position in the stock perceived to be relatively underpriced and a short position in the stock perceived to be relatively overpriced.
700
post-earnings-announcement drift
A post-earnings-announcement drift anomaly has been documented, in which investors can profit from positive surprises by buying immediately after the earnings announcement or selling short immediately after a negative earnings surprise.
701
price momentum
Price momentum is trending in prices such that an upward price movement indicates a higher expected price and a downward price movement indicates a lower expected price
702
providing liquidity
Providing liquidity refers to the placement of limit orders or other actions that increase the number of shares available to be bought or sold near the current best bid and offer prices.
703
share buyback program
When a company chooses to reduce its shares outstanding, a share buyback program is initiated, and the company purchases its own shares from investors in the open market or through a tender offer.
704
short interest
Short interest is the percentage of outstanding shares that are currently held short.
705
short-bias funds
Short-bias funds have larger short positions than long positions, leaving a persistent net short position relative to the market index that allows these funds to profit during times of declining equity prices.
706
speculation
Speculation is defined as bearing abnormal risk in anticipation of abnormally high expected returns.
707
standardized unexpected earnings
Standardized unexpected earnings (SUE) is a measure of earnings surprise
708
taking liquidity
More generally, taking liquidity refers to the execution of market orders by a market participant to meet portfolio preferences that cause a decrease in the supply of limit orders immediately near the current best bid and offer prices.
709
test of joint hypotheses
An empirical test of market efficiency is a test of joint hypotheses, because the test assumes the validity of a model of the risk-return relationship to test whether a given trading strategy earns consistent risk-adjusted profits.
710
underreacting
Another potential source of abnormal profits for hedge funds is underreacting in which short-term price changes are too small relative to the value changes that should occur in a market with perfect informational efficiency
711
uptick rule
An uptick rule permits short sellers to enter a short sale only at a price that is equal to or higher than the previous transaction price of the stock.
712
variance neutrality
Variance neutrality is when fund returns are uncorrelated to changes in market risk, including extreme risks in crisis market scenarios.
713
access
Access is an investor’s ability to place new or increased money in a particular fund.
714
conservative funds of funds
Conservative funds of funds have underlying hedged positions.
715
diversified funds of funds
Diversified funds of funds represent a broad mix of funds.
716
fee netting
Fee netting in the case of a multistrategy fund is when the investor pays incentive fees based only on net profits of the combined strategies, rather than on all profitable strategies.
717
liquidity facility
A liquidity facility is a standby agreement with a major bank to provide temporary cash for specified needs with pre- specified conditions.
718
market-defensive funds of funds
Market-defensive funds of funds tend to have underlying and unhedged short positions.
719
nontraditional bond funds
Nontraditional or unconstrained bond funds do not simply take long positions in investment-grade sovereign and credit securities, but may also invest in high-yield or emerging markets debt, often including leverage and short positions.
720
operational due diligence
Operational due diligence is the process of evaluating the policies, procedures, and internal controls of an asset management organization.
721
seeding funds
Seeding funds, or seeders, are funds of funds that invest in newly created individual hedge funds, often taking an equity stake in the management companies of the newly minted hedge funds.
722
strategic funds of funds
Strategic funds of funds tend to have underlying directional bets.
723
unconstrained bond funds
Nontraditional or unconstrained bond funds do not simply take long positions in investment-grade sovereign and credit securities, but may also invest in high-yield or emerging markets debt, often including leverage and short positions.
724
burn rate
The burn rate of young businesses describes the speed with which cash is being depleted through time and can be used to project when the organization will again require outside funding.
725
business development companies (BDCs)
Business development companies (BDCs) are publicly traded funds with underlying assets typically consisting of equity or equity-like positions in small, private companies. BDCs use a closed-end structure and trade on major stock exchanges, especially the NASDAQ.
726
buyouts
In the context of private equity, buyouts are the purchase of a public company by an entity that has a private ownership structure.
727
call option view of private equity
This call option view of private equity from the perspective of the investor reflects the frequent total losses and occasional huge gains of private equity investments, especially venture capital.
728
charge-off loans
Charge-off loans are the loans of a financial institution or other lender that have been sold to investors and written off the books of the lender at a loss.
729
conversion price
The conversion price is the price per share at which the convertible security can be exchanged into shares of common stock, expressed in terms of the principal value of the convertible security.
730
conversion ratio
The conversion ratio is the number of shares of common stock into which each convertible security can be exchanged.
731
covenant-lite loans
Covenant-lite loans are loans that place minimal restrictions on the debtor in terms of loan covenants.
732
distressed debt investing
Distressed debt investing is the practice of purchasing the debt of troubled companies, requiring special expertise and subjecting the investor to substantial risk.
733
equity kicker
An equity kicker is an option for some type of equity participation in the firm (e.g., options to buy shares of common stock) that is packaged with a debt financing transaction.
734
equity line of credit
An equity line of credit (ELC) is a contractual agreement between an issuer and an investor that enables the issuer to sell a formula-based quantity of stock at set intervals of time.
735
haircut
In finance, the term haircut usually refers to a percentage reduction applied to the value of securities in determining their value as collateral.
736
incurrence covenants
Incurrence covenants typically require a borrower to take or not take a specific action once a specified event occurs.
737
junk bond
Junk bonds are debt instruments with high credit risk, also referred to as high-yield, noninvestment-grade, or speculative- grade debt.
738
leveraged loans
Leveraged loans are syndicated bank loans to non-investment grade borrowers.
739
maintenance covenants
Maintenance covenants are stricter than incurrence covenants in that they require that a standard be regularly met to avoid default.
740
merchant banking
Merchant banking is the practice whereby financial institutions purchase nonfinancial companies as opposed to merging with or acquiring other financial institutions.
741
middle market
The middle market refers to companies that are not as large as those companies that have ready access to the financial markets but are larger than companies seeking venture capital.
742
negative covenants
Negative covenants are promises by the debtor not to engage in particular activities, such as paying dividends or issuing new debt.
743
positive covenants
Positive covenants are promises to do particular things, such as maintain a specified cash level.
744
private equity firms
Private equity firms invest in private equity and serve as managers to private equity funds.
745
private equity funds
Private equity funds are investment pools created to hold portfolios of private equity securities.
746
private investments in public equity (PIPE)
Private investments in public equity (PIPE) transactions are privately issued equity or equity-linked securities that are placed outside of a public offering and are exempt from registration.
747
prudent person standard
The prudent person standard is a requirement that specifies levels of care that should be exercised in particular decision- making roles, such as investment decisions made by a fiduciary.
748
segmentation
Segmentation in this context denotes the grouping of market participants into clienteles that focus their activities within specific areas of the market, rather than varying their range of activities more broadly throughout all available opportunities.
749
story credit
A story credit is a debt issue with credit risk based on unusual circumstances, and may involve special aspects, such as corporate reorganizations, that distinguish their analysis from more traditional circumstances and as such involve a story.
750
structured PIPEs
Structured PIPEs include more exotic securities, like floating-rate convertible preferred stock, convertible resets, and common stock resets.
751
syndicated
The term syndicated refers to the use of a group of entities, often investment banks, in underwriting a security offering or, more generally, jointly engaging in other financial activities.
752
toxic PIPE
A toxic PIPE is a PIPE with adjustable conversion terms that can generate high levels of shareholder dilution in the event of deteriorating prices in the firm’s common stock.
753
traditional PIPEs
The large majority of PIPE transactions are traditional PIPEs, in which investors can buy common stock at a fixed price.
754
underlying business enterprises
Underlying business enterprises in private equity are the unlisted, typically small businesses seeking to grow through investment from private equity funds or private equity firms.
755
venture capital (VC)
Venture capital (VC), the best known of the private equity categories, is early-stage financing for young firms with high potential growth that do not have a sufficient track record to attract investment capital from traditional sources, like public markets or lending institutions.
756
venture capital securities
Venture capital securities are the privately held stock, or equity-linked securities, that venture capitalists obtain when investing in business ventures that are striving to become larger and to go public.
757
vintage year
The year a particular private equity fund commences operations is known as its vintage year.
758
20-bagger
The terminology 20-bagger indicates a company that appreciates in value 20-fold compared to the cost of the VC investment.
759
angel investing
Angel investing refers to the earliest stage of venture capital, in which investors fund the first cash needs of an entrepreneurial idea.
760
auction process
An auction process involves bidding among several private equity firms, with the deal going to the highest bidder.
761
business plan
The business plan should clearly state the business strategy, identify the niche that the new company will fill, and describe the resources needed to fill that niche, including the expenses, personnel, and assets.
762
buy-and-build strategy
A buy-and-build strategy is an LBO value-creation strategy involving the synergistic combination of several operating companies or divisions through additional buyouts.
763
buy-in management buyout
A buy-in management buyout is a hybrid between an MBI and an MBO in which the new management team is a combination of new managers and incumbent managers.
764
buyout-to-buyout deal
A buyout-to-buyout deal takes place when a private equity firm sells one of its portfolio companies to another buyout firm.
765
capital calls
Capital calls are options for the manager to demand, according to the subscription agreement, that investors contribute additional capital.
766
club deal
In a club deal, two or more LBO firms work together to share costs, present a business plan, and contribute capital to the deal.
767
committed capital
Committed capital is the cash investment that has been promised by an investor but not yet delivered to the fund.
768
compound option
A compound option is an option on an option. In other words, a compound option allows its owner the right but not the obligation to pay additional money at some point in the future to obtain an option.
769
conglomerates
Conglomerates have many different divisions or subsidiaries, often operating in completely different industries.
770
early-stage venture capital
First or early-stage venture capital denotes the funding after seed capital but before commercial viability has been established.
771
efficiency buyouts
Efficiency buyouts are LBOs that improve operating efficiency.
772
entrepreneurship stimulators
Entrepreneurship stimulators are LBOs that create value by helping to free management to concentrate on innovations.
773
escrow agreement
There is often an escrow agreement, in which a portion of the manager’s incentive fees are held in a segregated account until the entire fund is liquidated.
774
exit plan
The exit plan describes how venture capitalists can liquidate their investment in the start-up company to realize a gain for themselves and their investors.
775
expansion stage venture capital
```
Expansion stage (i.e., Second or late-stage) venture capital
fills the cash flow deficiency once commercial viability is established.
```
776
first stage venture capital
First or early-stage venture capital denotes the funding after seed capital but before commercial viability has been established.
777
golden parachute
A generous compensation scheme, known as a golden parachute, is often given to top managers whose careers are being negatively affected by a corporate reorganization.
778
J-curve
The J-curve is the classic illustration of the early losses and later likely profitability of venture capital.
779
leveraged buyout (LBO)
A leveraged buyout (LBO) is distinguished from a traditionalinvestment bythreeprimaryaspects:(1)anLBO buys out control of the assets, (2) an LBO uses leverage, and (3) an LBO itself is not publicly traded.
780
limited liability
Limited liability is the protection of investors from losses that exceed their investment.
781
management buy-in (MBI)
A management buy-in (MBI) is a type of LBO in which the buyout is led by an outside management team.
782
management buyout (MBO)
A management buyout (MBO) is a buyout that is led by the target firm’s current management.
783
mezzanine venture capital
Mezzanine venture capital, or pre-IPO financing, is the last funding stage before a start-up company goes public or is sold to a strategic buyer.
784
milestone
A milestone is a set of goals that must be met to complete a phase and usually denotes when the entrepreneur will be eligible for the next round of financing.
785
second or late-stage venture capital
Second or late-stage (i.e., expansion stage) venture capital
| fills the cash flow deficiency once commercial viability is established.
786
secondary buyout
In a secondary buyout, one private equity firm typically sells a private company to another private equity firm.
787
seed capital stage
The seed capital stage is the first stage where VC firms invest their capital into a venture and is typically prior to having established the viability of the product.
788
sourcing investments
Sourcing investments is the process of locating possible investments (i.e., generating deal flow), reading business plans, preparing intense due diligence on start-up companies, and determining the attractiveness of each start-up company.
789
turnaround strategy
A turnaround strategy is an approach used by LBO funds that look for underperforming companies with excessive leverage or poor management.
790
venture capital fund
A venture capital fund is a private equity fund that pools the capital of large sophisticated investors to fund new and start-up companies.
791
absolute priority rule
An absolute priority rule is a specification of which claims in a liquidation process are satisfied first, second, third, and so forth in receiving distributions.
792
acceleration
Acceleration is a requirement that debt be repaid sooner than originally scheduled, such as when the senior lender can declare the senior debt due and payable immediately.
793
blanket subordination
A blanket subordination prevents any payment of principal or interest to the mezzanine investor until after the senior debt has been fully repaid.
794
bridge financing
Bridge financing is a form of gap financing—a method of debt financing that is used to maintain liquidity while waiting for an anticipated and reasonably expected inflow of cash.
795
Chapter 11 bankruptcy
Chapter 11 bankruptcy attempts to maintain operations of a distressed corporation that may be viable as a going concern.
796
Chapter 7 bankruptcy
Chapter 7 bankruptcy is entered into when a company is no longer viewed as a viable business and the assets of the firm are liquidated. Essentially, the firm shuts down its operations and parcels out its assets to various claimants and creditors.
797
cramdown
A cramdown is when a bankruptcy court judge implements a plan of reorganization over the objections of an impaired class of security holders.
798
debtor-in-possession financing
When secured lenders extend additional credit to the debtor company, it is commonly known as debtor-in-possession financing (DIP financing).
799
fulcrum securities
Fulcrum securities are the more junior debt securities that are most likely to be converted into the equity of the reorganized company.
800
intercreditor agreement
An intercreditor agreement is an agreement with the company’s existing creditors that places restrictions on both the senior creditor and the mezzanine investor.
801
PIK toggle
A PIK toggle allows the underlying company to choose whether it will make required coupon payments in the form of cash or in kind, meaning with more mezzanine bonds.
802
plan of reorganization
A plan of reorganization is a business plan for emerging from bankruptcy protection as a viable concern, including operational changes.
803
springing subordination
A springing subordination allows the mezzanine investor to receive interest payments while the senior debt is still outstanding.
804
stretch financing
In stretch financing, a bank lends more money than it believes would be prudent with traditional lending standards and traditional lending terms.
805
takeout provision
A takeout provision allows the mezzanine investor to purchase the senior debt once it has been repaid to a specified level.
806
weighted average cost of capital
The weighted average cost of capital for a firm is the sum of the products of the percentages of each type of capital used to finance a firm times its annual cost to the firm.
807
attachment point
The first percentage loss in the collateral pool that begins to cause reduction in a tranche is known as the lower attachment point, or simply the attachment point.
808
bull call spread
A bull call spread has two calls that differ only by strike price, in which the long position is in the lower strike price and the short position is in the higher strike price.
809
bull put spread
A bull put spread has two puts that differ only by strike price, in which the long position is in the lower strike price and the short position is in the higher strike price.
810
call option view of capital structure
The call option view of capital structure views the equity of a levered firm as a call option on the assets of the firm.
811
collateralized debt obligation (CDO)
A collateralized debt obligation (CDO) applies the concept of structuring to cash flows from a portfolio of debt securities into multiple claims; these claims are securities and are referred to as tranches.
812
complete market
A complete market is a financial market in which enough different types of distinct securities exist to meet the needs and preferences of all participants.
813
contraction risk
Contraction risk is dispersion in economic outcomes caused by uncertainty in the longevity—especially decreased longevity—of cash flow streams.
814
detachment point
The higher percentage loss point at which the given tranche is completely wiped out is known as the upper attachment point, or the detachment point.
815
equity tranche
The equity tranche has lowest priority and serves as the residual claimant.
816
extension risk
Extension risk is dispersion in economic outcomes caused by uncertainty in the longevity—especially increased longevity—of cash flow streams.
817
floating-rate tranches
Floating-rate tranches earn interest rates that are linked to an interest rate index, such as the London Interbank Offered Rate (LIBOR), and are usually used to finance collateral pools of adjustable-rate mortgages.
818
interest-only (IO)
Interest-only (IO) tranches receive only interest payments from the collateral pool.
819
inverse floater tranche
An inverse floater tranche offers a coupon that increases when interest rates fall and decreases when interest rates rise.
820
lower attachment point
The first percentage loss in the collateral pool that begins to cause reduction in a tranche is known as the lower attachment point, or simply the attachment point.
821
mezzanine tranche
A mezzanine tranche is a tranche with a moderate priority to cash flows in the structured product and with lower priority than the senior tranche.
822
planned amortization class (PAC) tranches
Planned amortization class (PAC) tranches receive principal payments in a more complex manner than do sequential pay CMOs.
823
principal-only (PO)
Principal-only (PO) tranches receive only principal payments from the collateral pool.
824
put option view of capital structure
The put option view of capital structure views the equity holders of a levered firm as owning the firm’s assets through riskless financing and having a put option to deliver those assets to the debt holders.
825
senior tranche
The senior tranche is a tranche with the first or highest priority to cash flows in the structured product.
826
sequential-pay collateralized mortgage obligation
The sequential-pay collateralized mortgage obligation is the simplest form of CMO.
827
state of the world
A state of the world, or state of nature (or state), is a precisely defined and comprehensive description of an outcome of the economy that specifies the realized values of all economically important variables.
828
structural credit risk models
Structural credit risk models use option theory to explicitly take into account credit risk and the various underlying factors that drive the default process, such as (1) the behavior of the underlying assets, and (2) the structuring of the cash flows (i.e., debt levels).
829
structuring
In the context of alternative investments, structuring is the process of engineering unique financial opportunities from existing asset exposures.
830
targeted amortization class (TAC) tranches
Targeted amortization class (TAC) tranches receive principal payments in a manner similar to PAC tranches but generally with an even narrower and more complex set of ranges.
831
tranche
A tranche is a distinct claim on assets that differs substantially from other claims in such aspects as seniority, risk, and maturity.
832
upper attachment point
The higher percentage loss point at which the given tranche is completely wiped out is known as the upper attachment point, or the detachment point.
833
American credit options
American credit options are credit options that can be exercised prior to or at expiration.
834
assignment
A novation or an assignment is when one party to a contract reaches an agreement with a third party to take over all rights and obligations to a contract.
835
binary options
Binary options (sometimes termed digital options) offer only two possible payouts, usually zero and some other fixed value.
836
calibrate a model
To calibrate a model means to establish values for the key parameters in a model, such as a default probability or an asset volatility, typically using an analysis of market prices of highly liquid assets.
837
cash settlement
In a cash settlement, the credit protection seller makes the credit protection buyer whole by transferring to the buyer an amount of cash based on the contract.
838
CDS indices
CDS indices are indices or portfolios of single-name CDSs.
839
CDS premium
The CDS spread or CDS premium is paid by the credit protection buyer to the credit protection seller and is quoted in basis points per annum on the notional value of the CDS.
840
CDS spread
The CDS spread or CDS premium is paid by the credit protection buyer to the credit protection seller and is quoted in basis points per annum on the notional value of the CDS.
841
credit default swap (CDS)
A credit default swap (CDS) is an insurance-like bilateral contract in which the buyer pays a periodic fee (analogous to an insurance premium) to the seller in exchange for a contingent payment from the seller if a credit event occurs with respect to an underlying credit-risky asset.
842
credit derivatives
Credit derivatives transfer credit risk from one party to another such that both parties view themselves as having an improved position as a result of the derivative.
843
credit protection buyer
In a CDS, the credit protection buyer pays a periodic premium on a predetermined amount (the notional amount) in exchange for a contingent payment from the credit protection seller if a specified credit event occurs.
844
credit protection seller
The credit protection seller receives a periodic premium in exchange for delivering a contingent payment to the credit protection buyer if a specified credit event occurs.
845
credit risk
Credit risk is dispersion in financial outcomes associated with the failure or potential failure of a counterparty to fulfill its financial obligations.
846
credit-linked notes (CLNs)
Credit-linked notes (CLNs) are bonds issued by one entity with an embedded credit option on one or more other entities.
847
default risk
Default risk is the risk that the issuer of a bond or the debtor on a loan will not repay the interest and principal payments of the outstanding debt in full.
848
derivatives
Derivatives are cost-effective vehicles for the transfer of risk, with values driven by an underlying asset.
849
European credit options
European credit options are credit options exercisable only at expiration.
850
exposure at default
Exposure at default (EAD) specifies the nominal value of the position that is exposed to default at the time of default.
851
funded credit derivatives
Funded credit derivatives require cash outlays and create exposures similar to those gained from traditional investing in corporate bonds through the cash market.
852
hazard rate
Hazard rate is a term often used in the context of reduced- form models to denote the default rate.
853
loss given default
Loss given default (LGD) specifies the economic loss in case of default.
854
mark-to-market adjustment
The process of altering the value of a CDS in the accounting and financial systems of the CDS parties is known as a mark- to-market adjustment.
855
multiname instruments
Multiname instruments, in contrast to single-name instruments, make payoffs that are contingent on one or more credit events (e.g., defaults) affecting two or more reference entities.
856
novation
A novation or an assignment is when one party to a contract reaches an agreement with a third party to take over all rights and obligations to a contract.
857
physical settlement
Under physical settlement, the credit protection seller purchases the impaired loan or bond from the credit protection buyer at par value.
858
price revelation
Price revelation, or price discovery, is the process of providing observable prices being used or offered by informed buyers and sellers.
859
probability of default
Probability of default (PD) specifies the probability that the counterparty fails to meet its obligations.
860
recovery rate
The recovery rate is the percentage of the credit exposure that the lender ultimately receives through the bankruptcy process and all available remedies.
861
reduced-form credit models
Reduced-form credit models focus on default probabilities based on observations of market data of similar-risk securities.
862
referenced asset
The referenced asset (also called the referenced bond, referenced obligation, or referenced credit) is the underlying security on which the credit protection is provided.
863
risk-neutral approach
A risk-neutral approach models financial characteristics, such as asset prices, within a framework that assumes that investors are risk neutral.
864
risk-neutral investor
A risk-neutral investor is an investor that requires the same rate of return on all investments, regardless of levels and types of risk, because the investor is indifferent with regard to how much risk is borne.
865
single-name credit derivatives
Single-name credit derivatives transfer the credit risk associated with a single entity. This is the most common type of credit derivative and can be used to build more complex credit derivatives.
866
standard ISDA agreement
The standard ISDA agreement serves as a template to negotiated credit agreements that contains commonly used provisions used by market participants.
867
total return swap
In a total return swap, the credit protection buyer, typically the owner of the credit risky asset, passes on the total return of the asset to the credit protection seller in return for a certain payment.
868
unfunded credit derivatives
Unfunded credit derivatives involve exchanges of payments that are tied to a notional amount, but the notional amount does not change hands until a default occurs.
869
arbitrage CDOs
Arbitrage CDOs are created to attempt to exploit perceived opportunities to earn superior profits through money management.
870
balance sheet CDOs
Balance sheet CDOs are created to assist a financial institution in divesting assets from its balance sheet.
871
bankruptcy remote
Bankruptcy remote means that if the sponsoring bank or money manager goes bankrupt, the CDO trust is not affected.
872
cash flow CDO
In a cash flow CDO, the proceeds of the issuance and sale of securities (tranches) are used to purchase a portfolio of underlying credit-risky assets, with attention paid to matching the maturities of the assets and liabilities.
873
cash-funded CDO
A cash-funded CDO involves the actual purchase of the portfolio of securities serving as the collateral for the trust and to be held in the trust.
874
collateralized fund obligation (CFO)
A collateralized fund obligation (CFO) applies the CDO structure concept to the ownership of hedge funds as the collateral pool.
875
copula approach
A copula approach to analyzing the credit risk of a CDO may be viewed like a simulation analysis of the effects of possible default rates on the cash flows to the CDO’s tranches and the values of the CDO’s tranches.
876
distressed debt CDO
A distressed debt CDO uses the CDO structure to securitize and structure the risks and returns of a portfolio of distressed debt securities, in which the primary collateral component is distressed debt.
877
diversity score
A diversity score is a numerical estimation of the extent to which a portfolio is diversified.
878
external credit enhancement
An external credit enhancement is a protection to tranche investors that is provided by an outside third party, such as a form of insurance against defaults in the loan portfolio.
879
financial engineering risk
Financial engineering risk is potential loss attributable to securitization, structuring of cash flows, option exposures, and other applications of innovative financing devices.
880
internal credit enhancement
An internal credit enhancement is a mechanism that protects tranche investors and is made or exists within the CDO structure, such as a large cash position.
881
market value CDO
In a market value CDO, the underlying portfolio is actively traded without a focus on cash flow matching of assets and liabilities.
882
overcollateralization
Overcollateralization refers to the excess of assets over a given liability or group of liabilities.
883
ramp-up period
The ramp-up period, is the first period in a CDO life cycle, during which the CDO trust issues securities (tranches) and uses the proceeds from the CDO note sale to acquire the initial collateral pool (the assets).
884
reference portfolio
The underlying portfolio or pool of assets (and/or derivatives) held in the SPV within the CDO structure is also known as the collateral or reference portfolio.
885
reserve account
A reserve account holds excess cash in highly rated instruments,suchasU.S.Treasurysecurities orhigh-grade commercial paper, to provide security to the debt holders of the CDO trust.
886
revolving period
The second phase in the CDO life cycle is normally called the revolving period, during which the manager of the CDO trust may actively manage the collateral pool for the CDO, potentially buying and selling securities and reinvesting the excess cash flows received from the CDO collateral pool.
887
risk shifting
Risk shifting is the process of altering the risk of an asset or a portfolio in a manner that differentially affects the risks and values of related securities and the investors who own those securities.
888
single-tranche CDO
In a single-tranche CDO, the CDO may have multiple tranches, but the sponsor issues (sells) only one tranche from the capital structure to an outside investor.
889
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.
890
sponsor of the trust
The sponsor of the trust establishes the trust and bears the associated administrative and legal costs.
891
subordination
Subordination is the most common form of credit enhancement in a CDO transaction, and it flows from the structure of the CDO trust.
892
synthetic CDO
In a synthetic CDO, the CDO obtains risk exposure for the collateral pool through the use of a credit derivative, such as a total return swap or a CDS.
893
tranche width
The tranche width is the percentage of the CDO’s capital structure that is attributable to a particular tranche.
894
weighted average rating factor (WARF)
The weighted average rating factor (WARF), as described by Moody's Investors Service, is a numerical scale ranging from 1 (for AAA-rated credit risks) to 10,000 (for the worst credit risks) that reflects the estimated probability of default.
895
weighted average spread (WAS)
The weighted average spread (WAS) of a portfolio is a weighted average of the return spreads of the portfolio’s securities in which the weights are based on market values.
896
absolute return structured product
An absolute return structured product offers payouts over some or all underlying asset returns that are equal to the absolute value of the underlying asset’s returns.
897
active option
An active option in a barrier option is an option for which the underlying asset has reached the barrier.
898
analytical
The solution is analytical because the model can be exactly solved using a finite set of common mathematical operations.
899
Asian option
An Asian option is an option with a payoff that depends on the average price of an underlying asset through time.
900
barrier option
A barrier option is an option in which a change in the payoff is triggered if the underlying asset reaches a prespecified level during a prespecified time period.
901
boundary condition
A boundary condition of a derivative is a known relationship regarding the value of that derivative at some future point in time that can be used to generate a solution to the derivative’s current price.
902
building blocks approach
The building blocks approach (i.e., portfolio approach) models a structured product or other derivative by replicating the investment as the sum of two or more simplified assets, such as underlying cash-market securities and simple options.
903
cash-and-call strategy
A cash-and-call strategy is a long position in cash, or a zero- coupon bond, combined with a long position in a call option.
904
dynamic hedging
Dynamic hedging is when the portfolio weights must be altered through time to maintain a desired risk exposure, such as zero risk.
905
equity-linked structured products
Equity-linked structured products are distinguished from structured products by one or more of the following three aspects: (1) They are tailored to meet the preferences of the investors and to generate fee revenue for the issuer; (2) they are not usually collateralized with risky assets; and (3) they rarely serve as a pass-through or simple tranching of the risks of a long-only exposure to an asset, such as a risky bond or a loan portfolio.
906
exotic option
Although there is no universally accepted definition of an exotic option, a useful definition is that an exotic option is an option that has one or more features that prevent it from being classified as a simple option, including payoffs based on values prior to the expiration date, and/or payoffs that are nonlinear or discontinuous functions of the underlying asset.
907
knock-in option
A knock-in option is an option that becomes active if and only if the underlying asset reaches a prespecified barrier.
908
knock-out option
A knock-out option is an option that becomes inactive (i.e., terminates) if and only if the underlying asset reaches a prespecified barrier.
909
numerical methods
Numerical methods for derivative pricing are potentially complex sets of procedures to approximate derivative values when analytical solutions are unavailable.
910
overconfidence bias
An overconfidence bias is a tendency to overestimate the true accuracy of one’s beliefs and predictions.
911
partial differential equation approach (PDE approach)
The partial differential equation approach (PDE approach)
finds the value to a financial derivative based on the assumption that the underlying asset follows a specified stochastic process and that a hedged portfolio can be constructed using a combination of the derivative and its underlying asset(s).
912
participation rate
The participation rate indicates the ratio of the product’s payout to the value of the underlying asset.
913
path-dependent option
A path-dependent option is any option with a payoff that depends on the value of the underlying asset at points prior to the option’s expiration date.
914
payoff diagram level
The payoff diagram level determines the amount of money or the percentage return that an investor can anticipate in exchange for paying the price of the product.
915
payoff diagram shape
The payoff diagram shape indicates the risk exposure of a product relative to an underlier.
916
power reverse dual-currency note
At its core, in a power reverse dual-currency note (PRDC), an investor pays a fixed interest rate in one currency in exchange for receiving a payment based on a fixed interest rate in another currency.
917
principal protected absolute return barrier note
A principal protected absolute return barrier note offers to pay absolute returns to the investor if the underlying asset stays within both an upper barrier and a lower barrier over the life of the product.
918
principal-protected structured product
A principal-protected structured product is an investment that is engineered to provide a minimum payout guaranteed by the product’s issuer (counterparty).
919
quanto option
A quanto option is an option with a payoff based in one currency using the numerical value of the underlying asset expressed in a different currency.
920
simple option
A simple option has (1) payoffs based only on the value of a single underlying asset observed at the expiration date, and (2) linear payoffs to the long position of the calls and puts based on the distance between the option’s strike price and the value of the underlying asset.
921
spread option
A spread option has a payoff that depends on the difference between two prices or two rates.
922
static hedge
A static hedge is when the positions in the portfolio do not need to be adjusted through time in response to stochastic price changes to maintain a hedge.
923
tax deduction
Tax deduction of an item is the ability of a taxpayer to reduce taxable income by the value of the item.
924
tax deferral
Tax deferral refers to the delay between when income or gains on an investment occur and when they are taxed.
925
wrapper
A wrapper is the legal vehicle or construct within which an investment product is offered.
926
affinity fraud
Affinity fraud is the commission of fraud against people or entities with which the perpetrator of the fraud shares a common bond, such as race, ethnicity, or religious affiliation.
927
anchoring
Anchoring may be viewed in this context as a tendency to rely too heavily on previous beliefs.
928
behavioral biases
Behavioral biases are tendencies or patterns exhibited by humans that conflict with prescriptions based on rationality and empiricism.
929
behavioral finance
Behavioral finance studies the potential impacts of cognitive, emotional, and social factors on financing decision-making.
930
circuit breaker
A circuit breaker is a decision rule and procedure wherein exchange authorities invoke trading restrictions (even exchange closures) in an attempt to mute market fluctuations and to give market participants time to digest information and formulate their trading responses.
931
confirmation bias
Confirmation bias is the tendency to disproportionately interpret results that confirm a previously held opinion as being true.
932
crowded trade
When large investors hold substantial positions in the same asset or similar assets, it is known as a crowded trade.
933
fraud
Fraud is intentional deception typically for the purpose of financial gain.
934
painting the tape
Placing transactions to record high or low prices on the transaction records of public markets is a fraudulent activity often termed painting the tape, in reference to the historical use of ticker tape to broadcast prices.
935
Ponzi scheme
A Ponzi scheme is a fraudulent program that returns deposits to investors and identifies the returned capital as a distribution of profit in order to overstate the profitability of the enterprise and to attract additional and larger deposits.
936
restitution
Restitution is the restoration of lost funds.
937
return on assets (ROA)
Return on assets (ROA) is profit before financing costs (and taxes), expressed as a percentage of assets. ROE can be expressed as a function of ROA, leverage (L, which is defined here as the ratio of assets to equity), and interest costs on the financing (r): ROE = (ROA × L) − [r × (L − 1)]
938
return on equity (ROE)
Return on equity (ROE) is profit after financing costs, expressed as a percentage of equity.
939
spoofing
Spoofing is the placing of large orders to influence market prices with no intention of honoring the orders if executed.
940
unwind hypothesis
The unwind hypothesis suggests that hedge fund losses began with the forced liquidation of one or more large equity market-neutral portfolios, primarily to raise cash or reduce leverage.
941
window dressing
Window dressing is a term used in the investment industry to denote a variety of legal and illegal strategies to improve the outward appearance of an investment vehicle.
942
actual investment strategy
The actual investment strategy of a fund at a particular point in time is the investment strategy being implemented by the fund.
943
business activities
Business activities include the indirect support of the investment activities of the fund, including all of the normal activities of running any similarly sized organization, such as human resources management, technology, infrastructure, and facility maintenance.
944
business risk
Business risk is the added economic dispersion caused by unexpected performance of the business team and business activities.
945
custody
Custody refers to the safekeeping of the cash and securities of a fund.
946
fund culture
A fund culture is a generally shared set of priorities and values within the fund’s organization.
947
gaming
Gaming refers to strategic behavior to gain benefits from circumventing the intention of the rules of a particular system.
948
investment activities
Investment activities span the investment process, involving all aspects of determining and implementing investment decisions.
949
investment management governance process
The investment process in discretionary cases centers on the investment management governance process, which is the explicit or implicit set of procedures through which investment decisions are made.
950
investment mandate
An investment mandate is an explicit or implicit statement of the allowable and intended strategy, goals, and/or risks of an investment program.
951
investment process
The investment process includes the methods a manager uses to formulate, execute, and monitor investment decisions, and spans the range of investment activities, from the design of the investment strategy, through the implementation of the ideas into decisions, and ultimately to the placing and execution of trading orders.
952
investment process risk
Investment process risk is economic dispersion caused by imperfect application of the stated investment strategy by the investment team.
953
investment strategy
A fund’s investment strategy refers to the sets of objectives, principles, techniques, and procedures used to construct and modify the fund’s portfolio.
954
market risk in the investment process
In discussions of investment process, the market risk in the investment process describes any systematic or idiosyncratic dispersion in economic outcomes attributable to changes in market prices and rates.
955
operational activities
Operational activities include the direct support of investment activities, often described as middle office and back office operations.
956
operational errors
Operational errors are inadvertent mistakes made in the process of executing a fund’s investment strategy.
957
operational fraud
Operational fraud from the perspective of an investor is any intentional, self-serving, deceptive behavior in the operational activities of a fund that is generally harmful to the investor.
958
operational risk
A broad interpretation of operational risk is that it is any economic dispersion caused by investment, operational, or business activities.
959
permitted investment strategies
The permitted investment strategies of a fund delineate the range of investment strategies that the fund’s managers have communicated and are mandated as allowable for the fund to implement.
960
position limit
A position limit is a specific restriction on the size of the holdings of a particular security or combination of securities.
961
risk limits
Risk limits are the maximum levels of measured risk that are allowed in a portfolio, in terms of both individual risks and aggregated risks.
962
rogue trader
A rogue trader intentionally establishes substantial positions well outside the investment mandate.
963
slack variable
A slack variable is the variable in an optimization problem that takes on whatever value is necessary to allow an optimum to be feasible but, while doing so, does not directly alter the value of the objective function.
964
stated investment strategy
The stated investment strategy of a fund is the investment strategy that a diligent investor would expect the fund to pursue, based on a reasonable analysis of information made available by the fund.
965
style drift
Style drift (or strategy drift) is the change through time of a fund’s investment strategy based on purposeful decisions by the fund manager in an attempt to improve risk-adjusted performance in light of changing market conditions
966
synergistic risk effect
A synergistic risk effect is the potential for the combination of two or more risks to have a greater total risk than the sum of the individual risks.
967
annual volatility
Thus, annual volatility is only about 16 times larger than daily volatility based on 256 trading days per year and zero autocorrelation.
968
bias blind spot
The bias blind spot is people’s tendency to underestimate the extent to which they possess biases.
969
chief risk officer
The chief risk officer (CRO) oversees the fund manager’s program for identifying, measuring, monitoring, and managing risk.
970
daily volatility
Annual volatility is only about 16 times larger than daily volatility based on 256 trading days per year and zero autocorrelation.
971
due diligence
Due diligence is the process of performing a review of an investment with an appropriate level of competence, care, and thoroughness.
972
expectation bias
Expectation bias is synonymous with confirmation bias and is a tendency to overweight those findings that most agree with one’s prior beliefs.
973
feeder fund
A feeder fund is a legal structure through which investors have access to the investment performance of the master trust.
974
financial firewall
A limited liability shield or financial firewall is a legal construct that prevents creditors from pursuing restitution from investors or other participants involved in an economic activity beyond the amount of capital that they have contributed.
975
fund style index
A fund style index is a collection of fund managers operating with a similar strategy to the fund manager in question that can be used as a benchmark.
976
hard lockup period
In a hard lockup period, withdrawals are contractually not allowed for the entire duration of the lockup period.
977
herd behavior
Herd behavior is the extent to which people are overly eager to adopt beliefs that conform to those of their peers.
978
information filtering
Information filtering is the fund manager’s ability to use data available to others but to be better able to glean tradable insights from it.
979
information gathering
Information gathering indicates the ability of the manager to create access to information or to have access to better information than do other managers.
980
investment objective
The investment objective of a fund specifies the goals, nature, and strategies of the fund’s investment program.
981
key personnel clause
A key personnel clause is a provision that allows investors to withdraw their assets from the fund, immediately and without penalty, when the identified key personnel are no longer making investment decisions for the fund.
982
league table
Common in many industries, a league table is a listing of organizations, generated by a research or media firm, that ranks organizations by size, volume, or other indicators of activity.
983
level 1 assets
Level 1 assets are those assets that can be valued based on an unadjusted market price quote from an actively traded market of identical assets.
984
level 2 assets
Level 2 assets are best valued based on nonactive market price quotes, active market price quotes for similar assets, or non-quoted values based on observable inputs that can be corroborated.
985
level 3 assets
Level 3 assets must be valued substantially on the basis of unobservable inputs, critical assumptions, and/or imprecise valuation techniques.
986
limited liability shield
A limited liability shield or financial firewall is a legal construct that prevents creditors from pursuing restitution from investors or other participants involved in an economic activity beyond the amount of capital that they have contributed.
987
lockup period
A lockup period is a provision preventing, or providing financial disincentives for, redemption or withdrawal of an investor’s funds for a designated period, typically one to three years for hedge funds, and up to ten years or more for real estate and private equity funds.
988
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.
989
master-feeder structure
Together, the master trust and feeder funds are referred to as a master-feeder structure.
990
N-sigma event
An N-sigma event is an event that is N standard deviations from the mean.
991
omega-score
The omega-score is a measure of future risk that is computed as a function of a fund’s age, size, past performance, volatility, and fee structure.
992
shorting volatility
Shorting volatility is a strategy whereby a fund manager sells call or put options, especially out-of-the-money options, without an offsetting position.
993
side pocket arrangement
In a side pocket arrangement, illiquid investments held by a hedge fund are segregated from the rest of the portfolio.
994
soft lockup period
In a soft lockup period, investors may be allowed to withdraw capital from the fund before the expiration of the lockup period but only after the payment of a redemption fee, which is frequently 1% to 5% of the withdrawal amount.
995
trade allocation
Trade allocation, in this context, refers to the process by which—and priorities with which—an attractive investment opportunity is distributed among the manager’s various funds and accounts.
996
actively managed portfolio
An actively managed portfolio involves trading with the intent of generating improved performance.
997
distinguishing alpha and beta
Distinguishing alpha and beta involves measurement and attribution and the process of identifying how much of an asset’s return is generated by alpha and how much is generated by beta.
998
enhanced index products
Enhanced index products are designed to take slightly more risk than the index within tightly controlled parameters and offer a little extra return, usually on a large pool of capital.
999
index products
Index products take little or no active risk, extract no added value, and are not expected to generate active return.
1000
new investment model
In the new investment model, investments are allocated with flexibility and in the explicit context of alpha and beta management.
1001
passively managed portfolio
A passively managed portfolio, such as an indexed buy-and- hold portfolio, seeks to match the return of an index or a benchmark without engaging in active trading that attempts to generate improved performance.
1002
portable alpha
Portable alpha is the ability of a particular investment product or strategy to be used in the separation of alpha and beta.
1003
separating alpha and beta
Separating alpha and beta involves portfolio management and refers to attempts to independently manage a portfolio’s alpha and its exposure to beta, each toward desired levels.
1004
smart beta
Smart beta is the strategy of implementing a rules-based portfolio weighting scheme based on one or more characteristics in the underlying assets that generates portfolio weights that differ from a market-capitalization weighting scheme.
1005
strategic asset allocation decision
The strategic asset allocation decision is the long-term target asset allocation based on investor objectives and long-term expectations of returns and risk.
1006
tactical asset allocation
Tactical asset allocation is the process of making portfolio decisions to alter the systematic risks of the portfolio through time in an attempt to earn superior risk adjusted returns.
1007
traditional approach to portfolio allocation
In the traditional approach to portfolio allocation, the top- level decision is a long-term target allocation decision, known as the strategic asset allocation decision.
1008
zero-sum game
A zero-sum game is a market, environment, or situation in which any gains to one party must be equally offset by losses to one or more other parties.
