Investment Analysis and Portfolio Management Flashcards

Comprehensive vocabulary flashcards covering the investment process, risk and return measures, asset allocation, securities market organization, trading mechanisms, and security market indexes.

Investment

The commitment of funds for a period of time, sacrificing or delaying current consumption in anticipation of future return.

Required Compensations for Investment

The three factors an investment return must compensate for: (1) the time funds are committed, (2) the expected rate of inflation, and (3) the uncertainty of future flow of funds.

Measurable Risk

A form of risk where historical data is available, allowing probability distributions to be assigned and outcomes to be quantified.

Unmeasurable Risk (Uncertainty)

A state of risk where no historical data exists, preventing the objective assignment of probabilities to potential outcomes.

Systematic Risk

Market-wide risk attributable to macroeconomic factors that affects all securities and cannot be eliminated through diversification.

Unsystematic Risk

Unique, firm-specific or industry-specific risk (such as business risk) that can be reduced or eliminated through portfolio diversification.

Business Risk

Uncertainty of operating income caused by the nature of a firm's operations, determined by the trend/variability of sales and the proportion of operating fixed costs.

Degree of Operating Leverage (DOL)

The proportion of fixed production costs relative to variable costs in a firm's cost structure; higher fixed costs lead to greater operating leverage and higher business risk.

Financial Risk

The additional uncertainty of returns to equity holders resulting from the use of fixed-cost debt financing in the capital structure.

Liquidity Risk

The uncertainty surrounding how quickly an asset can be converted into cash and the degree of certainty regarding the price that will be realized.

Exchange Rate Risk

The variability in investment returns denominated in home currency caused by fluctuating exchange rates between currencies when holding foreign assets or liabilities.

Country Risk (Political Risk)

Uncertainty in return arising from potential changes in the political, legal, economic, or natural environment of a country.

Real Risk-Free Rate (RRFR)

The pure exchange rate between current consumption and future consumption, assuming zero inflation and absolute certainty of payment.

Nominal Risk-Free Rate (NRFR)

The government-backed interest rate that reflects conditions in the capital market, consisting of the real risk-free rate adjusted for expected inflation: $NRFR = [(1 + RRFR) \times (1 + \text{Rate of Inflation})] - 1$.

Security Market Line (SML)

The visual line showing the equilibrium trade-off between risk and expected return for all risky assets in the capital market at a given point in time.

Risk Premium (RP)

The additional expected return above the nominal risk-free rate required by investors to compensate for bearing risk: $RP = E(R) - NRFR$.

Pure Rate of Interest

The market-determined rate (driven by supply and demand of funds) that rewards and motivates individuals to sacrifice or postpone current consumption.

Pure Time Value of Money

The economic principle that funds available at the present time are worth more than the identical sum in the future solely due to the passage of time.

Holding Period Return (HPR)

The ratio of an investment's ending value (including realized cash flows) to its beginning value: $HPR = \frac{\text{Ending Value}}{\text{Beginning Value}}$.

Holding Period Yield (HPY)

The percentage change in the total value of an investment over a specific holding period: $HPY = HPR - 1$.

Arithmetic Mean Return (AM)

The simple average of single-period returns over a historical time horizon ($AM = \frac{\sum HPY}{n}$), suitable for short-term return expectations.

Geometric Mean Return (GM)

The compound annual growth rate of an investment over multiple holding periods: $GM = \left[\prod (HPY + 1)\right]^{\frac{1}{n}} - 1$, which is strictly less than or equal to AM whenever variance exists.

Risk-Averse Investor

An investor who demands higher expected return as compensation for accepting additional units of risk.

Risk-Neutral Investor

An investor whose required return remains unchanged regardless of the level of risk incurred.

Risk-Seeking Investor

An investor willing to accept the possibility of financial losses without demanding proportionate risk premiums for the opportunity of large potential gains.

Coefficient of Variation (CV)

A relative measure of risk per unit of expected return defined as standard deviation divided by expected return: $CV = \frac{\sigma}{E(R)}$.

Asset Allocation

The strategic portfolio decision-making process of distributing an investor's wealth among broad asset classes based on individual goals, risk preferences, and constraints.

Asset Class

A group of securities that exhibit similar economic characteristics, regulatory attributes, and risk-return behavior.

Cash Reserve

A pool of highly liquid funds maintained in a preliminary financial plan, typically equivalent to 6 months of living expenses.

Accumulation Phase

The early-to-middle working life cycle stage where living expenses and debt are high relative to net worth, but longer horizons allow higher risk tolerance.

Consolidation Phase

The mid-to-late working life cycle stage where debts are repaid, earnings exceed expenses, and the capacity to take risk begins to decline.

Spending Phase

The post-retirement life cycle phase where individuals transition from accumulating wealth to financing lifestyle needs from estates or pensions, preferring low-risk investments.

Gifting Phase

The life cycle stage where individuals with abundant accumulated assets transfer excess wealth to family members, relatives, or social and charitable institutions.

Investment Policy Statement (IPS)

A comprehensive written roadmap that specifies an investor's return objectives, risk tolerance, and investment constraints to guide all portfolio management decisions.

Capital Preservation

A conservative return objective aimed at minimizing the risk of nominal and real capital losses to ensure asset safety.

Capital Appreciation

An aggressive return objective focused on growing the portfolio's real purchasing power over time through long-term capital gains.

Current Income

A return objective prioritizing high ongoing cash inflows (such as bond coupons and equity dividends) to meet regular living expenditures over capital appreciation.

Total Return

A return objective that seeks portfolio growth through both capital appreciation and the reinvestment of current income with moderate risk exposure.

Prudent Investor Rule

A fiduciary legal principle requiring money managers and trustees to handle client assets with professional care, caution, and consideration of portfolio risk-return objectives.

Market

A mechanism that brings buyers and sellers together to facilitate the transfer of goods, services, or financial assets, not requiring a physical location.

Price Continuity

A property of a liquid market where security prices do not change substantially between successive trades unless new relevant information reaches the market.

Market Depth

The existence of numerous potential buyers and sellers with orders positioned immediately above and below the current market price.

Internal Efficiency

A market characteristic where transaction costs (including brokerage fees, administrative charges, and taxes) are kept to a minimum.

External Efficiency

A market characteristic where security prices adjust rapidly and accurately in response to new market information.

Primary Market

The capital market where new securities are created, issued, and sold by corporations or governments directly to initial investors.

Secondary Market

The financial market where previously issued securities are traded among investors, providing continuous liquidity and accurate market pricing.

Unseasoned Issue (IPO)

The initial public offering of securities by a company selling equity to the general public for the very first time.

Seasoned Issue

An issuance of additional new shares by a company whose stock is already actively trading in the public secondary market.

Underwriting Syndicate

A temporary alliance of multiple investment banks formed by a lead manager to jointly share underwriting risk and distribute a large security issue.

Origination

The advisory and planning phase in underwriting where an investment bank works with an issuing firm to structure, price, and schedule a security offering.

Firm Commitment Underwriting

An underwriting arrangement where the investment banker purchases the entire security issue directly from the issuing company, absorbing all risk of unsold securities.

Best-Efforts / Agency Basis

An offering method where the investment banker acts as an agent to sell as many securities as possible without guaranteeing total sale or purchasing the issue outright.

Negotiated Offering

A common method of issuance where the corporate issuer selects an investment banking firm early to collaboratively design, structure, and underwrite the security package.

Competitive Bid Offering

An issuance method where the issuing corporation specifies the securities independently and invites underwriting syndicates to submit competing price and fee bids.

Treasury Bills (T-bills)

Short-term sovereign debt securities sold at a discount to par value that pay no explicit coupon interest and mature in one year or less.

Treasury Notes (T-notes)

Coupon-bearing government debt securities issued with original maturities ranging from 2 to 10 years.

Treasury Bonds (T-bonds)

Long-term coupon-bearing government debt securities issued with original maturities greater than 10 years.

Broker

An agent who facilitates security transactions between buyers and sellers without holding inventory, earning revenue via commission.

Dealer

A market participant who maintains an inventory of securities, acting as principal to buy and sell for their own account and earning the bid-ask spread.

Pure Auction Market

An order-driven market where public buyers and sellers submit bid and ask prices to a centralized venue where orders match directly.

Dealer Market

A quote-driven market where designated dealers actively publish bid and ask price quotations and provide immediate liquidity to trade against their own book.

Call Market

A trading system where orders are accumulated and traded at specific set times of day at a single market-clearing price.

Continuous Market

A trading arrangement where security transactions occur continuously throughout the trading day at the best available prices as orders arrive.

Third Market

The over-the-counter (OTC) trading of exchange-listed securities conducted through non-exchange-member broker-dealers.

Market Order

An order placed through a broker to immediately buy or sell a security at the best prevailing price currently available in the market.

Limit Order

An order to buy or sell a security at a designated limit price or better, remaining unexecuted if the market does not reach that price.

Stop-Loss Order

A conditional sell order that automatically transforms into a market order to sell if the stock's price falls to or below a specified stop price.

Stop-Buy Order

A conditional buy order triggered to purchase stock once the market price increases to a designated level, commonly used to cap losses on short sales.

Short Sale

The sale of borrowed shares by an investor anticipating a price drop, who must pay all interim dividends to the lender and eventually repurchase the shares in the open market.

Margin Requirement

The required proportion of equity capital that an investor must deposit with a broker when purchasing securities or borrowing shares on credit.

Margin Transaction

A transaction in which an investor funds only a fraction of the security cost in cash and borrows the remaining portion from the broker using the purchased securities as collateral.

Active Investors

Investors who believe market inefficiencies allow for mispriced assets, trading actively and absorbing research costs to generate abnormal returns.

Passive Investors

Investors who believe markets are efficient, choosing to minimize transactions and management fees by holding diversified portfolios designed to mirror a benchmark market index.

Price-Weighted Index

A stock index computed by summing the share prices of all component stocks and dividing by a divisor, giving higher-priced stocks greater influence on index movements.

Value-Weighted Index

A stock index weighted by the aggregate market capitalization (price times shares outstanding) of each component firm relative to the base period market value.

Unweighted Index

An equally weighted stock index where an identical dollar amount or equal percentage weighting is assigned to each member stock regardless of price or company size.

Dow Jones Industrial Average (DJIA)

The oldest and most well-known price-weighted index in the United States, tracking 30 prominent blue-chip industrial companies listed on the NYSE.

Stock Split

A corporate restructuring that increases the number of outstanding shares by a set ratio while proportionally lowering the share price, leaving total market capitalization unchanged.

Divisor Adjustment

A mathematical adjustment applied to a price-weighted index's divisor when a component stock undergoes a split or sample change to prevent unnatural jumps in the index level.

Nikkei-Dow Jones Average

A price-weighted index tracking 225 blue-chip stocks traded on the First Section of the Tokyo Stock Exchange (TSE), calculated using the Dow Jones method.