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Terms in this set (68)
The buying of a security such as a stock, commodity or currency, with the expectation that the asset will rise in value.
The sale of a BORROWED security, commodity or currency with the expectation that the asset will fall in value.
The selling of a security that the seller does not own, or any sale that is completed by the delivery of a security borrowed by the seller. Short sellers assume that they will be able to buy the stock at a lower amount than the price at which they sold short.
When securities are held in the name of a broker or other nominee, as opposed to holding them in the customer's name.
Borrowed money that is used to purchase securities. This practice is referred to as "buying on margin".
The percentage of the purchase price of securities (that can be purchased on margin) that the investor must pay for with his or her own cash or marginable securities.
The minimum amount of equity that must be maintained in a margin account. In the context of the NYSE and NASD, after an investor has bought securities on margin, the minimum required level of margin is 25% of the total market value of the securities in the margin account. Keep in mind that this level is a minimum, and many brokerages have higher maintenance requirements of 30-40%.
The use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment.
Indexes - What are they?
A statistical measure of change in an economy or a securities market. In the case of financial markets, an index is an imaginary portfolio of securities representing a particular market or a portion of it. Each index has its own calculation methodology and is usually expressed in terms of a change from a base value. Thus, the percentage change is more important than the actual numeric value.
Indexes - What purpose do they serve?
Indexes - Why are there so many?
Indexes - How to compare
A standard against which the performance of a security, mutual fund or investment manager can be measured. Generally, broad market and market-segment stock and bond indexes are used for this purpose.
An agent that charges a fee or commission for executing buy and sell orders submitted by an investor.
The quick drop and recovery in securities prices that occurred shortly after 2:30pm Eastern Standard Time on May 6, 2010. Initial reports that the crash was caused by a mistyped order proved to be erroneous, and the causes of the flash crash remain unknown. Both the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) have investigated the incident.
The act of attempting to predict the future direction of the market, typically through the use of technical indicators or economic data.
An order that an investor makes through a broker or brokerage service to buy or sell an investment immediately at the best available current price. A market order is the default option and is likely to be executed because it does not contain restrictions on the buy/sell price or the timeframe in which the order can be executed.
A market order is also sometimes referred to as an "unrestricted order."
An order placed with a brokerage to buy or sell a set number of shares at a specified price or better. Limit orders also allow an investor to limit the length of time an order can be outstanding before being canceled.
An order to buy or sell a security when its price surpasses a particular point, thus ensuring a greater probability of achieving a predetermined entry or exit price, limiting the investor's loss or locking in his or her profit. Once the price surpasses the predefined entry/exit point, the stop order becomes a market order.
Pros & Cons of Market Orders
Pros & Cons of LImit Orders
Pros & Cons of Stop Orders
Time Limits of Orders
1. An increase in the value of a capital asset (investment or real estate) that gives it a higher worth than the purchase price. The gain is not realized until the asset is sold. A capital gain may be short term (one year or less) or long term (more than one year) and must be claimed on income taxes. A capital loss is incurred when there is a decrease in the capital asset value compared to an asset's purchase price.
2. Profit that results when the price of a security held by a mutual fund rises above its purchase price and the security is sold (realized gain). If the security continues to be held, the gain is unrealized. A capital loss would occur when the opposite takes place.
The loss incurred when a capital asset (investment or real estate) decreases in value. This loss is not realized until the asset is sold for a price that is lower than the original purchase price.
The investment objective for a moderately conservative portfolio of securities or mutual funds that provides high dividend and annuity payments to satisfy an investor's steady income requirements.
Costs incurred when buying or selling securities. These include brokers' commissions and spreads (the difference between the price the dealer paid for a security and the price at which it can be sold).
Internal Risk Factors
External Risk Factors
Time Value of Money
The idea that money available at the present time is worth more than the same amount in the future due to its potential earning capacity. This core principle of finance holds that, provided money can earn interest, any amount of money is worth more the sooner it is received.
Also referred to as "present discounted value".
The ability of an asset to generate earnings, which are then reinvested in order to generate their own earnings. In other words, compounding refers to generating earnings from previous earnings.
Present Value of Money
The current worth of a future sum of money or stream of cash flows given a specified rate of return. Future cash flows are discounted at the discount rate, and the higher the discount rate, the lower the present value of the future cash flows. Determining the appropriate discount rate is the key to properly valuing future cash flows, whether they be earnings or obligations.
Also referred to as "discounted value".
Future Value of Money
The value of an asset or cash at a specified date in the future that is equivalent in value to a specified sum today.
Rate of Return
The gain or loss on an investment over a specified period, expressed as a percentage increase over the initial investment cost. Gains on investments are considered to be any income received from the security plus realized capital gains.
The interest rate used in discounted cash flow analysis to determine the present value of future cash flows. The discount rate takes into account the time value of money (the idea that money available now is worth more than the same amount of money available in the future because it could be earning interest) and the risk or uncertainty of the anticipated future cash flows (which might be less than expected).
A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique contends that a portfolio of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio.
Diversification strives to smooth out unsystematic risk events in a portfolio so that the positive performance of some investments will neutralize the negative performance of others. Therefore, the benefits of diversification will hold only if the securities in the portfolio are not perfectly correlated.
Required rate of return
The minimum annual percentage earned by an investment that will induce individuals or companies to put money into a particular security or project. The required rate of return (RRR) is used in both equity valuation and in corporate finance.
Investors use the RRR to decide where to put their money. They compare the return of an investment to all other available options, taking the risk-free rate of return, inflation and liquidity into consideration in their calculation. For investors using the dividend discount model to pick stocks, the RRR affects the maximum price they are willing to pay for a stock. The RRR is also used in calculations of net present value in discounted cash flow analysis.
Corporations use the RRR to decide if they should pursue a new project or business expansion; in corporate finance, the RRR is equal to the weighted average cost of capital (WACC).
The annual percentage return realized on an investment, which is adjusted for changes in prices due to inflation or other external effects. This method expresses the nominal rate of return in real terms, which keeps the purchasing power of a given level of capital constant over time.
This is the rate that is added to an investment to adjust it for the market's expectation of future inflation. For example, the inflation premium required for a one year corporate bond might be a lot lower than a thirty year corporate bond by the same company because investors think that inflation will be low over the short-run, but pick up in the future as a result of the trade and budget deficits of years past.
The return in excess of the risk-free rate of return that an investment is expected to yield. An asset's risk premium is a form of compensation for investors who tolerate the extra risk - compared to that of a risk-free asset - in a given investment.
Risk Free Rate
The theoretical rate of return of an investment with zero risk. The risk-free rate represents the interest an investor would expect from an absolutely risk-free investment over a specified period of time.
Proxies for RAte of Return
Holding Period returns
Internal Rate of Return
The discount rate often used in capital budgeting that makes the net present value of all cash flows from a particular project equal to zero. Generally speaking, the higher a project's internal rate of return, the more desirable it is to undertake the project. As such, IRR can be used to rank several prospective projects a firm is considering. Assuming all other factors are equal among the various projects, the project with the highest IRR would probably be considered the best and undertaken first.
IRR is sometimes referred to as "economic rate of return (ERR)".
Pros & Cons of Different Return and Risk Measurements
Sources of Risk
Black Swan Events
An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult to predict. This term was popularized by Nassim Nicholas Taleb, a finance professor and former Wall Street trader.
Pros & Cons of Common Stock
How and why stock prices move
The total dollar market value of all of a company's outstanding shares. Market capitalization is calculated by multiplying a company's shares outstanding by the current market price of one share. The investment community uses this figure to determine a company's size, as opposed to sales or total asset figures.
Frequently referred to as "market cap".
1. The current quoted price at which investors buy or sell a share of common stock or a bond at a given time. Also known as "market price".
2. The market capitalization plus the market value of debt. Sometimes referred to as "total market value".
The actual value of a company or an asset based on an underlying perception of its true value including all aspects of the business, in terms of both tangible and intangible factors. This value may or may not be the same as the current market value. Value investors use a variety of analytical techniques in order to estimate the intrinsic value of securities in hopes of finding investments where the true value of the investment exceeds its current market value.
Issuing rights to a company's existing shareholders to buy a proportional number of additional securities at a given price (usually at a discount) within a fixed period.
A corporate action in which a company's existing shares are divided into multiple shares. Although the number of shares outstanding increases by a specific multiple, the total dollar value of the shares remains the same compared to pre-split amounts, because no real value has been added as a result of the split.
A program by which a company buys back its own shares from the marketplace, reducing the number of outstanding shares. Share repurchase is usually an indication that the company's management thinks the shares are undervalued. The company can buy shares directly from the market or offer its shareholder the option to tender their shares directly to the company at a fixed price.
Dividends - Why they are paid
Dividends - How they are paid
Dividends - Relationship to stock prices
Dividends - Cash & Stock Dividends
Concept of Investment Strategies
Recommended textbook explanations
Principles of Economics
N. Gregory Mankiw
Economics: New Ways of Thinking
Roger A. Arnold
Principles of Economics
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