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Terminology

Alpha - a measure of performance on a risk-adjusted basis. Alpha takes the volatility (price risk) of a mutual fund and compares its risk-adjusted performance to a benchmark index. The excess return of the fund relative to the return of the benchmark index is a fund's alpha.

Benchmark - 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.

Beta Coefficient - measure of a stock’s relative volatility. The beta is the covariance of a stock in relation to the rest of the stock market. The Standard & Poor’s 500 Stock Index has a beta coefficient of 1. Any stock with a higher beta is more volatile than the market, and any with a lower beta can be expected to rise and fall more slowly than the market.

Churning - excessive trading of a client’s account. Churning increases the broker’s commissions, but usually leaves the client worse off or no better off than before. Churning is illegal under SEC and exchange rules, but is difficult to prove.

Correlation Coefficient - statistical measure of the degree which the movements of tow variable are related.

Covariance - statistical term of the correlation between two variables multiplied by the standard deviation for each of the variables.

Diversification - spreading of risk by putting assets in several categories of investments—stock, bonds, money market instruments, and precious metals, for instance, or several industries, or a mutual fund, with its broad range of stocks in one portfolio.

Dividend - distribution of earnings to shareholders, prorated by class of security and paid in the form of money, stock, scrip, or, rarely, company products or property. The amount is decided by the board of directors and is usually paid quarterly. Dividends must be declared as income in the year they are received.

EFT - a security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange. ETFs experience price changes throughout the day as they are bought and sold.

Fiduciary - person, company, or association holding assets in trust for a beneficiary. The fiduciary is charged with the responsibility of investing the money wisely for the beneficiary’s benefit. Some examples of fiduciaries are executors of wills and estates, receivers in bankruptcy, trustees, and those who administer the assets of underage or incompetent beneficiaries. Most U.S. states have laws about what a fiduciary may or may not do with a beneficiary’s assets. For instance, it is illegal for fiduciaries to invest or misappropriate the money for their personal gain.

Information Ratio - a ratio of portfolio returns above the returns of a benchmark (usually an index) to the volatility of those returns. The information ratio (IR) measures a portfolio manager's ability to generate excess returns relative to a benchmark, but also attempts to identify the consistency of the investor. This ratio will identify if a manager has beaten the benchmark by a lot in a few months or a little every month. The higher the IR the more consistent a manager is and consistency is an ideal trait.

Insolvency - inability to pay debts when due.

Investment Advisory Act 1940 - legislation passed by Congress in 1940 that requires all investment advisers to register with the Securities and Exchange Commission. The Act is designed to protect the public from fraud or misrepresentation by investment advisers.

IRR - Internal Rate of Return, discount rate at which the present value of the future cash flows of an investment equal the cost of the investment.

Liquidity - characteristic of a security or commodity with enough units outstanding to allow large transactions without a substantial drop in price. A stock, bond, or commodity that has a great many shares outstanding therefore has liquidity. Ability of an individual or company to convert assets into cash or cash equivalents without significant loss.

Mutual Funds - fund operated by an investment company that raises money from shareholders and invests it in stocks, bonds, options, commodities, or money market securities. These funds offer investors the advantages of diversification and professional management.

Portable Alpha - a strategy in which portfolio managers separate alpha from beta by investing in securities that differ from the market index from which their beta is derived. Alpha is the return achieved over and above the return that results from the correlation between the portfolio and the market (beta). In simple terms, portable alpha is a strategy that involves investing in areas that have little to no correlation with the market.

Risk Adjusted Return - a concept that refines an investment's return by measuring how much risk is involved in producing that return, which is generally expressed as a number or rating. Risk-adjusted returns are applied to individual securities and investment funds and portfolios.

Sharp Ratio - the Sharpe ratio tells us whether a portfolio's returns are due to smart investment decisions or a result of excess risk. Although one portfolio or fund can reap higher returns than its peers, it is only a good investment if those higher returns do not come with too much additional risk. The greater a portfolio's Sharpe ratio, the better its risk-adjusted performance has been. A negative Sharpe ratio indicates that a risk-less asset would perform better than the security being analyzed.

Standard Deviation - statistical measure of the degree to which and individual value in a probability distribution tends to vary from the mean of the distribution.  

Total Return - return on an investment, taking into account capital appreciation/depreciation , dividends or interest. This contrasts with the price return, which takes into account only the capital gain on an investment. The difference lead to the transposition of performance with equity or bond ETF's / Funds paying high dividends by excluding its cash flows.

Tracking Error - a divergence between the price behavior of a position or a portfolio and the price behavior of a benchmark. This is often in the context of a hedge or mutual fund that did not work as effectively as intended, creating an unexpected profit or loss instead.

Volatility - characteristic of a security, commodity, or market to rise or fall sharply in price within a short-term period.

 

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