BUS 422 Final Exam

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 (debt) securities

pay a specified cash flow over a specified period

equity

an ownership share in a corporation

derivative securities

securities providing payoffs that depend on the values of other assets

asset allocation

portfolio choice among broad investment classes

security selection

choice of specific securities within each asset class

security analysis

analysis of the value of securities

risk-return trade-off

assets with higher expected returns entail greater risk

passive management

buying and holding a diversified portfolio without attempting to identify misplaced securities

active management

attempting to identify mispriced 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 for new issues of securities

secondary market

market for already-existing securities

venture capital (VC)

money invested to finance a new, privately held firm

private equity

investments in companies whose shares are not traded in public stock markets

securitization

pooling loans into standardized securities backed by those loans, which can then be traded like any other security

systematic risk

risk of breakdown in the financial system, particularly due to spillover effects from one market into others

money market

include short-term, highly liquid, and relatively low-risk debt instruments

Treasury bills

short-term government securities issued at a discount from face value and returning the face amount at maturity

certificate of deposit (CD)

a bank time deposit

commercial paper

short-term unsecured debt issued by large corporations

banker’s 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 (repos)

short-term sales of 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

London Interbank Offer Rate (LIBOR)

lending rate among banks in the London market

Treasury notes or bonds

debt obligations of the federal government with original maturities of one year or more

municipal bonds

tax-exempt bond 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

market value-weighted index

index return equals the weighted average of the returns of each component security, with weights proportional to outstanding market

equally weighted index

an index computed from a simple average of returns

derivative asset

a security with a payoff that depends on the prices of other securities

call option

the right to buy an asset at a specified exercise price on or before a specified expiration date

put option

the right to sell an asset at a specified exercise price on or before a specified expiration date

futures contract

obliges traders to purchase or sell an asset at an agreed-upon price at a specified future date

primary-market

market for new issues of securities

secondary market

market for already-existing securities

private placement

primary offerings in which shares are sold directly to a small group of institutional or wealthy investors

initial public offering (IPO)

first public sale of stock by a formerly private company

underwriters

underwriters purchase securities from the issuing company and resell them to the public

prospectus

a description of the firm and the security it is issuing

direct listing

a previously private company floats existing shares on the stock market but does not raise funds by issuing new shares to the public

dealer markets

markets in which traders specializing in particular assets buy and sell for their own accounts

auction market

an exchange or electronic platform where all traders can convene to buy or sell an asset

bid price

the price at which a dealer or other trader is willing to purchase a security

ask (or asked) price

the price at which a dealer or other trader will sell a security

bid-ask spread

the difference between the bid and asked prices

limit buy (sell) order

an order specifying a price at which an investor is willing to buy or sell a security

over-the-counter (OTC) market

an informal network of brokers and dealers who negotiate sales of securities

NASDAQ stock market

the computer-linked price quotation and trade execution system

electronic communication networks (ECNs)

computer networks that allow direct trading without the need for market makers

designated market maker

a market maker designated by the exchange to commit its own capital to provide quotes and help maintain a “fair and orderly market” by trading from its own inventory of shares

stock exchange

secondary markets where already-issued securities are bought and sold by members

latency

the time it takes to accept, process, and deliver a trading order

algorithmic trading

the use of computer programs to make rapid trading decisions

high-frequency trading

a subset of algorithmic trading that relies on computer programs to make very rapidly trading decisions

blocks

large transactions in which at least 10,000 shares of stock are bought or sold

dark pools

electronic trading networks where participants can anonymously buy or sell large blocks of securities

margin

describes securities purchased with money borrowed in part from a broker. the margin is the net worth of the investor’s amount

short sale

the 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

investment companies

financial intermediaries that invest the funds of individual investors in securities or other assets

net asset value (NAV)

assets minus liabilities expressed on a per-share basis

(market value of assets minus liabilities)/shares outstanding

unit investment trusts

money pooled from many investors that is invested in a portfolio fixed for the life of the fund

open-ended funds

ready to redeem or issue shares at their net asset value

closed-end funds

do not redeem or issue shares; prices can differ from NAV

load

a sales fee you pay when you invest in a mutual fund

exchange-traded funds (ETFs)

collections of stocks, bonds, and other investments that are traded on exchanges but are traded more like individual stocks than like mutual funds;

hedge funds

limited partnerships that manage portfolios of funds for wealthy individuals and financial institutions; allow private investors to pool assets to be invested by a fund manager

funds of funds

hedge funds that invest in other funds

12b-1 fees

fees that a mutual fund may charge to cover marketing and advertising expenses

soft dollars

the value of research services that brokerage houses provide “free of charge” in exchange for the investment manager’s business

turnover

the ratio of the trading activity of a portfolio to the assets of the portfolio

holding-period return (HPR)

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 rate of return

the internal rate of return on an investment

nominal interest rate

the interest rate in terms of nominal (not adjusted for purchasing power) dollars

real interest rate

the growth rate of purchasing power derived from an investment

inflation rate

the rate at which prices are rising, measured as the rate of increase of the CPI

scenario analysis

a list of possible economic scenarios, the likelihood of each, and the HPR that will be realized in each case

probability distribution

list of possible outcomes with associated probabilities

expected return

the mean value of the distribution of HPR

standard deviation

the square root of the variance

value at risk (VaR)

measure of downside risk. the worst loss that will be suffered with a given probability, often 1% or 5%

kurtosis

measure of the fatness of the tails of a probability distribution relative to that of a normal distribution. indicates likelihood of extreme outcomes

skew

measure of the asymmetry of a probability distribution

risk-free rate

the rate of return that can be earned with certainty, often measured by the rate of Treasury bills

risk premium

an expected return in excess of that on risk-free securities

excess return

rate of return in excess of the risk-free rate

risk aversion

reluctance to accept risk

price of risk

the ratio of portfolio risk premium to variance

Sharpe ratio

ratio of portfolio risk premium to standard deviation

mean-variance analysis

evaluating portfolios according to their expected returns and standard deviations (or variances)