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Investment Terms & Definitions

Accrued Interest

Accrued interest is calculated based on the last day of the accounting period. For example, if interest is payable on the 20th of each month and the accounting period is the end of each calendar month, the month of April will require an accrual of 10 days (21st to the 30th) of interest. Accrued interest is reported on the income statement as a revenue or expense. Alternatively, the portion of revenue or expense yet to the paid or collected is reported on the balance sheet as an asset or liability. Because accrued interest is expected to be received or paid within one year, it is often classified as a current asset or current liability.

Alpha

Alpha, often considered the active return on an investment, gauges the performance of an investment against a market index used as a benchmark, since they are often considered to represent the market’s movement as a whole. The excess returns of a fund relative to the return of a benchmark index is the fund’s alpha.

Alpha is most often used for mutual funds and other similar investment types. It is often represented as a single number (like 3 or -5), but this refers to a percentage measuring how the portfolio or fund performed compared to the benchmark index (i.e. 3% better or 5% worse).

Basis Point (BPS)

Basis point (BPS) refer to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01% (0.0001), and is used to denote the percentage change in a financial instrument. The relationship between percentage changes and basis points can be summarized as follows: 1% change = 100 basis points, and 0.01% = 1 basis point.

Beta

Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. Beta is used in the capital asset pricing model (CAPM), which calculates the expected return of an asset based on its beta and expected market returns. Beta is also known as the beta coefficient.

Bond

A bond is a debt investment in which an investor loans money to an entity (typically corporate or governmental) which borrows the funds for a defined period of time at a variable or fixed interest rate. Bonds are used by companies, municipalities, states and sovereign governments to raise money and finance a variety of projects and activities. Owners of bonds are debt holders, or creditors, of the issuer.

Break-Even Point

The breakeven point is the price level at which the market price of a security is equal to the original cost. For options trading, the breakeven point is the market price that a stock must reach for an option buyer to avoid a loss if they exercise the option. For a call buyer, the breakeven point is the strike price plus the premium paid, while breakeven for a put position is the strike price minus the premium paid.

Brokerage Accounts

A brokerage account is an arrangement between an investor and a licensed brokerage firm that allows the investor to deposit funds with the firm and place investment orders through the brokerage. The investor owns the assets contained in the brokerage account and must usually claim as income any capital gains he incurs from the account.

Capitalization

Capitalization, in accounting, is when the costs to acquire an asset are expensed over the life of that asset rather than in the period it was incurred. In finance, capitalization is the sum of a corporation’s stock, long-term debt and retained earnings. Capitalization also refers to the number of outstanding shares multiplied by share price.

Capital Gain

Capital gain is an increase in the value of a capital asset (investment or real estate) that gives it a higher worth than the purchase price. The gain is not realized until the asset is sold. A capital gain may be short-term (one year or less) or long-term (more than one year) and must be claimed on income taxes.

Cash Equivalents

Cash equivalents are investments securities that are for short-term investing, and they have high credit quality and are highly liquid.

Cash equivalents, also known as “cash and equivalents,” are one of the three main asset classes, along with stocks and bonds. These securities have a low-risk, low-return profile and include U.S. government Treasury bills, bank certificates of deposit, bankers’ acceptances, corporate commercial paper and other money market instruments.

Common and Prefered Stock

Common stock is a security that represents ownership in a corporation. Holders of common stock exercise control by electing a board of directors and voting on corporate policy. Common stockholders are on the bottom of the priority ladder for ownership structure; in the event of liquidation, common shareholders have rights to a company’s assets only after bondholders, preferred shareholders and other debtholders are paid in full.

A preferred stock is a class of ownership in a corporation that has a higher claim on its assets and earnings than common stock. Preferred shares generally have a dividend that must be paid out before dividends to common shareholders, and the shares usually do not carry voting rights.

Preferred stock combines features of debt, in that it pays fixed dividends, and equity, in that it has the potential to appreciate in price. The details of each preferred stock depend on the issue.

Custodial & Guardian Accounts

A custodial account is a savings account accessible through a financial institution, mutual fund company or brokerage firm that an adult controls for a minor under the age of 18, depending on state laws. It can also be a retirement account handled for eligible employees by a custodian. In a custodial account, approval from the custodian is mandatory for a minor to transact securities.

There are two types of custodial accounts: the Uniform Transfers to Minors Act (UTMA) and the Uniform Gift to Minors Act (UGMA). The UTMA allows parents to postpone distributions, but age limits vary by state. However, the UGMA allows parents to give funds to their child in the form of money, life insurance, savings bonds, stocks or annuities.

Dividend And Yield

A dividend is a distribution of a portion of a company’s earnings, decided by the board of directors, to a class of its shareholders. Dividends can be issued as cash payments, as shares of stock, or other property.

Dividend Yield is a financial ratio that indicates how much a company pays out in dividends each year relative to its share price. Dividend yield is represented as a percentage and can be calculated by dividing the dollar value of dividends paid in a given year per share of stock held by the dollar value of one share of stock. The formula for calculating dividend yield may be represented as follows:

Efficient Market Hypothesis

The efficient market hypothesis (EMH) is an investment theory that states it is impossible to “beat the market” because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. According to the EMH, stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. As such, it should be impossible to outperform the overall market through expert stock selection or market timing, and the only way an investor can possibly obtain higher returns is by purchasing riskier investments.

Emerging Markets

Emerging markets generally do not have the level of market efficiency and strict standards in accounting and securities regulation to be on par with advanced economies (such as the United States, Europe and Japan), but emerging markets do typically have a physical financial infrastructure, including banks, a stock exchange and a unified currency.

Investors seek out emerging markets for the prospect of high returns, as they often experience faster economic growth as measured by GDP. Investments in emerging markets come with much greater risk due to political instability, domestic infrastructure problems, currency volatility and limited equity opportunities, as many large companies may still be “state-run” or private. Also, local stock exchanges may not offer liquid markets for outside investors.

Equity

A stock or any other security representing an ownership interest. This may be in a private company (not publicly traded), in which case it is called private equity.

In terms of investment strategies, equity (stocks) is one of the principal asset classes. The other two are fixed-income (bonds) and cash/cash-equivalents. These are used in asset allocation planning to structure a desired risk and return profile for an investor’s portfolio.

Fixed Income

Fixed income is a type of investing for which real return rates or periodic income is received at regular intervals and at reasonably predictable levels. Fixed-income investors are typically retired individuals who rely on their investments to provide a regular, stable income stream. This demographic tends to invest heavily in fixed-income investments because of the reliable returns they typically offer.

Joint Tenants With Rights of Survivorship

Joint tenants with right of survivorship (JTWROS) is a type of brokerage account owned by at least two people, where all tenants have an equal right to the account’s assets and are afforded survivorship rights in the event of the death of another account holder.

In this type of brokerage account, a surviving member will inherit the total value of the other member’s share of account assets upon the death of that other member. All members of the account are afforded the power to conduct investment transactions within the account as well.

Large-, Mid-, Small- Cap Stocks

Small cap stocks are generally defined as the stock of publicly traded companies that have a market capitalization ranging from $300 million to about $2 billion.

Mid-cap company is a company with a market capitalization between $2 billion and $10 billion.

Large cap stocks are generally defined as the stock of publicly traded companies that have a market capitalization above $10 billion.

Market Capitalization

Market capitalization refers to the total dollar market value of a company’s outstanding shares. Commonly referred to as “market cap,” it is calculated by multiplying a company’s shares outstanding by the current market price of one share. The investment community uses this figure to determine a company’s size, as opposed to using sales or total asset figures.

Money Market Fund

A money market fund’s purpose is to provide investors with a safe place to invest easily accessible, cash-equivalent assets. However, a money market fund is not insured against loss. It is a type of mutual fund characterized as a low-risk, low-return investment. Since money market funds have relatively low returns, investors such as those participating in employer-sponsored retirement plans, might not want to use money market funds as a long-term investment option because they will not see the capital appreciation they require to meet their financial goals.

Mutual Fund

A mutual fund is an investment vehicle made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. Mutual funds are operated by money managers, who invest the fund’s capital and attempt to produce capital gains and income for the fund’s investors. A mutual fund’s portfolio is structured and maintained to match the investment objectives stated in its prospectus.

Personal Trust

A trust created for a person or persons. Personal trusts can be used by wealthy or middle-class beneficiaries to accomplish a variety of financial objectives. Personal trusts are separate legal entities that have the authority to buy, sell, hold and manage property for the benefit of their beneficiaries.

Price/Earnings (P/E) Ratio

In essence, the price-earnings ratio indicates the dollar amount an investor can expect to invest in a company in order to receive one dollar of that company’s earnings. This is why the P/E is sometimes referred to as the multiple because it shows how much investors are willing to pay per dollar of earnings. If a company were currently trading at a multiple (P/E) of 20, the interpretation is that an investor is willing to pay $20 for $1 of current earnings.

In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E. A low P/E can indicate either that a company may currently be undervalued or that the company is doing exceptionally well relative to its past trends. When a company has no earnings or is posting losses, in both cases P/E will be expressed as “N/A.” Though it is possible to calculate a negative P/E, this is not the common convention.

Prospectus

A prospectus is a formal legal document that is required by and filed with the Securities and Exchange Commission that provides details about an investment offering for sale to the public. The preliminary prospectus is the first offering document provided by a security issuer and includes most of the details of the business and transaction in question; the final prospectus, containing finalized background information including such details as the exact number of shares/certificates issued and the precise offering price, is printed after the deal has been made effective. In the case of mutual funds, a fund prospectus contains details on its objectives, investment strategies, risks, performance, distribution policy, fees and expenses, and fund management.

Risk & Return

Risk involves the chance an investment’s actual return will differ from the expected return. Risk includes the possibility of losing some or all of the original investment. Different versions of risk are usually measured by calculating the standard deviation of the historical returns or average returns of a specific investment.

A return is the gain or loss of a security in a particular period. The return consists of the income and the capital gains relative on an investment, and it is usually quoted as a percentage. The general rule is that the more risk you take, the greater the potential for higher returns and losses.

Sharpe Ratio (Efficiency)

The Sharpe Ratio is a measure for calculating risk-adjusted return, and this ratio has become the industry standard for such calculations. It was developed by Nobel laureate William F. Sharpe. The Sharpe ratio is the average return earned in excess of the risk-free rate per unit of volatility or total risk. Subtracting the risk-free rate from the mean return, the performance associated with risk-taking activities can be isolated. One intuition of this calculation is that a portfolio engaging in “zero risk” investment, such as the purchase of U.S. Treasury bills (for which the expected return is the risk-free rate), has a Sharpe ratio of exactly zero. Generally, the greater the value of the Sharpe ratio, the more attractive the risk-adjusted return.

Split

A corporate action in which a company divides its existing shares into multiple shares. Although the number of shares outstanding increases by a specific multiple, the total dollar value of the shares remains the same compared to pre-split amounts, because the split did not add any real value. The most common split ratios are 2-for-1 or 3-for-1, which means that the stockholder will have two or three shares for every share held earlier.
Also known as a “forward stock split.”

In the U.K., a stock split is referred to as a “scrip issue,” “bonus issue,” “capitalization issue” or “free issue.”

Stock

A holder of stock (a shareholder) has a claim to a part of the corporation’s assets and earnings. In other words, a shareholder is an owner of a company. Ownership is determined by the number of shares a person owns relative to the number of outstanding shares. For example, if a company has 1,000 shares of stock outstanding and one person owns 100 shares, that person would own and have claim to 10% of the company’s assets.

Stock Dividend

A stock dividend is a dividend payment made in the form of additional shares rather than a cash payout, also known as a “scrip dividend.” Companies may decide to distribute this type of dividend to shareholders of record if the company’s availability of liquid cash is in short supply. These distributions are generally acknowledged in the form of fractions paid per existing share, such as if a company issued a stock dividend of 0.05 shares for each single share held by existing shareholders.

Standard Deviation

In finance, standard deviation is applied to the annual rate of return of an investment to measure the investment’s volatility. Standard deviation is a statistical measurement that sheds light on historical volatility. For example, a volatile stock has a high standard deviation, while the deviation of a stable blue-chip stock is lower. A large dispersion indicates how much the return on the fund is deviating from the expected normal returns.

Treasury Bills

A Treasury bill (T-Bill) is a short-term debt obligation backed by the U.S. government with a maturity of less than one year, sold in denominations of $1,000 up to a maximum purchase of $5 million. T-bills have various maturities and are issued at a discount from par. When an investor purchases a T-Bill, the U.S. government writes an IOU; investors do not receive regular payments as with a coupon bond, but a T-Bill pays an interest rate.

Traditional IRA, ROTH IRA, and SEP IRA

A traditional individual retirement account (IRA) allows individuals to direct pretax income towards investments that can grow tax-deferred; no capital gains or dividend income is taxed until it is withdrawn. Individual taxpayers are allowed to contribute 100% of any earned compensation up to a specified maximum dollar amount. Contributions to a traditional IRA may be tax-deductible depending on the taxpayer’s income, tax-filing status and other factors.

Named for Delaware Senator William Roth and established by the Taxpayer Relief Act of 1997, a Roth IRA is an individual retirement plan (a type of qualified retirement plan) that bears many similarities to the traditional IRA. The biggest distinction between the two is how they’re taxed. Since traditional IRAs contributions are made with pretax dollars, you pay income tax when you withdraw the money from the account during retirement. Conversely, Roth IRAs are funded with after-tax dollars; the contributions are not tax deductible (although you may be able to take a tax credit of 10 to 50% of the contribution), depending on your income and life situation). But when you start withdrawing funds, these qualified distributions are tax free.

A simplified employee pension (SEP) is a retirement plan that an employer or self-employed individuals can establish. The employer is allowed a tax deduction for contributions made to the SEP plan and makes contributions to each eligible employee’s SEP IRA on a discretionary basis.

Yield, Face Value, & Coupon

The yield is the income return on an investment, such as the interest or dividends received from holding a particular security. The yield is usually expressed as an annual percentage rate based on the investment’s cost,current market value or face value. Yields may be considered known or anticipated depending on the security in question as certain securities may experience fluctuations in value.

Face value is the nominal value or dollar value of a security stated by the issuer. For stocks, it is the original cost of the stock shown on the certificate. For bonds, it is the amount paid to the holder at maturity, generally $1,000. It is also known as “par value” or simply “par.”

Coupon is the annual interest rate paid on a bond, expressed as a percentage of the face value. It is also referred to as the “coupon rate,” “coupon percent rate” and “nominal yield.”

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