Key Concepts in Financial Securities and Investments

Derivative Security

Financial contract whose value derives from an underlying asset.

Financial Intermediary

Entity that facilitates transactions between investors and markets.

Real Assets

Tangible assets used to produce goods and services.

Financial Asset Creation

New financial asset generated from loan agreements.

Share Price Reaction

Price rises when market optimism increases about a firm.

Capital Resource Allocation

Distribution primarily managed by financial markets.

Agency Problem

Conflict of interest between stakeholders and management.

Risk Exposure Adjustment

Firms manage business risks through commodity and derivative markets.

Financial Intermediary Examples

Includes investment companies, banks, and insurance firms.

Historical Stock Returns

Highest return in 1933; lowest in 1931.

CDS Contracts

Credit default swaps sold by AIG before 2008 crash.

Nonconforming Mortgage Loans

Higher default risk; also known as subprime loans.

Debenture

Unsecured bond with no collateral backing.

Federal Funds

Deposits of commercial banks at the Federal Reserve.

Money Market Securities

Safe, marketable instruments with low returns.

Municipal Bonds

Debt obligations issued by state or local governments.

Dow Jones Industrial Average

Index measuring stock performance of 30 large companies.

Call Option

Contract giving the holder the right to buy stock.

Promissory Note

Written promise to pay a specified amount at a future date.

Economies of Scale

Cost advantages gained by large-scale operations.

Investment Risk

Potential for loss in investment value.

Securitization

Process of pooling various types of debt to sell as securities.

Capital Markets

Markets for buying and selling equity and debt instruments.

Claims on Income

Rights to a portion of a company's earnings.

Market Optimism

Positive sentiment affecting stock prices and fundraising.

Interest Income Exemption

Municipal bond interest exempt from federal taxation.

Callable Bond

Bond that can be redeemed by issuer before maturity.

Value-weighted average

Average based on market capitalization of stocks.

Price-weighted average

Average based on stock prices of selected stocks.

DJIA

Price-weighted average of 30 large industrial stocks.

FTSE

U.K. stock index representing top companies.

Wilshire 5000

Broadest U.S. stock market index, value-weighted.

Nasdaq Composite

Market value-weighted index of Nasdaq stocks.

S&P 500

Market value-weighted index of 500 large companies.

NYSE Composite

Value-weighted index of all NYSE listed stocks.

SIPC

Insures investors against brokerage firm failures.

Underwriting syndicate

Group of investment banks underwriting securities.

Firm-commitment underwriting

Underwriter assumes full risk of unsold shares.

Primary market

Market for new stock issues.

Investment bankers

Professionals providing underwriting services.

Initial public offerings (IPOs)

First sale of stock to the public.

Underpriced IPOs

Stocks priced lower than market value initially.

Gross trading profit

Profit calculated from trading activities.

Ask price

Price at which a dealer sells a security.

Bid price

Price at which a dealer buys a security.

Stop-loss order

Sell order triggered at a specified price.

Buy stop order

Buy order triggered above a specified price.

Market order

Order to buy/sell at current market price.

Bid-ask spread

Difference between bid price and ask price.

Maintenance requirements

Minimum equity required in margin accounts.

Initial margin requirements

Minimum amount required to open a margin account.

Dealer

Market participant facilitating trades between buyers and sellers.

Trading volume

Total number of shares traded during a period.

Limit order book

List of buy/sell orders at specified prices.

Market value-weighted

Index calculated based on total market value.

Clearing price

Price at which a transaction is settled.

Bid Price

Price buyers are willing to pay for a stock.

Ask Price

Price sellers are willing to accept for a stock.

Transaction Cost

Total fees incurred when buying or selling stocks.

Market Order

Order to buy or sell at current market price.

Limit Order

Order to buy or sell at a specified price.

Stop-Loss Order

Sell order triggered when stock price falls.

Buy Stop Order

Buy order triggered when stock price rises.

Dealer Market

Market where dealers post bid and ask prices.

Broker Market

Market where brokers execute trades for clients.

Electronic Market

Market where trades are matched automatically by computers.

Margin Account

Account allowing borrowing to purchase securities.

Equity in Margin Account

Market value minus amount owed on margin loan.

Short Selling

Selling borrowed shares with intention to buy back cheaper.

Maximum Gain from Short Sale

Proceeds from short sale minus minimum replacement cost.

Stop-Buy Order

Order to buy stock to limit losses on short sale.

Initial Margin

Percentage of purchase price required to be paid upfront.

Maintenance Margin

Minimum equity required to maintain a margin account.

Commission Fee

Flat fee charged for executing a trade.

Implied Transaction Cost

Cost calculated from bid-ask spread and commissions.

Flat Commission

Fixed fee charged per transaction, regardless of size.

Proceeds from Short Sale

Total amount received from selling borrowed shares.

Margin Call

Request for additional funds to maintain margin requirements.

Market Value of Stock

Current price at which stock can be sold.

Amount Owed on Margin Loan

Total borrowed amount used to purchase securities.

Limit Order Book

List of buy and sell limit orders in market.

Transaction Cost Formula

Cost = shares × (ask price - bid price) + commissions.

Short-Seller

Investor who sells borrowed shares expecting price decline.

Cash Deposited with Broker

Funds held by broker to meet margin requirements.

Margin Account

Account for borrowing funds to purchase securities.

Short Sale

Selling borrowed securities to repurchase later.

Maintenance Margin

Minimum equity percentage required in margin account.

Initial Margin

Percentage of purchase price paid upfront.

Margin Call

Demand for additional funds when equity falls.

Net Asset Value (NAV)

Value per share of mutual fund assets.

Rate of Return

Percentage gain or loss on investment.

Hedge Funds

Investment funds using complex strategies for high returns.

REITs

Real Estate Investment Trusts for real estate investments.

Balanced Funds

Mutual funds holding equities and fixed-income securities.

Dividend Yield

Annual dividend payment divided by stock price.

Assets

Total resources owned by an investment fund.

Liabilities

Total debts or obligations of an investment fund.

Equity

Ownership interest in an asset after liabilities.

Cash from Short Sale

Funds received from selling borrowed shares.

Cash for Equity

Funds invested in purchasing equity securities.