A
Absolute Return
The return that an asset achieves over a period of time. This measure simply looks at the appreciation or depreciation (expressed as a percentage) that an asset – usually a stock or a mutual fund – experiences over a period of time. Absolute return differs from relative return because it is concerned with the return of the asset being looked at and does not compare it to any other measure.
Accumulation Share/Unit
A type of share/unit that enables the income derived by a fund to be re-invested in the fund and reflected in the price.
Active Management
A style of fund management which aims to generate better returns than a stock market index or benchmark.
Algorithm
In mathematics, computing, linguistics and related disciplines, an algorithm is a type of effective method in which a definite list of well-defined instructions for completing a task, when given an initial state, will proceed through a well-defined series of successive states, eventually terminating in an end-state. The transition from one state to the next is not necessarily deterministic; some algorithms, known as probabilistic algorithms, incorporate randomness.
The concept of an algorithm originated as a means of recording procedures for solving mathematical problems such as finding the common divisor of two numbers or multiplying two numbers; such algorithms were in use by the Babylonians as early as 1600 BC.
Alpha
Alpha is a measure of a fund’s over- or under-performance in comparison with its benchmark. It represents the return of the fund when the benchmark is assumed to have a return of zero and thus indicates the extra value that the manager’s activities have contributed. If the Alpha is 5, the fund has outperformed its benchmark by 5%.
A further aspect of Alpha emerges when it is taken in conjunction with Beta. Assuming that a strong R-Squared correlation exists, the Beta will show how volatile the fund is compared to its benchmark, and thus indicate how much extra risk the manager has taken on in order to get that high-Alpha performance. Negative Alpha in conjunction with 1+ Beta is an indication of poor performance: managers are subjecting funds to volatility that is higher than the benchmark, while achieving returns that are lower than the benchmark attained. So, if Alpha indicates better/worse performance compared with the index, Beta shows higher/lower risk.
American Depositary Receipt (ADR)
Certificates traded in United States stock markets which represent an interest in the shares of a foreign company. ADRs were created to make it possible for foreign issuers to meet United States security registration requirements and to enable dividend collection by dollar-based investors. Some ADRs sold in the United States under Section 144a exemptions are not readily resaleable to all US investors; but most ADRs are nearly as freely traded in the United States as a domestic issue.
Annualised Return
The average rate of return for a number of years given as a yearly rate.
Annuity
An arrangement to pay a regular income bought with a lump sum, usually the final value of a personal pension fund. The regular payment rates for annuities are closely tied to the prices and yields of UK government bonds.
Arbitrage
Arbitrage can be defined as the opportunity to buy an asset at a low price and then immediately sell it on a different market for a higher price. For more detailed information, please click here.
Asset Class
Broad categories of investments, including shares, bonds, cash and property – even works of art. In all cases, a market exists for the transfer of these assets from one person to another.
At a Premium
Frequently used in relation to an investment trust, when its share price is greater than the value of the underlying assets per share. In general, a description of an investment when its market price is greater than its underlying value.
B
Bare Trust
A means to transfer investments to children when they reach 18 years of age.
Basis Point
A measure of change equal to one hundredth of one per cent.
Bear Market
A falling market (as opposed to a bull market).
Beta
Beta measures the sensitivity of a share or portfolio compared to the underlying market or benchmark. If a share moves perfectly in line with the market, it has a beta of 1. If it moves only half as much as the market, its beta is 0.5.
If this Beta is an advantage in a rising market, for example a 15% gain for every 10% rise in the benchmark, then obviously the converse is the case when falls are expected. It is important to emphasise that Beta is just an estimate, however, the stronger the R Squared correlation between fund and benchmark, the more reliable this estimate becomes.
Bid Price
The price at which an investor in a unit trust can sell units back to the fund manager.
Blue Chip
A major well-established listed company investors assume has excellent management and strong finances. The term has become a generic one for any high quality securities.
Bond
A debt investment where investors loan money to an entity (company, government or supra sovereign) that borrows the funds for a defined period of time at a specified interest rate. The indebted entity issues investors a certificate (bond) that states the interest rate (coupon) and the frequency it will be paid and when the loaned funds are to be returned (maturity date). In general, the higher the rate of return the bond offers, the more risky the investment. So, to entice investors, most corporate bonds will offer a higher return than a government bond.
Bonus Issue
A handout of new free shares to existing shareholders.
Book to Price
The ratio of the company’s book value (the sum of shareholder’s equity plus accumulated retained earnings from the profit & loss account) to its market capitalisation.
Bottom-up Fund Management
A method used by some fund managers to build a portfolio by picking companies considered to be winners and ignoring broader economic issues or asset allocation guidelines.
Bull Market
An advancing market (as opposed to a bear market).
Business Cycle (or Economic Cycle)
The way in which an economy moves from expansion, prosperity, to recession and then recovery. In periods of long bull markets, some investors tend to think the cycle no longer exists.
Buying on margin
This is when a deposit is left with a broker to cover adverse movements in the price of stocks that the broker has bought on your behalf.
C
Calmar Ratio
Calmar Ratio is a performance measure which is used in comparing Commodity Trading Advisors (CTAs) or alternative asset managers. It is the absolute value of the ratio of the annual compounded return divided by the largest drawdown incurred to date.
It is also quite commonly referred to the MAR ratio. Calmar or MAR ratios of 1 are very rare in real world trading for an extended period of time. From this we can infer that if we are striving for a compounded annual return of 20% than we can expect our largest drawdown to be at least -20%.
Capital Gains Tax
The tax paid by individuals on all gains from the sale of assets. Every person has an annual allowance before the tax is payable and can claim taper relief depending on how long the asset has been held. Individual Savings Accounts (ISAs) avoid any capital gains tax liability.
Capital Shares
Some investment trusts have more than one type of share, and they are called ‘Split Capital’ trusts. Capital shares take all the gains made by the fund after the other share classes have been paid off. They are high risk but have the potential to deliver superior capital appreciation compared to other share classes.
Cash Equivalents
Substitutes for cash, which can be converted readily back into cash. They are often investments in a cash unit trust.
Cash Flow Yield
The annual cash flow per share divided by the share price.
CAT Standard
These were Government guidelines for financial products that set out reasonable Charges, easy Access and fair Terms within Individual Savings Accounts. The low ceiling for charges excludes many products from the voluntary guidelines.
Certificate of Deposit (CD)
Certificate issued by a bank or financial institution stating that an amount has been deposited for a fixed period of time at a set rate of interest. CDs are used a source of income by cash unit trusts and help to give a return better than an ordinary deposit account.
Closed End Fund
A fund which has a fixed number of shares, usually listed on a major stock exchange. Changes in demand are reflected in changes in the share price. An investment trust is a closed end fund.
Collateralised Debt Obligations (CDOs)
Leveraged vehicles that repackage loans into securities. Credit risk can be divided into different tranches, ranked from ‘AAA’ to unrated and any losses are applied in reverse order of seniority. The most risk tranches offer the highest coupons and compensation.
Collective Investment
A general term for investments, such as unit trusts, which are managed by professional managers on behalf of investors.
Contract For Difference (CFD)
A Contract For Difference (CFD) is a contract between two parties, buyer and seller, stipulating that the seller will pay to the buyer the difference between the current value of an asset and its value at contract time. If the difference is negative, then the buyer pays instead to the seller. For example, when applied to equities, such a contract is an equity derivative that allows investors to speculate on share price movements without the need for ownership of the underlying shares.
CFDs allow investors to take long or short positions, and, unlike futures contracts, have no fixed expiry date or contract size. Trades are conducted on a leveraged basis with margins typically ranging from 1% to 30% of the notional value for CFDs on leading equities. For a more detailed explanation, please click here. For leverage, see Gearing.
Convertible Loan Stock
Fixed interest stock issued by a company that can be converted into ordinary shares at a future date. In the meantime, they pay interest.
Corporate Bond
A debt investment issued by a company. Generally considered to be higher risk than government bonds.
Correction
A word used to describe a general fall in share prices but viewed as necessary to stop investors getting carried away and creating a bubble. A correction brings prices to realistic levels in line with likely profits.
Correlation
In probability theory and statistics, correlation (often measured as a correlation coefficient) indicates the strength and direction of a linear relationship between two random variables. In general statistical usage, correlation or co-relation refers to the departure of two variables from independence. In this broad sense there are several coefficients, measuring the degree of correlation, adapted to the nature of the data.
Coupon
The term used to describe the rate of interest on the face value of a bond. Yield is what investors actually receive.
Creation Price
The value of a unit in a unit trust before the initial charge is added. A creation price of a unit is equivalent to the cost of buying the trust’s portfolio at current market levels, with all the expenses included. From the creation price, the buying price charged to investors is calculated.
Credit
Strictly a contractual agreement where a borrower has an agreement to repay the lender at some date in the future, but is also used as a descriptor for a corporate bond.
Credit Default Swap (CDS)
A product designed to transfer the credit risk of fixed income products between two counterparties. The counterparties form an agreement under which one counterparty pays a periodic fee to another in return for insurance over the creditworthiness of a specific fixed income security/index. By doing this, the risk of default associated with the fixed income security/index is transferred from the holder of the fixed income security to the CDS issuer.
Credit Event
The risk due to unforeseen events undertaken by or associated with a company, such as corporate reorganisation or bond buybacks. These may have positive or negative impacts on a bond’s market price.
Credit Risk
The possibility of loss being incurred due to the failure to meet contractual debt obligations.
Cyclical Stock
A share which is closely linked to economic conditions. Cyclical shares tend to rise when an economy is recovering, but fall markedly on any signs of an economic downturn.
