UF FIN4504: Units 1.1 & 1.2 w/ Half of 1.3 Terms (Spring 2026)

Investment

The current commitment of resources in the expectation of reaping future benefits. This can help individuals “smooth” their consumption timing. For instance, when you pay for stock, you hope to receive some capital gains or cash flows in the future. Types involve financial, real, and human capital.

Financial Investment

A type of investment that can involve purchasing a stock today in the expectation of receiving future dividends and capital gains.

Real Investment

A type of investment that can involve a company building a factory today in the expectation of selling more goods later.

Human Capital Investment

A type of investment that can involve forgoing working full-time today with the expectation of earning more in the future by taking a class.

Real Assets

The assets used to produce goods and services. Examples include land, buildings, equipment, knowledge, and human capital. These assets do not have to be tangible. In aggregate, these assets only remain.

Financial Assets

Claims on real assets and the income they generate. Examples include stocks, bonds, and cash. These assets must be balanced with financial liabilities (i.e., a financial asset that you owe can be a financial liability to the company you bought said asset from). The three major types of these claims include debt securities, equity securities, and derivatives.

Debt Security

A major type of financial asset that includes fixed, promised future payments. This fixed-income security has a higher-priority claim compared to equity securities but does not have an ownership interest. The two payment types related to this security are interest payments and principal payments.

Equity Security

A major type of financial asset that represents an ownership share in a company. It also includes residual claimants to a firm’s cash flows. This security has a lower-priority claim compared to debt securities.

Derivative

A major type of financial asset that includes securities whose payoff depends on the performance of other securities. Its payoff can also depend on the value of other variables, such as commodity prices, bond or stock prices, interest rates, and index values. This asset can be used to hedge risk or speculate future price movements.

Asset Allocation

The primary determinant of a portfolio’s return. It also shows the percentage of a portfolio in different asset classes (i.e., equity, bonds, and bills). The top-down approach starts with this process since it allocates an investment portfolio across broad asset classes.

Security Selection

The process of choosing individual investments in an investment fund. The bottom-up approach starts with this process since it chooses specific securities within each asset class.

Stock Prices

Prices that reflect investors’ collective assessment of a firm’s prospects. If the prices are too high, the investors sell and the price drops. On the other hand, if the prices are too low, the investors buy and the price increases. These prices are informative because they help allocate capital within the economy through creditors, regulators, and firms. Firms also react sharply to price changes.

The price can be found by dividing the expected change in demand and price by the sum of 1 and the expected return.

Business Firm

A key market participant that sells debt and equity securities to finance real investments. It is also known as a net borrower.

Household

A key market participant that purchases securities to smooth consumption over time. It is also known as a net saver that supplies funds to borrowers.

Government

A key market participant that issues bonds to finance government operations. It can also run a surplus and pay down debts. This participant can be a net borrower and a net saver.

Financial Intermediaries

Entities that can connect net borrowers with net savers. Examples include commercial banks, investment companies, insurance companies, pension funds, hedge funds, investment banks, and private equity (venture capital).

Interest Payments

Periodic payments for debt securities that compensate investors for the use of their money.

Principal Payments

Periodic payments for debt securities that include the return of the investor’s initial outlay.

Money Market

A market that consists of short-term, highly liquid, and low-risk debt securities. Short-term refers to the fact that the promised cash flows occur very soon (i.e., the time is small). Highly liquid refers to the fact that these debt securities can easily be sold to other investors without affecting the price. Low risk refers to the fact that it is likely that the borrower will repay the promised amount.

Treasury Bill

A money market instrument that the U.S. government issues. It does not have any explicit interest paid. The interest paid is also implied in the discount from face value.

The ask or bid price for this instrument can be found by multiplying the face value by 1 minus the product of the ask or bid yield percentage and the days to maturity divided by 360.

Certificate of Deposit (CD)

A money market instrument that is also a time deposit with a bank. You promise to lend your money to the bank for a fixed amount of time. The bank then pays interest and principal to the depositor at maturity. The time deposit is also insured by the FDIC for up to $250,000.

Commercial Paper

A short-term unsecured (no collateral) money market instrument that is issued by firms. Only large, well-known companies can use it. The instrument is considered safe, matures in 1 or 2 months, and is rated by agencies like Standard and Poor’s.

Eurodollar

A money market instrument that has dollar-denominated deposits at foreign banks or foreign branches of American banks. Since this instrument is outside the United States, it can escape regulation from the Federal Reserve Board or get more favorable tax treatments. Active participants include Caribbean U.S. bank branches and European banks.

Repurchase Agreement (Repo)

A money market instrument that is a short-term sale of securities with an agreement to repurchase them at a higher price (i.e., sell and then buy). This sale typically uses overnight loans and other money market instruments as collateral. The other side of the trade (i.e., looking to buy and then sell) is called a reverse repo.

Federal Fund

A money market instrument that is a minimum balance or deposit that banks maintain with the Federal Reserve. Banks with any excess deposits then lend them to others at the federal funds rate.

Federal Funds Rate

The Federal Reserve’s primary instrument of monetary policy that has a major influence on other money market rates. This is also the instrument that people are referring to when they mention that the Federal Reserve is raising or lowering interest rates.

LIBOR

A premier short-term interest rate that used to be quoted in European money markets. It was also a benchmark interest rate for short-term loans between major global banks since it acted as a reference rate for financial transactions. The rate was calculated via a survey of various banks.

It is also known as the London Interbank Offer Rate.

SOFR

A weighted average of secured rates paid in overnight repurchase agreements collateralized by treasuries. It replaced LIBOR in the U.S. by 2023 and reflects the cost of borrowing overnight. The rate is based on actual transactions, making it a risk-free rate indicative of market conditions.

Money Market Fund (MMF)

A mutual fund that only invests in money market instruments. This fund pools together cash from many people to make other money market instruments accessible to everyday investors. It seeks to maintain a stable net-asset value of $1 (i.e., investors can buy or sell shares of the fund at a price of $1). It is also a very close substitute to bank deposits.

Bond Market

A market that consists of longer-term, less liquid, and higher risk debt securities. The two payments related to bonds are coupons and the face value (principal).

Coupons

Interest payments that are paid at a specified frequency until maturity.

Face Value (Principal)

The value that is repaid at maturity. It is used to calculate coupon payments.

Yield to Maturity (YTM)

The discount rate that equates the present value of a bond’s promised payments (future cash flows) to its current market price.

In other words, this rate will produce a present value of cash flows equal to the current price of a bond.

Treasury Notes and Bonds

Debt securities with longer terms that the U.S. government issues. While the notes have maturities of 2-10 years, the bonds have maturities of 20-30 years. Moreover, both have a par value (FV) of $1,000 and typically make semiannual coupon payments.

Inflation-Protected Treasury Bonds

Bonds issued by the U.S. government that are linked to an index of the cost of living. They also hedge inflation risk for bond investors (since inflation is bad for regular bondholders). The principal amount is adjusted in proportion to increases in the Consumer Price Index (CPI), one of the main measures of inflation that tracks how the price of a “basket of goods” changes.

Federal Agency Debt

Bonds issued by specific agencies of the U.S. Federal Government that were formed for public policy reasons to channel credit to sectors of the economy. These agencies include the Federal Home Loan Bank (FHLB), Federal National Mortgage Association, Government National Mortgage Association, and Federal Home Loan Mortgage Corporation.

Municipal Bond

A bond that is issued by state and local governments and is exempt from federal income taxation. The two types of this bond are the general obligation bond and the revenue bond.

The return or yield for this bond can be calculated by multiplying the return or yield of a taxable or corporate bond by 1 minus the tax rate.

General Obligation Bond

A municipal bond that is backed by the taxing power of a state or local government.

Revenue Bond

A municipal bond that is backed to finance a particular project that is used to pay investors. Airports and hospitals use this municipal bond.

Corporate Bond

A bond issued by firms that has a similar structure to treasuries. However, this bond can have higher rates due to greater risk. Regardless, it is used to fund business activities and offer investors regular interest payments and the return of a principal amount at maturity.

Mortgage and Asset Backed Securities

Securities that are backed by a pool of underlying assets, such as a pool of mortgages, credit card balances, car loans, or student loans. These securities involve sellers who service the loans, issuers who package the loans, and investors who seek higher yields. They also carry risks tied to borrower defaults and interest rate changes.

An example of this security includes families taking out mortgages to purchase a home, a bank selling mortgages to another entity, the entity pooling the mortgages and selling securities to investors, and the investors receiving payments as homeowners pay their mortgages.

Common Stock

Ownership shares in a corporation. Each share entities its owner to voting rights on any matter of corporate governance during annual meetings and a share of any financial benefit of ownership (dividends). The two key characteristics of this stock are residual claimants (i.e., shareholders get paid last) and limited liability (i.e., shareholders only lose their original investment).

Preferred Stock

Stock that has features in common with debt and equity. Like debt, it has a priority claim to dividends relative to common shareholders and does not give voting rights to its stockholders. On the other hand, like equity, it has no guarantee of cash flows (i.e., it has residual cash flows).

Index

A numeric score that measures the performance of a group of securities. They can be used for asset classes (stocks or bonds) and industries (tech stocks or bank stocks). They can be constructed by either rules-based or discretionary criteria for the addition or deletion of securities, or by choosing between equal-weighted or value-weighted methods.

Examples include Dow Jones Industrial Average (DJIA), S&P 500, the Russell Indexes, and the equal-weighted index (which requires active rebalancing).

Dow Jones Industrial Average (DJIA)

An 1896 major stock market index that contains 30 large “blue chip” companies. This index averages the stock price across its firms, emphasizes firms with higher stock prices, and covers around 35% of the U.S. stock market.

S&P 500

A major stock market index that contains around 500 firms. It weighs its firms with market capitalization and puts more emphasis on larger firms. It is also easy to purchase exposure to this index through an index fund or an exchange-traded fund (ETF).

Russell Indexes

A family of major stock market indexes that groups firms by size and uses market capitalization. While the 3000 index measures 3000 U.S. stocks (98% of the market), the 2000 index focuses on the bottom 2000 of the 3000 index (small capitalization stocks). Moreover, the 1000 index refers to the top 1000 of the 3000 index (large capitalization stocks).

Call Option

A derivative option that gives a holder the right to purchase an asset for a specified price on or before an expiration date. You get “in the money” (“out the money”) with this option if the payoff is greater than (less than) the strike price.

In simpler terms, if the price of the underlying asset is above the strike price, you can purchase it for less than you can sell it for.

Put Option

A derivative option that gives a holder the right to sell an asset for a specified price on or before an expiration date. You can get “in the money” (“out the money”) with this option if the payoff is less than (greater than) the strike price.

In simpler terms, if the price of the underlying asset is below the strike price, you can sell it for more than you can purchase it for.

Strike Price

The price set for calling or putting an asset.

Futures Contract

A contract that calls for the delivery of an asset at a specified date for an agreed-upon price. The key difference between this contract and a call option is that the contract requires a long position to make the purchase (i.e., it gives a right and obligation). This contract also does not have a price since it is an agreement to a future transaction.

Primary Market

A market that has the initial sale of securities to the public. Firms typically employ investment banks to help them do the initial sale and set a beginning price range. This market is a source of new securities.

Secondary Market

A market that trades existing securities. The bulk of exchange trading occurs in this market daily after firms complete their initial sales in the primary market. It also brings buyers and sellers together and motivates risk (hedging), exploits superior information (speculation), and rebalances portfolios (liquidity shocks).

Public Firm

A company whose shares can be freely traded by the public. Although it has a deeper pool of investors to raise money from, more liquid shares, and more informative prices, it also has stricter regulatory requirements (disclosure or governance). Examples are Amazon, Tesla, Starbucks, and Disney.

Private Firm

A company whose shares are not traded in public markets. Although it has fewer obligations to release financial statements, the ability to hide information, and freedom from quarterly earnings pressure, it also has a smaller pool of investors and less liquid shares that require a discount for investors to hold them. Examples are OpenAI, SpaceX, Publix, and IKEA.

Merger

An agreement that combines two companies into one. Since it counts as a deletion of a firm, some headlines claim that the number of public firms has declined. However, the deleted firm still exists, but not as a separate company.

Initial Public Offering (IPO)

The first issuance of shares to the public. Its price serves as a costly signal of quality (i.e., an underprice suggests that its firm is good). While a good firm does not need to get everything from its first issuance, a bad firm wants as much money as possible before it reveals its true nature.

Seasoned Equity Offering (SEO)

A subsequent issuance of additional shares that follows an initial public offering in the primary market.

Underwriter

An investment banker who markets offerings and organizes road shows to generate interest among investors and provide information to the issuing firm about demand. After the road show, they set the offer price and the allocation of shares across investors.

These investment bankers resolve hidden information issues by rewarding investors who report high valuations with large allocations, underpricing IPOs, and freezing out investors who low-ball. They also assume the risk that the shares cannot be sold to the public at the stipulated (demanded) offering price.

Syndicate Structure

A structure that lets a lead underwriter of a main investment bank find other investment banks to share the risk and distribution of a share issue. The main investment bank then advises the issuing firm that hired it on the terms it should sell securities with.

Firm Commitment

A procedure where an issuing firm goes to a lead underwriter who then must find other investment banks that are interested in the IPO. First, the investment bank purchases securities from the issuing firm. The bank then resells the shares to the public (at a price which equals the public price minus a spread), which allows the firm to transfer risk to the investment bank. The banking syndicate then must sell the shares, but the lead underwriters can divide the risk among the syndicate.

Winner’s Curse

A possible reason for IPO underpricing that occurs when auction bids exceed an item’s intrinsic value. It is most commonly noticed after an investor overpays for an IPO at an auction. Since uninformed investors lose on average with “correct” pricing, they do not participate in auctions. This means the underwriter must underprice the IPO to get the uninformed investors to participate.

Greenshoe Option

A provision in an initial public offering underwriting agreement that lets underwriters establish a short position and sell more shares than initially planned if demand exceeds expectations. If the IPO succeeds, the underwriter closes the position at a lower price. If the IPO fails, the underwriter covers up the position and purchases shares at the lower price.

Direct Listing

An alternative to an IPO in which a previously private company allows existing shares to trade publicly on the stock market without raising new funds. While this alternative saves on IPO costs, it also forfeits the ability to stabilize prices. Examples are Spotify, Slack, ZipRecruiter, and Coinbase.

Lockup Period

A period that an underwriter sets to prohibit investors from selling their shares after an IPO or during a hedge fund investment. It helps stabilize prices and is one of the benefits to an IPO. Underwriters may also purchase shares to further stabilize prices.

Special Purpose Acquisition Company (SPAC)

A company that is formed to raise capital through an IPO that is then used to acquire or merge with another company. If it fails to acquire a company within 2 years, its investors get their money back. While this company is faster and has lower costs (if a target is found), it is also risky.

Direct Search Market

A market where buyers and sellers must search each other out and negotiate. Examples are Craigslist and Facebook Marketplace.

Brokered Market

A market where buyers and sellers outsource their search to specialized brokers. Examples are the real estate market and the primary market for IPOs.

Dealer Market

A market where dealers collect an inventory of assets from traders and then buy or sell them for their accounts. This market has low share costs since everyone knows who the dealers are. The dealers can also trade with each other in an inter-dealer market.

Although reaching out to more dealers provides liquidity and immediacy and can improve a trader’s expected price, the search process takes time and can leak information. These dealers are also typically paid with the bid-ask spread.

Auction

A market that uses centralized trading with rules-based price formation. It also has no search process or negotiation. An example is the New York Stock Exchange.

Limit Order Book (LOB)

A record that lists all outstanding buy and sell orders from an auction market. These orders are then matched according to their best price or time of submission or quantity if there are multiple best prices. The two versions of the record are the continuous limit order market (which matches orders continuously) and the call limit order market (which matches orders at discrete times).

Market Order

A buy or sell order that is executed immediately at the current market price. The trader only needs to specify the quantity and direction (buy or sell). While it promotes immediacy by allowing traders to buy or sell their desired quantity immediately, it also has price uncertainty since the trader cannot condition the price and will get whatever the market price is.

Buy Limit Order

A limit order that specifies the maximum buy price at which a trader will buy. Although it allows traders to specify a quantity, direction, and “worst case” trading price, the trade may not execute immediately since the trader may need to wait until the price falls into their desired range. These orders are sorted from highest to lowest, are treated at the highest possible price, and determine the quantities that traders are willing to buy at each price.

Sell Limit Order

A limit order that specifies the minimum ask price at which a trader will sell. Although it allows traders to specify a quantity, direction, and “worst case” trading price, the trade may not execute immediately since the trader may need to wait until the price falls into their desired range. These orders are sorted from lowest to highest, are treated at the lowest possible price, and determine the quantities that traders are willing to sell at each price.

Round Trip Trade

A trade that involves selling and repurchasing an asset within a short time at similar prices. In other words, it is a buy market order immediately followed by an equal-sized sell market order. Greater costs will make the market less liquid.

Bid-Ask Spread

A measure of market liquidity that is the difference between a dealer’s ask and bid price for an asset. It is also how securities dealers earn their profit. While market orders (and marketable limit orders) consume liquidity, aggressive unmarketable limit orders improve liquidity.

You can find this measure by subtracting the bid price of a sell order from the ask price of a buy order. You could also multiply the informed probability percentage by the difference between the good and bad values of a bond.

Bid Price

The highest price a buyer is willing to pay in a sell order. Although it is typically lower than the ask price, its highest value is at the top of its column in a LOB.

In other words, unlike the ask price, the highest price is at the top of its column in an LOB. This further means that the lowest price is at the bottom.

Ask Price

The lowest price a seller is willing to accept from a buyer. It is typically at the top of its column in an LOB (i.e., the lowest value is at the top while the highest value is at the bottom).

Algorithmic Trading

The use of computers for submitting market and limit orders and order cancellations according to codified rules. It uses technology to automate the order submission process. An important subset is high frequency trading.

High Frequency Trading (HFT)

A form of algorithmic trading that uses high-speed computers to submit new orders. It exploits a high volume of small discrepancies in prices and helps improve price discovery. Market makers can use this to exploit bid-ask spreads by posting buy and sell limit orders and relying on speed to exploit new information to avoid being “picked off” by other informed traders.

Dark Pools

Private exchanges that allow anonymous securities trading and offer benefits for institutional investors like price stability in large trades. Since orders are not available to the public in these exchanges, trades are reported after they are carried out. While these exchanges accept unpriced orders and match orders at certain prices, they are criticized for not contributing to price discoveries.

Internalization

A way for trades to occur off-exchange that involves dealers executing trades on their accounts. It occurs when a business wants to handle a transaction internally instead of paying an outside entity to do so. It also often stems from payment for order flow (PFOF), which has brokers routing orders with certain characteristics to dealers for a small fee.

Payment for Order Flow (PFOF)

The compensation brokers receive for directing orders with certain characteristics to dealers and executing trades to a market maker. Although the brokers receive small fees, their compensation accumulates across larger volume of orders.