Principles of Investments: Fixed Income, Equity, and Mutual Funds

Money Market Securities

Debt securities that mature within one year.

Treasury bills (T-Bills)

Short-term U.S. government securities issued at a discount.

Maturities of T-Bills

28, 91, 182 days; sold in $100 minimums, but $10,000 is more common.

Bank-discount method

Pricing method for T-Bills using a 360-day year.

Ask yield

The yield at which a T-bill is offered for sale.

Bond-equivalent yield

The actual yield for a 365-day year calculated from T-Bill pricing.

Certificates of Deposit (negotiable CDs)

Bank time-deposits larger than $100,000 that can be sold to investors.

Commercial Paper

Large, unsecured notes issued by high-quality companies, usually in $100,000 multiples.

Federal Funds (Fed Funds)

Bank deposits of member banks with the Federal Reserve Bank.

Fed Funds Rate

A market interest rate at which banks lend to each other, usually overnight.

Eurodollars

Dollar-denominated deposits at foreign banks or foreign branches of U.S. banks.

Capital Market Securities

Securities with longer than a year to maturity.

Bonds

Debt instruments with over one-year to maturity, obligating the issuer to make payments over a specified period.

Treasuries

Debt issued by the U.S. government.

T-Notes

Treasuries with maturities up to 10 years.

T-Bonds

Treasuries with maturities of 10 to 30 years.

Treasury STRIPS

Separate Trading of Registered Interest and Principal Securities, individual zero-coupon securities created from Treasury bond cash flows.

TIPS

Treasury Inflation Protected Securities, where the principal amount is adjusted by the CPI for inflation.

Federal Agency Debt

Debt issued by agencies of the federal government, providing slightly higher returns than equivalent Treasury securities.

Corporate Bonds

Long-term debt issued by private corporations, usually paying semi-annual coupons.

Callable bonds

Bonds that allow the issuer to buy back bonds before maturity, sometimes above par.

Convertible bonds

Bonds that allow bondholders to convert them to a specified number of shares of stock.

Zero-coupon bonds

Bonds that do not pay a coupon and sell at a discount to par, only paying par at maturity.

Municipal Bonds (Munis)

Long-term debt issued by state and local governments, with interest income exempt from federal tax.

Equivalent Taxable Yield

Calculated as rm = r (1 - t), where rm = tax-free muni yield, r = equivalent taxable yield.

CMOs

Collateralized Mortgage Obligations, bonds backed by a pool of underlying mortgages.

Securitization

The process by which firms purchase mortgages, pool them, and issue bonds funded by the cash flows of the mortgage pool.

Equity

Residual ownership in a corporation.

Common Stock

Owners have voting rights, residual claim to firm's earnings after all others have been paid, and limited liability.

Preferred Stock

A hybrid security that provides non-voting ownership, receives dividends before common stockholders, and usually has cumulative dividends.

International Stocks/Securities

Securities that operate in global/international capital markets which have become more integrated over the past decades.

ADRs

American Depository Receipts.

IPO

Initial Public Offering, where a firm issues/sells stock to the public for the first time in the Primary Market.

Primary Markets

Markets where firms issue new securities to investors and raise capital.

Secondary Markets

Markets where securities that have already been issued trade, and no new capital is raised.

Indexes

Provide an average/broad-based performance of a market or market segment.

Price-Weighted Index

Computed by adding prices of components and dividing by a divisor, e.g., Dow Jones Industrial Average (DJIA).

Market-Value Weighted Index

Computed by a weighted average of the market values of all firms in the index, e.g., Standard & Poor's (S&P) 500, NASDAQ 100.

Equally-Weighted Index

Computed as an average of returns from one period to the next, e.g., Value-Line Index.

Barclays Aggregate Bond Index

An index that tracks the performance of the U.S. bond market.

Nikkei

Japan stock index.

FTSE

U.K. stock index.

Bid

The price at which a dealer is willing to buy.

Ask

The price at which a dealer is willing to sell.

Spread

The difference between the ask and bid prices.

Market Order

A buy or sell order to be executed immediately at the best current market price.

Limit Order

An order to buy or sell a specific quantity of shares at a specific price.

Stop Order

A limit order that is not filled until the price hits the limit.

Stop-Loss Order

A stop order placed to sell below the current market price.

Stop-Buy Order

A stop order placed to buy above the current market price.

Buying on Margin

Involves the investor borrowing money from the broker to purchase securities worth more than the value of the funds that the investor puts up.

Margin

The funds that the investor deposits.

Initial Margin Requirement

Set by the Federal Reserve Board of Governors through Regulation T, currently at 50%.

Maintenance Margin

The funds that the investor must keep in the account at all times, which is less than the initial margin.

Margin Call

The price at which the investor will get a margin call can be computed using the maintenance margin level, the number of shares in the investment, and the amount borrowed.

Short Selling

Involves the investor selling a security that is not owned by the investor, but that is borrowed from the broker, profiting from a decline in the price of the security.

Dividends in Short Selling

Short sellers must pay dividends on the securities they sold short since the lender of the security must be paid the dividend.

Margin Computation for Short Selling

Computed differently than margin used to purchase a security, taking into account the value of the short position and the posted margin.

Initial Margin

The percentage of the purchase price that the investor must pay for with their own funds when buying on margin.

Margin Call Price Calculation

Can be computed using the formula for purchasing on margin.

Rate of Return on Margin

Calculated based on the selling price of the stock compared to the purchase price and the amount borrowed.

Mutual Funds

Financial intermediaries that pool investors' funds to invest in securities and other assets.

Functions of Investment Companies

Include record keeping, diversification, professional management, and lower transaction costs.

Unit Trusts

Pooled funds that are invested in a portfolio that is fixed over the fund's life and unmanaged.

Diversification

The practice of spreading investments across various financial assets to reduce risk.

Professional Management

Investment companies provide access to professional managers for managing investor funds.

Lower Transaction Costs

Achieved by investment companies trading large blocks of securities, benefiting from economies of scale.

Investment Information Record Keeping

Investment companies keep track of capital gains, dividends, voting, etc., for investors.

Economies of Scale

Cost advantages that investment companies have due to their large volume of transactions.

Amount Borrowed in Margin Purchase

Calculated as the total purchase price multiplied by the initial margin percentage.

Price for Margin Call in Short Selling

Determined by the maintenance margin and the amount of shares sold short.

Stock Price for Margin Call

The price at which the short seller will receive a margin call based on the maintenance margin requirement.

Investment Companies

Organizations that pool funds from investors to purchase securities.

Exchange Traded Funds (ETFs)

Trade on stock exchanges just like stock and allow investors to purchase exposure to index portfolios, commodities, and other security portfolios.

Closed-end funds

Funds that have a fixed number of shares outstanding - shares trade from one investor to another and can trade at a premium or discount to NAV.

Open-end funds (aka Mutual Funds)

Funds that issue or buy back shares as investors purchase or sell shares of the fund, at the NAV. The number of shares of the fund outstanding changes.

Net Asset Value (NAV)

The value of an investment company, per share, taking into account both assets and liabilities of the fund. NAV = $Mkt. Value of Assets - $Liabilities / #shares outstanding.

Real Estate Investment Trusts (REITs)

Funds that invest in real estate or mortgages and real estate loans (operate as closed-end funds).

Equity Trusts

Invest directly in real estate.

Mortgage trusts

Invest in mortgages and construction loans.

Hybrid

Invest in both equity trusts and mortgage trusts.

Hedge Funds

Private investment pools for 'sophisticated' investors that are currently exempt from SEC regulation and often invest in assets with large return potential (hence higher risk).

Operating Expenses

Fees charged to cover operation, administrative, and advisory fees; generally 0.2%-2%.

Front-end load

Sales charges paid when an investor purchases a fund.

Back-end load

Sales charges paid when an investor sells a fund, often reduced for every year the fund is owned.

No-load fund

Have no front or back-end load but generally have other fees.

12b-1 fees

Annual fees charged to pay marketing and distribution costs, often to the broker who sells the fund.

Mutual Fund Returns

The rate of return on a fund, to the investor, equals the change in the NAV plus any income received, minus any fees paid, taking into account any load charges.

Money Market Mutual Funds

Provide money market returns and liquidity. Invest in Treasury Bills, Commercial paper, Negotiable CDs, and Short-term debt.

Fixed Income Funds

Invest in fixed income with maturities of months to 30+ years.

Equity Mutual Funds

Invest in stocks/equities with varying objectives (e.g. income, growth, aggressive growth, etc.).

Hybrid or Balance Funds

Invest in money market, fixed-income, and/or equity securities in varying weights, depending on the objective of the fund.

Turnover Ratio

A measure of how frequently assets within a fund are bought and sold by the managers.

Pinnacle Fund

Had year-end assets of $825,000,000 and liabilities of $25,000,000. If Pinnacle's NAV was $32.18, how many shares must have been held in the fund?

Stone Harbor Fund

A closed-end investment company with a portfolio currently worth $300 million, liabilities of $5 million, and 9 million shares outstanding.