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Finance Exam 1 Definitions


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commitment of current resources in the expectation of deriving greater resources in the future
Real assets
assets used to produce goods and services
Financial assets
claims on real assets or the income generated by them.
Fixed income securities
pay a specified cash flow over a specific period
an ownership share in a corporation
Derivative securities
securities providing payoffs that depend on the values of other assets
Agency problem
conflicts of interest between managers and stockholders
Asset allocation
portfolio choice among broad investment class
Security selection
choice of specific securities within each asset class
Security analysis
analysis of the value of securities
Risk-return tradeoff
assets with higher expected returns have greater risk
Passive management
buying and holding a diversified portfolio without attempting to identify mis-priced securities
Active management
attempting to identify mis-priced securities or to forecast broad market trends
Financial intermediaries
institutions that connect borrowers and lenders by accepting funds from lenders and loaning funds to borrowers
Investment companies
financial intermediaries that invest the funds of individual investors in securities or other assets
Investment bankers
firms specializing in the sale of new securities to the public, typically by underwriting the issue
Primary market
market in which new issues of securities are offered to the public
Dealer Markets
markets in which traders specializing in particular assets buy and sell for their own accounts
Secondary markets
already existing securities are bought and sold on the exchanges or in the OTC market
tendency toward a worldwide investment environment, and the integration of national capital markets
Pass through securities
pools of loans sold in one package. Owners of pass-throughs receive all of the principal and interest payments made by the borrowers
pooling loans into standardized securities backed by those loans, which can then be traded like any other security
Bundling, unbundling
creation of new securities either by combining primitive and derivative securities into one composite hybrid or by separating returns on an asset into classes
Financial engineering
process of creating and designing securities with custom-tailored characteristics
Money markets
include short-term highly liquid, and relatively low-risk debt instruments
Capital markets
include longer-term relatively riskier securities
Treasury bills
short term government securities issued at a discount from face value and returning the face amount at maturity
a bank time deposit
Commercial paper
short-term unsecured debt issued by large corporations
Bankers’ acceptance
an order to a bank by a customer to pay a sum of money at a future date
dollar-denominated deposits at foreign banks or foreign branches of American banks
Repurchase agreements
short-term sales of government securities with an agreement to repurchase the securities at a higher price
Federal funds
funds in the accounts of commercial banks at the federal reserve bank
lending rate among banks in the London market
Treasury notes or bonds
debt obligations of the federal government with original maturities of 1 year or more
Municipal bonds
tax-exempt bonds issued by state and local governments
Corporate bonds
long-term debt issued by private corporations typically paying semiannual coupons and returning the face value of the bond at maturity
Common stocks
ownership shares in a publicly held corporation. Shareholders have voting rights and may receive dividends
Preferred stock
nonvoting shares in a corporation, usually paying a fixed stream of dividends
Price-weighted average
an average computed by adding prices of the stocks and dividing by a divisor
Market value-weighted index
computed by calculating a weighted average of the returns of each security in the index, with weights proportional to outstanding market value
Equally weighted index
an index computed from a simple average of returns
Derivative asset or contingent claim
a security with a payoff that depends on the prices of other securities
Put option
the right to sell an asset at a specified exercise price on or before a specified expiration date
first sale of stock by a formerly private company
they purchase securities from the issuing company and resell them
a description of the firm and the security it is issuing
Private placement
primary offerings in which shares are sold directly to a small group of institutional or wealthy investors
Stock exchanges
secondary market where already issued securities are bought and sold by members
Over the counter market (OTC)
an informal network of brokers and dealers who negotiate sales of securities
computer linked price quotation system for the OTC market
Ask price
price at which a dealer will sell a security
Third market
trading of exchange listed securities on the OTC market
Fourth market
direct trading in exchange listed securities between one investor and another without the benefit of a broker
Electronic communication networks (ECNs)
computer networks that allow direct trading without the need for market makers
a trader who makes a market in the shares of one or more firms and who maintains a fair and orderly market by dealing personally in the market
Block transactions
large transactions in which at least 10,000 shares of stock are bought or sold
Program trade
coordinated sale or purchase of a portfolio of stocks
Bid-ask spread
the difference between a dealer’s bid and asked price
describes securities purchased with money borrowed in part from a broker. The margin is the net worth of the investor’s account
Short sale
sale of shares not owned by the investor but borrowed through a broker and later purchased to replace the loan
Inside information
nonpublic knowledge about a corporation possessed by corporate officers, major owners, or other individuals with privileged access to information about the firm
Net asset value (NAV)
assets minus liabilities expressed on a per share basis
Unit investment trusts
money pooled from many investors that is invested in a portfolio fixed for the life of the fund
Open-end funds
a fund that issues or redeems it shares at net asset value
Close-end funds
a fund whose shares are traded at prices that can differ from net asset value. Shares may not be redeemed at NAV
sales commission charged on a mutual fund
Hedge fund
a private investment pool, open to wealthy or institutional investors, that is exempt from SEC regulation and can therefore pursue more speculative policies than mutual funds
12b-1 fees
annual fees charged by a mutual fund to pay for marketing and distribution costs
Soft dollars
the value of research services brokerage houses provide free of charge in exchange for the investment manager’s business
ratio of the trading activity of a portfolio to the assets of the portfolio
Exchange-traded funds
offshoots of mutual funds that allow investors to trade index portfolios
Holding period return
rate of return over a given investment period
Arithmetic average
the sum of returns in each period divided by the number of periods
Geometric average
the single per-period return that gives the same cumulative performance as the sequence of actual returns
Dollar-weighted average return
the internal rate of return on an investment
Scenario analysis
process of devising a list of possible economic scenarios and specifying the likelihood of each one, as well as the HPR that will be realized in each case
Probability distribution
list of possible outcomes with associated probabilities
Expected return
mean value of the distribution of holding period returns
expected value of the squared deviation from the mean
Standard deviation
the square root of the variance
Risk-free rate
rate of return that can be earned with certainty
Risk premium
expected rate of return in excess of that on risk-free securities
Excess return
rate of return in excess of the T-bill rate
Risk aversion
reluctance to accept risk
Inflation rate
the rate at which prices are rising, measured as the rate of increase of the CPI
Nominal interest rate
interest rate in terms of nominal dollars (not adjusted for purchasing power)
Real interest rate
excess of the interest rate over the inflation rate. The growth rate of purchasing power derived from an investment
Complete portfolio
entire portfolio including risky and risk-free assets
Capital allocation line
plot of risk-return combinations available by varying portfolio allocation between a risk-free asset and a risky portfolio
Reward to variability ratio
ratio of risk premium to standard deviation
Passive strategy
investment policy that avoids security analysis
Capital Market line
capital allocation line using the market index portfolio as the risky asset

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