Arithmetic means Simple average determined by dividing the sum of two or more items by the number of items.
Asset allocation An investment strategy intended to reduce the volatility and risk of loss of an individual`s holdings by assigning the holdings to several different types of asset classes, such as stocks, bonds, mutual funds, precious metals and real estate. Asset allocation is considered the main determinant of portfolio performance. The term can also apply to spreading assets across different regional and national markets.
Asset classes The various types of investments, such as stocks, bonds, currencies and commodities, that are available to investors.
Average annual return The average yearly profit (or loss) from an investment calculated over a period of years. Often confused with "compound annual return. (Please see compound annual return.)
Basis points The smallest measure of the yield paid by a bond or note. One basis point is equal to 0.0 1% (one-one hundredth of a percent) of yield. If a bond`s yield moves from 9.5 percent to 10.5 percent, that would be a move of 100 basis points.
Beta A measure of volatility and risk which reflects the degree to which the price of a security or portfolio tends to rise or fall with the market. The higher the beta, the higher the volatility.
Bear market A period of declining stock prices.
Bill A short-term debt security such as a U.S. Treasury bill with a maturity ranging from 13 weeks to a year.
Blue chip The stock of the largest, most well-established companies. Also referred to as large-capitalization stocks, blue chip stocks are generally considered strong, growing companies with market values of in the range of $1 billion or more. Most blue chips pay dividends, and are considered to be the most stable, least risky stocks on the market.
Bond A long-term debt instrument in which the issuing concern (usually a corporation or government body) is obligated to repay the debt on a given date, and must pay interest on the debt throughout the term of the bond. For example, a corporation may issue 10-year bonds to finance an expansion project, paying its bond investors a preset rate of interest each year, and repaying the original principal when the bonds mature after 10 years. Interest is usually paid semi-annually.
Bond quality The safety of principal and dependability of interest payments of a bond. Quality depends on the financial soundness of the issuer. The lower the quality, the higher the interest rate an issuer must pay to attract investors.
Book value The assessed value of a company`s assets. ("Book value per share," which is frequently used in assessing the potential value of a company`s stock, is defined as the per-share assessed value of a company`s assets.
Bottom-up analysis Stock market investment approach in which the emphasis is on analyzing individual stocks rather than broad economic trends. Opposite of the top-down analysis. Analysts try to identify stocks that are undervalued or have strong growth potential. It is far more popular than the top-down approach. (Also see top-down analysis.)
Brady bonds Named for former U.S. Treasury Secretary Nicholas Brady, Brady bonds were created to alleviate Latin America`s debt crisis in the 1980s. Under the Brady plan, creditor banks exchanged existing bonds for new bonds with lower face value but with principal backed by U.S. Treasury bonds.
Bretton Woods Agreement An agreement in effect from 1945 to 1972, under which exchange rates of the major currencies were fixed, and moved in lockstep. After the agreement collapsed in 1972, currencies began to trade at fluctuating levels.
Bull market A period of high and rising stock prices.
Call An option that allows the option holder to buy an investment at a predetermined price until a pre-set date.
Call Option The right to buy a specific number of shares of an investment (such as stock) at a pre-set price by a certain date. With stock options, for instance, in exchange for a premium, a call gives the holder the right to buy 100 shares of a stock at a "strike" price at any time during a set period that may vary from 1 to 90 days. Call options are appropriate for investors who feel that a certain stock is going to go up in value. If the stock increases in value, the investor would exercise the option and collect a profit on the price increase. If the stock drops, the investor would let the option expire, forfeiting the price of the premium. (Also see Option.)
Call provision A stipulation allowing some bond issuers to pay off their bond debt before maturity. Bond issuers tend to exercise call provisions when interest rates fall significantly, allowing them to issue new bonds at lower interest rates.
Capital appreciation An increase in the market value of an asset.
Capital gain The profits earned from an investment.
Capital loss An investment loss sustained as a result of a decline in the value of an investment such as a stock or bond.
Capital market instruments Longer-term debt instruments such as government and corporate bonds.
Cash equivalents An asset or investment that has a monetary value equal to a specified sum of money. Cash equivalent investments are securities of high liquidity and safety -- such as money market funds or Treasury bills -- that are considered virtually as good as cash.
Cash markets A commodities market where physical commodities are bought and sold.
Cash flow A company`s annual profits plus depreciation.
Coincident indicators Economic data that tend to coincide with the economic cycle. Examples include industrial production, employment and personal income. In other words, during an economic upswing, industrial production, employment and personal income are all on the rise, while during a recession, they tend to be on the decline. (Also see leading indicators and lagging indicators.)
Commerical paper Short-term debt instrument issued by corporations to facilitate their cash flow. Commercial paper is usually unsecured, with maturities of two to 270 days. The large denomination notes (at least $25,000 ) are normally issued by financial companies and large corporations.
Corporate bond A long-term debt instrument issued by corporations to raise capital. The issuing corporation is obligated to repay the bond debt on a specified date, and to pay a specified rate of interest on the debt throughout the term of the bond. While most bonds are backed by property or other assets, some bonds, known as "debentures," are backed strictly by the word ("full faith and credit") of the corporation.
Commodities Bulk goods such as metals, foods, grain, livestock, currency and lumber that are traded on a commodities exchange or a spot market.
Commodities indexes Statistical composite that tracks levels of commodities prices in general. The two primary indexes are the Commodity Research Bureau index, published by Knight- Ridder Financial Publishing, and the Goldman Sachs Commodity Index (GSCI).
Common stock Unit of ownership of a public corporation. The vast majority of stocks traded on the exchanges are common stocks (as opposed to "preferred stock"). Typically, common stock owners are entitled to vote on company directors and important policy matters, and may also receive dividends from the company. (Also see preferred stock.)
Compounding Interest paid on interest from previous periods in addition to the principal. Though small at first, the additional returns can become substantial over time.
Compound annual return Measure of the rate at which an investment or portfolio has grown in value over a period of years, averaged out on a yearly basis. Varies from "average annual return" in that it measures what the fixed annual rate of return of an investment would have been based on its total long-term return. For instance, a stock that grows 75 percent in three years would have an "average annual return" of 25 percent (75% divided by 3 = 25%), and a compound annual return (calculated through a complex formula) of about 20 percent. In other words, if an investment were to go up 20 percent each year for three years, through compounding, that would equal a total of a 75 percent return. (See average annual return.)
Compound rate of return The annual return rate of an investment over a period of years, determined by calculating what fixed rate of return that investment would have to have earned in order to achieve its total return over that specific time period.
Conversion price A preset dollar amount a stock must reach before convertible bonds or preferred stock may be exchanged for shares of common stock.
Convertible bonds Bonds that pay a fixed rate of interest and are convertible to common stock if the stock reaches a certain price known as the "conversion price." They offer regular fixed income -- although usually less than bonds issued by the same company -- and appreciation potential if the company is growing, but not as much as the company`s common stock.
Convertible preferred stock Preferred stock that may be converted to common stock at a preset price. Convertibles appeal to investors seeking higher income than common stocks provide, and greater appreciation potential than bonds offer. (Also see common stock and preferred stock.)
Correlation A measure of association or co-movement between two variables. If two variables tend to rise and fall together, they have a positive correlation. If one is rising while the other is declining, they have a negative correlation.
Coupon rate The stated annual interest paid on a bond or other debt security. For instance, the coupon on a $ 1,000 bond that pays 10 percent interest would be $100. On coupon bonds, the owner must detach the coupon from the bond to present for interest payments.
Currency fluctuations Changes in the relative value of various currencies in relation to other currencies. For instance, the Japanese yen constantly fluctuates in value compared with the U.S. dollar.
Currency hedging Policy of protecting a portfolio against currency fluctuations (and large losses) by investing in a combination of currency options and futures and other diversified investments.
Currency investments Options and futures contracts that allow investors to buy or sell a specific amount of a foreign currency at a set price on or before a set date. Investors may also play the currencies market by buying foreign bonds and certificates of deposit.
Current income The income an investor receives while holding a specific investment. Examples of current income include stock dividends and bond interest payments.
Current returns Earnings from an income-producing asset such as a bond that pays interest or a stock that pays dividends.
Current yield Interest rate paid by a bond or other fixed rate investment, calculated by dividing the annual interest payment by the current market price. Since the annual return is fixed, the yield automatically falls if the price rises, and vice versa.
Cyclical industries Industries such as automotive and other heavy manufacturers that are subject to broad swings in economic activity. Cyclical stocks often anticipate changes in the economy, reaching their highs (or lows) just before major shifts in the economy.
Cyclical stocks Stocks of cyclical industries such as automotive and other heavy manufacturers that are subject to broad swings in economic activity. Cyclical stocks often anticipate changes in the economy, reaching their highs (or lows) just before major shifts in the economy.
Debt instrument A fixed income investment, such as a bond, note or bill, issued by governments and corporations. The issuer is obligated to repay the purchase amount on the date the instrument comes due (maturity date), and must pay a pre- determined interest rate either during the course of the agreement or when the investment reaches maturity.
Debt-to-asset ratio A measure used by value-oriented investor to help assess the strength of a company, and the value of its stock. The ratio compares a company `s outstanding debt with its total holdings. A high debt-to- asset ratio indicates a company with high debt, and a shakier financial structure than a company with a low debt-to-asset ratio.
Debt-to-earnings ratio A measure used by value-oriented investors to help assess the strength of a company, and the value of its stock. The ratio compares a company`s outstanding debt with its annual earnings (profits). A low debt-to-earnings ratio is preferable, and indicates a low debt, and more stable financial footing.
Depression A severe economic downturn with a slump in output of 10 percent or more, and a dramatic rise in unemployment.
Derivatives Options, futures and other investments that derive their value from other underlying assets, such as currencies, stocks, bonds or commodities. In recent years, the variety and complexity of derivatives has grown dramatically.
Direct business ownership Controlling interest in a private company.
Discount Refers to a bond that is trading on the secondary market at a price below its issuing price. For instance, a bond issued at $1,000 par value may drop below $1,000 on the bond market if interest rates increase. A bond or other security that is selling at under par value is said to be trading "at a discount." (Also see premium.)
Discounted future earnings Projected earnings of a company relative to its current stock price. It is used by fundamental stock analysts to help determine the potential future value of the company`s stock.
Diversification The strategy of investing in several different types of assets, (and, in some cases, investing in several different regions of the world) in order to balance the portfolio and protect against large losses and high volatility.
Dividend income Monetary payment a stock shareholder receives from the company. The dividend, which is allocated from the company`s earnings, is paid on a pro-rated basis in a fixed amount for each share of stock held. Dividends are usually paid quarterly. Dividends are not guaranteed, but many companies with consistent earnings pay them on a regular basis.
Dividend Yield The annual dividend payment divided by its market price per share. Example: if a stock is trading at $10 a share, and it pays a $1 dividend, the dividend yield is 10 percent. While the yield may also be considered the "current return" on a stock, it does not take into consideration gains and losses in the trading price of the stock.
Duration Referring to a bond or other fixed rate investment: the number of years it would take to receive the present value of future payments, including both interest and principal, from the bond.
Early upswing The healthiest segment of the economic cycle, when the recovering economy gains momentum without experiencing sharply higher inflation. The period is characterized by rising consumer confidence, healthy economic growth, low inflation, low short-term interest rates, and strong stock growth.
Earnings Profit or income from a business. Earnings usually refers to after-tax income.
Efficient frontier The point at which a portfolio is diversified in such a way as to provide the maximum possible return with the least amount of risk.
Emerging growth stock Stock of a small, rapidly-expanding company. Emerging growth stocks offer great long-term appreciation potential, but tend to be the most risky and most volatile of all stocks.
Equity investment A security -- usually common or preferred stock --that represents a share of ownership.
Exchange (see Securities exchange)
Exchange rate The price at which the currency of one country can be converted into another`s. For instance the exchange rate between the U.S. dollar and the Japanese yen is about 1 to 90 ($1 = 90 yen).
Exchange rate protection An investment strategy designed to keep an investor from losing money on international investments due to fluctuations in the exchange rate. For instance, an American investing in British stocks could buy put options on British pounds (to sell at a pre-set price) as an exchange rate hedge just in case the pound declined in value relative to the dollar. While the investor might lose money on the stock if the pound dropped in price, the investor would make up the difference through the profits from the currency option.
Expected returns Projected annual return from a specific asset class (such as the stock market or the bond market) based on the average return of that investment over a long- term period.
Face value The issuing price or "par value" of a bond, note or security as stated on the certificate. For instance, many bonds are issued at $1,000 face value -- and redeemed at maturity at that same $1,000 value. (The bondholder profits from the interest paid on the bond throughout the bond holding period.)
Fiscal policy Governmental economic policy designed to maintain a stable economy, high employment, low inflation and strong growth.
Fixed-income investment Debt instrument, such as a bond, note or bill, issued by governments and corporations. The investment buyer is essentially making a loan to the issuer. The issuer is obligated to repay the purchase amount on the date the instrument comes due (maturity date), and must pay a pre-determined interest rate either during the course of the agreement or when the investment reaches maturity.
Fixed rate of return Annual profit from an investment that remains the same from year to year. For instance, a certificate of deposit may have a fixed rate of return of 5 percent per year over a five-year period.
Floating rates Exchange rates (or interest rates) that are set by the market rather than by some type of governmental mandates.
Forward trade A transaction on the currencies market in which the exchange rate is established now, but settlement occurs at a specified future date. Forward trades make up about 5 percent of all currency trades.
Futures contracts Essentially a promise to buy or sell a currency (or other type of investment) at a specified price on a particular date. The buyer is required to accept and the seller is required to deliver an investment such as currency or a security on that date at the specified price.
Fundamental analysis A stock market investment approach based on the premise that a stock`s value depends on the company`s present and future earnings. The objective is to identify individual stocks or groups of stocks that have exceptional earnings potential or are currently undervalued relative to earnings potential -- and therefore are likely to appreciate in the future. (Also see technical analysis.)
Fundamentals Basic financial and economic factors affecting the success of a company and the price of its stock. Fundamentals of a company would include factors such as earnings and revenue growth, price-earnings ratio, dividend yield and debt-to-equity ratio.
Geometric mean A method of calculating an investment`s growth over a period of years to determine its compound annual return.
Growth-oriented strategy A stock market investment approach in which the emphasis is on identifying stocks with superior long-term earnings and stock growth potential. Opposite of a value-oriented strategy in which analysts look for undervalued stocks. (Also see value-oriented strategy.)
Growth stock Stock of a small to mid-capitalization company that is expanding rapidly. Growth stocks offer the greatest long-term appreciation potential, but are also the most volatile and vulnerable to changing business conditions .
High yield bond Also referred to as a "junk bond," it is a bond issued by a corporation or government whose ability to pay interest and repay the principal is in question to varying degrees. Normally, smaller, newer companies and third world countries must offer higher yields to attract investors.
Income stocks Technically, any stock that pays a dividend, but income stocks are normally thought of as stocks that pay a higher than average dividend. Exactly what would be considered a "high" dividend depends on current interest rates, but generally, a dividend yield of 4% or more would be considered high. Income stocks tend to be the more established mid- to high-capitalization stocks.
Inefficient portfolio An investment portfolio that is structured in such a way that it offers less than the maximum return potential for the risk assumed. (Also see efficient frontier.)
lnflection point The point in an efficient frontier curve at which the slope of the curve shifts from the negative to the positive. The portfolio becomes increasingly risky as the investment weighting within the portfolio becomes further and further unbalanced.
Investment returns The profit (or loss) earned from a specific investment or a portfolio of investments over a specific period of time.
Interbank market Currency market, made up primarily of leading banks and broker-dealers, that is responsible for 96 percent of all currency trading.
Internal rate of return Also referred to as the "compound annual return," it is a measure of the rate at which an investment or portfolio has grown in value over a period of years, averaged out on a yearly basis. (See compound annual return and average annual return.)
Investment grade bond Considered among the highest quality bonds based on safety of principal and dependability of interest payments. Investment grade bonds are generally divided into four rating categories, lead by bonds issued by the most stable governments and the largest, most financially-secure corporations.
Investment horizon The amount of time an investor expects to hold a specific investment. The longer the investment horizon, the less likely an investor will be to lose money on a volatile investment.
Junk bond Also referred to as a "high yield bond," it is a bond issued by a corporation or government whose ability to pay interest and repay the principal is in question to varying degrees. (Also see high yield bond.)
Lagging indicators Economic data that trail the economy, rising or falling after the economy has shifted. Examples of lagging indicators include expenditures for new plants and equipment, commercial and industrial loans outstanding, and unemployment rates for medium and long-term unemployed.
Large cap (or "large-capitalization") stock Stocks of the largest, most well-established companies. Also referred to as "blue chips," large cap stocks are generally considered to be those with market values of $1 billion or more (such as Unilever, IBM, and Sony). Most large cap stocks pay dividends, and are considered to be the most stable, least risky stocks on the market.
Late upswing A period in the economic cycle (after the recovery and early upswing periods) when the economy is growing rapidly, creating a "boom" mentality. The period is characterized by rising inflation, rising interest rates, flat stock growth, soaring commodity prices, falling bond prices and rising employment.
Leading indicators Economic data that usually predate turning points in the economy. Examples include average weekly hours, manufacturers new orders, unemployment claims, stock prices, inventories, money supply and consumer confidence. (Also see coincident indicators and lagging indicators.)
Letter of credit Document issued by a financial institution that substitutes the credit of the institution for the borrower. Used extensively in international trade, it guarantees the payment of a customer`s drafts up to a stated amount for a certain period.
Liquid asset Cash or an type of investment that can be easily converted into cash, such as a money market account, bank deposits and U.S. Treasury bills.
Market capitalization Can refer to a corporation or an entire national stock market: The value of a corporation -- or an entire stock market -- as determined by the market price of its issued and outstanding common stock.
Market indicators Economic data that either predates, follows are occurs simultaneously with turning points in the economy. Technical analysts track market indicators to time investment buy and sell decisions. (See coincident indicators and lagging indicators and leading indicators.)
Market risk Also known as "systematic risk," it refers to the risk attached to the overall market, rather than to an individual stock or bond. When an entire national bond or stock market rises or falls, most of the individual securities tend to rise and fall with the market. (Also see unsystematic risk.)
Market timing A classic buy low -- sell high investment approach in which investors try to anticipate the ups and downs of the market, and make their buy and sell decisions accordingly. Market timers buy when they expect the market to go up, and sell -- or lighten their position -- when they expect the market to go down.
Maturity (or maturity date) The pre-specified date on which a financial obligation (such as a bond or promissory note) must repay the principal to the bondholder.
Mid-cap (or "mid-capitalization") stock The stock of companies with market valuations of about $ 00 million to $1 billion. They are larger than the small, emerging stocks, but smaller than the "large-capitalization" or " blue chip" stocks.
Modern portfolio theory Investment asset allocation theory developed by 20th Century investment analysts and researchers that stresses diversification in order to reduce risk and increase long-term performance. Key assumptions of the theory are that investors prefer higher returns to lower, less risk to more, and that they have long-term time horizons. Under the theory, by adding a relatively risky, high-return asset to a portfolio, you can not only increase the expected return, you also decrease the risk.
Monetary policy Governmental policy regulating the supply of money in the economy. For instance, in a weak economy, the government might stimulate growth by extending more credit to the banking industry. That action serves to increase the amount of money in circulation, which bolsters the economy. By the same token, the government can temper an overheating economy by reducing the money supply through bank credit restrictions.
Money market fund A mutual fund that invests in high quality, short-term debt instruments such as Treasury bills or certificates of deposit. Money market fund investors earn a steady stream of interest income that varies with short-term interest rates. Generally investors may cash out at anytime.
Money market instrument A short-term, low-risk security such as commercial paper, U.S. Treasury bills, certificates of deposit and bankers` acceptances
Moody`s Investor Service A company that rates the quality of bonds issued by corporations and governments. The rating system includes a number of fine gradation between the safest "investment grade" bonds and the riskiest "high yield" or "junk" bonds.
Mortgage-backed security A debt instrument backed by a pool of mortgages issued by a mortgage lender or government agency that investors may buy to receive periodic interest payments and principal payments as the mortgages are repaid.
Note A short-term debt instrument issued by a corporation or government, usually with a maturity ranging from 13 weeks to one year. Considered a cash equivalent investment, notes are also referred to as "promissory notes."
Optimal portfolio An investment portfolio that provides the best possible return in relation to its risk.
Option A contract that permits the optionholder to buy or sell an asset (such as a stock or a currency) at a fixed price on or before a specific date. An option to purchase an asset is a " call," and an option to sell an asset is a "put."
Options on futures An agreement that gives the buyer or seller the right, but not the obligation, to accept or deliver a futures contract at a "strike price" specified in the option contract. (See strike price.)
Option on physical currencies An agreement that gives the buyer or seller the right, but not the obligation, to accept or deliver a currency at the option`s strike price by a specified date. (See strike price.)
OTC (commodities) market Over-the-counter exchange in which broker-dealers create (and buy and sell) customized products such as commodity swaps and index derivatives.
Par value The face value or issuing price of a bond. A bond issued at $1,000 would have a par value of $1,000. (Also see face value.)
Perfect negative correlation Two portfolios of different make-ups that move in opposite directions at the same rate. In other words, one portfolio increases in value at exactly the same rate the other p ortfolio is declines in value.
Portfolio construction Act of assembling a core of different investments in a portfolio with the intention of providing diversity and strong long-term performance with a minimum of volatility.
Preferred stock Like common stock, it is a unit of ownership in a corporation, but preferred stock pays a fixed dividend, set when the stock is issued. Although payment of the dividend is not an obligation, holders of preferred stock have the right to receive dividends before common shareholders. And should the company be liquidated, preferred shareholders would have claims satisfied before common shareholders. (Also see common stock and convertible preferred stock.)
Premium Refers to a bond or other security that is trading on the secondary market at a price in excess of its issuing price. For instance, a bond issued with a $1,000 face value may increase in value to more than $1,000 on the bond market if market interest rates drop. A bond or other security that sells for more than par value is said to be trading "at a premium." (Also see discount.)
Price/book value ratio A measurement used by value-oriented investors to assess the value of a stock. Specifically, the company`s share price divided by the book value per share (per-share assessed value of the company`s assets).
Price/cash flow ratio A measurement used by value-oriented investors to assess
the value of a stock. Specifically, the company`s stock price divided by its cash flow (profits plus depreciation) per share.
Price/earnings ratio (PE) A commonly used measure of a company`s stock price relative to its earnings per share. Specifically, it is a company`s stock price divided by its earnings per share over the past 12 months. For instance, a company with a stock price o f $10 and earnings-per-share of $1 has a 10 PE ($10 divided by $1). The higher a stock`s PE, the more expensive the stock is relative to its earnings.
Principal The purchase amount of a bond or other debt instrument.
Promissory note See note.
Quality See bond quality.
Quantitative asset allocation Investment approach derived from "modern portfolio theory," which states that the best performing, most consistent investment portfolios tend to be well diversified, and even include some risky, high return assets.
Quantitative analysis An investment strategy in which stocks are judged based on factors that can be precisely measured such as earnings, revenue, assets, liabilities, etc. By contrast, "qualitative" analysis is based on subjective measures such as the character and experience of management.
Real estate Piece of land, all physical attachments such as buildings, plants and fences as well as all rights to the air above and the earth below the property. (Items not attached are considered "personal property.")
Real estate investment trust (See REIT)
Real estate limited partnerships An investment that pools money from a limited number of investors to purchase commercial real estate. It may provide current income from rent, and may also appreciate in value. But limited partnerships are illiquid, and generally require a fairly large initial investment.
Real estate mutual fund Sector mutual fund that invests primarily in stocks of real estate-oriented companies.
Realized capital gain The profit earned from an asset that is sold at a higher price than the investor paid.
Realized loss The loss from the sale of an investment that declined in value from the time it was purchased to the time it was sold.
Recession A down period in the economic cycle. It is defined as two consecutive quarters of negative economic growth in gross domestic product. A recession is characterized by falling production and sales, rising unemployment, peaking inflation, stimulatory economic policies, falling interest rates, and depressed commodities prices. Stock prices usually hit bottom in a recession and begin to rebound.
Recovery A period in the economic cycle when new growth begins. Recoveries are often characterized by an upturn in the economy as a result of stimulatory economic policies, rising consumer confidence, falling inflation, low bond yields and rising stock and commodity prices.
Reinvested earnings Earnings from money that has already been earned from a particular asset, and then reinvested in that asset. For instance, a bank makes periodic interest payments to each of its savings account customers. If the customer leaves that interest in the savings account, then that money will itself begin to earn more interest.
REIT (real estate investment trust) Publicly traded stocks that invest in commercial property. REIT investors receive current income from rent, and may also enjoy some capital appreciation if properties held by the trust increase in value.
Repurchase agreement An agreement in which an asset is sold with the intention of repurchasing it later at a specified price and date. Essentially, it is the process of taking out a loan using the asset as collateral.
Return correlations Comparison between the expected returns of two different investment portfolios. By combining portfolios that move in different directions depending on the state of the economy, an investor can achieve true diversification and stabilize the year-to-year returns of the total portfolio.
Return projections Anticipated profit from an investment.
Risk The level of volatility or variability of returns of an investment.
Risk-adjusted returns Projected return from a portfolio when accounting for the combined risk and the return potential of all the investments in the portfolio. A portfolio with the maximum risk-adjusted returns is said to be at the efficient frontier, which is the point at which a portfolio is diversified in such a way as to provide the maximum possible return with the least amount of risk.
Risk-averse The concept that an investor makes investment choices based on the risk and reward potential of investments, expecting greater return for greater risk, and seeking investments that offer the highest return for the least amount of risk.
Risk premium A higher yield offered by bonds and similar investments that carry a high risk rating. For example, government bonds are considered the safest bond investments, and pay among the lowest yields. Corporate bonds, on the other hand, must offer higher yields to attract investors because those bonds carry a higher risk than government bonds.
Secondary markets A trading market for bonds and other debt instruments after they have been issued. A bond may be issued at a par value of $1,000, but, depending on fluctuations in interest rates, it may sell for more or less than the $1,000 issuing price on the secondary market.
Securities exchange A facility for the organized trading of securities such as stocks, bonds and commodities. There are many national and regional exchanges around the world.
Short-term, cash equivalent investment A highly liquid interest-bearing investment such as money market funds or Treasury bills that have a maturity of less than 12 months and are considered to be virtually as good as cash.
Sinking fund A custodial account used by a bond issuer (such as a corporation or government body) to place a predetermined amount each year toward payment of the principal on its bond issue. The sinking fund helps an issuer receive a higher rating for its bonds by essentially guaranteeing that the money needed to redeem the bonds will be available at maturity.
Slowdown A period in the economic cycle when the economy begins to decline after an extended period of strong growth. The period is characterized by slowing consumer demand, falling confidence, rising inflation, high interest rates, and declining stock and commodity prices.
Small cap (or "small-capitalization") stock The smallest, and generally considered to be, the riskiest class of stocks. Despite their risk and volatility, however, the small cap stocks also tend to hold the greatest potential for appreciation, according to historical comparisons with mid- and large capitalization stocks. Small caps have market values of under $500 million. Sometimes referred to as "emerging" stocks. (Also see mid cap stock and large cap stock.)
Spot trade Currency market transaction in which settlement occurs within two business days. Spot trades make up about 50 percent of all currency trades.
Standard deviation A measure of an investments volatility. It summarizes in one number how far a portfolio`s returns for individual years deviate from the average or expected return value. The higher the standard deviation, the more variable the returns and the riskier the investment.
Stock An equity asset that represents a proportionate share of ownership in a company. The total number of shares is set by the company`s charter. Stock shareholders may vote on directors and important corporate resolutions, and share in the profits and growth of the company through dividends and stock price appreciation. Stocks are traded on exchanges around the world.
Strike price Price at which an option holder can exercise the option and purchase the underlying security or currency.
Swap Currency market transaction in which a spot market commitment (where payment and settlement is due within two days) is exchanged for a forward market commitment (in which payment and settlement is due at some specified future date). (Also see spot trade and forward trade.)
Systematic risk Also known as "market risk," it refers to the risk attached to the overall market, rather than to an individual stock or bond. When an entire national bond or stock market rises or falls, most of the individual securities in that market tend to rise and fall with the market. (Also see unsystematic risk.)
Time horizon The period for which an investor intends to hold an investment or a portfolio of investments. An investor with a short time horizon would normally buy stable investments to protect against short-term market fluctuations, while an investor with a long time horizon can buy more volatile investments that have greater long-term growth potential.
Technical analysis A stock market investment approach that examines recurring patterns in the market to predict price movements. Technical analysts assume that all information about the fundamentals of a stock, industry or national market is fully reflected in the price of the stock. So, unlike fundamental analysts, technician are not concerned with the financial strength of individual companies -- only with the anticipated movement of the overall market. (Also see fundamental analysis.)
Top-down analysis Stock market investment approach in which the emphasis is on economic trends rather than individual stocks. Opposite of bottom-up analysis. Analysts attempt to identify industries or geographic regions with the greatest potential for gain, and then invest in stocks of those categories. (Also see bottom-up analysis.)
Total return The total profit earned from an investment. Includes the sum of the income plus capital appreciation over a given time period, stated as a percentage of its value at the beginning of the period.
Treasury bills A government debt security sold in minimum amounts of $10,000, with a maturity date of 13 weeks to one year . Referred to as "T-bills," they are purchased at a discount to face value, pay no interest, but mature at full face value.
Treasury bonds A long-term, interest-bearing government security with a maturity date of 10 to 30 years. U.S. Treasury bonds pay interest semi-annually.
Trough The lowest period of a recession when economic activity is at its slowest.
Unrealized capital gain The gain in value of an asset that an investor owns, but has not yet sold. Only after the asset is sold does the profit become a "realized capital gain."
Unsystematic risk The risk attached to a particular security, independent of the movement of the market (as opposed to "systematic risk" or "market risk, " which refers to the risks attached to the movements of the overall market). For instance, bad earnings news may cause a stock`s price to fall even on a day when the overall market i s moving up. (Also see systematic risk.)
Value-oriented strategy A stock market investment approach in which the emphasis is on identifying undervalued stocks -- those that may have been knocked down in price by the market further than they should have been. Value-oriented investors try to buy those stocks when they appear to be poised for a rebound. (Also see growth-oriented strategy.)
Volatility A sharp fluctuation in the price of an investment (such as a stock, bond or commodity) over a relatively short period. The more volatile an investment, the more risky it is considered to be.
Yield The interest rate percentage a bond or other income investment pays to investors. A bond`s current yield is calculated by dividing the annual interest payment by the current market price. Since the annual return is fixed, the yield automatically fluctuates if the market price for the bond rises or falls.
Yield curve A graph showing the relationship between maturities of fixed-income investments and their current yields.
Yield to maturity the rate of return investors would receive if they held a bond or other long-term, fixed-income investment to its maturity date. It takes into account not only the income stream generated by a bond, but also the capital gain (or loss) expected if an investor buys the bond at a discount (or premium) and holds to maturity.
Zero coupon bond A bond that pays no interest but is priced at a discount to face value at maturity. The interest rate is stated as yield to maturity, compounded rather than simple interest. In other words, the bond pays no interest until it reaches maturity, at which point the issuer pays off the bond in full, including the principal and compounded interest.