G-14 Glossary
FX swap The combination of a spot and a forward FX Gross domestic product The market value of all final goods
transaction. and services produced within the economy in a given
period of time (output definition) or, equivalently, the
G-spread The yield spread in basis points over an actual or aggregate income earned by all households, all companies,
interpolated government bond. and the government within the economy in a given period
of time (income definition).
Gains Asset inflows not directly related to the ordinary activ-
ities of the business. Gross margin Sales minus the cost of sales (i.e., the cost of
goods sold for a manufacturing company).
Game theory The set of tools decision makers use to incorpo-
rate responses by rival decision makers into their strategies. Gross profit Sales minus the cost of sales (i.e., the cost of
goods sold for a manufacturing company).
Gamma A numerical measure of how sensitive an option’s
delta (the sensitivity of the derivative’s price) is to a change Gross profit margin The ratio of gross profit to revenues.
in the value of the underlying. Grouping by function With reference to the presentation of
GDP deflator A gauge of prices and inflation that measures expenses in an income statement, the grouping together
the aggregate changes in prices across the overall economy. of expenses serving the same function, e.g. all items that
are costs of goods sold.
General partner (GP) The partner that runs the business and Grouping by nature With reference to the presentation of
theoretically bears unlimited liability. expenses in an income statement, the grouping together of
expenses by similar nature, e.g., all depreciation expenses.
Geometric mean A measure of central tendency computed by Growth cyclical A term sometimes used to describe companies
taking the nth root of the product of n non-n egative values. that are growing rapidly on a long-t erm basis but that still
experience above-a verage fluctuation in their revenues and
Giffen goods Goods that are consumed more as the price profits over the course of a business cycle.
of the good rises because it is a very inferior good whose Growth investors With reference to equity investors, investors
income effect overwhelms its substitution effect when who seek to invest in high-e arnings-g rowth companies.
price changes. Guarantee certificate A type of structured financial instru-
ment that provides investors capital protection. It combines
Gilts Bonds issued by the UK government. a zero-coupon bond and a call option on some underlying
Giro system An electronic payment system used widely in asset.
Haircut See repo margin.
Europe and Japan. Harmonic mean A type of weighted mean computed by
Global depository receipt A depository receipt that is issued averaging the reciprocals of the observations, then taking
the reciprocal of that average.
outside of the company’s home country and outside of the Head and shoulders pattern In technical analysis, a rever-
United States. sal pattern that is formed in three parts: a left shoulder,
Global minimum-variance portfolio The portfolio on the head, and right shoulder; used to predict a change from
minimum-v ariance frontier with the smallest variance an uptrend to a downtrend.
of return. Headline inflation The inflation rate calculated based on
Global registered share A common share that is traded on the price index that includes all goods and services in an
different stock exchanges around the world in different economy.
currencies. Hedge funds Private investment vehicles that typically use
Gold standard With respect to a currency, if a currency is on leverage, derivatives, and long and short investment
the gold standard a given amount can be converted into a strategies.
prespecified amount of gold. Hedge portfolio A hypothetical combination of the derivative
Golden cross A technical analysis term that describes a situa- and its underlying that eliminates risk.
tion where a short-t erm moving average crosses from below Held for trading Debt or equity financial assets bought with
a longer-term moving average to above it; this movement the intention to sell them in the near term, usually less
is considered bullish. than three months; securities that a company intends to
Good-on-close An execution instruction specifying that an trade. Also called trading securities.
order can only be filled at the close of trading. Also called Held-to-maturity Debt (fixed-income) securities that a com-
market on close. pany intends to hold to maturity; these are presented at
Good-on-open An execution instruction specifying that an their original cost, updated for any amortization of dis-
order can only be filled at the opening of trading. counts or premiums.
Good-till-cancelled order An order specifying that it is valid Herding Clustered trading that may or may not be based on
until the entity placing the order has cancelled it (or, com- information.
monly, until some specified amount of time such as 60 days Hidden order An order that is exposed not to the public but
has elapsed, whichever comes sooner). only to the brokers or exchanges that receive it.
Goodwill An intangible asset that represents the excess of the High-frequency trading A form of algorithmic trading that
purchase price of an acquired company over the value of makes use of vast quantities of data to execute trades on
the net assets acquired. ultra-h igh-s peed networks in fractions of a second.
Government equivalent yield A yield that restates a yield- High-water marks The highest value, net of fees, that a fund
to-m aturity based on 30/360 day-c ount to one based on has reached in history. It reflects the highest cumulative
actual/actual. return used to calculate an incentive fee.
Green bonds A bond used in green finance whereby the Histogram A bar chart of data that have been grouped into
proceeds are earmarked towards environmental-related a frequency distribution.
products.
Green finance A type of finance that addresses environmental
concerns while achieving economic growth.
Grey market The forward market for bonds about to be issued.
Also called “when issued” market.
Glossary G-15
Historical cost In reference to assets, the amount paid to Immediate or cancel order An order that is valid only upon
purchase an asset, including any costs of acquisition and/ receipt by the broker or exchange. If such an order can-
or preparation; with reference to liabilities, the amount not be filled in part or in whole upon receipt, it cancels
of proceeds received in exchange in issuing the liability. immediately. Also called fill or kill.
Historical equity risk premium approach An estimate of a Impact investing Investing that seeks to achieve targeted
country’s equity risk premium that is based upon the his- social or environmental objectives along with measurable
torical averages of the risk-free rate and the rate of return financial returns through engagement with a company or
on the market portfolio. by direct investment in projects or companies.
Historical simulation Another term for the historical method Impact lag The lag associated with the result of actions affect-
of estimating VaR. This term is somewhat misleading in that ing the economy with delay.
the method involves not a simulation of the past but rather
what actually happened in the past, sometimes adjusted to Implicit price deflator for GDP A gauge of prices and inflation
reflect the fact that a different portfolio may have existed that measures the aggregate changes in prices across the
in the past than is planned for the future. overall economy.
Holder-of-record date The date that a shareholder listed on Implied forward rates Calculated from spot rates, an implied
the corporation’s books will be deemed to have owner- forward rate is a break-e ven reinvestment rate that links
ship of the shares for purposes of receiving an upcoming the return on an investment in a shorter-term zero-c oupon
dividend. bond to the return on an investment in a longer-term
zero-coupon bond.
Holding period return The return that an investor earns
during a specified holding period; a synonym for total Implied volatility The volatility that option traders use to
return. price an option, implied by the price of the option and a
particular option-p ricing model.
Holding period yield (HPY) The return that an investor earns
during a specified holding period; holding period return Import license Specifies the quantity of a good that can be
with reference to a fixed-income instrument. imported into a country.
Homogeneity of expectations The assumption that all inves- Imports Goods and services that a domestic economy (i.e.,
tors have the same economic expectations and thus have house-holds, firms, and government) purchases from other
the same expectations of prices, cash flows, and other countries.
investment characteristics.
In the money Options that, if exercised, would result in
Horizon yield The internal rate of return between the total the value received being worth more than the payment
return (the sum of reinvested coupon payments and the required to exercise.
sale price or redemption amount) and the purchase price
of the bond. Incentive fee Fees paid to the general partner from the limited
partner(s) based on realized profits.
Horizontal analysis Common-s ize analysis that involves com-
paring a specific financial statement with that statement in Income Increases in economic benefits in the form of inflows
prior or future time periods; also, cross-s ectional analysis or enhancements of assets, or decreases of liabilities that
of one company with another. result in an increase in equity (other than increases result-
ing from contributions by owners).
Horizontal demand schedule Implies that at a given price,
the response in the quantity demanded is infinite. Income elasticity of demand A measure of the responsiveness
of demand to changes in income, defined as the percentage
Hostile takeover An attempt by one entity to acquire a com- change in quantity demanded divided by the percentage
pany without the consent of the company’s management. change in income.
Household A person or a group of people living in the same Income tax paid The actual amount paid for income taxes in
residence, taken as a basic unit in economic analysis. the period; not a provision, but the actual cash outflow.
Human capital The accumulated knowledge and skill that Income tax payable The income tax owed by the company
workers acquire from education, training, or life experience on the basis of taxable income.
and the corresponding present value of future earnings to
be generated by said skilled individual. Income trust A type of equity ownership vehicle established
as a trust issuing ownership shares known as units.
Hurdle rate The rate of return that must be met for a project
to be accepted. Increasing marginal returns When the marginal product
of a resource increases as additional units of that input
Hypothesis With reference to statistical inference, a statement are employed.
about one or more populations.
Increasing returns to scale When a production process leads
Hypothesis testing With reference to statistical inference, the to increases in output that are proportionately larger than
subdivision dealing with the testing of hypotheses about the increase in inputs.
one or more populations.
Incremental cash flow The cash flow that is realized because
I-spread The yield spread of a specific bond over the standard of a decision; the changes or increments to cash flows
swap rate in that currency of the same tenor. resulting from a decision or action.
Iceberg order An order in which the display size is less than Indenture Legal contract that describes the form of a bond, the
the order’s full size. obligations of the issuer, and the rights of the bondholders.
Also called the trust deed.
If-converted method A method for accounting for the effect
of convertible securities on earnings per share (EPS) that Independent With reference to events, the property that the
specifies what EPS would have been if the convertible secu- occurrence of one event does not affect the probability of
rities had been converted at the beginning of the period, another event occurring.
taking account of the effects of conversion on net income
and the weighted average number of shares outstanding. Independent projects Independent projects are projects
whose cash flows are independent of each other.
G-16 Glossary
Independently and identically distributed (IID) With respect Initial public offering (IPO) The first issuance of common
to random variables, the property of random variables shares to the public by a formerly private corporation.
that are independent of each other but follow the identical
probability distribution. Input productivity The amount of output produced by work-
ers in a given period of time—for example, output per hour
Index-linked bond Bond for which coupon payments and/ worked; measures the efficiency of labor.
or principal repayment are linked to a specified index.
Installment method With respect to revenue recognition, a
Index of Leading Economic Indicators A composite of eco- method that specifies that the portion of the total profit of
nomic variables used by analysts to predict future economic the sale that is recognized in each period is determined by
conditions. the percentage of the total sales price for which the seller
has received cash.
Indexing An investment strategy in which an investor con-
structs a portfolio to mirror the performance of a specified Installment sales With respect to revenue recognition, a
index. method that specifies that the portion of the total profit of
the sale that is recognized in each period is determined by
Indifference curve A curve representing all the combinations the percentage of the total sales price for which the seller
of two goods or attributes such that the consumer is entirely has received cash.
indifferent among them.
Intangible assets Assets lacking physical substance, such as
Indirect format With reference to cash flow statements, a patents and trademarks.
format for the presentation of the statement which, in the
operating cash flow section, begins with net income then Interbank market The market of loans and deposits between
shows additions and subtractions to arrive at operating banks for maturities ranging from overnight to one year.
cash flow. Also called indirect method.
Interbank money market The market of loans and deposits
Indirect method See indirect format. between banks for maturities ranging from overnight to
Indirect taxes Taxes such as taxes on spending, as opposed one year.
to direct taxes. Interest Payment for lending funds.
Industry A group of companies offering similar products Interest coverage A solvency ratio calculated as EBIT divided
and/or services. by interest payments.
Industry analysis The analysis of a specific branch of manu- Interest-only mortgage A loan in which no scheduled prin-
facturing, service, or trade. cipal repayment is specified for a certain number of years.
Inelastic Said of a good or service when the magnitude of Interest rate A rate of return that reflects the relationship
elasticity is less than one. Insensitive to price changes. between differently dated cash flows; a discount rate.
Inferior goods A good whose consumption decreases as Interest rate swap A swap in which the underlying is an
income increases. interest rate. Can be viewed as a currency swap in which
Inflation The percentage increase in the general price level both currencies are the same and can be created as a
combination of currency swaps.
from one period to the next; a sustained rise in the overall Intergenerational data mining A form of data mining that
level of prices in an economy. applies information developed by previous researchers
Inflation-linked bond Type of index-linked bond that offers using a dataset to guide current research using the same
investors protection against inflation by linking the bond’s or a related dataset.
coupon payments and/or the principal repayment to an Intermarket analysis A field within technical analysis that
index of consumer prices. Also called linkers. combines analysis of major categories of securities—
Inflation premium An extra return that compensates investors namely, equities, bonds, currencies, and commodities—to
for expected inflation. identify market trends and possible inflections in a trend.
Inflation rate The percentage change in a price index—that Internal rate of return (IRR) The discount rate that makes
is, the speed of overall price level movements. net present value equal 0; the discount rate that makes the
Inflation Reports A type of economic publication put out by present value of an investment’s costs (outflows) equal to
many central banks. the present value of the investment’s benefits (inflows).
Inflation uncertainty The degree to which economic agents Internet of Things A network arrangement of structures and
view future rates of inflation as difficult to forecast. devices whereby the objects on the network are able to
Information cascade The transmission of information from interact and share information.
those participants who act first and whose decisions influ- Interpolated spread The yield spread of a specific bond over
ence the decisions of others. the standard swap rate in that currency of the same tenor.
Information-motivated traders Traders that trade to profit Interquartile range The difference between the third and first
from information that they believe allows them to predict quartiles of a dataset.
future prices. Interval With reference to grouped data, a set of values within
Informationally efficient market A market in which asset which an observation falls.
prices reflect new information quickly and rationally. Interval scale A measurement scale that not only ranks data
Initial coin offering An unregulated process whereby com- but also gives assurance that the differences between scale
panies raise capital by selling crypto tokens to inves- values are equal.
tors in exchange for fiat money or another agreed-u pon Intrinsic value See exercise value.
cryptocurrency. Inventory blanket lien The use of inventory as collateral for
Initial margin The amount that must be deposited in a clear- a loan. Though the lender has claim to some or all of the
inghouse account when entering into a futures contract. company’s inventory, the company may still sell or use the
Initial margin requirement The margin requirement on the inventory in the ordinary course of business.
first day of a transaction as well as on any day in which Inventory investment Net change in business inventory.
additional margin funds must be deposited.
Glossary G-17
Inventory turnover An activity ratio calculated as cost of Lagging economic indicators Turning points that take place
goods sold divided by average inventory. later than those of the overall economy; they are believed
to have value in identifying the economy’s past condition.
Inverse demand function A restatement of the demand
function in which price is stated as a function of quantity. Laspeyres index A price index created by holding the com-
position of the consumption basket constant.
Inverse floater A type of leveraged structured financial instru-
ment. The cash flows are adjusted periodically and move Law of demand The principle that as the price of a good rises,
in the opposite direction of changes in the reference rate. buyers will choose to buy less of it, and as its price falls,
they will buy more.
Investing activities Activities which are associated with the
acquisition and disposal of property, plant, and equipment; Law of diminishing marginal returns The observation that
intangible assets; other long-term assets; and both long- a variable factor’s marginal product must eventually fall as
term and short-term investments in the equity and debt more of it is added to a fixed amount of the other factors.
(bonds and loans) issued by other companies.
Law of diminishing returns The smallest output that a
Investment banks Financial intermediaries that provide firm can produce such that its long run average costs are
advice to their mostly corporate clients and help them minimized.
arrange transactions such as initial and seasoned securities
offerings. Law of one price The condition in a financial market in which
two equivalent financial instruments or combinations of
Investment opportunity schedule A graphical depiction of a financial instruments can sell for only one price. Equivalent
company’s investment opportunities ordered from highest to the principle that no arbitrage opportunities are possible.
to lowest expected return. A company’s optimal capital
budget is found where the investment opportunity schedule Lead underwriter The lead investment bank in a syndicate
intersects with the company’s marginal cost of capital. of investment banks and broker–dealers involved in a
securities underwriting.
Investment policy statement (IPS) A written planning doc-
ument that describes a client’s investment objectives and Leading economic indicators Turning points that usually
risk tolerance over a relevant time horizon, along with precede those of the overall economy; they are believed
constraints that apply to the client’s portfolio. to have value for predicting the economy’s future state,
usually near-term.
Investment property Property used to earn rental income
or capital appreciation (or both). Legal tender Something that must be accepted when offered
in exchange for goods and services.
IRR rule An investment decision rule that accepts projects or
investments for which the IRR is greater than the oppor- Lender of last resort An entity willing to lend money when
tunity cost of capital. no other entity is ready to do so.
January effect Calendar anomaly that stock market returns Leptokurtic Describes a distribution that has fatter tails than
in January are significantly higher compared to the rest of a normal distribution.
the months of the year, with most of the abnormal returns
reported during the first five trading days in January. Also Lessee The party obtaining the use of an asset through a lease.
called turn-of-the-year effect. Lessor The owner of an asset that grants the right to use the
Joint probability The probability of the joint occurrence of asset to another party.
stated events. Letter of credit Form of external credit enhancement whereby
Joint probability function A function giving the probability a financial institution provides the issuer with a credit
of joint occurrences of values of stated random variables. line to reimburse any cash flow shortfalls from the assets
backing the issue.
Just-in-time (JIT) method Method of managing inventory Level of significance The probability of a Type I error in
that minimizes in-p rocess inventory stocks. testing a hypothesis.
Leverage In the context of corporate finance, leverage refers
Key rate duration A method of measuring the interest rate to the use of fixed costs within a company’s cost structure.
sensitivities of a fixed-income instrument or portfolio to Fixed costs that are operating costs (such as depreciation or
shifts in key points along the yield curve. rent) create operating leverage. Fixed costs that are financial
costs (such as interest expense) create financial leverage.
Keynesians Economists who believe that fiscal policy can Leveraged buyout (LBO) A transaction whereby the target
have powerful effects on aggregate demand, output, and company management team converts the target to a pri-
employment when there is substantial spare capacity in vately held company by using heavy borrowing to finance
an economy. the purchase of the target company’s outstanding shares.
Liabilities Present obligations of an enterprise arising from
Kondratieff wave A 54-y ear long economic cycle postulated past events, the settlement of which is expected to result
by Nikolai Kondratieff. in an outflow of resources embodying economic benefits;
creditors’ claims on the resources of a company.
Kurtosis The statistical measure that indicates the combined Life-cycle stage The stage of the life cycle: embryonic, growth,
weight of the tails of a distribution relative to the rest of shakeout, mature, declining.
the distribution. LIFO layer liquidation With respect to the application of the
LIFO inventory method, the liquidation of old, relatively
Labor force The portion of the working age population (over low-p riced inventory; happens when the volume of sales
the age of 16) that is employed or is available for work but rises above the volume of recent purchases so that some
not working (unemployed). sales are made from relatively old, low-priced inventory.
Also called LIFO liquidation.
Labor productivity The quantity of goods and services (real
GDP) that a worker can produce in one hour of work.
Laddering strategy A form of active strategy which entails
scheduling maturities on a systematic basis within the
investment portfolio such that investments are spread out
equally over the term of the ladder.
G-18 Glossary
LIFO method The last in, first out, method of accounting for Load fund A mutual fund in which, in addition to the annual
inventory, which matches sales against the costs of items fee, a percentage fee is charged to invest in the fund and/
of inventory in the reverse order the items were placed or for redemptions from the fund.
in inventory (i.e., inventory produced or acquired last are
assumed to be sold first). Loan-to-value ratio The ratio of a property’s purchase price
to the amount of its mortgage.
LIFO reserve The difference between the reported LIFO inven-
tory carrying amount and the inventory amount that would Lockbox system A payment system in which customer pay-
have been reported if the FIFO method had been used ments are mailed to a post office box and the banking
(in other words, the FIFO inventory value less the LIFO institution retrieves and deposits these payments several
inventory value). times a day, enabling the company to have use of the fund
sooner than in a centralized system in which customer
Likelihood The probability of an observation, given a partic- payments are sent to the company.
ular set of conditions.
Locked limit A condition in the futures markets in which a
Limit down A limit move in the futures market in which the transaction cannot take place because the price would be
price at which a transaction would be made is at or below beyond the limits.
the lower limit.
Lockup period The minimum period before investors are
Limit order Instructions to a broker or exchange to obtain the allowed to make withdrawals or redeem shares from a fund.
best price immediately available when filling an order, but
in no event accept a price higher than a specified (limit) Logarithmic scale A scale in which equal distances represent
price when buying or accept a price lower than a specified equal proportional changes in the underlying quantity.
(limit) price when selling.
London interbank offered rate (Libor) Collective name for
Limit order book The book or list of limit orders to buy and multiple rates at which a select set of banks believe they
sell that pertains to a security. could borrow unsecured funds from other banks in the
London interbank market for different currencies and
Limit up A limit move in the futures market in which the different borrowing periods ranging from overnight to
price at which a transaction would be made is at or above one year.
the upper limit.
Long The buyer of a derivative contract. Also refers to the
Limitations on liens Meant to put limits on how much secured position of owning a derivative.
debt an issuer can have.
Long-lived assets Assets that are expected to provide eco-
Limited partners Partners with limited liability. Limited part- nomic benefits over a future period of time, typically
nerships in hedge and private equity funds are typically greater than one year. Also called long-term assets.
restricted to investors who are expected to understand
and to be able to assume the risks associated with the Long position A position in an asset or contract in which
investments. one owns the asset or has an exercisable right under the
contract.
Line chart In technical analysis, a plot of price data, typically
closing prices, with a line connecting the points. Long-run average total cost The curve describing average
total cost when no costs are considered fixed.
Linear interpolation The estimation of an unknown value
on the basis of two known values that bracket it, using a Long-term contract A contract that spans a number of
straight line between the two known values. accounting periods.
Linear scale A scale in which equal distances correspond Longitudinal data Observations on characteristic(s) of the
to equal absolute amounts. Also called arithmetic scale. same observational unit through time.
Linker See inflation-linked bond. Look-ahead bias A bias caused by using information that was
Liquid market Said of a market in which traders can buy or sell unavailable on the test date.
with low total transaction costs when they want to trade. Loss aversion The tendency of people to dislike losses more
Liquidation To sell the assets of a company, division, or than they like comparable gains.
subsidiary piecemeal, typically because of bankruptcy; the Loss severity Portion of a bond’s value (including unpaid
form of bankruptcy that allows for the orderly satisfaction interest) an investor loses in the event of default.
of creditors’ claims after which the company ceases to exist.
Liquidity The ability to purchase or sell an asset quickly and Losses Asset outflows not directly related to the ordinary
easily at a price close to fair market value. The ability to activities of the business.
meet short-term obligations using assets that are the most
readily converted into cash. Lower bound The lowest possible value of an option.
Liquidity premium An extra return that compensates inves- M2 A measure of what a portfolio would have returned if it
tors for the risk of loss relative to an investment’s fair value
if the investment needs to be converted to cash quickly. had taken on the same total risk as the market index.
Liquidity ratios Financial ratios measuring the company’s Macaulay duration The approximate amount of time a bond
ability to meet its short-term obligations.
Liquidity risk The risk that a financial instrument cannot be would have to be held for the market discount rate at pur-
purchased or sold without a significant concession in price chase to be realized if there is a single change in interest
due to the size of the market. rate. It indicates the point in time when the coupon rein-
Liquidity trap A condition in which the demand for money vestment and price effects of a change in yield-to- maturity
becomes infinitely elastic (horizontal demand curve) so offset each other.
that injections of money into the economy will not lower Machine learning Diverse approaches by which computers
interest rates or affect real activity. are programmed to improve performance in specified
tasks with experience.
Macroeconomics The branch of economics that deals with
aggregate economic quantities, such as national output
and national income.
Maintenance covenants Covenants in bank loan agreements
that require the borrower to satisfy certain financial ratio
tests while the loan is outstanding.
Glossary G-19
Maintenance margin The minimum amount that is required Market-capitalization weighting An index weighting method
by a futures clearinghouse to maintain a margin account in which the weight assigned to each constituent security is
and to protect against default. Participants whose margin determined by dividing its market capitalization by the total
balances drop below the required maintenance margin market capitalization (sum of the market capitalization)
must replenish their accounts. of all securities in the index. Also called value weighting.
Maintenance margin requirement The margin requirement Market discount rate The rate of return required by investors
on any day other than the first day of a transaction. given the risk of the investment in a bond; also called the
required yield or the required rate of return.
Management buy-ins Leveraged buyout in which the current
management team is being replaced and the acquiring team Market float The number of shares that are available to the
will be involved in managing the company. investing public.
Management buyout (MBO) A leveraged buyout event in Market liquidity risk The risk that the price at which investors
which a group of investors consisting primarily of the com- can actually transact—buying or selling—may differ from
pany’s existing management purchase at least controlling the price indicated in the market.
interest of its outstanding shares. They may purchase all
shares and take the company private. Market model A regression equation that specifies a linear
relationship between the return on a security (or portfolio)
Management fee A fee based on assets under management and the return on a broad market index.
or committed capital, as applicable, also called a base fee.
Market multiple models Valuation models based on share
Manufacturing resource planning (MRP) The incorporation price multiples or enterprise value multiples.
of production planning into inventory management. A
MRP analysis provides both a materials acquisition sched- Market-on-close An execution instruction specifying that an
ule and a production schedule. order can only be filled at the close of trading.
Margin The amount of money that a trader deposits in a Market order Instructions to a broker or exchange to obtain
margin account. The term is derived from the stock mar- the best price immediately available when filling an order.
ket practice in which an investor borrows a portion of the
money required to purchase a certain amount of stock. In Market-oriented investors With reference to equity investors,
futures markets, there is no borrowing so the margin is investors whose investment disciplines cannot be clearly
more of a down payment or performance bond. categorized as value or growth.
Margin bond A cash deposit required by the clearinghouse Market rate of interest The rate demanded by purchases of
from the participants to a contract to provide a credit bonds, given the risks associated with future cash payment
guarantee. Also called a performance bond. obligations of the particular bond issue.
Margin call A request for the short to deposit additional funds Market risk The risk that arises from movements in interest
to bring their balance up to the initial margin. rates, stock prices, exchange rates, and commodity prices.
Margin loan Money borrowed from a broker to purchase Market value The price at which an asset or security can
securities. currently be bought or sold in an open market.
Marginal cost The cost of producing an additional unit of Marketable limit order A buy limit order in which the limit
a good. price is placed above the best offer, or a sell limit order in
which the limit price is placed below the best bid. Such
Marginal probability The probability of an event not condi- orders generally will partially or completely fill right away.
tioned on another event.
Markowitz efficient frontier The graph of the set of portfolios
Marginal product Measures the productivity of each unit offering the maximum expected return for their level of
of input and is calculated by taking the difference in total risk (standard deviation of return).
product from adding another unit of input (assuming other
resource quantities are held constant). Matching principle The accounting principle that expenses
should be recognized when the associated revenue is
Marginal propensity to consume The proportion of an addi- recognized.
tional unit of disposable income that is consumed or spent;
the change in consumption for a small change in income. Matching strategy An active investment strategy that includes
intentional matching of the timing of cash outflows with
Marginal propensity to save The proportion of an additional investment maturities.
unit of disposable income that is saved (not spent).
Matrix pricing Process of estimating the market discount rate
Marginal revenue The change in total revenue divided by and price of a bond based on the quoted or flat prices of
the change in quantity sold; simply, the additional revenue more frequently traded comparable bonds.
from selling one more unit.
Maturity premium An extra return that compensates investors
Marginal value curve A curve describing the highest price for the increased sensitivity of the market value of debt to
consumers are willing to pay for each additional unit of a change in market interest rates as maturity is extended.
a good.
Maturity structure A factor explaining the differences in yields
Mark to market The revaluation of a financial asset or liability on similar bonds; also called term structure.
to its current market value or fair value.
Mean absolute deviation With reference to a sample, the
Market A means of bringing buyers and sellers together to mean of the absolute values of deviations from the sample
exchange goods and services. mean.
Market anomaly Change in the price or return of a security Mean excess return The average rate of return in excess of
that cannot directly be linked to current relevant infor- the risk-free rate.
mation known in the market or to the release of new
information into the market. Mean–variance analysis An approach to portfolio analysis
using expected means, variances, and covariances of asset
Market bid–ask spread The difference between the best bid returns.
and the best offer.
Measure of central tendency A quantitative measure that
specifies where data are centered.
G-20 Glossary
Measure of value A standard for measuring value; a function Monetary policy Actions taken by a nation’s central bank to
of money. affect aggregate output and prices through changes in bank
reserves, reserve requirements, or its target interest rate.
Measurement scales A scheme of measuring differences. The
four types of measurement scales are nominal, ordinal, Monetary transmission mechanism The process whereby
interval, and ratio. a central bank’s interest rate gets transmitted through
the economy and ultimately affects the rate of increase
Measures of location A quantitative measure that describes of prices.
the location or distribution of data; includes not only
measures of central tendency but also other measures Monetary union An economic union in which the members
such as percentiles. adopt a common currency.
Median The value of the middle item of a set of items that Money A generally accepted medium of exchange and unit
has been sorted into ascending or descending order; the of account.
50th percentile.
Money convexity For a bond, the annual or approximate
Medium of exchange Any asset that can be used to purchase convexity multiplied by the full price.
goods and services or to repay debts; a function of money.
Money creation The process by which changes in bank
Medium-term note A corporate bond offered continuously to reserves translate into changes in the money supply.
investors by an agent of the issuer, designed to fill the fund-
ing gap between commercial paper and long-term bonds. Money duration A measure of the price change in units of
the currency in which the bond is denominated given a
Menu costs A cost of inflation in which businesses constantly change in its yield-to-m aturity.
have to incur the costs of changing the advertised prices
of their goods and services. Money market The market for short-term debt instruments
(one-year maturity or less).
Mesokurtic Describes a distribution with kurtosis identical
to that of the normal distribution. Money market securities Fixed-income securities with matur-
ities at issuance of one year or less.
Mezzanine financing Debt or preferred shares with a rela-
tionship to common equity resulting from a feature such Money market yield A yield on a basis comparable to the
as attached warrants or conversion options. Mezzanine quoted yield on an interest-bearing money market instru-
financing is subordinate to both senior and high-yield ment that pays interest on a 360-d ay basis; the annualized
debt. It is referred to as mezzanine because of its location holding period yield, assuming a 360-d ay year.
on the balance sheet.
Money multiplier Describes how a change in reserves is
Microeconomics The branch of economics that deals with expected to affect the money supply; in its simplest form,
markets and decision making of individual economic units, 1 divided by the reserve requirement.
including consumers and businesses.
Money neutrality The thesis that an increase in the money
Minimum efficient scale The smallest output that a firm supply leads in the long-run to an increase in the price
can produce such that its long-run average total cost is level, while leaving real variables like output and employ-
minimized. ment unaffected.
Minimum-v ariance portfolio The portfolio with the minimum Money-weighted return The internal rate of return on a
variance for each given level of expected return. portfolio, taking account of all cash flows.
Minority shareholders A particular shareholder or block of Moneyness The relationship between the price of the under-
shareholders holding a small proportion of a company’s lying and an option’s exercise price.
outstanding shares, resulting in a limited ability to exercise
control in voting activities. Monopolistic competition Highly competitive form of imper-
fect competition; the competitive characteristic is a notably
Minsky moment Named for Hyman Minksy: A point in a large number of firms, while the monopoly aspect is the
business cycle when, after individuals become overextended result of product differentiation.
in borrowing to finance speculative investments, people
start realizing that something is likely to go wrong and a Monopoly In pure monopoly markets, there are no substi-
panic ensues leading to asset sell-o ffs. tutes for the given product or service. There is a single
seller, which exercises considerable power over pricing
Mismatching strategy An active investment strategy whereby and output decisions.
the timing of cash outflows is not matched with investment
maturities. Monte Carlo simulation An approach to estimating a prob-
ability distribution of outcomes to examine what might
Modal interval With reference to grouped data, the most happen if particular risks are faced. This method is widely
frequently occurring interval. used in the sciences as well as in business to study a variety
of problems.
Mode The most frequently occurring value in a set of
observations. Moral principles Beliefs regarding what is good, acceptable,
or obligatory behavior and what is bad, unacceptable, or
Modern portfolio theory (MPT) The analysis of rational forbidden behavior.
portfolio choices based on the efficient use of risk.
Mortgage-backed securities Debt obligations that represent
Modified duration A measure of the percentage price change claims to the cash flows from pools of mortgage loans,
of a bond given a change in its yield-to-m aturity. most commonly on residential property.
Momentum oscillators A graphical representation of market Mortgage loan A loan secured by the collateral of some
sentiment that is constructed from price data and calcu- specified real estate property that obliges the borrower to
lated so that it oscillates either between a high and a low make a predetermined series of payments to the lender.
or around some number.
Mortgage pass-t hrough security A security created when one
Monetarists Economists who believe that the rate of growth or more holders of mortgages form a pool of mortgages
of the money supply is the primary determinant of the and sell shares or participation certificates in the pool.
rate of inflation.
Mortgage rate The interest rate on a mortgage loan; also
called contract rate or note rate.
Glossary G-21
Moving average The average of the closing price of a security Negative screening An ESG implementation approach that
over a specified number of periods. With each new period, excludes certain sectors or companies that deviate from
the average is recalculated. an investor’s accepted standards. Also called exclusionary
screening or norms-based screening.
Moving-average convergence/divergence oscilla-
tor (MACD) A momentum oscillator that is constructed Neo-Keynesians A group of dynamic general equilibrium
based on the difference between short-t erm and long-t erm models that assume slow-to-a djust prices and wages.
moving averages of a security’s price.
Net book value The remaining (undepreciated) balance of
Multi-factor model A model that explains a variable in terms an asset’s purchase cost. For liabilities, the face value of
of the values of a set of factors. a bond minus any unamortized discount, or plus any
unamortized premium.
Multi-market indexes Comprised of indexes from different
countries, designed to represent multiple security markets. Net exports The difference between the value of a country’s
exports and the value of its imports (i.e., value of exports
Multi-step format With respect to the format of the income minus imports).
statement, a format that presents a subtotal for gross profit
(revenue minus cost of goods sold). Net income The difference between revenue and expenses;
what remains after subtracting all expenses (including
Multilateral trading facilities See alternative trading systems. depreciation, interest, and taxes) from revenue.
Multinational corporation A company operating in more
Net operating cycle An estimate of the average time that
than one country or having subsidiary firms in more than elapses between paying suppliers for materials and col-
one country. lecting cash from the subsequent sale of goods produced.
Multiplication rule for probabilities The rule that the joint
probability of events A and B equals the probability of A Net present value (NPV) The present value of an investment’s
given B times the probability of B. cash inflows (benefits) minus the present value of its cash
Multiplier models Valuation models based on share price outflows (costs).
multiples or enterprise value multiples.
Multivariate distribution A probability distribution that Net profit margin An indicator of profitability, calculated as
specifies the probabilities for a group of related random net income divided by revenue; indicates how much of
variables. each dollar of revenues is left after all costs and expenses.
Multivariate normal distribution A probability distribution Also called profit margin or return on sales.
for a group of random variables that is completely defined
by the means and variances of the variables plus all the Net realisable value Estimated selling price in the ordinary
correlations between pairs of the variables. course of business less the estimated costs necessary to
Muni A type of non-s overeign bond issued by a state or local make the sale.
government in the United States. It very often (but not
always) offers income tax exemptions. Net revenue Revenue after adjustments (e.g., for estimated
Municipal bonds A type of non-sovereign bond issued by a returns or for amounts unlikely to be collected).
state or local government in the United States. It very often
(but not always) offers income tax exemptions. Net tax rate The tax rate net of transfer payments.
Mutual fund A professionally managed investment pool in Neural networks Computer programs based on how our own
which investors in the fund typically each have a pro-r ata
claim on the income and value of the fund. brains learn and process information.
Mutually exclusive projects Mutually exclusive projects com- Neutral rate of interest The rate of interest that neither spurs
pete directly with each other. For example, if Projects A
and B are mutually exclusive, you can choose A or B, but on nor slows down the underlying economy.
you cannot choose both. New classical macroeconomics An approach to macroeco-
n Factorial For a positive integer n, the product of the first
n positive integers; 0 factorial equals 1 by definition. n nomics that seeks the macroeconomic conclusions of
factorial is written as n!. individuals maximizing utility on the basis of rational
Narrow money The notes and coins in circulation in an econ- expectations and companies maximizing profits.
omy, plus other very highly liquid deposits. New Keynesians A group of dynamic general equilibrium
Nash equilibrium When two or more participants in a non- models that assume slow-to-a djust prices and wages.
coop-erative game have no incentive to deviate from their No-load fund A mutual fund in which there is no fee for
respective equilibrium strategies given their opponent’s investing in the fund or for redeeming fund shares,
strategies. although there is an annual fee based on a percentage of
National income The income received by all factors of produc- the fund’s net asset value.
tion used in the generation of final output. National income Node Each value on a binomial tree from which successive
equals gross domestic product (or, in some countries, gross moves or outcomes branch.
national product) minus the capital consumption allowance Nominal GDP The value of goods and services measured at
and a statistical discrepancy. current prices.
Natural language processing Computer programs developed Nominal rate A rate of interest based on the security’s face
to analyze and interpret human language. value.
Natural rate of unemployment Effective unemployment rate, Nominal risk-free interest rate The sum of the real risk-free
below which pressure emerges in labor markets. interest rate and the inflation premium.
Nominal scale A measurement scale that categorizes data
but does not rank them.
Non-a ccelerating inflation rate of unemployment Effective
unemployment rate, below which pressure emerges in
labor markets.
Non-agency RMBS In the United States, securities issued
by private entities that are not guaranteed by a federal
agency or a GSE.
G-22 Glossary
Non-cumulative preference shares Preference shares for Notice period The length of time (typically 30 to 90 days) in
which dividends that are not paid in the current or subse- advance that investors may be required to notify a fund
quent periods are forfeited permanently (instead of being of their intent to redeem.
accrued and paid at a later date).
Notional principal An imputed principal amount.
Non-current assets Assets that are expected to benefit the NPV rule An investment decision rule that states that an
company over an extended period of time (usually more
than one year). investment should be undertaken if its NPV is positive
but not undertaken if its NPV is negative.
Non-current liabilities Obligations that broadly represent a Number of days of inventory An activity ratio equal to the
probable sacrifice of economic benefits in periods generally number of days in a period divided by the inventory ratio
greater than one year in the future. for the period; an indication of the number of days a com-
pany ties up funds in inventory.
Non-cyclical A company whose performance is largely inde- Number of days of payables An activity ratio equal to the
pendent of the business cycle. number of days in a period divided by the payables turnover
ratio for the period; an estimate of the average number of
Non-deliverable forwards Cash-settled forward contracts, days it takes a company to pay its suppliers.
used predominately with respect to foreign exchange for- Number of days of receivables Estimate of the average num-
wards. Also called contracts for differences. ber of days it takes to collect on credit accounts.
Objective probabilities Probabilities that generally do not
Non-financial risks Risks that arise from sources other than vary from person to person; includes a priori and objective
changes in the external financial markets, such as changes probabilities.
in accounting rules, legal environment, or tax rates. Off-the-run Seasoned government bonds are off-the-run
securities; they are not the most recently issued or the
Non-participating preference shares Preference shares that most actively traded.
do not entitle shareholders to share in the profits of the Offer The price at which a dealer or trader is willing to sell an
company. Instead, shareholders are only entitled to receive asset, typically qualified by a maximum quantity (ask size).
a fixed dividend payment and the par value of the shares Official interest rate An interest rate that a central bank sets
in the event of liquidation. and announces publicly; normally the rate at which it is
willing to lend money to the commercial banks. Also called
Non-recourse loan Loan in which the lender does not have a official policy rate or policy rate.
shortfall claim against the borrower, so the lender can look Official policy rate An interest rate that a central bank sets
only to the property to recover the outstanding mortgage and announces publicly; normally the rate at which it is
balance. willing to lend money to the commercial banks.
Oligopoly Market structure with a relatively small number
Non-renewable resources Finite resources that are depleted of firms supplying the market.
once they are consumed, such as oil and coal. On-the-run The most recently issued and most actively traded
sovereign securities.
Non-sovereign bonds A bond issued by a government below One-s ided hypothesis test A test in which the null hypothesis
the national level, such as a province, region, state, or city. is rejected only if the evidence indicates that the population
parameter is greater than (smaller than) θ0. The alternative
Non-sovereign government bonds A bond issued by a gov- hypothesis also has one side.
ernment below the national level, such as a province, One-tailed hypothesis test A test in which the null hypothesis
region, state, or city. is rejected only if the evidence indicates that the population
parameter is greater than (smaller than) θ0. The alternative
Nonconventional cash flow In a nonconventional cash flow hypothesis also has one side.
pattern, the initial outflow is not followed by inflows only, Open economy An economy that trades with other countries.
but the cash flows can flip from positive (inflows) to nega- Open-end fund A mutual fund that accepts new investment
tive (outflows) again (or even change signs several times). money and issues additional shares at a value equal to
the net asset value of the fund at the time of investment.
Nonparametric test A test that is not concerned with a Open interest The number of outstanding contracts in a
parameter, or that makes minimal assumptions about the clearinghouse at any given time. The open interest figure
population from which a sample comes. changes daily as some parties open up new positions, while
other parties offset their old positions.
Nonsystematic risk Unique risk that is local or limited to Open market operations The purchase or sale of bonds by
a particular asset or industry that need not affect assets the national central bank to implement monetary policy.
outside of that asset class. The bonds traded are usually sovereign bonds issued by
the national government.
Normal distribution A continuous, symmetric probability Operating activities Activities that are part of the day-t o-d ay
distribution that is completely described by its mean and business functioning of an entity, such as selling inventory
its variance. and providing services.
Operating breakeven The number of units produced and sold
Normal goods Goods that are consumed in greater quantities at which the company’s operating profit is zero (revenues
as income increases. = operating costs).
Operating cash flow The net amount of cash provided from
Normal profit The level of accounting profit needed to just operating activities.
cover the implicit opportunity costs ignored in accounting
costs.
Norms-based screening An ESG implementation approach
that excludes certain sectors or companies that deviate
from an investor’s accepted standards. Also called negative
screening or exclusionary screening.
Notching Ratings adjustment methodology where specific
issues from the same borrower may be assigned different
credit ratings.
Note rate See mortgage rate.
Notes payable Amounts owed by a business to creditors as
a result of borrowings that are evidenced by (short-term)
loan agreements.
Glossary G-23
Operating cycle A measure of the time needed to convert raw Other comprehensive income Items of comprehensive
materials into cash from a sale; it consists of the number income that are not reported on the income statement;
of days of inventory and the number of days of receivables. comprehensive income minus net income.
Operating efficiency ratios Ratios that measure how effi- Out-of-sample test A test of a strategy or model using a
ciently a company performs day-to-d ay tasks, such as the sample outside the time period on which the strategy or
collection of receivables and management of inventory. model was developed.
Operating lease An agreement allowing the lessee to use some Out of the money Options that, if exercised, would require
asset for a period of time; essentially a rental. the payment of more money than the value received and
therefore would not be currently exercised.
Operating leverage The use of fixed costs in operations.
Operating profit A company’s profits on its usual business Outcome A possible value of a random variable.
Over-the-counter (OTC) markets A decentralized market
activities before deducting taxes. Also called operating
income. where buy and sell orders initiated from various locations
Operating profit margin A profitability ratio calculated as are matched through a communications network.
operating income (i.e., income before interest and taxes) Overbought A market condition in which market sentiment
divided by revenue. Also called operating margin. is thought to be unsustainably bullish.
Operating risk The risk attributed to the operating cost struc- Overcollateralization Form of internal credit enhancement
ture, in particular the use of fixed costs in operations; the that refers to the process of posting more collateral than
risk arising from the mix of fixed and variable costs; the needed to obtain or secure financing.
risk that a company’s operations may be severely affected Overfitting An undesirable result from fitting a model so
by environmental, social, and governance risk factors. closely to a dataset that it does not perform well on new
Operational independence A bank’s ability to execute mon- data.
etary policy and set interest rates in the way it thought Oversold A market condition in which market sentiment is
would best meet the inflation target. thought to be unsustainably bearish.
Operational risk The risk of loss from failures in a company’s Own price The price of a good or service itself (as opposed
systems and procedures. to the price of something else).
Operationally efficient Said of a market, a financial system, Own-price elasticity of demand The percentage change in
or an economy that has relatively low transaction costs. quantity demanded for a percentage change in good’s own
Opportunity cost The value that investors forgo by choosing price, holding all other things constant.
a particular course of action; the value of something in its Owners’ equity The excess of assets over liabilities; the resid-
best alternative use. ual interest of shareholders in the assets of an entity after
Option A financial instrument that gives one party the right, deducting the entity’s liabilities. Also called shareholders’
but not the obligation, to buy or sell an underlying asset equity.
from or to another party at a fixed price over a specific Paasche index An index formula using the current compo-
period of time. Also referred to as contingent claim or sition of a basket of products.
option contract. Paired comparisons test A statistical test for differences
Option-adjusted price The value of the embedded option based on paired observations drawn from samples that
plus the flat price of the bond. are dependent on each other.
Option-adjusted spread OAS = Z-spread – Option value (in Paired observations Observations that are dependent on
basis points per year). each other.
Option-adjusted yield The required market discount rate Pairs arbitrage trade A trade in two closely related stocks
whereby the price is adjusted for the value of the embed- involving the short sale of one and the purchase of the
ded option. other.
Option contract See option. Panel data Observations through time on a single character-
Option premium The amount of money a buyer pays and istic of multiple observational units.
seller receives to engage in an option transaction. Par curve A sequence of yields-to-m aturity such that each
Order A specification of what instrument to trade, how much bond is priced at par value. The bonds are assumed to
to trade, and whether to buy or sell. have the same currency, credit risk, liquidity, tax status,
Order-driven markets A market (generally an auction market) and annual yields stated for the same periodicity.
that uses rules to arrange trades based on the orders that Par value The amount of principal on a bond.
traders submit; in their pure form, such markets do not Parallel shift A parallel yield curve shift implies that all rates
make use of dealers. change by the same amount in the same direction.
Order precedence hierarchy With respect to the execution Parameter A descriptive measure computed from or used to
of orders to trade, a set of rules that determines which describe a population of data, conventionally represented
orders execute before other orders. by Greek letters.
Ordinal scale A measurement scale that sorts data into cat- Parametric test Any test (or procedure) concerned with
egories that are ordered (ranked) with respect to some parameters or whose validity depends on assumptions
characteristic. concerning the population generating the sample.
Ordinary annuity An annuity with a first cash flow that is Pari passu On an equal footing.
paid one period from the present. Partial duration See key rate duration.
Ordinary shares Equity shares that are subordinate to all Participating preference shares Preference shares that entitle
other types of equity (e.g., preferred equity). Also called shareholders to receive the standard preferred dividend
common stock or common shares. plus the opportunity to receive an additional dividend if
Organized exchange A securities marketplace where buyers the company’s profits exceed a pre-s pecified level.
and seller can meet to arrange their trades.
G-24 Glossary
Pass-through rate The coupon rate of a mortgage pass- Permissioned networks Networks that are fully open only
through security. to select participants on a DLT network.
Passive investment A buy and hold approach in which Permissionless networks Networks that are fully open to any
an investor does not make portfolio changes based on user on a DLT network.
short-term expectations of changing market or security
performance. Permutation An ordered listing.
Perpetual bonds Bonds with no stated maturity date.
Passive strategy In reference to short-term cash management, Perpetuity A perpetual annuity, or a set of never-ending level
it is an investment strategy characterized by simple decision
rules for making daily investments. sequential cash flows, with the first cash flow occurring one
period from now. A bond that does not mature.
Payable date The day that the company actually mails out (or Personal consumption expenditures All domestic personal
electronically transfers) a dividend payment. consumption; the basis for a price index for such consump-
tion called the PCE price index.
Payment date The day that the company actually mails out Personal disposable income Equal to personal income less
(or electronically transfers) a dividend payment. personal taxes.
Personal income A broad measure of household income
Payments system The system for the transfer of money. that includes all income received by households, whether
Peak The highest point of a business cycle. earned or unearned; measures the ability of consumers to
Peer group A group of companies engaged in similar business make purchases.
Plain vanilla bond Bond that makes periodic, fixed coupon
activities whose economics and valuation are influenced payments during the bond’s life and a lump-sum payment
by closely related factors. of principal at maturity. Also called conventional bond.
Pennants A technical analysis continuation pattern formed Platykurtic Describes a distribution that has relatively less
by trendlines that converge to form a triangle, typically weight in the tails than the normal distribution.
over a short period. Point and figure chart A technical analysis chart that is con-
Per capita real GDP Real GDP divided by the size of the pop- structed with columns of X’s alternating with columns of
ulation, often used as a measure of the average standard O’s such that the horizontal axis represents only the num-
of living in a country. ber of changes in price without reference to time or volume.
Per unit contribution margin The amount that each unit sold Point estimate A single numerical estimate of an unknown
contributes to covering fixed costs—that is, the difference quantity, such as a population parameter.
between the price per unit and the variable cost per unit. Point of sale (POS) Systems that capture transaction data at
Percentage-of-completion A method of revenue recogni- the physical location in which the sale is made.
tion in which, in each accounting period, the company Policy rate An interest rate that a central bank sets and
estimates what percentage of the contract is complete and announces publicly; normally the rate at which it is willing
then reports that percentage of the total contract revenue to lend money to the commercial banks.
in its income statement. Population All members of a specified group.
Percentiles Quantiles that divide a distribution into 100 equal Population mean The arithmetic mean value of a population;
parts. the arithmetic mean of all the observations or values in
Perfect competition A market structure in which the individ- the population.
ual firm has virtually no impact on market price, because Population standard deviation A measure of dispersion
it is assumed to be a very small seller among a very large relating to a population in the same unit of measurement
number of firms selling essentially identical products. as the observations, calculated as the positive square root
Perfectly elastic When the quantity demanded or supplied of of the population variance.
a given good is infinitely sensitive to a change in the value Population variance A measure of dispersion relating to a
of a specified variable (e.g., price). population, calculated as the mean of the squared devia-
Perfectly inelastic When the quantity demanded or supplied tions around the population mean.
of a given good is completely insensitive to a change in the Portfolio company In private equity, the company in which
value of a specified variable (e.g., price). the private equity fund is investing.
Performance appraisal The evaluation of risk-a djusted per- Portfolio demand for money The demand to hold specula-
formance; the evaluation of investment skill. tive money balances based on the potential opportunities
Performance bond See margin bond. or risks that are inherent in other financial instruments.
Performance evaluation The measurement and assessment Portfolio planning The process of creating a plan for building
of the outcomes of investment management decisions. a portfolio that is expected to satisfy a client’s investment
Performance fee Fees paid to the general partner from the objectives.
limited partner(s) based on realized profits. Position The quantity of an asset that an entity owns or owes.
Performance measurement The calculation of returns in a Positive screening An ESG implementation approach that
logical and consistent manner. seeks to identify companies that embrace desired ESG-
Period costs Costs (e.g., executives’ salaries) that cannot be related principles.
directly matched with the timing of revenues and which Posterior probability An updated probability that reflects or
are thus expensed immediately. comes after new information.
Periodicity The assumed number of periods in the year, typ- Potential GDP The level of real GDP that can be produced
ically matches the frequency of coupon payments. at full employment; measures the productive capacity of
Permanent differences Differences between tax and financial the economy.
reporting of revenue (expenses) that will not be reversed Power of a test The probability of correctly rejecting the
at some future date. These result in a difference between null—that is, rejecting the null hypothesis when it is false.
the company’s effective tax rate and statutory tax rate and
do not result in a deferred tax item.
Glossary G-25
Precautionary money balances Money held to provide a Price to book value A valuation ratio calculated as price per
buffer against unforeseen events that might require money. share divided by book value per share.
Precautionary stocks A level of inventory beyond anticipated Price to cash flow A valuation ratio calculated as price per
needs that provides a cushion in the event that it takes share divided by cash flow per share.
longer to replenish inventory than expected or in the case
of greater than expected demand. Price to earnings ratio (P/E ratio or P/E) The ratio of share
price to earnings per share.
Preference shares A type of equity interest which ranks above
common shares with respect to the payment of dividends Price to sales A valuation ratio calculated as price per share
and the distribution of the company’s net assets upon divided by sales per share.
liquidation. They have characteristics of both debt and
equity securities. Also called preferred stock. Price value of a basis point A version of money duration, it is
an estimate of the change in the full price of a bond given
Preferred stock See preference shares. a 1 basis point change in the yield-to-m aturity.
Premium In the case of bonds, premium refers to the amount
Price weighting An index weighting method in which the
by which a bond is priced above its face (par) value. In the weight assigned to each constituent security is determined
case of an option, the amount paid for the option contract. by dividing its price by the sum of all the prices of the
Prepaid expense A normal operating expense that has been constituent securities.
paid in advance of when it is due.
Prepayment option Contractual provision that entitles the Priced risk Risk for which investors demand compensation
borrower to prepay all or part of the outstanding mortgage for bearing (e.g. equity risk, company-specific factors,
principal prior to the scheduled due date when the prin- macroeconomic factors).
cipal must be repaid. Also called early repayment option.
Prepayment penalty mortgages Mortgages that stipulate a Primary bond markets Markets in which issuers first sell
monetary penalty if a borrower prepays within a certain bonds to investors to raise capital.
time period after the mortgage is originated.
Prepayment risk The uncertainty that the timing of the actual Primary capital markets (primary markets) The market
cash flows will be different from the scheduled cash flows where securities are first sold and the issuers receive the
as set forth in the loan agreement due to the borrowers’ proceeds.
ability to alter payments, usually to take advantage of
interest rate movements. Primary dealers Financial institutions that are authorized
Present value (PV) The present discounted value of future to deal in new issues of sovereign bonds and that serve
cash flows: For assets, the present discounted value of primarily as trading counterparties of the office responsible
the future net cash inflows that the asset is expected to for issuing sovereign bonds.
generate; for liabilities, the present discounted value of the
future net cash outflows that are expected to be required Primary market The market where securities are first sold
to settle the liabilities. and the issuers receive the proceeds.
Present value models Valuation models that estimate the
intrinsic value of a security as the present value of the Prime brokers Brokers that provide services including custody,
future benefits expected to be received from the security. administration, lending, short borrowing, and trading.
Also called discounted cash flow models.
Pretax margin A profitability ratio calculated as earnings Principal The amount of funds originally invested in a project
before taxes divided by revenue. or instrument; the face value to be paid at maturity.
Price elasticity of demand Measures the percentage change
in the quantity demanded, given a percentage change in Principal–agent relationship A relationship in which a prin-
the price of a given product. cipal hires an agent to perform a particular task or service;
Price index Represents the average prices of a basket of goods also known as an agency relationship.
and services.
Price limits Limits imposed by a futures exchange on the price Principal amount Amount that an issuer agrees to repay the
change that can occur from one day to the next. debt holders on the maturity date.
Price multiple A ratio that compares the share price with
some sort of monetary flow or value to allow evaluation Principal business activity The business activity from which a
of the relative worth of a company’s stock. company derives a majority of its revenues and/or earnings.
Price priority The principle that the highest priced buy orders
and the lowest priced sell orders execute first. Principal value Amount that an issuer agrees to repay the
Price relative A ratio of an ending price over a beginning price; debt holders on the maturity date.
it is equal to 1 plus the holding period return on the asset.
Price return Measures only the price appreciation or percent- Principle of no arbitrage See arbitrage-free pricing.
age change in price of the securities in an index or portfolio. Prior probabilities Probabilities reflecting beliefs prior to the
Price return index An index that reflects only the price appre-
ciation or percentage change in price of the constituent arrival of new information.
securities. Also called price index. Priority of claims Priority of payment, with the most senior
Price stability In economics, refers to an inflation rate that is
low on average and not subject to wide fluctuation. or highest ranking debt having the first claim on the cash
Price takers Producers that must accept whatever price the flows and assets of the issuer.
market dictates. Private equity securities Securities that are not listed on
public exchanges and have no active secondary market.
They are issued primarily to institutional investors via
non-p ublic offerings, such as private placements.
Private investment in public equity An investment in the
equity of a publicly traded firm that is made at a discount
to the market value of the firm’s shares.
Private placement Typically a non-underwritten, unregis-
tered offering of securities that are sold only to an inves-
tor or a small group of investors. It can be accomplished
directly between the issuer and the investor(s) or through
an investment bank.
Probability A number between 0 and 1 describing the chance
that a stated event will occur.
G-26 Glossary
Probability density function A function with non-n egative Put An option that gives the holder the right to sell an under-
values such that probability can be described by areas lying asset to another party at a fixed price over a specific
under the curve graphing the function. period of time.
Probability distribution A distribution that specifies the Put–call–forward parity The relationship among puts, calls,
probabilities of a random variable’s possible outcomes. and forward contracts.
Probability function A function that specifies the probability Put–call parity An equation expressing the equivalence (par-
that the random variable takes on a specific value. ity) of a portfolio of a call and a bond with a portfolio of
a put and the underlying, which leads to the relationship
Producer price index Reflects the price changes experienced between put and call prices.
by domestic producers in a country.
Put/call ratio A technical analysis indicator that evaluates
Production function Provides the quantitative link between market sentiment based upon the volume of put options
the level of output that the economy can produce and the traded divided by the volume of call options traded for a
inputs used in the production process. particular financial instrument.
Productivity The amount of output produced by workers Put option An option that gives the holder the right to sell
in a given period of time—for example, output per hour an underlying asset to another party at a fixed price over
worked; measures the efficiency of labor. a specific period of time.
Profit The return that owners of a company receive for the use Putable bonds Bonds that give the bondholder the right to
of their capital and the assumption of financial risk when sell the bond back to the issuer at a predetermined price
making their investments. on specified dates.
Profit and loss (P&L) statement A financial statement that Putable common shares Common shares that give investors
provides information about a company’s profitability over the option (or right) to sell their shares (i.e., “put” them)
a stated period of time. back to the issuing company at a price that is specified
when the shares are originally issued.
Profit margin An indicator of profitability, calculated as net
income divided by revenue; indicates how much of each Quantile A value at or below which a stated fraction of the
dollar of revenues is left after all costs and expenses. data lies. Also called fractile.
Profitability ratios Ratios that measure a company’s ability Quantitative easing An expansionary monetary policy based
to generate profitable sales from its resources (assets). on aggressive open market purchase operations.
Project sequencing To defer the decision to invest in a future Quantity equation of exchange An expression that over
project until the outcome of some or all of a current a given period, the amount of money used to purchase
project is known. Projects are sequenced through time, all goods and services in an economy, M × V, is equal to
so that investing in a project creates the option to invest monetary value of this output, P × Y.
in future projects.
Quantity theory of money Asserts that total spending (in
Promissory note A written promise to pay a certain amount money terms) is proportional to the quantity of money.
of money on demand.
Quartiles Quantiles that divide a distribution into four equal
Property, plant, and equipment Tangible assets that are parts.
expected to be used for more than one period in either the
production or supply of goods or services, or for admin- Quasi-fixed cost A cost that stays the same over a range of
istrative purposes. production but can change to another constant level when
production moves outside of that range.
Prospectus The document that describes the terms of a new
bond issue and helps investors perform their analysis on Quasi-government bonds A bond issued by an entity that
the issue. is either owned or sponsored by a national government.
Also called agency bond.
Protective put An option strategy in which a long position in
an asset is combined with a long position in a put. Quick assets Assets that can be most readily converted to cash
(e.g., cash, short-term marketable investments, receivables).
Proxy contest Corporate takeover mechanism in which
shareholders are persuaded to vote for a group seeking Quick ratio A stringent measure of liquidity that indicates a
a controlling position on a company’s board of directors. company’s ability to satisfy current liabilities with its most
liquid assets, calculated as (cash + short-t erm marketable
Proxy voting A process that enables shareholders who are investments + receivables) divided by current liabilities.
unable to attend a meeting to authorize another individual
to vote on their behalf. Quintiles Quantiles that divide a distribution into five equal
parts.
Pseudo-random numbers Numbers produced by random
number generators. Quota rents Profits that foreign producers can earn by raising
the price of their goods higher than they would without
Public offer See public offering. a quota.
Public offering An offering of securities in which any member
Quotas Government policies that restrict the quantity of a
of the public may buy the securities. Also called public offer. good that can be imported into a country, generally for a
Pull on liquidity When disbursements are paid too quickly specified period of time.
or trade credit availability is limited, requiring companies Quote-driven market A market in which dealers acting as
to expend funds before they receive funds from sales that principals facilitate trading.
could cover the liability.
Pure discount bonds See zero-coupon bonds. Quoted interest rate A quoted interest rate that does not
Pure discount instruments Instruments that pay interest account for compounding within the year. Also called
as the difference between the amount borrowed and the stated annual interest rate.
amount paid back.
Pure-play method A method for estimating the beta for a Quoted margin The specified yield spread over the reference
company or project; it requires using a comparable compa- rate, used to compensate an investor for the difference
ny’s beta and adjusting it for financial leverage differences. in the credit risk of the issuer and that implied by the
reference rate.
Glossary G-27
Random number An observation drawn from a uniform Renewable resources Resources that can be replenished,
distribution. such as a forest.
Random number generator An algorithm that produces Rent Payment for the use of property.
uniformly distributed random numbers between 0 and 1. Reorganization Agreements made by a company in bank-
Random variable A quantity whose future outcomes are ruptcy under which a company’s capital structure is altered
uncertain. and/or alternative arrangements are made for debt repay-
ment; US Chapter 11 bankruptcy. The company emerges
Range The difference between the maximum and minimum from bankruptcy as a going concern.
values in a dataset. Replication The creation of an asset or portfolio from another
asset, portfolio, and/or derivative.
Ratio scales A measurement scale that has all the character- Repo A form of collateralized loan involving the sale of a
istics of interval measurement scales as well as a true zero security with a simultaneous agreement by the seller to
point as the origin. buy the same security back from the purchaser at an
agreed-o n price and future date. The party who sells the
Real GDP The value of goods and services produced, measured security at the inception of the repurchase agreement and
at base year prices. buys it back at maturity is borrowing money from the other
party, and the security sold and subsequently repurchased
Real income Income adjusted for the effect of inflation on the represents the collateral.
purchasing power of money. Also known as the purchasing Repo margin The difference between the market value of the
power of income. If income remains constant and a good’s security used as collateral and the value of the loan. Also
price falls, real income is said to rise, even though the num- called haircut.
ber of monetary units (e.g., dollars) remains unchanged. Repo rate The interest rate on a repurchase agreement.
Repurchase agreement A form of collateralized loan involv-
Real interest rate Nominal interest rate minus the expected ing the sale of a security with a simultaneous agreement by
rate of inflation. the seller to buy the same security back from the purchaser
at an agreed-o n price and future date. The party who sells
Real risk-f ree interest rate The single-period interest rate for the security at the inception of the repurchase agreement
a completely risk-free security if no inflation were expected. and buys it back at maturity is borrowing money from
the other party, and the security sold and subsequently
Realizable (settlement) value With reference to assets, the repurchased represents the collateral.
amount of cash or cash equivalents that could currently Repurchase date The date when the party who sold the secu-
be obtained by selling the asset in an orderly disposal; rity at the inception of a repurchase agreement buys the
with reference to liabilities, the undiscounted amount of security back from the cash lending counterparty.
cash or cash equivalents expected to be paid to satisfy the Repurchase price The price at which the party who sold the
liabilities in the normal course of business. security at the inception of the repurchase agreement
buys the security back from the cash lending counterparty.
Rebalancing Adjusting the weights of the constituent secu- Required margin The yield spread over, or under, the ref-
rities in an index. erence rate such that an FRN is priced at par value on a
rate reset date.
Rebalancing policy The set of rules that guide the process of Required rate of return See market discount rate.
restoring a portfolio’s asset class weights to those specified Required yield See market discount rate.
in the strategic asset allocation. Required yield spread The difference between the yield-to-
maturity on a new bond and the benchmark rate; additional
Recession A period during which real GDP decreases (i.e., compensation required by investors for the difference in
negative growth) for at least two successive quarters, or risk and tax status of a bond relative to a government bond.
a period of significant decline in total output, income, Sometimes called the spread over the benchmark.
employment, and sales usually lasting from six months Reserve accounts Form of internal credit enhancement that
to a year. relies on creating accounts and depositing in these accounts
cash that can be used to absorb losses. Also called reserve
Recognition lag The lag in government response to an eco- funds.
nomic problem resulting from the delay in confirming a Reserve funds See reserve accounts.
change in the state of the economy. Reserve requirement The requirement for banks to hold
reserves in proportion to the size of deposits.
Recourse loan Loan in which the lender has a claim against Resistance In technical analysis, a price range in which selling
the borrower for any shortfall between the outstanding activity is sufficient to stop the rise in the price of a security.
mortgage balance and the proceeds received from the Responsible investing The practice of identifying companies
sale of the property. that can efficiently manage their financial, environmental,
and human capital resoruces to generate attractive long-
Redemption yield See yield to maturity. term profitability; often synonymous with sustainable
Redemptions Withdrawals of funds by investors. investing.
Refinancing rate A type of central bank policy rate. Restricted payments A bond covenant meant to protect
Registered bonds Bonds for which ownership is recorded by creditors by limiting how much cash can be paid out to
shareholders over time.
either name or serial number.
Relative dispersion The amount of dispersion relative to a
reference value or benchmark.
Relative frequency With reference to an interval of grouped
data, the number of observations in the interval divided by
the total number of observations in the sample.
Relative price The price of a specific good or service in com-
parison with those of other goods and services.
Relative strength analysis A comparison of the performance
of one asset with the performance of another asset or a
benchmark based on changes in the ratio of the securities’
respective prices over time.
Relative strength index A technical analysis momentum
oscillator that compares a security’s gains with its losses
over a set period.
G-28 Glossary
Retail method An inventory accounting method in which Risk management The process of identifying the level of
the sales value of an item is reduced by the gross margin risk an entity wants, measuring the level of risk the entity
to calculate the item’s cost. currently has, taking actions that bring the actual level of
risk to the desired level of risk, and monitoring the new
Retracement In technical analysis, a reversal in the movement actual level of risk so that it continues to be aligned with
of a security’s price such that it is counter to the prevailing the desired level of risk.
longerterm price trend.
Risk management framework The infrastructure, process,
Return-generating model A model that can provide an esti- and analytics needed to support effective risk management
mate of the expected return of a security given certain in an organization.
parameters and estimates of the values of the independent
variables in the model. Risk-neutral pricing Sometimes said of derivatives pricing,
uses the fact that arbitrage opportunities guarantee that
Return on assets (ROA) A profitability ratio calculated as net a risk-free portfolio consisting of the underlying and the
income divided by average total assets; indicates a compa- derivative must earn the risk-free rate.
ny’s net profit generated per dollar invested in total assets.
Risk-neutral probabilities Weights that are used to compute
Return on equity (ROE) A profitability ratio calculated as net a binomial option price. They are the probabilities that
income divided by average shareholders’ equity. would apply if a risk-n eutral investor valued an option.
Return on sales An indicator of profitability, calculated as Risk premium An extra return expected by investors for
net income divided by revenue; indicates how much of bearing some specified risk.
each dollar of revenues is left after all costs and expenses.
Risk shifting Actions to change the distribution of risk
Return on total capital A profitability ratio calculated as EBIT outcomes.
divided by the sum of short- and long-t erm debt and equity.
Risk tolerance The amount of risk an investor is willing and
Revaluation model The process of valuing long-lived assets at able to bear to achieve an investment goal.
fair value, rather than at cost less accumulated depreciation.
Any resulting profit or loss is either reported on the income Risk transfer Actions to pass on a risk to another party, often,
statement and/or through equity under revaluation surplus. but not always, in the form of an insurance policy.
Revenue The amount charged for the delivery of goods or Robo-adviser A machine-b ased analytical tool or service that
services in the ordinary activities of a business over a stated provides technology-driven investment solutions through
period; the inflows of economic resources to a company online platforms.
over a stated period.
Robust The quality of being relatively unaffected by a violation
Reversal patterns A type of pattern used in technical analysis of assumptions.
to predict the end of a trend and a change in direction of
the security’s price. Rule of 72 The principle that the approximate number of years
necessary for an investment to double is 72 divided by the
Reverse repo A repurchase agreement viewed from the per- stated interest rate.
spective of the cash lending counterparty.
Running yield See current yield.
Reverse repurchase agreement A repurchase agree- Safety-first rules Rules for portfolio selection that focus on
ment viewed from the perspective of the cash lending
counterparty. the risk that portfolio value will fall below some minimum
acceptable level over some time horizon.
Reverse stock split A reduction in the number of shares Safety stock A level of inventory beyond anticipated needs
outstanding with a corresponding increase in share price, that provides a cushion in the event that it takes longer to
but no change to the company’s underlying fundamentals. replenish inventory than expected or in the case of greater
than expected demand.
Revolving credit agreements The strongest form of short- Sales Generally, a synonym for revenue; “sales” is generally
term bank borrowing facilities; they are in effect for multi- understood to refer to the sale of goods, whereas “revenue”
ple years (e.g., 3–5 years) and may have optional medium- is understood to include the sale of goods or services.
term loan features. Sales risk Uncertainty with respect to the quantity of goods
and services that a company is able to sell and the price
Rho The sensitivity of the option price to the risk-free rate. it is able to achieve; the risk related to the uncertainty of
Ricardian equivalence An economic theory that implies that revenues.
Sales-type leases A type of finance lease, from a lessor per-
it makes no difference whether a government finances a spective, where the present value of the lease payments
deficit by increasing taxes or issuing debt. (lease receivable) exceeds the carrying value of the leased
Risk Exposure to uncertainty. The chance of a loss or adverse asset. The revenues earned by the lessor are operating
outcome as a result of an action, inaction, or external event. (the profit on the sale) and financing (interest) in nature.
Risk averse The assumption that an investor will choose the Sample A subset of a population.
least risky alternative. Sample excess kurtosis A sample measure of the degree of
Risk aversion The degree of an investor’s inability and unwill- a distribution’s kurtosis in excess of the normal distribu-
ingness to take risk. tion’s kurtosis.
Risk budgeting The establishment of objectives for individ- Sample kurtosis A sample measure of the degree of a distri-
uals, groups, or divisions of an organization that takes bution’s peakedness.
into account the allocation of an acceptable level of risk. Sample mean The sum of the sample observations, divided
Risk exposure The state of being exposed or vulnerable to a by the sample size.
risk. The extent to which an entity is sensitive to under-
lying risks.
Risk governance The top-d own process and guidance that
directs risk management activities to align with and support
the overall enterprise.
Glossary G-29
Sample selection bias Bias introduced by systematically Securitization A process that involves moving assets into a
excluding some members of the population according to special legal entity, which then uses the assets as guarantees
a particular attribute—for example, the bias introduced to secure a bond issue.
when data availability leads to certain observations being
excluded from the analysis. Securitized assets Assets that are typically used to create
asset-b acked bonds; for example, when a bank securitizes
Sample skewness A sample measure of degree of asymmetry a pool of loans, the loans are said to be securitized.
of a distribution.
Security characteristic line A plot of the excess return of a
Sample standard deviation The positive square root of the security on the excess return of the market.
sample variance.
Security market index A portfolio of securities representing
Sample statistic A quantity computed from or used to a given security market, market segment, or asset class.
describe a sample.
Security market line (SML) The graph of the capital asset
Sample variance A sample measure of the degree of dis- pricing model.
persion of a distribution, calculated by dividing the sum
of the squared deviations from the sample mean by the Security selection The process of selecting individual secu-
sample size minus 1. rities; typically, security selection has the objective of
generating superior risk-adjusted returns relative to a
Sampling The process of obtaining a sample. portfolio’s benchmark.
Sampling distribution The distribution of all distinct possible
Self-investment limits With respect to investment limitations
values that a statistic can assume when computed from applying to pension plans, restrictions on the percentage
samples of the same size randomly drawn from the same of assets that can be invested in securities issued by the
population. pension plan sponsor.
Sampling error The difference between the observed value
of a statistic and the quantity it is intended to estimate. Sell-side firm A broker or dealer that sells securities to and
Sampling plan The set of rules used to select a sample. provides independent investment research and recommen-
Say on pay A process whereby shareholders may vote on dations to investment management companies.
executive remuneration (compensation) matters.
Say’s law Named for French economist J.B. Say: All that is pro- Semi-strong-form efficient market A market in which
duced will be sold because supply creates its own demand. security prices reflect all publicly known and available
Scenario analysis Analysis that shows the changes in key information.
financial quantities that result from given (economic)
events, such as the loss of customers, the loss of a sup- Semiannual bond basis yield An annual rate having a peri-
ply source, or a catastrophic event; a risk management odicity of two; also known as a semiannual bond equiv-
technique involving examination of the performance of alent yield.
a portfolio under specified situations. Closely related to
stress testing. Semiannual bond equivalent yield See semiannual bond
Screening The application of a set of criteria to reduce a set basis yield.
of potential investments to a smaller set having certain
desired characteristics. Semideviation The positive square root of semivariance
Seasoned offering An offering in which an issuer sells addi- (sometimes called semistandard deviation).
tional units of a previously issued security.
Second-d egree price discrimination When the monopolist Semilogarithmic Describes a scale constructed so that equal
charges different per-u nit prices using the quantity pur- intervals on the vertical scale represent equal rates of
chased as an indicator of how highly the customer values change, and equal intervals on the horizontal scale repre-
the product. sent equal amounts of change.
Second lien A secured interest in the pledged assets that
ranks below first lien debt in both collateral protection Semivariance The average squared deviation below the mean.
and priority of payment. Seniority ranking Priority of payment of various debt
Secondary bond markets Markets in which existing bonds
are traded among investors. obligations.
Secondary market The market where securities are traded Sensitivity analysis Analysis that shows the range of possible
among investors.
Secondary precedence rules Rules that determine how to outcomes as specific assumptions are changed.
rank orders placed at the same time. Separately managed account (SMA) An investment port-
Sector A group of related industries.
Sector indexes Indexes that represent and track different eco- folio managed exclusively for the benefit of an individual
nomic sectors—such as consumer goods, energy, finance, or institution.
health care, and technology—on either a national, regional, Serial maturity structure Structure for a bond issue in which
or global basis. the maturity dates are spread out during the bond’s life; a
Secured bonds Bonds secured by assets or financial guaran- stated number of bonds mature and are paid off each year
tees pledged to ensure debt repayment in case of default. before final maturity.
Secured debt Debt in which the debtholder has a direct Settlement The process that occurs after a trade is completed,
claim—a pledge from the issuer—on certain assets and the securities are passed to the buyer, and payment is
their associated cash flows. received by the seller.
Settlement date Date when the buyer makes cash payment
and the seller delivers the security.
Settlement price The official price, designated by the clearing-
house, from which daily gains and losses will be determined
and marked to market.
Share repurchase A transaction in which a company buys
back its own shares. Unlike stock dividends and stock
splits, share repurchases use corporate cash.
Shareholder activism Strategies used by shareholders to
attempt to compel a company to act in a desired manner.
Shareholder engagement The process whereby companies
engage with their shareholders.
G-30 Glossary
Shareholders’ equity Assets less liabilities; the residual inter- Solvency risk The risk that an entity does not survive or
est in the assets after subtracting the liabilities. succeed because it runs out of cash, even though it might
otherwise be solvent.
Sharpe ratio The average return in excess of the risk-free rate
divided by the standard deviation of return; a measure Sovereign bonds A bond issued by a national government.
of the average excess return earned per unit of standard Sovereign yield spread An estimate of the country spread
deviation of return.
(country equity premium) for a developing nation that is
Shelf registration Type of public offering that allows the based on a comparison of bonds yields in country being
issuer to file a single, all-e ncompassing offering circular analyzed and a developed country. The sovereign yield
that covers a series of bond issues. spread is the difference between a government bond yield
in the country being analyzed, denominated in the currency
Short The seller of an asset or derivative contract. Also refers to of the developed country, and the Treasury bond yield on
the position of being short an asset or derivative contract. a similar maturity bond in the developed country.
Sovereigns A bond issued by a national government.
Short position A position in an asset or contract in which Spearman rank correlation coefficient A measure of cor-
one has sold an asset one does not own, or in which a relation applied to ranked data.
right under a contract can be exercised against oneself. Special dividend A dividend paid by a company that does
not pay dividends on a regular schedule, or a dividend that
Short-r un average total cost The curve describing average supplements regular cash dividends with an extra payment.
total cost when some costs are considered fixed. Special purpose entity A non-o perating entity created to
carry out a specified purpose, such as leasing assets or
Short selling A transaction in which borrowed securities are securitizing receivables; can be a corporation, partnership,
sold with the intention to repurchase them at a lower price trust, limited liability, or partnership formed to facilitate a
at a later date and return them to the lender. specific type of business activity. Also called special purpose
vehicle or variable interest entity.
Shortfall risk The risk that portfolio value will fall below Special purpose vehicle See special purpose entity.
some minimum acceptable level over some time horizon. Specific identification method An inventory accounting
method that identifies which specific inventory items were
Shutdown point The point at which average revenue is equal sold and which remained in inventory to be carried over
to the firm’s average variable cost. to later periods.
Speculative demand for money The demand to hold specu-
Simple interest The interest earned each period on the orig- lative money balances based on the potential opportunities
inal investment; interest calculated on the principal only. or risks that are inherent in other financial instruments.
Also called portfolio demand for money.
Simple random sample A subset of a larger population cre- Speculative money balances Monies held in anticipation
ated in such a way that each element of the population that other assets will decline in value.
has an equal probability of being selected to the subset. Split coupon bond See deferred coupon bond.
Sponsored A type of depository receipt in which the foreign
Simple random sampling The procedure of drawing a sample company whose shares are held by the depository has a
to satisfy the definition of a simple random sample. direct involvement in the issuance of the receipts.
Spot curve A sequence of yields-to-m aturity on zero-c oupon
Simple yield The sum of the coupon payments plus the bonds. Sometimes called zero or strip curve because coupon
straight-line amortized share of the gain or loss, divided payments are “stripped” off of the bonds.
by the flat price. Spot markets Markets in which assets are traded for imme-
diate delivery.
Simulation Computer-g enerated sensitivity or scenario anal- Spot prices The price of an asset for immediately delivery.
ysis that is based on probability models for the factors that Spot rates A sequence of market discount rates that cor-
drive outcomes. respond to the cash flow dates; yields-to-maturity on
zero-coupon bonds maturing at the date of each cash flow.
Simulation trial A complete pass through the steps of a Spread In general, the difference in yield between different
simulation. fixed income securities. Often used to refer to the differ-
ence between the yield-to-m aturity and the benchmark.
Single-step format With respect to the format of the income Spread over the benchmark See required yield spread.
statement, a format that does not subtotal for gross profit Spread risk Bond price risk arising from changes in the yield
(revenue minus cost of goods sold). spread on credit-r isky bonds; reflects changes in the mar-
ket’s assessment and/or pricing of credit migration (or
Sinking fund arrangement Provision that reduces the credit downgrade) risk and market liquidity risk.
risk of a bond issue by requiring the issuer to retire a por- Stackelberg model A prominent model of strategic deci-
tion of the bond’s principal outstanding each year. sionmaking in which firms are assumed to make their
decisions sequentially.
Situational influences External factors, such as environmental Stagflation When a high inflation rate is combined with a high
or cultural elements, that shape our behavior. level of unemployment and a slowdown of the economy.
Staggered boards Election process whereby directors are
Skewed Not symmetrical. typically divided into multiple classes that are elected sep-
Skewness A quantitative measure of skew (lack of symmetry); arately in consecutive years—that is, one class every year.
a synonym of skew.
Small country A country that is a price taker in the world
market for a product and cannot influence the world
market price.
Smart contract A computer program that is designed to self-
execute on the basis of pre-specified terms and conditions
agreed to by parties to a contract.
Socially responsible investing An investment approach that
excludes investments in companies or industries that devi-
ate from an organization’s beliefs and sometimes includes
investments with favorable environmental or social profiles.
Solvency With respect to financial statement analysis, the
ability of a company to fulfill its long-term obligations.
Solvency ratios Ratios that measure a company’s ability to
meet its long-term obligations.
Glossary G-31
Stakeholder management The identification, prioritization, Stock split An increase in the number of shares outstanding
and understanding of the interests of stakeholder groups, with a consequent decrease in share price, but no change
and managing the company’s relationships with these to the company’s underlying fundamentals.
groups.
Stop-loss order See stop order.
Stakeholders Individuals or groups of individuals who may Stop order An order in which a trader has specified a stop
be affected either directly or indirectly by a decision and
thus have an interest, or stake, in the decision. price condition. Also called stop-loss order.
Store of value The quality of tending to preserve value.
Standard cost With respect to inventory accounting, the Store of wealth Goods that depend on the fact that they
planned or target unit cost of inventory items or services.
do not perish physically over time, and on the belief that
Standard deviation The positive square root of the variance; a others would always value the good.
measure of dispersion in the same units as the original data. Straight-line method A depreciation method that allocates
evenly the cost of a long-lived asset less its estimated
Standard normal distribution The normal density with mean residual value over the estimated useful life of the asset.
(μ) equal to 0 and standard deviation (σ) equal to 1. Straight voting A shareholder voting process in which share-
holders receive one vote for each share owned.
Standardizing A transformation that involves subtracting the Strategic analysis Analysis of the competitive environment
mean and dividing the result by the standard deviation. with an emphasis on the implications of the environment
for corporate strategy.
Standards of conduct Behaviors required by a group; estab- Strategic asset allocation The set of exposures to IPS-
lished benchmarks that clarify or enhance a group’s code permissible asset classes that is expected to achieve the
of ethics. client’s long-term objectives given the client’s investment
constraints.
Standing limit orders A limit order at a price below market Strategic groups Groups sharing distinct business models
and which therefore is waiting to trade. or catering to specific market segments in an industry.
Street convention Yield measure that neglects weekends and
Stated annual interest rate A quoted interest rate that does holidays; the internal rate of return on cash flows assuming
not account for compounding within the year. Also called payments are made on the scheduled dates, even when the
quoted interest rate. scheduled date falls on a weekend or holiday.
Stress testing A specific type of scenario analysis that esti-
Statement of changes in equity (statement of owners’ equity) mates losses in rare and extremely unfavorable combina-
A financial statement that reconciles the beginning-of- tions of events or scenarios.
period and end-o f-p eriod balance sheet values of share- Strong-form efficient market A market in which security
holders’ equity; provides information about all factors prices reflect all public and private information.
affecting shareholders’ equity. Also called statement of Structural (or cyclically adjusted) budget deficit The deficit
owners’ equity. that would exist if the economy was at full employment
(or full potential output).
Statement of financial condition The financial statement that Structural subordination Arises in a holding company struc-
presents an entity’s current financial position by disclosing ture when the debt of operating subsidiaries is serviced by
resources the entity controls (its assets) and the claims on the cash flow and assets of the subsidiaries before funds
those resources (its liabilities and equity claims), as of a can be passed to the holding company to service debt at
particular point in time (the date of the balance sheet). the parent level.
Structured financial instruments Financial instruments
Statement of financial position The financial statement that that share the common attribute of repackaging risks.
presents an entity’s current financial position by disclosing Structured financial instruments include asset-b acked
resources the entity controls (its assets) and the claims on securities, collateralized debt obligations, and other struc-
those resources (its liabilities and equity claims), as of a tured financial instruments such as capital protected, yield
particular point in time (the date of the balance sheet). enhancement, participation and leveraged instruments.
Subjective probability A probability drawing on personal or
Statement of operations A financial statement that provides subjective judgment.
information about a company’s profitability over a stated Subordinated debt A class of unsecured debt that ranks
period of time. below a firm’s senior unsecured obligations.
Subordination Form of internal credit enhancement that
Statistic A quantity computed from or used to describe a relies on creating more than one bond tranche and ordering
sample of data. the claim priorities for ownership or interest in an asset
between the tranches. The ordering of the claim priorities is
Statistical inference Making forecasts, estimates, or judg- called a senior/subordinated structure, where the tranches
ments about a larger group from a smaller group actually of highest seniority are called senior followed by subor-
observed; using a sample statistic to infer the value of an dinated or junior tranches. Also called credit tranching.
unknown population parameter. Substitutes Said of two goods or services such that if the price
of one increases the demand for the other tends to increase,
Statistically significant A result indicating that the null holding all other things equal (e.g., butter and margarine).
hypothesis can be rejected; with reference to an estimated Sunk cost A cost that has already been incurred.
regression coefficient, frequently understood to mean a Supervised learning A machine learning approach that makes
result indicating that the corresponding population regres- use of labeled training data.
sion coefficient is different from 0.
Statutory voting A common method of voting where each
share represents one vote.
Step-u p coupon bond Bond for which the coupon, which
may be fixed or floating, increases by specified margins
at specified dates.
Stock dividend A type of dividend in which a company distrib-
utes additional shares of its common stock to shareholders
instead of cash.
Stock-out losses Profits lost from not having sufficient inven-
tory on hand to satisfy demand.
G-32 Glossary
Supply shock A typically unexpected disturbance to supply. Target semivariance The average squared deviation below
Support In technical analysis, a price range in which buying a target value.
activity is sufficient to stop the decline in the price of a Tariffs Taxes that a government levies on imported goods.
security. Tax base The amount at which an asset or liability is valued
Support tranche A class or tranche in a CMO that protects
the PAC tranche from prepayment risk. for tax purposes.
Supranational bonds A bond issued by a supranational agency Tax expense An aggregate of an entity’s income tax payable (or
such as the World Bank.
Surety bond Form of external credit enhancement whereby recoverable in the case of a tax benefit) and any changes in
a rated and regulated insurance company guarantees to deferred tax assets and liabilities. It is essentially the income
reimburse bondholders for any losses incurred up to a tax payable or recoverable if these had been determined
maximum amount if the issuer defaults. based on accounting profit rather than taxable income.
Survey approach An estimate of the equity risk premium Tax loss carry forward A taxable loss in the current period
that is based upon estimates provided by a panel of finance that may be used to reduce future taxable income.
experts. Taxable income The portion of an entity’s income that is sub-
Survivorship bias The bias resulting from a test design that ject to income taxes under the tax laws of its jurisdiction.
fails to account for companies that have gone bankrupt, Taxable temporary differences Temporary differences that
merged, or are otherwise no longer reported in a database. result in a taxable amount in a future period when deter-
Sustainable growth rate The rate of dividend (and earnings) mining the taxable profit as the balance sheet item is
growth that can be sustained over time for a given level recovered or settled.
of return on equity, keeping the capital structure constant Technical analysis A form of security analysis that uses price
and without issuing additional common stock. and volume data, which is often displayed graphically, in
Sustainable investing The practice of identifying companies decision making.
that can efficiently manage their financial, environmen- Technology The process a company uses to transform inputs
tal, and human capital resources to generate attractive into outputs.
long-t erm profitability; often synonymous with responsible Tender offer Corporate takeover mechanism which involves
investing. shareholders selling their interests directly to the group
Sustainable rate of economic growth The rate of increase seeking to gain control.
in the economy’s productive capacity or potential GDP. Tenor The time-t o-m aturity for a bond or derivative contract.
Swap contract An agreement between two parties to exchange Also called term to maturity.
a series of future cash flows. Term maturity structure Structure for a bond issue in which
Syndicated loans Loans from a group of lenders to a single the bond’s notional principal is paid off in a lump sum at
borrower. maturity.
Syndicated offering A bond issue that is underwritten by a Term structure See maturity structure.
group of investment banks. Term structure of credit spreads The relationship between
Synthetic lease A lease that is structured to provide a com- the spreads over the “risk-free” (or benchmark) rates and
pany with the tax benefits of ownership while not requir- times-to-maturity.
ing the asset to be reflected on the company’s financial Term structure of yield volatility The relationship between the
statements. volatility of bond yields-to-m aturity and times-to-m aturity.
Systematic risk Risk that affects the entire market or econ- Terminal stock value The expected value of a share at the end
omy; it cannot be avoided and is inherent in the overall of the investment horizon—in effect, the expected selling
market. Systematic risk is also known as non-d iversifiable price. Also called terminal value.
or market risk. Terminal value The expected value of a share at the end of the
Systematic sampling A procedure of selecting every kth investment horizon—in effect, the expected selling price.
member until reaching a sample of the desired size. The Terms of trade The ratio of the price of exports to the price
sample that results from this procedure should be approx- of imports, representing those prices by export and import
imately random. price indexes, respectively.
t-Test A hypothesis test using a statistic (t-statistic) that follows Text analytics The use of computer programs to analyze and
a t-distribution. derive meaning from typically large, unstructured text- or
Tactical asset allocation The decision to deliberately deviate voice-based datasets.
from the strategic asset allocation in an attempt to add Thematic investing An ESG implementation approach that
value based on forecasts of the near-term relative perfor- focuses on investing in companies within a specific sector
mance of asset classes. or industry theme.
Target balance A minimum level of cash to be held avail- Third-degree price discrimination When the monopolist
able—estimated in advance and adjusted for known funds segregates customers into groups based on demographic
transfers, seasonality, or other factors. or other characteristics and offers different pricing to
Target capital structure A company’s chosen proportions each group.
of debt and equity. Time-period bias The possibility that when we use a time-
Target independent A bank’s ability to determine the defi- series sample, our statistical conclusion may be sensitive
nition of inflation that they target, the rate of inflation to the starting and ending dates of the sample.
that they target, and the horizon over which the target is Time-series data Observations of a variable over time.
to be achieved. Time tranching The creation of classes or tranches in an ABS/
Target semideviation The positive square root of target MBS that possess different (expected) maturities.
semivariance. Time value The difference between the market price of the
option and its intrinsic value.
Glossary G-33
Time value decay Said of an option when, at expiration, Trade payables Amounts that a business owes to its vendors
no time value remains and the option is worth only its for goods and services that were purchased from them but
exercise value. which have not yet been paid.
Time value of money The principles governing equivalence Trade protection Government policies that impose restric-
relationships between cash flows with different dates. tions on trade, such as tariffs and quotas.
Time-weighted rate of return The compound rate of growth Trade surplus (deficit) When the value of exports is greater
of one unit of currency invested in a portfolio during a (less) than the value of imports.
stated measurement period; a measure of investment per-
formance that is not sensitive to the timing and amount Trading securities Securities held by a company with the
of withdrawals or additions to the portfolio. intent to trade them. Also called held-for-trading securities.
Tokenization The process of representing ownership rights Traditional investment markets Markets for traditional
to physical assets on a blockchain or distributed ledger. investments, which include all publicly traded debts and
equities and shares in pooled investment vehicles that hold
Top-down analysis With reference to investment selection publicly traded debts and/or equities.
processes, an approach that starts with macro selection
(i.e., identifying attractive geographic segments and/or Transactions money balances Money balances that are held
industry segments) and then addresses selection of the to finance transactions.
most attractive investments within those segments.
Transactions motive In the context of inventory management,
Total comprehensive income The change in equity during a the need for inventory as part of the routine production–
period resulting from transaction and other events, other sales cycle.
than those changes resulting from transactions with owners
in their capacity as owners. Transfer payments Welfare payments made through the social
security system that exist to provide a basic minimum level
Total cost The summation of all costs, for which costs are of income for low-income households.
classified as fixed or variable.
Transparency Said of something (e.g., a market) in which infor-
Total factor productivity A scale factor that reflects the por- mation is fully disclosed to the public and/or regulators.
tion of growth that is not accounted for by explicit factor
inputs (e.g. capital and labor). Treasury Inflation-P rotected Securities A bond issued by
the United States Treasury Department that is designed
Total fixed cost The summation of all expenses that do not to protect the investor from inflation by adjusting the
change as the level of production varies. principal of the bond for changes in inflation.
Total invested capital The sum of market value of common Treasury stock method A method for accounting for the effect
equity, book value of preferred equity, and face value of of options (and warrants) on earnings per share (EPS) that
debt. specifies what EPS would have been if the options and
warrants had been exercised and the company had used
Total probability rule A rule explaining the unconditional the proceeds to repurchase common stock.
probability of an event in terms of probabilities of the event
conditional on mutually exclusive and exhaustive scenarios. Tree diagram A diagram with branches emanating from nodes
representing either mutually exclusive chance events or
Total probability rule for expected value A rule explain- mutually exclusive decisions.
ing the expected value of a random variable in terms of
expected values of the random variable conditional on Trend A long-term pattern of movement in a particular
mutually exclusive and exhaustive scenarios. direction.
Total return Measures the price appreciation, or percentage Treynor ratio A measure of risk-a djusted performance that
change in price of the securities in an index or portfolio, relates a portfolio’s excess returns to the portfolio’s beta.
plus any income received over the period.
Triangle patterns In technical analysis, a continuation chart
Total return index An index that reflects the price appreciation pattern that forms as the range between high and low
or percentage change in price of the constituent securities prices narrows, visually forming a triangle.
plus any income received since inception.
Trimmed mean A mean computed after excluding a stated
Total return swap A swap in which one party agrees to pay the small percentage of the lowest and highest observations.
total return on a security. Often used as a credit derivative,
in which the underlying is a bond. TRIN A flow of funds indicator applied to a broad stock market
index to measure the relative extent to which money is
Total variable cost The summation of all variable expenses. moving into or out of rising and declining stocks.
Tracking error The standard deviation of the differences
Triple bottoms In technical analysis, a reversal pattern that
between a portfolio’s returns and its benchmark’s returns; is formed when the price forms three troughs at roughly
a synonym of active risk. the same price level; used to predict a change from a
Tracking risk The standard deviation of the differences downtrend to an uptrend.
between a portfolio’s returns and its benchmark’s returns;
a synonym of active risk. Also called tracking error. Triple tops In technical analysis, a reversal pattern that is
Trade creation When regional integration results in the formed when the price forms three peaks at roughly the
replacement of higher cost domestic production by lower same price level; used to predict a change from an uptrend
cost imports from other members. to a downtrend.
Trade credit A spontaneous form of credit in which a pur-
chaser of the goods or service is financing its purchase by Trough The lowest point of a business cycle.
delaying the date on which payment is made. True yield The internal rate of return on cash flows using the
Trade diversion When regional integration results in lower-
cost imports from non-m ember countries being replaced actual calendar including weekends and bank holidays.
with higher-c ost imports from members. Trust deed The governing legal credit agreement, typically
incorporated by reference in the prospectus. Also called
bond indenture.
G-34 Glossary
Trust receipt arrangement The use of inventory as collateral Units-of-production method A depreciation method that
for a loan. The inventory is segregated and held in trust, allocates the cost of a long-lived asset based on actual
and the proceeds of any sale must be remitted to the lender usage during the period.
immediately.
Univariate distribution A distribution that specifies the prob-
Turn-of-the-year effect Calendar anomaly that stock mar- abilities for a single random variable.
ket returns in January are significantly higher compared
to the rest of the months of the year, with most of the Universal owners Long-term investors, such as pension funds,
abnormal returns reported during the first five trading that have significant assets invested in globally diversified
days in January. portfolios.
Two-f und separation theorem The theory that all investors Unlimited funds An unlimited funds environment assumes
regardless of taste, risk preferences, and initial wealth will that the company can raise the funds it wants for all prof-
hold a combination of two portfolios or funds: a risk-free itable projects simply by paying the required rate of return.
asset and an optimal portfolio of risky assets.
Unsecured debt Debt which gives the debtholder only a
Two-s ided hypothesis test A test in which the null hypoth- general claim on an issuer’s assets and cash flow.
esis is rejected in favor of the alternative hypothesis if the
evidence indicates that the population parameter is either Unsponsored A type of depository receipt in which the foreign
smaller or larger than a hypothesized value. company whose shares are held by the depository has no
involvement in the issuance of the receipts.
Two-t ailed hypothesis test A test in which the null hypoth-
esis is rejected in favor of the alternative hypothesis if the Unsupervised learning A machine learning approach that
evidence indicates that the population parameter is either does not make use of labeled training data.
smaller or larger than a hypothesized value.
Up transition probability The probability that an asset’s
Two-w eek repo rate The interest rate on a two-w eek repur- value moves up.
chase agreement; may be used as a policy rate by a central
bank. Validity instructions Instructions which indicate when the
order may be filled.
Type I error The error of rejecting a true null hypothesis.
Type II error The error of not rejecting a false null hypothesis. Valuation allowance A reserve created against deferred tax
Unanticipated (unexpected) inflation The component of assets, based on the likelihood of realizing the deferred
tax assets in future accounting periods.
inflation that is a surprise.
Unconditional probability The probability of an event not Valuation ratios Ratios that measure the quantity of an asset
or flow (e.g., earnings) in relation to the price associated
conditioned on another event. with a specified claim (e.g., a share or ownership of the
Underemployed A person who has a job but has the qualifi- enterprise).
cations to work a significantly higher-paying job. Value at risk (VaR) A money measure of the minimum value
Underlying An asset that trades in a market in which buyers of losses expected during a specified time period at a given
level of probability.
and sellers meet, decide on a price, and the seller then
delivers the asset to the buyer and receives payment. The Value investors With reference to equity investors, investors
underlying is the asset or other derivative on which a par- who are focused on paying a relatively low share price in
ticular derivative is based. The market for the underlying relation to earnings or assets per share.
is also referred to as the spot market.
Underwriter A firm, usually an investment bank, that takes VaR See value at risk.
the risk of buying the newly issued securities from the Variable costs Costs that fluctuate with the level of produc-
issuer, and then reselling them to investors or to dealers,
thus guaranteeing the sale of the securities at the offering tion and sales.
price negotiated with the issuer. Variable-rate note Similar to a floating-r ate note, except that
Underwritten offering A type of securities issue mechanism
in which the investment bank guarantees the sale of the the spread is variable rather than constant.
securities at an offering price that is negotiated with the Variance The expected value (the probability-weighted
issuer. Also known as firm commitment offering.
Unearned revenue A liability account for money that has average) of squared deviations from a random variable’s
been collected for goods or services that have not yet been expected value.
delivered; payment received in advance of providing a good Variation margin Additional margin that must be deposited in
or service. Also called deferred revenue or deferred income. an amount sufficient to bring the balance up to the initial
Unemployed People who are actively seeking employment margin requirement.
but are currently without a job. Veblen goods Goods that increase in desirability with increas-
Unemployment rate The ratio of unemployed to the labor ing price.
force. Vega A measure of the sensitivity of an option’s price to
Unexpected inflation The component of inflation that is a changes in the underlying’s volatility.
surprise. Venture capital Investments that provide “seed” or start-u p
Unit elastic An elasticity with a magnitude of negative one. capital, early-stage financing, or later-stage financing
Also called unitary elastic. (including mezzanine-stage financing) to companies that
Unit labor cost The average labor cost to produce one unit are in early development stages and require additional
of output. capital for expansion or preparation for an initial public
Unit normal distribution The normal density with mean (μ) offering.
equal to 0 and standard deviation (σ) equal to 1. Venture capital fund A fund for private equity investors
that provides financing for development-s tage companies.
Vertical analysis Common-size analysis using only one report-
ing period or one base financial statement; for example,
an income statement in which all items are stated as per-
centages of sales.
Vertical demand schedule Implies that some fixed quantity
is demanded, regardless of price.
Glossary G-35
Volatility As used in option pricing, the standard deviation Weighted average life A measure that gives investors an
of the continuously compounded returns on the under- indication of how long they can expect to hold the MBS
lying asset. before it is paid off; the convention-b ased average time to
receipt of all principal repayments. Also called average life.
Voluntarily unemployed A person voluntarily outside the
labor force, such as a jobless worker refusing an available Weighted average maturity Weighting the remaining num-
vacancy. ber of months to maturity for each mortgage loan in the
pool by the amount of the outstanding mortgage balance.
Voluntary export restraint A trade barrier under which the
exporting country agrees to limit its exports of the good Weighted mean An average in which each observation is
to its trading partners to a specific number of units. weighted by an index of its relative importance.
Vote by proxy A mechanism that allows a designated party— Wholesale price index Reflects the price changes experienced
such as another shareholder, a shareholder representative, by domestic producers in a country.
or management—to vote on the shareholder’s behalf.
Winsorized mean A mean computed after assigning a stated
Warehouse receipt arrangement The use of inventory as percent of the lowest values equal to one specified low
collateral for a loan; similar to a trust receipt arrangement value, and a stated percent of the highest values equal to
except there is a third party (i.e., a warehouse company) one specified high value.
that supervises the inventory.
Working capital The difference between current assets and
Warrant Attached option that gives its holder the right to current liabilities.
buy the underlying stock of the issuing company at a fixed
exercise price until the expiration date. Working capital management The management of a compa-
ny’s short-term assets (such as inventory) and short-term
Weak-f orm efficient market hypothesis The belief that secu- liabilities (such as money owed to suppliers).
rity prices fully reflect all past market data, which refers
to all historical price and volume trading information. World price The price prevailing in the world market.
Yield The actual return on a debt security if it is held to
Wealth effect An increase (decrease) in household wealth
increases (decreases) consumer spending out of a given maturity.
level of current income. Yield duration The sensitivity of the bond price with respect
Weighted average cost method An inventory accounting to the bond’s own yield-to-m aturity.
method that averages the total cost of available inventory Yield to maturity Annual return that an investor earns on a
items over the total units available for sale.
bond if the investor purchases the bond today and holds it
Weighted average cost of capital A weighted average of the until maturity. It is the discount rate that equates the pres-
aftertax required rates of return on a company’s common ent value of the bond’s expected cash flows until maturity
stock, preferred stock, and long-term debt, where the with the bond’s price. Also called yield-to-redemption or
weights are the fraction of each source of financing in the redemption yield.
company’s target capital structure. Yield to redemption See yield to maturity.
Yield-to-worst The lowest of the sequence of yields-to-c all
Weighted average coupon rate Weighting the mortgage rate and the yield-to-maturity.
of each mortgage loan in the pool by the percentage of the Zero-coupon bonds Bonds that do not pay interest during
mortgage outstanding relative to the outstanding amount the bond’s life. It is issued at a discount to par value and
of all the mortgages in the pool. redeemed at par. Also called pure discount bonds.
Zero volatility spread (Z-spread) Calculates a constant yield
spread over a government (or interest rate swap) spot curve.
I-1
Index
A remuneration and company nominal returns, 260–262
AAR. see average accounting rate of performance, 32–33 real returns, 261–262
risk and return of, 260, 263
return shareholders’ rights, 34 robo-advisory services to manage,
Abbott Laboratories, 135–136 estimates of value by, 48
ability to take risk, investors’, 371–373. natural language processing for 467–468
in strategic asset allocation, 385–387
see also risk tolerance monitoring, 466 asset risk premium, 216
ABP (pension fund), 388–389 analytical tools, 456 assignments of accounts receivable, 192
absolute risk objectives, 370 Andrew W. Mellon Foundation, 219 assumptions
Abu Dhabi Investment Authority, 221 annual general meeting (AGM), 15 CAPM, 335–337, 348n.6
access, short-term borrowing strategy annualized return, 251–253 heterogeneous beliefs, 347, 350–351
anticipation stock, of inventory, 183 homogeneity of expectations, 317–318,
and, 191 Appendices, IPS, 369
accounting risk, 427 Apple, 334–335 336–337, 352
accounts payable management, arbitrage, 236 infinite divisibility, 337
arbitrage pricing theory (APT), 353 AstraZeneca PLC, 246
185–188 arithmetic return, 246 audit committee, 23
cash disbursements, 188 Armitage, Seth, 105 audit function, 17
evaluating, 188 artificial intelligence (AI), 456, 460–462. audit systems, 22
trade discounts, 187–188 Australia
accounts receivable aging schedule, see also machine learning equity risk premiums, 90
asset(s). see also investment robo-advisory services in, 466
180–181 Australian Financial Services license, 466
accounts receivable management, characteristics of assets Australian Securities and Investment
physical, 472
175–181 quick, 160 Commission, 466
customers’ receipts, 177–180 risk-free, 291–294 Austria, 19
evaluating, 180–181 authorities, investment policy, 172
trade granting process, 176–177 and capital allocation line, 291–292 automated advice, 457
accounts receivable turnover, 160 and capital market line, 319–321 Automated Clearing House (ACH),
accredited individuals, 236n.20 combining risky assets with, 315–318
ACH. see Automated Clearing House and homogeneity of expectations 177–178
acid-test ratio, 160 automated trading, 456
actively managed funds, 232 assumption, 317–318 average accounting rate of return (AAR),
active portfolios, capital market line for, two-fund separation theorem,
57–58
318 292–293 average inventory period, 161
active strategies utility theory and selection of, A.W. Jones & Co., 235
B
borrowing, 192 273–276 backtesting simulations, 469
short-term investing, 171–172 risk of two-asset portfolio, 258–259 Baidu, 244
activist shareholders. see shareholder risky balanced funds, 229–230, 232–233
Bancel, Franck, 108
activism combining risk-free assets with, bank certificates of deposit (CDs), 168
ADC Telecommunications, 209–210 315–318 banker’s acceptances (BAs), 168, 190
adviser-assisted digital wealth managers, bank runs, 429n.24
covariance and correlation of risks, bankruptcy, business risk and, 145–147
468 277–279 bankruptcy risk, 29
affiliated stockholders, as takeover banks
efficient frontier of, 291
defense, 34 importance of correlation of risks in credit from, 189–190
after-tax cost of debt, 85 portfolio management for, 220
after-tax nominal return, 254 portfolio, 282 risk management for, 410
agency relationship, 11. see also portfolio return, 276 bank sweep services, 168
portfolio risk, 276–282 Barings Bank, 428
principal–agent relationship risk and return relationship, 279–281 BAs. see banker’s acceptances
aging schedule, 180–181 utility theory and selection of, Belgium, 90
AGM. see annual general meeting beliefs, investors’, 336–337, 347,
AI. see artificial intelligence 273–276
algorithmic trading, 469 tradable, 319 350–351
algorithms, 462 variance of return for single, 256 benchmark rate, 174
Alibaba, 13, 32 asset allocation. see also strategic asset best-in-class, 37
Aloha Airlines, 438n.30 beta, 328–335
Alpha Natural Resources, 334–335 allocation (SAA)
alternative data, 457, 460 in portfolio management, 223 asset, 95–98
analysts tactical, 393–394 calculation and interpretation,
asset-based loans, 192
corporate governance considerations, asset beta, 95–98 331–332
31–36 asset class(es) and CAPM, 332–333, 352
adding to investment opportunity set,
board of directors representation, 32
composition of investors, 33–34 289
economic ownership and voting correlation matrix, 386–387
correlation of risk among, 285
control, 31–32 defining, 384
long-term risk management, 35 diversification with, 286
I-2 Index
beta (Continued) Brazil, 24 capital budget, planning of, 48
estimating, 94–100 breakeven points capital budgeting, 47–75
with CAPM, 332–333
inferring asset betas, 98 and leverage, 143–144 CAPM for, 340–341
pure-play method, 97, 98 operating, 143–145 and cost of capital, 82–84
and expected return, 333–335 breaking the buck, 231 importance of, 47–48
levering and unlevering, 95 break point, 102, 103 investment decision criteria, 52–68
return-generating models, 328–329 broad-based equity ETFs, 234
risk budgeting with, 422 brokerage commissions, 266 average accounting rate of return,
as risk metric, 436 Brounen, Dirk, 108 57–58
and security characteristic line, 346 Bruce, Roger, 209
Bruner, Robert F., 89n.12 internal rate of return, 53–54, 60–66
bid–ask spread, 266 budgeting, risk, 421–423 net present value, 52–53, 58–63
Big Data, 457–460 Bühner, Thomas, 105 payback period, 54–57
business processes, as Big Data sources, popularity and use of capital
challenges of, 460
defined, 457 458–460 budgeting methods, 66–68
extracting information from, 463–465 business risk profitability index, 58
in risk analysis, 468–469 popularity and use of, 66–68
sources of, 458–460 components of, 128 practice problems, 70–72
Bill & Melinda Gates Foundation, 219 for creditors and owners, 145–147 principles, 50–52
bill-to-bill terms, 177 defined, 95 process, 48–49
bitcoin, 471 financial risk, 136–140 solutions to problems, 73–75
blockchains, 470–471 and leverage, 128–136 capital gains taxes, 254
Blume, Marshall, 94n.22 operating risk, 130–136 capital market expectations, 385
board, risk governance, 413, 420 sales risk, 128–130 capital market line (CML), 318–326
board member–shareholder buy-and-hold strategies, 246n.2 defined, 319–321
buyout funds, 237 and definition of market, 319
relationships, 8–9, 12–13 buy-side firms, 225 of leveraged portfolios, 322–326
board of directors, 21–25 C with different lending/borrowing
CAC 40 Index, 318
committees, 22–25 Cadbury Report, 7 rates, 324–326
audit committee, 23 Canada with equal lending/borrowing rates,
governance committee, 23 ACH system, 178
investment committee, 24 common law system, 27 323
nomination committee, 23 equity risk premiums, 90 passive and active portfolios, 318
remuneration (compensation) say on pay, 18 risk and return on, 321–322
committee, 23 cannibalization, 51 and single-index model of beta, 329, 330
risk committee, 24 capital SML vs., 337–339
cost of (see cost of capital) capital market theory, 314–326
composition of, 21–22, 32 human, 419n.12 capital market line, 318–326
employee representation on, 19 proportions of, 81–82 portfolio of risk-free and risky assets,
functions and responsibilities, 22 capital allocation line. see also capital
manager relations with, 13 314–318
staggered boards, 21–22 market line combining risk-free asset with risky
stakeholder management mechanisms, defined, 273, 314
of optimal portfolio, 294–295 assets, 315–318
17 and optimal risky portfolio, 291–292 homogeneity of expectations
as stakeholders, 9–10 and portfolio selection, 273–276
bond equivalent yield, 170 for risk-free assets in portfolios of risky assumption, 317–318
bond ETFs, 234 capital rationing, 52
bond mutual funds, 229–232 assets, 316 capital structure
bonds SML vs., 337–339
correlation of T-bills/stocks with, 284, capital asset pricing model (CAPM), marginal cost of capital structure,
102–105
285 335–354
defined, 259 applications, 340–351 target, 80
government, 386 CAPM. see capital asset pricing model
historical risk and return, 259–260 capital budgeting, 340–341 captive finance subsidiaries, 175
investment grade, 386 estimate of expected return, 340–341 capture (data processing method), 463
municipal, 379 portfolio construction, 348–351 carbon assets, 39
nominal returns of, 262 portfolio performance evaluation, Carhart, Mark, 329
real returns of, 261–262 carrying costs, 184
surety, 443 341–346 cash
US Treasury, 88, 90, 386 security characteristic line, 346–347
bond yield plus risk premium approach, security selection, 347–348 minimum balances, 165
assumptions of, 335–337 monitoring uses and levels of, 166–167
93 and beta/expected return, 333–335 cash before delivery (CBD), 177
borrowers, size and short-term strategy cost of common equity, 88–92, cash collections systems, 177–180
cash concentration, 179
of, 191 107–108 cash conversion cycle, 163
borrowing extensions, 353–354 cash disbursements, 188
limitations, 351–352 cash dividends, in returns, 245
costs of, 186, 193–194 and portfolio construction, 348–351 cash flows, 164–167
short-term, 167, 191–192 security market line, 337–340 in capital budgeting, 50–51
borrowing rates, effects on leveraged conventional, 51
and expected return, 338–339 discounted cash flow techniques, 67n.5
portfolios, 324–326 portfolio beta, 339–340 free cash flow to equity, 84n.7
bottom-up portfolio analysis, 223 free cash flow to the firm, 84n.6
BP plc, 38 incremental, 51
IRR vs. NPV and patterns in, 60–61
Index I-3
monitoring cash uses and levels, common law system, 27 economic ownership and voting
166–167 common shares, 31–32 control, 31–32
communication
nonconventional, 51 long-term risk management, 35
short-term, 165–166 analysis of, 466 remuneration and company
in risk management framework, 412
cash forecasting systems, 166 co-movement patterns, 213–215 performance, 32–33
identifying typical cash flows, Companies Act 2006 (United Kingdom), shareholders’ rights, 34
board of directors representation, 32
165–166 14 boards of directors, 21–25
and minimum cash balances, 165 company(-ies) committees, 22–25
typical, 165–166 composition of, 21–22
cash inflows, in forecasts, 166 comparable, 95 functions and responsibilities, 22
cash management, 164–167 as risk drivers, 434 staggered boards, 21–22
cash on delivery (COD), 177 company stakeholders, 8–14 company stakeholders, 8–14
cash outflows, in forecasts, 166 relationships, 11–14 relationships, 11–14
cash position, 164–167 stakeholder groups, 8–11
Cathay Pacific Airways, 210–213 controlling shareholder–minority composition of investors, 33–34
CBD. see cash before delivery shareholder relationships, 12–13 defined, 6
C/C++ (programming language), 465 economic ownership and voting
CDs. see certificates of deposit manager–board relationships, 13
Central Bank of Brazil, 24 principal–agent relationship, 11 control, 31–32
central banks, 438 shareholder–manager/director factors affecting, 25–28
centralization, of financial organization,
relationships, 11–12 market factors, 25–26
186 shareholder vs. creditor interests, 13 non-market factors, 27–28
CEO duality, 21 various conflicts, 13 long-term risk management, 35
CEOs. see chief executive officers stakeholder groups, 8–11 non-profit organizations, 10–11
certificates of deposit (CDs), 168 board of directors, 9–10 remuneration and company
CFA Institute, 369 creditors, 9
CFOs. see chief financial officers customers, 10 performance, 32–33
Chapter 7 bankruptcy, 146n.8, 147 employees, 9 risks and benefits, 28–31
Chapter 11 bankruptcy, 146–147 governments, 10
charitable foundations, endowments for, managers, 9 benefits of effective governance, 29–31
regulators, 10 risks of poor governance, 28–29
218–220 shareholders, 8–9 shareholders’ rights, 34
charities, strategic asset allocation for, suppliers, 10 stakeholder management, 14–20
company value, cost of capital and, 78 about, 14
395–397 comparable company, 95 defined, 14
chief executive officers (CEOs), 21 compensation mechanisms, 15–20
chief financial officers (CFOs), 107–108 and company performance, 32–33 corporate governance committee, 23
chief risk officers (CROs), 419 policy development, 18 corporate governance industry, 28
China remuneration vs., 9n.3 corporate governance reports, 20
say on pay, 18–19 corporate transparency, 17
say on pay, 18 compensation committee, 23, 24 correlation(s)
two-tier boards, 10 compensation plans, 33 of asset classes, 285, 386–387
China Investment Corporation, 221 compensation policies, 29 defined, 277
Citibank Inc., 90 complacency, passive investment and historical risk, 284
Citigroup, Inc., 93 and investment opportunity set, 288–289
civil law system, 27 strategies and, 171 and portfolio risk, 277–279, 282
clearing, post-trade, 472–473 compliance, 473 and risk diversification, 284
clients “comply or explain” codes, 34 of risk-free asset in portfolio of risky
gathering information from, 381–384 component cost of capital, 78
individual investors as, 216 conditional value at risk (CVaR), 437 assets, 315
institutional investors as, 216–222 conflicts of interest, 18 risk from changing, 427n.21
Climate Bond Initiative, 38 Conroy, Robert M., 89n.12 correlation coefficient, 277
climate change, 38 consensus mechanism, 470, 471 COSCO Pacific, 210–213
closed-end funds, 228 contingent claims, 444 cost of capital, 50, 77–121
CML. see capital market line contractual infrastructure, 14 about, 78–79
COD. see cash on delivery contribution margin, 131 for capital budgeting and security
Code of Hammurabi, 441 control, governance practices and, 30
codes of ethics (generally), 20 controlling shareholders, 9 valuation, 82–84
collateral, 19 control systems and company value, 78
collateralized loans, 189, 191 cost of common equity, 88–93
Columbia University, 218 board’s role in, 22
Comcast, 13 weak, 28 bond yield plus risk premium
commercial paper (CP), 169, 190 conventional cash flow, 51 approach, 93
commissions, brokerage, 266 convertible arbitrage, 236
commitment fees, 193n.10 core–satellite approach, 397–398 CAPM approach, 88–92
committed lines of credit, 190 Corning, 209–210 dividend discount model approach,
Committee on the Financial Aspects of corporate bond mutual funds, 231
corporate exhaust, 459 92–93
Corporate Governance, 7 corporate governance, 5–36 and equity risk premium, 89–92
commodities, correlation with other about, 6–8 cost of debt, 84–86
analyst considerations, 31–36 debt-rating approach, 85
asset classes, 386 estimating, 86
common equity, cost of. see cost of board of directors representation, 32 yield-to-maturity approach, 84–85
composition of investors, 33–34 cost of preferred equity
common equity best estimate, 87–88
calculating, 87
I-4 Index
cost of capital (Continued) for short-term financing, 189–191 dealers, risk shifting to, 445
cost of preferred stock, 86–88 trade, 185, 186 debt
and country risk, 100–101 credit accounts, 176–177
defined, 78 credit default swaps, 438n.32 cost of (see cost of debt)
estimating, 93–108 credit events, 438 fixed- vs. floating-rate, 86
with beta and project beta, 94–100 credit insurance, 176 leveraging role of, 139–140
with weighted average cost of capital, credit limits, 159 nonrated, 86
98–100 credit lines with optionlike features, 86
flotation costs, 105–107 restrictions on, 159 debt incurrence test, 102
in investment decision-making by for short-term financing, 189–191 debt-rating approach, for cost of debt,
CFOs, 107–108 creditors
marginal cost of capital schedule, contractual agreements with, 19 85
102–105 legal protections for, 27 debt-to-equity ratio, 81–82
practice problems, 111–117 shareholder interests vs., 13 decision making, ineffective, 29
solutions to problems, 118–121 as stakeholders, 9 decisions
and taxes, 79–80 creditors, business risk for,
weights for, 80–82 capital budgeting, investment decision
145–147 criteria for, 52–68
cost of common equity, 88–93 credit rating agencies, 30
bond yield plus risk premium credit ratings, 101, 438 average accounting rate of return,
approach, 93 credit risk, 30, 171, 425, 438. see also 57–58
CAPM approach, 88–92
dividend discount model approach, default risk internal rate of return, 53–54
92–93 credit scoring model, 177 net present value, 52–53
and equity risk premium, 89–92 credit-worthiness, 159, 177, 191 payback period, 54–57
CROs. see chief risk officers popularity and use of capital
cost of debt, 84–86 cross-shareholdings, 33–34
after-tax, 85 cryptocurrencies, 472 budgeting methods, 66–68
for capital budgeting, 50 cryptography, 470 profitability index, 58
company’s, 93n.19 culture, risk, 416 CFOs, investment decision-making by,
debt-rating approach, 85 cumulative voting, 16
defined, 84 curation (data processing method), 107–108
estimating, 86 risk management, 407–408
and governance, 30 463 decomposition of total risk, 330
and taxes, 79 currency risk, managing, 409–410 dedicated short bias strategies, 236
yield-to-maturity approach, 84–85 current ratio, 160 deep learning, 462
customers Deepwater Horizon oil spill, 38
cost of preferred stock, 86–88 default risk. see also credit risk
costs contractual agreements with, 20 attributes and safety measures, 171
receipts of, 177–180 defined, 425
carrying, 184 shareholder conflicts with, 13 governance and, 29, 30
financing, 50 as stakeholders, 10 shareholder vs. creditor interests, 13
fixed supplier conflicts with, 13 defined benefit (DB) pension plans, 217
CVaR. see conditional value at risk defined contribution (DC) pension
and breakeven points, 145 CVS Corporation, 95
and degree of operating leverage, D plans, 216
Damodaran, Aswath, 101n.31 degree of financial leverage (DFL)
133–135 data
and degree of total leverage, 142–143 alternative, 457, 460 defined, 137
and leverage, 125–128 overfitting of, 461 and degree of total leverage,
flotation, 105–107 semi-structured, 458
inventory, 184 structured, 458 142–143
opportunity, 50, 51 traditional, 457 degree of operating leverage (DOL)
ordering, 184 unstructured, 458
policy, 184 databases, 465, 470 calculating, 135
stock-out, 184 data processing methods, 463 defined, 130
sunk, 51 data science, 463–465 and degree of total leverage, 142–143
transaction, 336, 348n.6, 425–426 data processing methods, 463 and financial risk, 140–142
variable, 126–128, 133–135 data visualization, 463–465 and operating risk, 130–135
cost structure, leverage and, 126–128 datasets degree of total leverage (DTL),
counterparty risk, 425, 431 analysis of large, 456
country risk, cost of capital and, 100–101 in machine learning, 461 141–143
covariance data visualization, 463–465 Dell Corporation, 184n.8
and correlation of risks in portfolio, Daves, Phillip R., 94n.21 delta, 436
David and Lucile Packard Foundation, Denmark, 90
277–279 derivatives
of return, 257 219
of risk-free asset in portfolio of risky days in receivables, 160, 181 beta for, 436
day’s sales outstanding, 160 risk shifting with, 443–445
assets, 315 DB pension plans. see defined benefit DFL. see degree of financial leverage
and strategic asset allocation, 390 digital wealth managers, 468
covenants, 9, 19 pension plans Dimson, Elroy, 89–90
CP. see commercial paper DC pension plans. see defined direct debit programs, 178
credit directors. see board members
and accounts receivable management, contribution pension plans disbursement float, 186
discounted cash flow techniques, 67n.5
175 discounted payback period, 56–57
as drag on liquidity, 158 discounted receivables, 190
discounted securities, yields of,
169–170
discount interest, 169
discounts, trade, 187–188
Index I-5
distributed ledger technology (DLT), electronic funds transfer (EFT), and marginal cost of capital
469–473 177–180 structure, 102–105
about, 469–471 emerging markets, 236 with weighted average cost of capital,
applications of, 472–473 employee(s), 9 98–100
employee benefit plans, 23
compliance, 473 employee representatives, 21 of cost of debt, 86
cryptocurrencies, 472 employee rights, 19–20 of cost of equity, 88–93
post-trade clearing and settlement, employee stock options, diversification of cost of preferred equity, 87–88
of expected returns, 340–341
472–473 and, 208–210, 286, 381 of value by analysts, 48
tokenization, 472 employee stock ownership plans of weighted average cost of capital,
financial record keeping with, 457
permissioned and permissionless (ESOPs), 19 98–100
employment contracts, 19 estimation period, beta, 94
networks, 471 endowments, portfolio management for, ETFs. see exchange traded funds
distributional characteristics of assets, ethics. see codes of ethics
218–220 EU. see European Union
264–266 energy sector Eurodollar rate, 190
kurtosis, 265–266 Eurodollar time deposits, 168
skewness, 264–265 ESG factors in investment analysis, 39 Europe
diversification thematic investing, 37
and employee stock options, 208–210, Enron Corporation, 28, 208–209, 432 correlation of equities, 386–387
enterprise risk management Giro system, 178
286, 381 defined, 411 hybrid/balanced funds, 232–233
and investing in portfolios vs. single process for, 413–415 money market funds, 230–231
risk governance in, 417–419 mutual fund assets, 230
equities, 208–210 risk tolerance in, 420 rights offerings, 105
and portfolio risk, 278 enterprise risk management system, 22 European Union
of portfolio risk, 282–287 environmental, social, governance (ESG) employee rights, 19
as risk modification method, 441 sell-out rights, 16
diversification ratio, 212 considerations, 36–40 European Works Councils, 19
dividend discount model approach about, 6 Evaluation and Review, IPS, 369
for cost of common equity, 92–93 as catalysts for growth, 38–39 evaluation datasets, 461
for cost of equity, 91 governance (see corporate governance) event-driven strategies, 236
in decision-making by CFOs’, 107 implementation methods, 37–38, 40 ex ante models, 352
dividend income, taxes on, 254 in investment analysis, 39–40 Excel VBA (programming language),
DLT. see distributed ledger technology in investment policy statements,
“The Doctrine of No Surprises,” 410 465
documentary credit accounts, 176 380–381 exchange traded funds (ETFs),
Dodd–Frank Act (2011), 18 market overview, 39
DOL. see degree of operating leverage terminology, 36–37 233–235
Dow Jones 30 Index, 332 environmental projects, capital exclusionary screening, 37
Dow Jones Industrial Average, 284 execution step (portfolio management),
downside risk, 213–215 budgeting for, 49
drag on liquidity, 158–159 EOQ-ROP approach. see economic 223–225
DTL. see degree of total leverage asset allocation, 223
dual-class share structure order quantity–reorder point portfolio construction, 223–225
and controlling–minority shareholder approach security analysis, 223
equities executive (management) board, 10
relationships, 12–13 correlation of, 386–387 executive (internal) directors, 9, 21
and voting control, 31–32 investing in portfolios vs., 207–208 expansion projects, capital budgeting
duration, 436 and diversification, 208–210
duty of care, 22 and downside risk, 213–215 for, 49
duty of loyalty, 22 and modern portfolio theory, expectations
E 215–216
e-commerce, 186–187 and portfolio composition, 212–213 capital market, 385
economic activity, risk and, 407 and risk–return tradeoff, 210–212 homogeneity of expectations
economic order quantity–reorder point equity market neutral strategies, 236
equity risk premium (ERP), 89–92 assumption, 317–318, 336–337,
(EOQ-ROP) approach, 183 Erb, Claude, 101n.32 352
EDI. see electronic data interchange ESG considerations. see environmental, expected inflation rate, 259
efficient frontier, 288–300 social, governance considerations expected return(s)
ESG integration/incorporation, 37 and beta, 333–335
indifference curve, 294–295 ESG investing, 37 CAPM estimation of, 340–341
investment opportunity set, 288–289 ESOPs. see employee stock ownership and historical mean return, 259–260
investor preferences and optimal plans and SML, 338–339
estimation and strategic asset allocation, 390
portfolio, 299–300 of beta, 94–100 expected risk premium, 259
Markowitz, 291, 319–320 inferring asset beta, 98 “expert system,” as artificial intelligence,
minimum-variance portfolios, 289–291 market model, 332–333 460
portfolio selection example, 294–299 pure-play method, 97, 98 ex post models, 352
for risk-free assets, 291–294 of cost of capital, 93–108 exposure, risk, 409–410
and strategic asset allocation, 390–391 with beta and project beta, 94–100 external auditors, 17
EFT. see electronic funds transfer and country risk, 100–101 external (non-executive) directors,
Ehrhardt, Michael C., 94n.21 and decision-making by CFOs, 10, 21
elasticity, 130 107–108 externality, 51
electronic data interchange (EDI), and flotation costs, 105–107 extreme value theory, 437
Ezzell, John R., 83n.3, 106n.37
186–187
I-6 Index
F Fitch Ratings, 438 global macro strategies, 236
Facebook, 13, 32 fixed costs global minimum-variance portfolios, 290
factoring, 190, 192 Global Reporting Initiative (GRI), 39
Fama, Eugene, 89n.11, 89n.12, 329 and breakeven points, 145 Global Sustainable Investing Alliance
FCA. see Financial Conduct Authority and degree of operating leverage,
FCFE. see free cash flow to equity (GSIA), 39
FCFF. see free cash flow to the firm 133–135 gold, correlation with other asset classes,
F&C Stewardship Growth Fund, and degree of total leverage, 142–143
and leverage, 125–128 386
380–381 fixed-income arbitrage, 236 Google, 13, 244
federal agency securities, 168 fixed-rate debt, 86 Gordon, Myron J., 92n.18
Federal Reserve, 438 fixed rate perpetual preferred stock, Gordon growth model, 92
feedback governance
86–87
in portfolio management, 225–226 flexibility, of short-term borrowing corporate (see corporate governance)
performance measurement and risk, 417–424
reporting, 226 strategy, 191
portfolio monitoring and rebalancing, float, 179 defined, 411
225 float factor, 179 for enterprises, 417–419
floating-rate debt, 86 establishing risk tolerance level,
in risk management framework, 415 flotation costs, 105–107
Fidelity, 341–342 Ford Foundation, 219 419–421
Financial Conduct Authority (FCA), forecasting, of short-term cash flows, example, 423–424
with risk budgeting, 421–423
368, 466 165–166 governance codes, 34
financial crisis (2008), 265–266, 429 foreign countries, diversification of governance committee, 23
financial leverage, 136–140 government(s)
investment in, 286 shareholder conflicts with, 13
degree of, 137–138, 142–143 foreign exchange risk, 171 as stakeholders, 10
leveraging role of debt, 139–140 forward commitments, 444 governmental infrastructure, 14
financial record keeping, 457 fossil fuels, 37 government bond mutual funds, 231
Financial Reporting Council, 7 foundations, portfolio management for, government bonds, 386
financial risks, 95 Government of Singapore Investment
defined, 424 218–220
drivers of, 434–435 401(k) plans, 208–210 Corporation, 221
and leverage, 136–140 four-factor models for beta, 329, 353–354 government policies, as risk drivers, 434
non-financial vs., 432–433 France governments, as Big Data sources, 458
types of, 424–426 Graham, John, 107
financing civil law system, 27 the “Greeks,” 436
short-term, 189–194 corporate governance systems, 14 green bonds, 38
equity risk premiums, 90 green finance, 38
asset-based loans, 192 frequency of capital budgeting, 67 GRI. see Global Reporting Initiative
borrowing approaches, 191–192 say on pay, 18 gross return, 253–254
costs of borrowing for, 193–194 free cash flow to equity (FCFE), 84n.7 growth rate, sustainable, 92–93
sources of, 189–191 free cash flow to the firm (FCFF), 84n.6 Gulf Cooperation Council, 24
financing costs, 50 French, Kenneth, 89n.11, 89n.12, 329 Gulf of Mexico oil spill (2010), 38
Finland, 10 frictionless markets, 336 H
fintech, in investment management, Frontier Airlines, 438n.30 hackers, 428
FTSE 100 Index, 370, 375 Hamada, Robert S., 95n.24
455–477 fully automated digital wealth managers, Hang Seng Index, 213–215
about, 455–456 Harvard University, 218
applications of, 465–469 468 Harvey, Campbell R., 100n.28, 101n.32,
fundamental factor models, 329
algorithmic trading, 469 G 107
natural language processing, 465–466 gamma, 436 health risk, 430
risk analysis, 468–469 Gascon, Henri (case study), 373–374, hedge funds, 26, 235–236
robo-advisory services, 466–468 hedges, risk budgeting with, 423
text analytics, 465 376, 382–384 Herstatt risk, 426n.19
artificial intelligence, 460–461 Gascon, Jacques (case study), 374–375 heterogeneous beliefs assumption, 347,
Big Data, 457–460 general meetings, 15–16
challenges of, 460 geometric mean return, 246–247 350–351
extracting information from, 463–465 Germany high-frequency trading (HFT), 469
sources of, 458–460 high-yield bond mutual funds, 231
data science, 463–465 civil law system, 27 Hirschleifer, John, 82n.2
data processing methods, 463 corporate governance systems, 14 historical equity risk premium approach,
data visualization, 463–465 cumulative voting rules, 16
defining, 456–457 employee representation on boards, 19 89–92
distributed ledger technology, 469–473 equity risk premiums, 90 historical mean return, 259–260
about, 469–471 flotation costs, 105 historical returns, 259–264
applications of, 472–473 frequency of capital budgeting, 67
permissioned and permissionless two-tier boards, 10 estimating cost of equity with, 89–92
Giro system, 177–178 historical mean return and expected
networks, 471 Gitman, Lawrence, 107n.39
machine learning, 460–462 GlaxoSmithKline Plc, 18, 340–341 return, 259–260
practice problems, 475–476 global bond mutual funds, 231 nominal and real returns of asset
solutions to problems, 477 global ETFs, 234
first-order risk, 436n.28 global financial crisis of late 2000s classes in other countries,
Fisher, Irving, 82n.2 corporate governance and, 6 262–263
media’s effect on regulation following, 27 nominal returns of major US asset
classes, 260–261
Index I-7
real returns of major US asset classes, infinite divisibility assumption, 337 types, 245
261–262 inflation, expected rate of, 259 variance of returns, 257
inflation-protected bond mutual funds, risk characteristics, 258–259
risk–return tradeoff for, 263–264 investment committee, 24
historical risk 231 investment companies, portfolio
informationally efficient markets, 318
risk of major asset classes, 263 information asymmetry, 12 management for, 221
risk–return tradeoff, 263–264 information ratio, 350 Investment Company Act (1940), 235
HKSE. see Hong Kong Stock Exchange infrastructure, risk, 412 Investment Company Institute,
holding period return, 245 initial coin offerings (ICOs), 472
holding periods, CAPM assumptions installment credit accounts, 176 226–227
institutional investors Investment Constraints, IPS, 369
about, 336 investment decision criteria for capital
Home Depot, 438 portfolio management for, 216–222
homogeneity of expectations assumption, banks, 220 budgeting, 52–68
defined-benefit pension plans, 217 average accounting rate of return,
317–318, 336–337, 352 endowments and foundations,
Hong Kong Monetary Authority 218–220 57–58
insurance companies, 220 internal rate of return, 53–54
Investment Portfolio, 221 investment companies, 221 net present value, 52–53
Hong Kong Stock Exchange (HKSE) sovereign wealth funds, 221 payback period, 54–57
popularity and use of capital budgeting
HSBC Holdings on, 317–318 relative risk objectives of, 370
volatility of returns, 210–213 insurance methods, 66–68
Hostess, 438n.30 profitability index, 58
hostile takeovers, 26 credit, 176 investment decision-making, by CFOs,
HSBC Holdings, 317–318 risk transfer with, 441–443
human capital, 419n.12 for risky portfolios, 287 107–108
human rights, 38, 40 insurance companies, 220, 440 investment grade bonds, 386
Hutchison Whampoa, 210–213 interest, discount, 169 Investment Guidelines, IPS, 369
hybrid ETFs, 234 interest rate, risk-free, 93n.19, 259 investment ideas, in capital budgeting
hybrid funds, 229–230, 232–233 interest rate risk, 171
I internal (executive) directors, 9, 21 process, 48
Ibbotson, Roger G., 94n.23 internal rate of return (IRR) investment instruments, for short-term
IBM, 394 for capital budgeting, 53–54
ICOs. see initial coin offerings funds management, 168–171. see
image recognition algorithms, 462 multiple IRR problem, 64–66 also specific types
impact investing, 38 no IRR problem, 64–66 investment management, fintech in,
incentive plans, 18 defined, 248 455–477
income needs, in portfolio management, ranking conflicts of NPV and IRR, about, 455–456
applications of, 465–469
222 60–63 algorithmic trading, 469
incremental cash flow, 51 due to cash flow patterns, 60–61 natural language processing,
indenture, 19 due to project scale, 62–63 465–466
independent directors, 21 international ETFs, 234 risk analysis, 468–469
independent projects, 51 Internet of Things (IoT), 459 robo-advisory services, 466–468
index funds Introduction, IPS, 369 text analytics, 465
inventory artificial intelligence, 460–461
actively managed funds vs., 232 anticipation stock, 183 Big Data, 457–460
diversification with, 286 average inventory period, 161 challenges of, 460
ETFs vs., 233, 235 as drag on liquidity, 158 extracting information from,
India number of days of, 161, 185 463–465
common law system, 27 precautionary stocks, 182 sources of, 458–460
one-tier boards, 10 purchasing–inventory–payables data science, 463–465
pension fund investment restrictions, data processing methods, 463
process, 186–187 data visualization, 463–465
380 safety stock, 183 defining, 456–457
indifference curves inventory blanket liens, 192 distributed ledger technology,
inventory costs, 184 469–473
of optimal investor portfolio, 294–295 inventory management, 182–185 about, 469–471
in portfolio selection, 274–276 and accounts payable management, applications of, 472–473
and risk aversion, 269–271 permissioned and permissionless
and strategic asset allocation, 391 186 networks, 471
individual investors approaches, 183–184 machine learning, 460–462
and enterprise risk management, evaluating, 184–185 practice problems, 475–476
financial impact of inventory methods, solutions to problems, 477
418–419 investment managers, selection of,
operational risks for, 430 185 397
portfolio management for, 216 and inventory costs, 184 Investment Objectives, IPS, 369
risk drivers for, 435 inventory turnover, 160, 184–185 investment opportunity schedule (IOS),
risk interactions for, 431–432 investment characteristics of assets, 82
risk management as concern of, 408 investment opportunity set, 288–289
risk management process for, 415 244–267 investment policies
risk tolerance of, 420n.14 distributional characteristics, components, 172–173
individually managed accounts, 235 evaluating, 173–174
individuals, as Big Data sources, 459, 460 264–266 short-term funds management in,
industry(-ies) market characteristics, 266–267 171–174
diversification according to, 381 return characteristics, 244–259
as risk drivers, 434
covariance of return, 257
historical returns, 259–264
I-8 Index
investment policy statements (IPSs), K liquidity management, 157–159
368–381 Kaplan, Paul D., 94n.23 as market characteristic, 266–267
Kaserer, Christoph, 105 measuring, 159–164, 438
components of, 369 Koedijk, Kees, 108 and portfolio management, 222
defined, 222 Kohl’s, 162–163 primary sources, 157
and investor constraints, 376–381 Kunkel, Robert A., 94n.21 secondary sources, 157–158
kurtosis, 265–266 liquidity management, 157–159
legal and regulatory factors, Kuwait Investment Authority, 221 liquidity ratios, 159–160
379–380 L liquidity risk
labor laws, 19 as financial risk, 425–426
liquidity, 376–378 labor unions, 19 interactions of market and solvency
tax concerns, 379 laddering strategies, 172
time horizon, 378–379 law, governance and, 20 risk with, 431
unique circumstances, 380–381 LBOs. see leveraged buyouts safety measures for, 171
in planning step of portfolio leases, 86 solvency risk vs., 429n.23
Lee, Inmoo, 105 Lleras, Miguel Palacios, 89n.12
management, 222–223 Lee, Rafaelina M., 100n.30 Lloyd’s of London, 442–443
and portfolio construction, 389–392 Leeson, Nick, 428 load funds, 228–229
return objectives, 375–376 legal environment, 27 loans
risk objectives, 370–375 legal factors, in IPSs, 379–380 asset-based, 192
investment risks, short-term funds legal infrastructure, 14 collateralized, 189, 191
legal risk, 29, 426–427 Lochhead, Scott, 105
management and, 170–171 Lehman Brothers, 429, 438 lockbox systems, 178
investment strategy, in portfolio lending portfolios, 322 London Interbank Offered Rate (Libor)
lending rates, effects on leveraged as benchmark for returns, 375
construction, 393–397 defined, 190
investor questionnaires, 467 portfolios, 324–326 floating-rate debt, 86
investors. see also individual investors leverage, 125–154 marginal cost of capital structure, 104
London Stock Exchange
beliefs of, 336–337, 347, 350–351 about, 126–128 board composition rules, 24
capital market expectations of, 385 breakeven points, 143–145 and Committee on the Financial
CAPM assumptions about, 336 business risk, 128–136
composition of, 33–34 Aspects of Corporate Governance,
constraints on components of business risk, 128 7
for creditors and owners, 145–147 long hedge fund strategies, 236
legal and regulatory factors, financial risk, 136–140 Long-Term Capital Management, 431
379–380 operating risk, 130–136 long-term risk management, 35
sales risk, 128–130 loss(es)
liquidity, 376–378 defined, 125 scenario, 422
and portfolio planning, 376–381 financial, 136–140 stock-out, 182
tax concerns, 379 degree of financial leverage, 137–138 low liquidity positions, 159
time horizon, 378–379 leveraging role of debt, 139–140 Luxembourg, 19
unique circumstances, 380–381 fixed costs as, 125 M
objectives of, 243–244 measuring, 438 M2, 342–343
preferences of, 299–300 practice problems, 149–152 machine learning (ML), 460–462
willingness and ability to take risk, solutions to problems, 153–154 defined, 461
total, 140–143 in risk analysis, 469
371–373 leveraged buyouts (LBOs), 237 types of, 461–462
IOS. see investment opportunity leveraged portfolios macroeconomic factor models, 328–329
capital market line for, 322–326 macroeconomic risk drivers, 434
schedule with different lending and borrowing managed accounts, 235
IoT. see Internet of Things management
IPSs. see investment policy statements rates, 324–326 risk governance by, 419
Ireland, 90 with equal lending and borrowing in risk management framework,
IRR. see internal rate of return 413–414
Italy, 27, 90 rates, 323 management (executive) board, 10
J leveraged positions, 255, 323 managers
J. Paul Getty Trust, 219 leveraged returns, 255 digital wealth, 468
Japan Li, Wei, 89n.12 relations with board, 13
Libor. see London Interbank Offered shareholder relationships, 11–12
civil law system, 27 as stakeholders, 9
“comply or explain” codes, 34 Rate use of fintech by, 455
corporate governance systems, 14 Li & Fung, 210–213 manufacturing resource planning (MRP)
cumulative voting rules, 16 Lilly Endowment, 219 systems, 183–184
employee involvement with decision limitations, investment policy, 172 marginal cost of capital (MCC), 82–83
lines of credit marginal cost of capital (MCC) schedule,
making, 19 102–105
equity risk premiums, 90 restrictions on, 159 Mariscal, Jorge O., 100n.30
pension fund investment restrictions, for short-term financing, 189–191 market characteristics of assets, 266–267
Lintner, John, 216, 335 market index, for beta, 94
380 liquidation, 146, 147
Java (programming language), 465 liquidity, 156–164
Jensen, Michael C., 94n.20 defined, 156–157
Jensen’s alpha drags and pulls on, 158–159
as investor constraints, 376–378
defined, 343–344
and security characteristic line, 346
and security selection, 347
JIT method. see just-in-time method
John D. and Catherine T. MacArthur
Foundation, 219
Jong, Abe de, 108
just-in-time (JIT) method, 183–184
Index I-9
market model, 94n.20, 330–333 MSCI EAFE Index no-load funds, 228
market portfolio, in CAPM, 352 co-movement patterns, 213–215 nominal rate, for securities, 169
market price of risk, 273 correlation with other indexes, 386 nominal returns
market risk, 171, 425, 431
markets MSCI Emerging Markets, 258–259, 386 of asset classes in other countries,
MSCI Europe, 386 262–263
algorithmic trading and fragmentation MSCI US Index, 386
of, 469 MSCI World Index, 386 of asset classes in United States,
multi-factor model, 328 260–261
as Big Data sources, 458 multiple-class share structure, 12–13
CAPM assumptions about, 336 multiple IRR problem, for capital defined, 254
defined, 319 nomination committee, 23
informationally efficient, 318 projects, 64–66 nonbank finance companies, 190
Markets in Financial Instruments municipal bonds, 379 non-controlling (minority) shareholders,
mutual funds, 226–233
Directive (MiFID), 368 9
Markowitz, Harry, 215, 335 about, 226–230 nonconventional cash flow, 51
Markowitz efficient frontier, 291, hedge funds vs., 235–236 non-executive (external) directors,
short-term investment, 169
319–320 SMAs vs., 235 9–10, 21
Marsh, Paul, 89–90 types, 230–233 non-financial risks
Massachusetts Institute of Technology,
bond mutual funds, 231–232 defined, 424
218 hybrid/balanced funds, 232–233 financial vs., 432–433
Massachusetts Mutual Life Insurance money market funds, 230–231 types of, 426–430
stock mutual funds, 232 nonmarket securities, weight of, 350
Company, 224–225 mutually exclusive projects, 51 non-profit organizations, 10–11
Massey Energy, 35 N nonrated debt, cost of, 86
matching strategies, 171–172, 192 NASDAQ, 284 nonsystematic risk, 326–328
matrix pricing, 85 NASDAQ 100 Index, 332 normal distribution, 264
MCC. see marginal cost of capital national tax-free bond mutual funds, norms-based screening, 37
MCC schedule. see marginal cost of Northern Telecom, 209–210
231 Northwestern University, 218
capital schedule National Welfare Fund, 221 Norwegian Government Pension
mean return, 246 natural language processing (NLP),
media, governance and, 27 Fund-Global, 221
Mercurio, V., 107n.39 465–466 NoSQL (database), 465
Metropolitan Life Insurance Company, NBC, 443n.36 NPV. see net present value
negative correlation, 277 NPV profile, 58–60
225 negative screening, 37 number of days of inventory, 161, 185
Mian, Shehzad L., 175n.5 net asset value number of days of payables, 161, 188
MiFID. see Markets in Financial number of days of receivables, 160, 181
breaking the buck, 231 NYSE. see New York Stock Exchange
Instruments Directive mutual fund, 226–227 O
Miles, James A., 83n.3 Netherlands objectives
Miller, Merton, 95n.24 “comply or explain” codes, 34
“mind maps,” 464 equity risk premiums, 90 of investors, 243–244
minimum cash balances, 165 fact finding requirements, 381 return, 375–376
minimum-variance frontier, 290 frequency of capital budgeting, 67 risk, 370–375
minimum-variance portfolios, 289–291 say on pay, 18 of strategic asset allocation, 388–389
two-tier boards, 10 OECD. see Organisation for Economic
and efficient frontier of risky assets, net operating cycle, 163–164
291 net present value (NPV), 58–63 Co-operation and Development
in capital-budgeting decisions, 83 O’Halloran, Elizabeth, 89n.12
global, 290 defined, 52–53 one-tier board structure, 9–10, 21
minimum-variance frontier, 290 and IRR, 53–54 open book credit accounts, 176
minority (non-controlling) shareholders, NPV profile, 58–60 open distributed ledger networks, 471
ranking conflicts between IRR and, open-end funds, 228
9, 12, 16 operating breakeven points, 143–145
mismatching strategies, 171–172 60–63 operating cycle, 163
Mittoo, Usha, 108 and stock prices, 67–68 operating income, 140
ML. see machine learning net return, 253–254 operating leverage. see degree of
model risk, 427 networks
modern portfolio theory (MPT), neural, 461, 462 operating leverage
permissioned and permissionless, 471 operating risk
215–216, 335, 435 neural networks, 461, 462
Modigliani, Franco, 95n.24, 342 new products, capital budgeting for, 49 defined, 95, 128
Modigliani, Leah, 342 New York Stock Exchange (NYSE) and leverage, 130–136
money market funds, 169, 230–231 board composition rules, 24 operational efficiency, 30
money market yield, 170 correlations of stocks, 284 operational risk, 428–430, 438–439
money-weighted return, 248–249 trading volume, 336 opportunity costs, 50, 51
monitoring Nikkei 300 Index, 318 optimal portfolio, 243–364
Nikkei 500 Index, 213–215 beta, 328–335
in capital budgeting process, 48–49 NLP. see natural language processing
in portfolio management, 225 no IRR problem, for capital projects, calculation and interpretation,
in risk management framework, 412 331–332
monthly billing terms, 177 64–66
Moody’s Analytics, 438 estimation, 332–333
mortality risk, 430 and expected return, 333–335
Mossin, Jan, 335 return-generating models,
MPT. see modern portfolio theory
MRP systems. see manufacturing 328–329
resource planning systems
I-10 Index
optimal portfolio (Continued) passive strategies and modern portfolio theory,
and capital asset pricing model, borrowing, 191 215–216
335–354 employed by robo-advisors, 467
applications, 340–351 short-term investing, 171 and portfolio composition, 212–213
assumptions, 335–337 risk–return tradeoff, 210–212
extensions, 353–354 payback period investment clients, 216–222
limitations, 351–352 capital budgeting, 54–56 individual investors, 216
security market line, 337–340 discounted, 56–57 institutional investors, 216–222
and capital market theory, 314–326 drawbacks of, 55–56 pooled investments, 226–237
capital market line, 318–326 buyout funds, 237
risk-free and risky assets, portfolio of, payments, as pull on liquidity, 158 exchange traded funds, 233–235
314–318 peer-to-peer (P2P) basis, of record hedge funds, 235–236
and efficient frontier, 288–300 mutual funds, 226–233
indifference curve, 294–295 keeping, 457 separately managed accounts, 235
investment opportunity set, 288–289 pension funds venture capital funds, 237
investor preferences and optimal practice problems, 239–240
portfolio, 299–300 enterprise risk management for, 418 risk budgeting for, 421–422
minimum-variance portfolios, investment restrictions for, 379–380 solutions to problems, 241
289–291 pension plans steps in, 222–226
portfolio selection example, 294–299 defined benefit, 217 execution, 223–225
risk-free assets, 291–294 defined contribution, 216 feedback, 225–226
and investment characteristics of Pensions Act (1995), 368 planning, 222–223
assets, 244–267 Pensions Regulator, 369 portfolio managers, risk management
distributional characteristics, performance evaluation, 342. see also
264–266 by, 408
market characteristics, 266–267 portfolio performance evaluation portfolio performance evaluation,
return characteristics, 244–259 performance measurement, in portfolio
as investor objective, 243–244 341–346
for investor with heterogeneous beliefs, management, 226 example, 344–346
350–351 performance reporting, in portfolio Jensen’s alpha, 343–344, 346
optimal risky portfolio, 313–314 M2, 342–343
and portfolio risk, 276–287 management, 226 Sharpe ratio, 342
diversification of risk, 282–287 periodicity, of beta return interval, 94 Treynor ratio, 342
portfolio with many risky assets, permissioned networks, 471 portfolio planning, 368–384
281–282 permissionless networks, 471 case studies, 373–376, 382–384
portfolio with two risky assets, per unit contribution margin, 131 gathering client information, 381–384
276–281 Peterson, James D., 94n.23 investment policy statements, 368–381
practice problems, 302–308, 356–361 pet projects, 49
pricing of risk, 326–328 physical assets, 472 components, 369
and risk aversion, 267–276 PI. see profitability index investor constraints, 376–381
concepts, 267–268 planning step (portfolio management), legal and regulatory factors, 379–380
indifference curves, 269–271 liquidity, 376–378
utility theory, 268–276 222–223 return objectives, 375–376
solutions to problems, 309–312, 362–364 point of sale (POS) systems, 178 risk objectives, 370–375
poison pills, 26 tax concerns, 379
optimal risky portfolio policy costs, 184 time horizon, 378–379
and capital market line, 320 policy portfolios, risk objectives for, 370 unique circumstances on, 380–381
and homogeneity of expectations, pooled investments, 226–237 portfolio returns
317–318 defined, 253
portfolio selection for, 313–314 buyout funds, 237 for portfolios of risky assets, 276,
exchange traded funds, 233–235
optionlike features, debt with, 86 hedge funds, 235–236 315–316
options, 444–445 mutual funds, 226–233 portfolio risk, 276–287
ordering costs, 184
ordinary terms, 176 about, 226–230 diversification, 282–287
Organisation for Economic types of, 230–233 avenues for diversification, 285–287
separately managed accounts, 235 correlation and risk diversification,
Co-operation and Development venture capital funds, 237 284
(OECD), 7, 38, 216–217 population standard deviation, 257 historical correlation among asset
organizational infrastructure, 14 Porter, R. Burr, 106n.37 classes, 285
overdraft lines of credit, 189 portfolio beta, SML and, 339–340 historical risk and correlation, 284
overfitting, of data, 461 portfolio construction, 384–398
overinvestment, in inventory, 182–183 about, 384–385 for portfolios of risky assets
Owens Corning Corporation, 146–147, capital market expectations, 385 with many risky assets, 281–282
209–210 and CAPM, 348–351 with one risk-free asset, 315–316
owners, business risk for, 145–147 implementing investment strategy, with two risky assets, 276–281
ownership, voting rights and, 31–32
P 393–397 scenario analysis for, 469
P2P basis. see peer-to-peer basis, of organizing principles for, 397–398 portfolios
record keeping and portfolio management, 223–225
passive portfolios, 318 strategic asset allocation, 385–393 composition of, 212–213
as investment approach, 207–208
for European charity, 395–397
objective of, 388–389 and diversification, 208–210
for private investor, 392–393 and downside risk, 213–215
specifying asset classes for, 386–387 and modern portfolio theory,
portfolio management, 207–241
investing in portfolios vs. single 215–216
and portfolio composition, 212–213
equities, 207–208 and risk–return tradeoff, 210–212
diversification, 208–210
downside risk, 213–215
Index I-11
portfolio selection rationing, capital, 52 nominal and real returns of asset
and capital allocation line, 273–276 real estate, correlation with other asset classes in other countries,
comprehensive example, 294–299 262–263
for optimal risky portfolio, 313–314 classes, 386
and risk aversion, 273–276 real returns nominal returns of major US asset
with utility theory, 273–276 classes, 260–261
of asset classes in other countries,
positive correlation, 277 262–263 real returns of major US asset classes,
positive screening, 37 261–262
POS systems. see point of sale systems of asset classes in United States,
post-auditing, 48–49 261–262 risk–return tradeoff, 263–264
post-trade clearing and settlement, historical mean, 259–260
defined, 254–255 holding period, 245
472–473 real risk-free interest rate, 259 leveraged, 255
precautionary stocks, of inventory, 182 rebalancing, in portfolio management, 225 mean, 246
preferred stock rebalancing policy, 395 money-weighted, 248–249
receipts, customers’, 177–180 net, 253–254
cost of, 86–88 receivables nominal
fixed rate perpetual, 86–87
premiums, of asset classes, 262. see also discounted, 190 of asset classes in other countries,
as drag on liquidity, 158 262–263
risk premiums number of days of, 160, 181
pre-tax nominal return, 254 record keeping, 457 of asset classes in United States,
PRI. see Principles of Responsible regression analysis, 332–333 260–261
regular lines of credit, 189, 190
Investment regulations, 20 pre-tax/after-tax, 254
priced risk, 89 regulators portfolio
price impact, in cost of trading, 266 and remuneration policies, 18
price takers, 337 shareholder conflicts with, 13 defined, 253
pricing. see also capital asset pricing as stakeholders, 10 for portfolios of risky assets, 276,
regulatory compliance, 473
model (CAPM) regulatory factors, in IPSs, 379–380 315–316
arbitrage pricing theory, 353 regulatory projects, capital budgeting real, 254–255
matrix, 85
risk, 326–328 for, 49 of asset classes in other countries,
primary sources of liquidity, 157 regulatory risk, 29, 427 262–263
Princeton University, 218 related-party transactions
principal–agent relationship, 11 of asset classes in United States,
Principles of Corporate Governance, 7, 22 and controlling–minority shareholder 261–262
Principles of Responsible Investment relationships, 12–13
defined, 254–255
(PRI) initiative, 39 policy development, 18 risk and, 279–281 (see also risk–return
private investors, strategic asset and poor governance, 29
relative risk objectives, 370 tradeoff )
allocation for, 392–393 remuneration. see compensation risk-free, 319–321
probability, 435 reorganization, 146–147 for risky assets, 276
Procedures, IPS, 369 replacement projects, capital budgeting uncorrelated, 277
profitability, degree of operating leverage variance of, 257
for, 49
and, 133–134 reporting, 17 for portfolio of assets, 257, 281–282
profitability index (PI), 58 reports for portfolio of risky assets, 315
programming languages, 464–465 for single asset, 256
project beta. see beta analyzed with machine learning, 466 and standard deviation, 257
project sequencing, 51–52 in portfolio management, 226 return-generating models for beta,
proposals, in capital budgeting process, 48 on short-term investment portfolio, 174
proxy, for market portfolio, 352 repurchase agreements, 168 328–329, 351. see also capital
proxy contests, 26 reputational risk, 29 asset pricing model (CAPM)
proxy voting, 16, 28 required rate of return, 50, 91 decomposition of total risk for, 330
pull on liquidity, 158–159 responsible investing (RI), 36–37 market model, 330–331
purchasing–inventory–payables process, restrictions, investment policy, 172 single-index models, 330
return(s), 244–259 three- and four-factor, 329
186–187 annualized, 251–253 return interval, beta, 94
pure-play method, for beta, 95–98 arithmetic, 246 return objectives, on IPSs, 375–376
purpose, investment policy, 172 and beta, 331–332, 339–340 reverse mortgage, 244n.1
Python (programming language), 464 on capital market line, 321–322 revolving credit accounts, 176
Q CAPM’s prediction of, 352 revolving credit agreements, 189–191
Qtel, 12 covariance of, 257 rho, 436
quality, investment policy, 173 expected RI. see responsible investing
quick assets, 160 rights, shareholder. see shareholder
quick ratio, 160 and beta, 333–335 rights
R CAPM estimation of, 340–341 risk(s). see also portfolio risk
R (programming language), 464 and historical mean return, 259–260 acceptance of, 441
rate of return and SML, 338–339 accounting, 427
and strategic asset allocation, 390 business
average accounting, 57–58 geometric mean, 246–247 components of, 128
internal (see internal rate of return gross, 253–254 for creditors and owners, 145–147
historical, 263 defined, 95
(IRR)) estimating cost of equity with, 89–92 financial risk, 136–140
required, 50, 91 historical mean return and expected and leverage, 128–136
operating risk, 130–136
return, 259–260 sales risk, 128–130
on capital market line, 321–322
counterparty, 425, 431
I-12 Index
risk(s) (Continued) unsystematic, 436n.27 risk governance, 417–424
country, 100–101 value at risk, 370n.1 for enterprises, 417–419
credit, 171, 425, 438 establishing risk tolerance level,
currency, 409–410 conditional, 437 419–421
default, 171, 425 and kurtosis, 265 example, 423–424
defined, 409 risk budgeting with, 422 with risk budgeting, 421–423
downside, 213–215 as risk metric, 436–438
and economic activity, 407 “wrong-way,” 431 risk management process, 409–417
financial, 95 risk analysis, 468–469 benefits from, 416
defined, 424 risk attitude, clients’, 371 for enterprises, 413–415
drivers of, 434–435 risk averse (term), 268 framework for, 411–417
and leverage, 136–140 risk aversion, 267–276 good vs. bad, 410–411
non-financial vs., 432–433 in CAPM assumptions, 336 for individuals, 415
types of, 424–426 concepts, 267–268 risk exposure in, 409–410
first- vs. second-order, 436n.28 and indifference curves, 269–271
foreign exchange, 171 and optimal portfolio, 299–300 risk modification methods, 439–447
health, 430 and portfolio selection, 273–276 acceptance of risk, 441
Herstatt, 426n.19 and utility theory, 268–276 example, 446–447
historical, 263–264 computation of utility, 272 prevention and avoidance of risk,
identification of, 424–433 portfolio selection with utility theory, 439–440
financial risks, 424–426, 432–433 selecting, 445–446
and interactions between risks, 273–276 shifting of risk, 443–445
430–432 risk aversion coefficient, 269 transfer of risk, 441–443
non-financial risks, 424, 426–430, risk budgeting, 393, 394, 421–423
432–433 risk committee, 24 solutions to problems, 453–454
in risk management framework, 411 risk culture, 416 risk management framework, 411–417
infrastructure, 412 risk drivers, 409n.1, 434–435 risk mitigation, 412
interactions between, 430–432 risk exposure, 409–410 risk modification, 439–447
interest rate, 171 risk-free assets, 291–294
investment, 170–171 acceptance of risk, 441
investors’ willingness/ability to take capital allocation line and optimal risky example, 446–447
risk, 371–373 portfolio, 291–292 prevention and avoidance of risk,
legal, 426–427
liquidity, 425–426 and capital market line, 319–321 439–440
as financial risk, 425–426 combining risky assets with, 315–318 selecting, 445–446
interactions of market and solvency and homogeneity of expectations shifting of risk, 443–445
risk with, 431 transfer of risk, 441–443
safety measures for, 171 assumption, 317–318 risk monitoring, 412
solvency risk vs., 429n.23 two-fund separation theorem, risk neutral (term), 268
of major asset classes, 263 risk objectives, on IPSs, 370–375
market, 171, 425, 431 292–293 risk position, 409n.1
market price of, 273 utility theory and selection of, risk premiums
measurement of, 411–412, 435–439, asset, 216
446–447 273–276 bond yield plus, 93
model, 427 risk-free rate of interest, 93n.19, 259 defined, 263
mortality, 430 risk-free return, capital market line and, equity, 89–92
non-financial, 424, 426–430, 432–433 expected, 259
nonsystematic, 326–328 319–321 historical equity risk premium
operating, 95, 128, 130–136 risk governance, 417–424
operational, 428–430, 438–439 approach, 89–92
prevention and avoidance of, 439–440 defined, 411 for real returns, 254
priced, 89 for enterprises, 417–419 risk–return tradeoff, 263–264
pricing of, 326–328 establishing risk tolerance level, and adding assets to portfolios, 287
regulatory, 427 and investing in portfolios vs. equities,
relationship of return and, 279–281 419–421
sales, 95, 128–130 example, 423–424 210–212
settlement, 426 with risk budgeting, 421–423 for strategic asset allocation, 387
solvency, 429, 431 risk infrastructure, 412 risk seeking (term), 267–268
systematic, 326–328 risk management, 407–454 risk shifting, 443–445
and calculation of beta, 331–332 and corporate governance, 35 risk tolerance, 419–421
drivers of, 435 in decision process, 407–408 defined, 268
in Jensen’s alpha, 343 defined, 410 in enterprise risk management, 417
for single-index model of beta, 331 and drivers of risk, 434–435 on investment policy statements,
and strategic asset allocation, 384 enterprise
in Treynor ratio, 342 371–373
tail, 427–428 defined, 411 in portfolio management, 222
tax, 427 process for, 413–415 and shareholder–manager
total, 330, 342 risk governance in, 417–419
tracking, 370n.2 risk tolerance in, 420 relationships, 12
of two-asset portfolio, 258–259 identification of risks, 424–433 shareholder vs. creditor interests, 13
financial risks, 424–426, 432–433 risk transfer, 441–443
and interactions between risks, risky assets
combining risk-free assets with, 315–318
430–432 covariance and correlation of risks,
non-financial risks, 424, 426–430,
277–279
432–433 efficient frontier of, 291
long-term, 35 importance of correlation of risks in
metrics for, 435–439, 446–447
in portfolio construction, 224 portfolio, 282
by portfolio managers, 408 portfolio return for, 276
practice problems, 450–452
in real time, with fintech, 468–469
Index I-13
portfolio risk with, 276–282 shareholder(s) SOX. see Sarbanes–Oxley Act of 2002
relationship of risk and return, 279–281 conflicts with governments or S&P 500 Index
utility theory and selection of, 273–276 regulators, 13
risky portfolios controlling shareholders vs. minority as benchmark, 375
insurance for, 287 shareholders, 12–13 co-movement patterns, 213–215
optimal risky portfolio creditor interests vs., 13 correlations of stocks, 284, 332
customer conflicts with, 13 diversification with stocks, 348–349
and capital market line, 320 legal protections for, 27 as market index, 318
and homogeneity of expectations, manager/director relationships, 11–12 as market proxy, 319–321
reported returns, 245
317–318 shareholder activism, 25–26, 34 return and risk of two-asset portfolio,
selection for, 313–314 shareholder engagement, 25
Rite Aid Corporation, 95 shareholder rights, 34 258–259
Ritter, Jay, 105 shareholder rights plan (poison pill), 26 returns for Enron vs., 208–209
Robert Wood Johnson Foundation, 219 shareholder theory, 7 tail risk with, 427
robo-advisory services, 455, 457, 466–468 Shari’a, 380 Spain, 16, 90
rogue traders, 428 Sharpe, William, 216, 335 Spartan 500 Index fund, 341–342
Ross, Stephen, 353 Sharpe ratio, 287, 342 SQL (database), 465
Russia, 379 short hedge fund strategies, 236 SQLite (database), 465
S short selling, 336n.4 SRI. see socially responsible investing
SAA. see strategic asset allocation short-term borrowing, 167 staggered boards, 21–22, 26
SAFE Investment Company, 221 short-term cash flows, 165–166 stakeholder(s), 8–14
safety projects, capital budgeting for, 49 relationships, 11–14, 25–28
safety stock, of inventory, 183 cash forecasting systems, 166
sales risk, 95, 128–130 identifying typical cash flows, 165–166 controlling shareholder–minority
SAMA Foreign Holdings, 221 minimum cash balances, 165 shareholder relationships, 12–13
sample standard deviation, 257 short-term financing, 189–194
Sampo, 377–378 asset-based loans, 192 manager–board relationships, 13
Sarbanes–Oxley Act of 2002 (SOX), 7 borrowing approaches, 191–192 market factors, 25–26
SASB. see Sustainability Accounting costs of borrowing for, 193–194 non-market factors, 27–28
sources of, 189–191 principal–agent relationship, 11
Standards Board short-term funds management, 167–174 shareholder–manager/director
say on pay, 18–19 evaluating, 174
scale, project, 62–63 investment instruments, 168–171 relationships, 11–12
scenario analysis, 437, 469 strategies for, 171–174 shareholder vs. creditor interests, 13
scenario loss, 422 short-term investment portfolio reports, various conflicts, 13
schedules stakeholder groups, 8–11
174 board of directors, 9–10
accounts receivable aging, 180–181 short-term investments, 168–171 creditors, 9
investment opportunity, 82 customers, 10
marginal cost of capital, 102–105 examples, 168–169 employees, 9
Scholz, Peter, 467 investment risks, 170–171 governments, 10
SCL. see security characteristic line managing cash positions with, 167 managers, 9
search (data processing method), 463 yields of, 169–170 regulators, 10
SEC. see US Securities and Exchange SI. see sustainable investing shareholders, 8–9
Siegel, Jeremy, 90n.14 suppliers, 10
Commission Singapore, 16 stakeholder management, 5–36, 14–20
secondary sources of liquidity, 157–158 single-factor models of beta, limitations about, 14
second-order risk, 436n.28 analyst considerations, 31–36
sector ETFs, 234 of, 352 board of directors representation, 32
Securities Act (1933), 235–236 single-index models for beta, 330. see composition of investors, 33–34
security analysis, in portfolio economic ownership and voting
also capital asset pricing model
management, 223 (CAPM) control, 31–32
security characteristic line (SCL), calculation and interpretation of beta long-term risk management, 35
with, 331–332 remuneration and company
346–347 decomposition of total risk for, 330
security market line (SML), 337–340 defined, 329 performance, 32–33
single-period models of beta, limitations shareholders’ rights, 34
and expected return, 338–339 of, 352 defined, 14
portfolio beta, 339–340 skewness, 264–265 mechanisms, 15–20
and security selection, 347–348 small-capitalization stocks, beta audit function, 17
security selection adjustments for, 94 board of directors, 17
and CAPM, 347–348 “smart contracts,” 470 contractual agreements with
defined, 394 SMAs. see separately managed accounts
security valuation, cost of capital for, Smith, Clifford W., 175n.5 creditors, 19
SML. see security market line contractual agreements with
82–84 smoothing techniques, for beta, 94
self-insurance, 441 socially responsible investing (SRI), 37, customers/suppliers, 20
self-investment limits, 379–380 380–381 employee laws/contracts, 19–20
sell-out rights, 16 social media, 27 general meetings, 15–16
sell-side firms, 225 solvency ratios, 438 laws and regulations, 20
semi-structured data, 458 solvency risk, 429, 431 related-party transaction policies, 18
sensors, as Big Data sources, 459, 460 South Africa, 18, 90 remuneration policies, 18
separately managed accounts (SMAs), 235 sovereign wealth funds (SWFs), 221 reporting and transparency, 17
settlement, post-trade, 472–473 sovereign yield spread, 100 say on pay, 18–19
settlement risk, 426 risks and benefits, 28–31
Shanghai Stock Exchange, 319 benefits of effective governance, 29–31
risks of poor governance, 28–29
I-14 Index
stakeholder theory, 7 for single-index model of beta, 331 Treynor, Jack, 216, 335
standard deviation and strategic asset allocation, 384 Treynor ratio, 342
in Treynor ratio, 342 trust receipt agreements, 192
and correlation, 277 T Turkey, 16
for portfolio of two assets, 277 T. Rowe Price Corporate Income Fund, turnover
risk budgeting with, 422
of risk-free asset, 320 231–232 accounts receivable, 160
as risk metric, 435–436 tactical asset allocation, 393–394 inventory, 160, 184–185
and variance of returns, 257 “tag clouds,” 464 two-asset portfolio, risk of, 258–259
Standard & Poor’s, 438 tail risk, 427–428 two-fund separation theorem, 292–293
Stanford University, 218 takeover(s), 12 two-tier board structure, 10
Statement of Duties and Responsibilities, takeover defenses typical cash flows, identifying, 165–166
U
IPS, 369 cross-shareholdings, 33–34 uncommitted lines of credit, 189, 190
Statement of Purpose, IPS, 369 poison pills, 26 uncorrelated returns, 277
statistical factor models, 329 takeover market, 26 underinvestment, in inventory, 183
Staunton, Mike, 89–90 Target, 162–163, 184 underlying, risk budgeting based on, 422
Steiner, Fabian, 105 target balance, 167 unions, 19
stock(s) target capital structure, 80 United Kingdom
tax-advantaged securities, 169 common law system, 27
correlation of T-bills/bonds with, 285 taxes “comply or explain” codes, 34
defined, 259 capital gains, 254 corporate governance systems, 14
employee stock options, 208–210, 286, in CAPM assumptions, 336 equity risk premiums, 90
and cost of capital, 79–80 flotation costs, 105
381 on dividend income, 254 frequency of capital budgeting, 67
fixed rate perpetual preferred, 86–87 and IPSs, 379 IPS requirement, 368
historical risk and correlation, 285 tax risk, 427 one-tier boards, 10
nominal returns, 259–262 T-bills. see US Treasury bills robo-advisory services in, 466
preferred, 86–88 Temasek Holdings, 221 say on pay, 18
real returns, 261–262 tender offers, 26 United Nations, 39
risk and return, 259–260 terrorism, as operational risk, 429 UN Global Compact, 37
skewness of stock returns, 264–265 Tertilt, Michael, 467 United States
stock funds, 229 Texas A&M University System, 218 ACH system, 178
stock mutual funds, 232 text analytics, 465 bank sources of credit, 189
stock-out costs, 184 thematic investing, 37 bond mutual funds, 231n.15
stock-out losses, 182 three-dimensional (3D) graphics, 463 capital budgeting, 67
stock price, net present value and, 67–68 three-factor models for beta, 329 cash underwritten offers, 105
storage (data processing method), 463 time horizon CEO duality, 21
straight voting, 12 for cash forecasting, 166 common law system, 27
stranded assets, 39 for portfolio management, 222 correlation of equities, 386–387
strategic analysis, 412 and portfolio planning, 378–379 equity risk premium, 89–90
strategic asset allocation (SAA), 385–393 and risk tolerance, 371 ETFs, 233
for European charity, 395–397 tokenization, 472 flotation costs, 105
objective of, 388–389 top-down portfolio analysis, 223, 397 four-factor model use, 354
for private investor, 392–393 TOPIX Index, 89, 371 money market funds, 230–231
specifying asset classes for, 385–387 total leverage, 140–143 municipal bonds, 379
stress testing, 437, 468 total risk mutual funds, 230–231
stretching payables, 187 decomposition of, 330 nominal returns of major asset classes,
structured data, 458 in Sharpe ratio, 342
subsidiary, captive finance, 175 tracking error, 370n.2 260–261
Summer Olympics (1980), 443n.36 tracking risk, 370n.2 one-tier boards, 10
sunk costs, 51 tradable assets, 319 pension fund investment restrictions,
supervised learning, 461–462 trade credit, 185, 186
supervisory board, 10 trade discounts, 187–188 379
suppliers trade granting process, 176–177 portfolio management by banks, 220,
contractual agreements with, 20 traders, rogue, 428
customer conflicts with, 13 trading 221
as stakeholders, 10 algorithmic, 469 real returns of major asset classes,
surety bonds, 443 automated, 456
survey approach, for cost of equity, 92 cost of, 266, 287 261–262
Sustainability Accounting Standards high-frequency, 469 risk diversification by insurance
traditional data, 457
Board (SASB), 39 training, in machine learning, 461 companies, 442
sustainable growth rate, 92–93 training datasets, 461 risk of asset classes, 263
sustainable investing (SI), 36–37 transaction costs, 336, 348n.6, 425–426 robo-advisory services in, 466
swaps, credit default, 438n.32 transactions motive, 182 say on pay, 18
Sweden, 90 transfer (data processing method), 463 taxes and cost of capital, 79
SWFs. see sovereign wealth funds transfer, risk, 441–443 US Bankruptcy Code, 146
Switzerland, 90, 105, 379 transparency. see corporate transparency US Federal Reserve, 231
syndicates, 442–443 Treasury bills, 259 US Securities and Exchange
systematic risk, 326–328
Commission (SEC)
and calculation of beta, 331–332 reporting requirements, 235
drivers of, 435 robo-advisory services regulated by, 466
in Jensen’s alpha, 343 and stakeholder relationships, 28
Index I-15
US Territories, ACH system, 178 for single asset, 256 accounts receivable management,
US Treasury bills (T-bills) and standard deviation, 257 175–181
for single-index model of beta, 330
as benchmark, 171 variety, of collected data, 457–458 customers’ receipts, 177–180
correlation of stocks/bonds with, 285 vega, 436 evaluating, 180–181
historical risk and correlation, 285 velocity, of collected data, 457, 458 trade granting process, 176–177
nominal returns, 260–261 vendors, number, size, location of, 186 cash flows, 164–167
as proxy of risk-free return, 319–321 Viskanta, Tadas, 101n.32 forecasting short-term, 165–166
real returns, 261–262 volatility, portfolio management and, monitoring cash uses and levels,
risk–return tradeoff, 261, 263
short-term investment, 168 210–212 166–167
in short-term portfolio report, 174 Volkswagen, emissions scandal, 38 cash position, 164–167
yield, 169–170 volume, of collected data, 457, 458 defined, 155
US Treasury bonds voting, 16 inventory management, 182–185
correlation with other asset classes, voting rights
approaches, 183–184
386 in dual-class share structure, 31–32 evaluating, 184–185
in cost of equity, 88, 90 shareholder, 31–32 financial impact of inventory
universal owners, 38–39 W
university endowments, 218 WACC. see weighted average cost of methods, 185
University of Michigan, 218 and inventory costs, 184
University of Texas System, 218 capital liquidity, 156–164
University of Virginia, 224 Walgreens, 95 drags and pulls on, 158–159
unlimited funds, 52 Wal-Mart Stores, Inc. liquidity management, 157–159
unstructured data, 458 measuring, 159–164
unsupervised learning, 462 inventory management, 184 primary sources, 157
unsystematic risk, 436n.27 liquidity management, 161–163 secondary sources, 157–158
utility, 269, 389–390 and market model, 330–331 practice problems, 196–198
computation of, 272 operating leverage, 135–136 short-term financing, 189–194
and risk seeking, 267 wage/hour discrimination suit, 38 asset-based loans, 192
utility maximization, 336 warehouse receipt agreements, 192 borrowing approaches, 191–192
utility theory Wataniya, 12 costs of borrowing for, 193–194
portfolio selection with, 273–276 weather, risk associated with, 428 sources of, 189–191
and risk aversion, 268–276 Webvan.com, 147 short-term funds management,
V weighing
validation datasets, 461 for cost of capital, 80–82 167–174
valuation principles, in capital of nonmarket securities in portfolio, 350 evaluating, 174
weighted average cost of capital investment instruments, 168–171
budgeting, 48 strategies for, 171–174
value, company, 78 (WACC) solutions to problems, 199–201
value at risk (VaR), 370n.1 in capital budgeting decisions, 82–83 wrap accounts, 235
computing, 79 “wrong-way” risk, 431
conditional, 437 defined, 79 Y
and kurtosis, 265 estimations, 98–100 Yahoo! Finance, 245
risk budgeting with, 422 and raising of additional capital, Yale University, 218–220, 224
as risk metric, 436–438 yields
value-based investing, 37 102–105 bond equivalent, 170
values-based investing, 37 risk factors in, 93 defined, 169–170
Vanguard Group, 232 Wellcome Trust, 220 of discounted securities, 169–170
VaR. see value at risk William and Flora Hewlett Foundation, money market, 170
variable costs on short-term investments,
and degree of operating leverage, 219
willingness to take risk, investors’, 169–170
133–135 sovereign yield spread, 100
and leverage, 126–128 371–373 yield-to-maturity (YTM) approach,
variance W.K. Kellogg Foundation, 219
of returns, 257 working capital management, 155–201 84–85
Yue Yuen Industrial, 210–213
for portfolio of assets, 257, 281–282 about, 155–156 Z
for portfolio of risky assets, 315 accounts payable management, 185–188 Zhao, Quanshui, 105
cash disbursements, 188
evaluating, 188
trade discounts, 187–188
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CFA Program Curriculum Level I Vol 4
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CFA Program Curriculum Level I Vol 4
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