Investments Comprehensive Review: Options, Portfolio Performance, Bonds, Funds, and Taxes

Vocabulary practice flashcards covering fundamental terms and formulas across options, portfolio performance, bonds, mutual funds and ETFs, and tax-advantaged investments.

Derivative Security

A financial contract whose value is derived from the value of another underlying asset, rate, or index.

Option

A financial contract that gives the buyer the right, but not the obligation, to transact at a specified exercise (strike) price under its terms, while the seller accepts a potential obligation in exchange for a premium.

Call Option

A contract that gives the holder the right to purchase the underlying asset at a specified strike price; generally purchased by investors with a bullish outlook.

Put Option

A contract that gives the holder the right to sell the underlying asset at a specified strike price; generally purchased by investors with a bearish outlook.

American Option

An option contract that may be exercised by the holder at any time prior to or on its expiration date.

European Option

An option contract that can only be exercised on its expiration date; the term refers to the exercise style rather than the geographic location of trading.

Intrinsic Value (Option)

The immediate payoff or value of an option if exercised right now, equal to $\max(S - K, 0)$ for a call option and $\max(K - S, 0)$ for a put option, where $S$ is the stock price and $K$ is the strike price.

Time Value (Option)

The portion of an option's premium that exceeds its intrinsic value ($\text{Time Value} = \text{Premium} - \text{Intrinsic Value}$), which reflects the remaining time to expiration and declines to zero at expiration.

Covered Call

An investment strategy in which an investor holds long shares of stock and writes (sells) call options against that stock position to earn premium income and cushion moderate declines, capping upside profit at the strike price.

Protective Put

An investment strategy consisting of a long stock position combined with the purchase of a put option, creating an expiration floor against downside losses while preserving upside participation minus the premium paid.

Long Straddle

A volatility strategy created by purchasing both a call option and a put option with the same strike price and same expiration date, seeking to profit from a large price move in either direction.

Holding-Period Return (HPR)

The total percentage return generated over a holding period, computed as $\frac{\text{Ending Value} - \text{Beginning Value} + \text{Distributions}}{\text{Beginning Value}}$.

Active Return

The excess return earned by an investment portfolio relative to the return of its benchmark ($\text{Active Return} = \text{Portfolio Return} - \text{Benchmark Return}$).

Sharpe Ratio

A risk-adjusted performance measure evaluating excess return per unit of total risk (standard deviation), defined as $\frac{R_p - R_f}{\sigma_p}$.

Treynor Ratio

A risk-adjusted performance metric that measures excess return per unit of systematic market risk (beta), defined as $\frac{R_p - R_f}{\beta_p}$.

Jensen Alpha

A CAPM-relative performance measure representing the portfolio's actual return minus its required rate of return: $\alpha = R_p - [R_f + \beta_p(R_m - R_f)]$.

Dollar-Cost Averaging

An investment technique where an investor commits a fixed dollar amount at regular intervals, automatically buying more shares when prices are low and fewer shares when prices are high.

Geometric Average Return

The mean annual compounded growth rate of an investment over multiple periods, calculated as $\left[\prod_{t=1}^{n}(1 + R_t)\right]^{1/n} - 1$.

Time-Weighted Return

A measure of portfolio compound growth that links subperiod returns together to eliminate the distorting effects of the timing and magnitude of external deposits and withdrawals.

Indenture

The legal, binding contract between a bond issuer and bondholders specifying the terms, covenants, payment schedules, and rights associated with the bond issue.

Debenture

An unsecured bond that is backed solely by the general creditworthiness and financial standing of the issuer, rather than by specific pledged physical assets or collateral.

Reinvestment Risk

The risk that future cash inflows from an investment (such as coupon payments or returned principal) will have to be reinvested at a lower interest rate than the original yield.

Call Risk

The risk to a bondholder that the issuer will exercise a call feature to retire the bond prior to maturity during a period of falling rates, cutting off high coupon payments.

Current Yield

A bond return metric calculated as the annual coupon payment divided by the current bond price ($\frac{\text{Annual Coupon}}{\text{Price}}$), which ignores principal gains or losses and the time value of money.

Yield to Maturity (YTM)

The internal discount rate that equates the present value of all scheduled future coupon payments and maturity par value to the bond's current market price.

Macaulay Duration

The weighted average time until a bond's cash flows are received; it is exactly equal to maturity for zero-coupon bonds and less than maturity for positive coupon-paying bonds.

Modified Duration

A metric that estimates a bond's percentage price sensitivity to interest-rate changes, calculated as $\frac{\text{Macaulay Duration}}{1 + \frac{y}{m}}$, where $\frac{\Delta P}{P} \approx -\text{Modified Duration} \times \Delta y$.

Bond Immunization

A strategy that protects a portfolio against interest-rate shifts by matching asset duration to liability duration and present values, offsetting price risk with reinvestment risk.

Net Asset Value (NAV)

The net per-share value of an investment fund, computed as the fund's total assets minus total liabilities, divided by the number of outstanding shares: $\frac{\text{Assets} - \text{Liabilities}}{\text{Shares}}$.

12b-1 Fee

An operational fee deducted annually from mutual fund assets to pay for marketing, distribution, and shareholder service costs.

Real Estate Investment Trust (REIT)

A corporate entity that owns, operates, or finances income-producing real estate (equity or mortgage assets), often providing liquid public trading on secondary exchanges.

Hedge Fund

A private, pooled investment vehicle characterized by flexible strategies (such as shorting, derivatives, and leverage), strict investor qualification standards, and limited redemption liquidity.

Tax-Equivalent Yield

The pretax yield required on a taxable bond to equal the after-tax yield of a tax-exempt municipal bond: $\frac{\text{Tax-Exempt Municipal Yield}}{1 - \text{Marginal Tax Rate}}$.

Defined-Benefit Pension

An employer-sponsored retirement plan that guarantees a predetermined benefit upon retirement based on a specific formula (e.g., pay and service years), with the plan sponsor bearing the investment risk.

Defined-Contribution Plan

A retirement plan in which contributions are deposited into individual participant accounts and the final retirement balance depends on investment performance, placing the investment risk on the employee.

401(k) Plan

An employer-sponsored defined-contribution retirement plan enabling eligible employees to contribute a portion of their salary on a pre-tax (or Roth) basis with potential employer matching.

403(b) Plan

A tax-advantaged retirement plan comparable to a 401(k), designed specifically for employees of public schools and certain tax-exempt 501(c)(3) organizations.

Keogh Plan (H.R. 10)

A tax-advantaged, qualified retirement plan designed specifically for self-employed individuals and unincorporated small business owners, structured as defined-benefit or defined-contribution plans.

Roth Account

A tax-advantaged retirement account funded with non-deductible after-tax contributions, allowing investments to grow tax-deferred and qualified distributions to be completely tax-free.

529 Education Plan

A state-sponsored education savings or prepaid tuition program funded with after-tax money that offers federal tax-deferred investment growth and tax-free withdrawals when used for qualified education expenses.

Coverdell Education Savings Account (ESA)

A tax-advantaged trust or custodial account created to pay for qualified elementary, secondary, or higher education expenses, featuring non-deductible contributions and tax-free qualified distributions.

Deferred Annuity

An insurance contract structured to accumulate investment earnings on a tax-deferred basis, delaying periodic payout distributions until a designated future date.