Finance Exam 1 Definitions
Terms
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- Investment
- 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
- Equity
- 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
- Globalization
- 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
- Securitization
- 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
- COD
- 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
- Eurodollars
- 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
- LIBOR
- 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
- IPO
- first sale of stock by a formerly private company
- Underwriters
- they purchase securities from the issuing company and resell them
- Prospectus
- 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
- NASDAQ
- 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
- Specialist
- 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
- Margin
- 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
- Load
- 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
- Turnover
- 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
- Variance
- 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