Zero Based Budgeting - ZBB

A method of budgeting in which all expenditures must be justified each new period, as opposed to only explaining the amounts requested in excess of the previous period's funding.

For example, if an organization used ZBB, each department would have to justify its funding every year. That is, funding would have a base at zero. A department would have to show why its funding efficiently helps the organization toward its goals. ZBB is especially encouraged for Government budgets because expenditures can easily run out of control if it is automatically assumed what was spent last year must be spent this year.

Supply Chain Management - SCM

The management and coordination of a product's supply chain for the purpose of increasing efficiency and profitability. Typically, SCM will attempt to centrally control or link the production, shipment, and distribution of a product. By managing the supply chain, companies are able to cut excess fat and provide products faster. This is done by keeping tighter control of internal inventories, internal production, distribution, sales, and the inventories of the company's product purchasers.

Just In Time - JIT

An inventory strategy companies employ to increase efficiency and decrease waste by receiving goods only as they are needed in the production process, thereby reducing investory costs. This method requires that producers are able to accurately forecast demand. A good example would be a car manufacturer that operates with very low inventory levels, relying on their supply chain to deliver the parts they need to build cars. The parts needed to manufacture the cars do not arrive before nor after they are needed, rather they arrive just as they are needed. This inventory supply system represents a shift away from the older "just in case" strategy where producers carried large inventories in case higher demand had to be met.

Inventory
Inventory can be either raw materials, finished items already available for sale, or goods in the process of being manufactured. Inventory is recorded as an asset on a company's balance sheet. High inventory isn't a good sign because there is a cost associated with storing the extra inventory.

Balance Sheet
A company's financial statement that reports the assets, liabilities and net worth at a specific time. You will notice that assets = liabilities + shareholders' equity. This equation is true for all balance sheets. If the balance sheet is "consolidated" it just means that the company is a corporate group rather than a single company.

Activity Based Budgeting - ABB

A method of budgeting in which activities that incur costs in each function of an organization are established and relationships are defined between activities. This information is then used to decide how much resource should be allocated to each activity. Basically, ABB is budgeting by activities rather than by cost elements.

Accounting
To provide a record such as funds paid or received for a person or business. Accounting summarizes and submits this information in reports and statements. The reports are intended both for the firm itself and outside parties.

Concise accounting helps management make accurate decisions.

Annual Report
A corporation's annual statement of financial operations. Annual reports include a balance sheet, income statement, auditor's report, and a description of the company's operations. This is usually a sleek, colorful, high gloss publication. Make sure to look beyond the marketing and dig into the numbers. This is the best way to discover the direction of the company. The 10-K is the version of the annual report which gets submitted to the SEC. It contains more detailed financial information.

Cook the Books

A fraudulent activity done by some corporations to falsify their financial statements. Cookie jar accounting is a great example of cooking the books.

Cookie Jar Accounting

An accounting practice where a company uses generous reserves from good years against losses that might be incurred in bad years.

This gives the sense of "income smoothing," because earnings

Certified Public Accountant CPA

A designation by the American Institute of Certified Public Accountants for those who pass an exam and meet work-experience requirements.

For the most part the accounting industry is self-regulated. The CPA is a designation designed to help ensure professional standards for the industry are enforced. Other countries have certifications equivalent to the CPA for their region. For example, in Canada, accountants similar to the CPA are called Chartered Accountants (CA).

Generally Accepted Accounting Principles - GAAP

The common set of accounting principles, standards and procedures that companies use to compile their financial statements. GAAP is a combination of authoritative standards (set by policy boards) and simply the accepted ways of doing accounting.

These are the rules that companies are expected to follow. If a financial statement is not prepared using GAAP principles, be very wary! That said, keep in mind that GAAP is only a set of standards. There is plenty of room within GAAP for unscrupulous accountants to distort figures. So even when a company uses GAAP, you still need to scrutinize its financial statements

Auditor's Report
Recorded in the annual report, the auditor's report tests to see that a corporation's financial statements comply with GAAP. This is sometimes referred to as the clean opinion.

Most auditor's reports consist of three paragraphs. The first states the responsibilities of the auditor and directors. The second is the scope, stating that GAAP was used. Finally, the third paragraph gives the auditor's opinion.

Cash Flow
The amount of cash a company generates and uses during a period, calculated by adding non-cash charges (such as depreciation) to the net income after taxes. Cash flow can be used as an indication of a company's financial strength.

Cash flow is crucial to companies, having ample cash on hand will ensure that creditors, employees, and others can be paid on time.

Income Statement
A financial report that - by summarizing revenues and expenses, and showing the net profit or loss in a specified accounting period - depicts a business entitys financial performance due to operations as well as other activities rendering gains or losses. Also known as the "profit and loss statement" or "statement of revenue and expense".

The income statement is the most analyzed portion of the financial statements. It displays how well the company can assure success for both itself and its shareholders through the earnings from operations.

Voodoo Accounting
Any form of accounting that does not follow principles of conservatism. While there are many methods by which financial statements can be fudged, it always comes down to inflating revenue or hiding expenses. Examples of accounting shenanigans include the big bath, cookie jar accounting and improper recognition of revenue.

Any method that boosts profitability through accounting tricks eventually catches up with the company. As soon as it does "poof", past profits disappear like magic. (Hence the name "voodoo accounting").

Big Bath
The strategy of manipulating a company's income statement to make poor results look even worse. The big bath is often implemented in a bad year to enhance artificially next year's earnings. The big rise in earnings might result in a larger bonus for executives. New CEOs sometimes use the big bath so they can blame the company's poor performance on the previous CEO and take credit for the next year's improvements.

For example, if a CEO concludes that the minimum earnings targets can't be made in a given year, he/she will have an incentive to move earnings from the present to the future since the CEO's compensation doesn't change regardless if he/she misses the targets by a little or a lot. By shifting profits forward - by prepaying expenses, taking write-offs and/or delaying the realization of revenues - the CEO increases the chances of getting a large bonus the following year.

Earnings
The net income of a company during a specific period. Generally, but not necessarily, referring to after-tax income. Earnings are perhaps the single most studied number in a company's financial statements. They show how profitable a company is.

Write-Off
A reduction in the value of an asset or earnings by the amount of an expense or loss. For example, if you spend money on dinner to take out a client, that meal is a possible write-off towards your income because you presumably discussed business opportunities during the dinner. The cost of a computer might be another write-off, as long as you use it for business purposes.

Bottom Line
Slang for net income or profit.

This term comes from the structure of the income statement: profit is recorded on the bottom line of the sheet.

Net Income - NI
An individual's or company's total earnings, calculated by revenues adjusted for costs of doing business, depreciation, interest, taxes and other expenses. Often referred to as "the bottom line".

In the U.K., net income is known as "profit attributable to shareholders".

Top Line
A reference to sales or revenue. This term refers to the fact that revenue is the top line appearing on a company's income statement

Revenue
1. The dollar amount of sales during a specific period, including discounts and returned merchandise. It is the "top line" figure from which costs are subtracted to determine net income. 2. When evaluating stocks, revenue growth serves as an indication of a company's health. Sometimes acquisitions and divestitures will skew revenue growth figures. Also known as REVs.

Core Earnings
The revenue derived from a company's main or principal business less all associated expenses. Compared to net income, core earnings remove all secondary activities performed by a company so that investors will be not be as easily fooled by activities unrelated to the main business. For example, a car manufacturer's main business is producing vehicles. All revenue and expenses associated with the production of cars would be included in the core earnings. Financing schemes, development of non automobile parts or engines, maintenance of pension funds, and real estate interests would be omitted from the core earnings figure.

Expenses
1. Money spent by a firm to continue its ongoing operations. 2. Money spent or costs incurred that are deductible and reduce your taxable income.

Expenses are the opposite of income. Costs that are not deductible are called "capital expenditures" and they must be depreciated or amortized instead

Capital Expenditure - CAPEX

Funds used by a company to acquire or upgrade physical assets such as property, industrial buildings, or equipment.

This can include everything from repairing a roof to building a fire escape.

Capital Asset
A long-term asset that is not bought or sold in the regular course of business.

Examples include land, buildings, machinery, etc. Generally, these are assets you can't turn into cash quickly.

Capital
1. Financial assets or the financial value of assets such as cash. 2. The factories, machinery, and equipment owned by a business. Capital is an extremely vague term that depends on the context for a specific definition. In general, it refers to financial resources available for use.

Capital Appreciation
A rise in the market price of an asset. The price goes up! Capital appreciation is the same as an unrealized capital gain.

Appreciation
The increase in value of an asset. Unless you are short selling, appreciation is always a good thing!

Depreciation

1. An expense recorded to reduce the value of a long-term tangible asset. Since it is a non-cash expense, it increases free cash flow while decreasing reported earnings. 2. A decrease in the value of a particular currency relative to other currencies. 1. Depreciation is used in accounting to try and match the expense of an asset to the income that the asset helps the company earn. For example, if a company bought a piece of equipment for $1 million and expected it would have a useful life of 10 years, it would be depreciated over the 10 years. Every accounting year the company would expense $100,000 (assuming straight line depreciation), and this would be matched with the money that the equipment helps to make each year. 2. Examples of currency depreciation are the infamous Russian rouble crisis, where the rouble lost 25% of its value in one day.

Accretion

1. Asset growth through addition or expansion. 2. In reference to discount bonds, it describes the accumulation of value until maturity. 1. Accretion can occur through a company's internal development or by way to mergers and acquisitions. 2. Bonds at discount are sold below face value and mature at par. In the duration between the bond's issuance and maturity, no additional value is actually being accumulated within the bond but accretion occurs with the paper or implied capital gain.

Earnings per Share - EPS

The portion of a company's profit allocated to each outstanding share of common stock. Calculated as:

Companies usually use a weighted average number of shares outstanding over the reporting term.

This is the single most popular variable in dictating a share's price. EPS indicates the profitability of a company. The diluted EPS means that the outstanding shares include any convertibles or warrants outstanding. Outstanding Shares Stock currently held by investors, including restricted shares owned by the company's officers and insiders as well as those held by the public. Shares that have been repurchased by the company are not considered outstanding stock. They are also known as "issued shares" or "issued and outstanding".

This number is shown on company's' balance sheets under the heading "Capital Stock" and is more important than the authorized shares or float. It is used in the calculation of many widely used metrics including "market capitalization" and "Earnings-per-Share (EPS)".

Outstanding Shares
Stock currently held by investors, including restricted shares owned by the company's officers and insiders as well as those held by the public. Shares that have been repurchased by the company are not considered outstanding stock. They are also known as "issued shares" or "issued and outstanding". This number is shown on company's' balance sheets under the heading "Capital Stock" and is more important than the authorized shares or float. It is used in the calculation of many widely used metrics including "market capitalization" and "Earnings-per-Share (EPS)".

Authorized Stock

The maximum number of shares that a corporation is legally permitted to issue under its articles of incorporation. This figure is usually listed in the capital accounts section of the balance sheet. This number can be changed only by a vote of all the shareholders. Management will typically keep the number of authorized shares higher than those actually issued. This allows the company to sell more shares if it needs to raise additional funds. Also known as authorized shares or authorized capital stock.

Stock
A type of security that signifies ownership in a corporation and represents a claim on part of the corporation's assets and earnings. There are two main types of stock: common and preferred. Common stock usually entitles the owner the right to vote at shareholder meetings and to receive dividends that the company has declared. Preferred stock generally does not have voting rights, but has a higher claim on assets and earnings than the common shares. For example, owners of preferred stock receive dividends before common shareholders and have priority in the event a company goes bankrupt and is liquidated. Also known as shares, or equity. A holder of stock (a shareholder) has a claim on a part of the corporation's assets and earnings. In other words, a shareholder is an owner of a company. Ownership is determined by the number of shares a person owns relative to the number of outstanding shares. For example, if a company has 1000 shares of stock outstanding, and one person owns 100 shares, that person would own and have claim to 10% of the company's assets. Stocks are the foundation of nearly every portfolio, and they have historically outperformed most all other investments over the long run.

American Depository Receipt ADR

A negotiable certificate issued by a U.S. bank representing a specified number of shares (or one share) in a foreign stock that is traded on a U.S. exchange. ADRs are denominated in U.S. dollars, with the underlying security held by a U.S. financial institution overseas, and help to reduce administration and duty costs on each transaction that would otherwise be levied. This is an excellent way to buy shares in a foreign company while realizing any dividends and capital gains in U.S. dollars. However, ADRs do not eliminate the currency and economic risks for the underlying shares in another country. For example, dividend payments in euros would be converted to U.S. dollars, net of conversion expenses and foreign taxes and in accordance with the deposit agreement. ADRs are listed on either the NYSE, AMEX or Nasdaq.

American Depository Share ADS

A share issued under deposit agreement that represents an underlying security in the issuer's home country. The term ADR and ADS are often thought to be the same. Technically, an ADS is the actual share trading, while an ADR represents a bundle of ADS's.

Forex FX
The foreign-exchange market ("forex" or "FX") is the place where currencies are traded. The forex market is the largest, most liquid market in the world with an average traded value of exceeds $1.9 trillion per day.

There is no central marketplace for currency exchange, rather, trade is conducted overthe-counter. It is open 24 hours a day, five days a week, with currencies being traded worldwide throughout the major financial centers of London, New York, Tokyo, Zurich, Frankfurt, Hong Kong, Singapore, Paris and Sydney - spanning most time zones.

Foreign Currency Effects

The extent to which the changes in a foreign currency affects the return on a foreign investment. Foreign investments are complicated by the currency fluctuation and conversion between countries. A high quality investment in another country may prove worthless because of a weak currency.

Repatriation
The process of converting a foreign currency into the currency of one's own country. If you are American, converting British Pounds back to U.S. dollars is an example of repatriation

Global Depository Receipt GDR

2. A financial instrument used by private markets to raise capital denominated in either U.S. dollars or Euros. 1. A GDR is very similar to an American Depository Receipt. 2. These instruments are called EDRs when private markets are attempting to obtain Euros.

1. A bank certificate issued in more than one country for shares in a foreign company. The shares are held by a foreign branch of an international branch. The shares trade as domestic shares, but are offered for sale globally through the various bank branches.

International Depository Receipt - IDR

A negotiable, bank-issued certificate representing ownership of stock securities by an investor outside the country of origin. An IDR is the non-U.S. equivalent of an American Depository Receipt (ADR).

Depository Receipt

A negotiable financial instrument issued by a bank to represents a foreign company's publicly traded securities. The depository receipt trades on a local stock exchange. Depository receipts make it easier to buy shares in foreign companies because the shares of the company don't have to leave the home state. When the depository bank is in the USA, the instruments are known as American Depository Receipts (ADR). European banks issue European depository receipts, and other banks issue global depository receipts (GDR).

Unsponsored American Depository Receipt (ADR)

An ADR that is issued without the involvement of the foreign company whose stock underlies the ADR. Shareholder benefits, voting rights, and other attached rights may not be extended to the holders of these particular securities. These securities generally trade over-the-counter rather than on the Nasdaq or NYSE.

Voting Right

The right of a stockholder to vote on matters of corporate policy as well as on who is to compose the board of directors. Most voting involves decisions on issuing securities, initiating stock splits, and making substantial changes in the corporation's operations.

Cumulative Voting

The procedure of voting for a company's directors, where each shareholder is entitled one vote per share times the number of directors to be elected. This is sometimes known as proportional voting. For example, if you owned 100 shares and there are 3 directors to be elected then you would have 300 votes. This is advantageous for individual investors because they can apply all their votes towards one person.

Statutory Voting

The procedure of voting for a company's directors where each shareholder is entitled to one vote per share. This is sometimes known as straight voting. For example, if you owned 100 shares, then you would have 100 votes.

Voting Shares
Shares that give the stockholder the right to vote on matters of corporate policy making as well as who will compose the members of the board of directors. Different classes of shares, such as preferred stock, sometimes don't allow for voting rights.

Callable Preferred Stock

A type of preferred stock that carries the provision that the issuer has the right to call in the stock at a certain price and retire it. Also referred to as a redeemable preferred stock. You can think of preferred stock as a security somewhere in-between stocks and bonds.

Callable Bond
A bond that can be redeemed by the issuer prior to its maturity. Usually a premium is paid to the bond owner when the bond is called. Also known as a "redeemable bond".

The main cause of a call is a decline in interest rates. If interest rates have declined since a company first issued the bonds, it will likely want to refinance this debt at a lower rate of interest. The company will call its current bonds and reissue them at a lower rate of interest

Call Premium
1. The dollar amount over the par value of a callable fixed-income debt security that is given to holders when the security is called by the issuer. 2. The amount the purchaser of a call option must pay to the writer. 1. The call premium is somewhat of a penalty paid by the issuer to the bondholders for the early redemption. 2. In order to receive the rights associated with a call option, the premium must be paid to the seller.

Conversion
1. The translation of a convertible security into a predetermined number of shares. 2. A strategy used by future traders whereby they mix the purchase of option and futures contracts. 1. Conversion can only be performed if so indicated in the bond indenture or security prospectus. Furthermore, the investor/issuer must adhere to any limitations specified. 2. A conversion involves the purchase of a futures contract and the selling of a call and purchase of a put with the same strike and expiration.

Bear Spread

1. An option strategy seeking maximum profit when the price of the underlying security declines. The strategy involves the simultaneous purchase and sale of options; puts or calls can be used. A higher strike price is purchased and a lower strike price is sold. The options should have the same expiration date. 2. A trading strategy used by futures traders who intend to profit from the decline in commodity prices while limiting potentially damaging losses. 1. You make money if the underlying goes down and lose if the underlying rises in price. 2. A bear spread is created through the simultaneous purchase and sale of two of the same or closely related futures contracts. This is accomplished in the agricultural commodity markets by selling a future and offsetting it by purchasing a similar contract with an extended delivery date.

Bear
An investor who believes that a particular security or market is headed downward. Bears attempt to profit from a decline in prices. Bears are generally pessimistic about the state of a given market. For example, if an investor were bearish on the S&P 500 they would attempt to profit from a decline in the broad market index. Bearish sentiment can be applied to all types of markets including commodity markets, stock markets and the bond market. Although you often hear that the stock market is constantly in a state of flux as the bears and their optimistic counterparts, "bulls", are trying to take control, do remember that over the last 100 years or so the U.S. stock market has increased an average 11% a year. This means that every single long-term market bear has lost money.

Bear Market
A market condition in which the prices of securities are falling or are expected to fall. Although figures can vary, a downturn of 15%-20% or more in multiple indexes (Dow or S&P 500) is considered an entry into a bear market.

When you see a bear what do you do? Tuck in your arms and play dead! Fighting back can be extremely dangerous. It is quite difficult for an investor to make stellar gains during a bear market, unless he or she is a short seller.

Bear Raid
The illegal practice of attempting to push the price of a stock lower by taking large short positions and spreading unfavorable rumors about the target firm. In a bear raid, the manipulators profit on the difference between the original stock price and the lower (manipulated) price. This was a popular practice in the early 1900s.

Bear Hug
An offer made by a company to buy the shares of another company that is too high for the board of the target firm to refuse. If the target company says the merger is okay but they want a higher price, it is called a "teddy bear hug."

Board of Directors - B of D

A group of individuals who are elected by stockholders to establish corporate management policies and make decisions on major company issues, such as dividend policies. These are the people who make decisions on your behalf for the company you invest in. Every public company must have a board of directors.

Dividend
Distribution of a portion of a company's earnings, decided by the board of directors, to a class of its shareholders. The amount of a dividend is quoted in the amount each share receives or in other words dividends per share. Dividends may be in the form of cash, stock, or property. Most secure and stable companies offer dividends to their stockholders. Their share prices might not move much, but the dividend attempts to make up for this. High-growth companies don't offer dividends because all their profits are reinvested to help sustain higher-than-average growth.

Cum Dividend

When a buyer of a security is entitled to receive a dividend that has been declared, but not paid. Cum dividend means "with dividend." A stock trades cum-dividend up until the exdividend date. On or after this point, the stock trades without its dividend rights

Cum Dividend

When a buyer of a security is entitled to receive a dividend that has been declared, but not paid. Cum dividend means "with dividend." A stock trades cum-dividend up until the exdividend date. On or after this point, the stock trades without its dividend rights

Ex-Date

The date on or after which a security is traded without a previously declared dividend or distribution. After the ex-date, a stock is said to trade ex-dividend. This is the date on which the seller, and not the buyer, of a stock will be entitled to a recently announced dividend. The ex-date is usually two business days before the record date. It is indicated in newspaper listings with an x.

Declaration Date

1. The date on which the next dividend payment is announced by the directors of a company. This statement includes the dividend's size, ex-dividend date and payment date. It is also referred to as the "announcement date". 2. The last day on which the holder of an option must indicate whether they will exercise the option. Also known as the "expiration date".

1. Once it is authorized, it is known as a declared dividend and becomes the company's legal liability to pay it. 2. The declaration date of all listed stock options in the U.S. is on the third Friday of the listed month. If there is a holiday on the Friday then the declaration date falls on the third Thursday.

Equalizing Dividend
An additional dividend paid to eligible stockholders when their divided income is reduced due to a change the board of directors makes to the dividend payment schedule. Equalizing dividends are paid to shareholders to compensate them for any dividend income lost from the change.

Dividend Policy
The policy a company uses to decide how much it will pay out to shareholders in dividends. Lots of research and economic logic suggests that dividend policy is irrelevant (in theory).

Dividend Payout Ratio

Calculated as:

The percentage of earnings paid to shareholders in dividends.

The payout ratio provides an idea of how well earnings support the dividend payments. More mature companies will typically have a higher payout ratio. In the UK there is a similar ratio is known as dividend cover, calculated as earnings per share divided by dividend per share.

Ex-Dividend

The trading of shares when a declared dividend belongs to the seller rather than the buyer. A stock trades ex-dividend on or after the ex-dividend date (ex-date).

Holder of Record
The name of the person who is the registered owner of a security. Securities can be issued in either "registered" or "bearer" form. Registered form means the issuing firm keeps records of a security's owner and mails out payments to him/her. Bearer form means the security is traded without any record of ownership; physical possession of the security is the sole evidence of ownership. Presently, securities are mostly issued in registered form.

Bearer Form
A security not registered in the books of issuing corporation but that is payable to its bearer (the person possessing it). Securities can be issued in two forms: registered or bearer. Registered form means the issuing firm keeps records of a security's owner and mails out payments to him/her. Bearer form means the security is traded without any record of ownership, so physical possession of the security is the sole evidence of ownership. Most securities issued today are in registered form. A bearer bond, also known as a coupon bond, has coupons that must be clipped from the security and presented in order to receive interest payments. The issuer will not remind the bearer of coupon payments. A bearer stock certificate is negotiable without endorsement and is transferred upon delivery.

Book-Entry Securities

Securities that are recorded in electronic records called book entries rather than as paper certificates. Also referred to as "book-entry receipt." Ownership of U.S. government book-entry securities is transferred over fedwire.

Automated Bond System - ABS

The electronic system on the NYSE that records bids and offers for inactively traded bonds until they are canceled or executed. Because the bid and ask prices of inactively traded bonds aren't constantly changing due to demand and supply conditions, investors looking for a quote may have difficulties. By having all inactive bonds electronically monitored, the NYSE is able to keep a good inventory of bond prices, just in case an investor is interested in purchasing them.

Ask
The price a seller is willing to accept for a security, also known as the offer price. Sometimes called "the ask," this is the price the seller is asking for.

Ask Size
The number of shares a seller is selling at a quoted ask price. If someone is willing to sell 10,000 shares @ $2 per share, then the ask size is 10,000 shares.

Bid Size
The number of shares a buyer is willing to purchase at the quoted bid price. For example, if the bid price is $20 and the bid size is 2000, that means someone is willing to purchase 2000 shares @ $20 per share.

Bid

1.An offer made by an investor, trader, or dealer to buy a security. 2. The price at which a market maker is willing to buy a security. In other words, the bid is what someone is willing to pay for an asset.

Best Bid

The highest quoted bid for a particular stock among all those offered by competing market makers. Simply put, this is the highest price someone is willing to pay for an asset.

Best Ask
The lowest quoted ask price for a particular stock among those offered from competing market makers. In layman's terms, this is the lowest price for which someone is willing to sell an asset.

Market Maker

A broker-dealer firm that accepts the risk of holding a certain number of shares of a particular security in order to facilitate trading in that security. Each market maker competes for customer order flow by displaying buy and sell quotations for a guaranteed number of shares. Once an order is received, the market maker immediately sells from its own inventory or seeks an offsetting order. This process takes place in mere seconds. The Nasdaq is the prime example of an operation of market makers. There are over 500 member firms that act as Nasdaq market makers, keeping the financial markets running efficiently because they are willing to quote both bid and offer prices for an asset.

Broker-Dealer

A person or firm in the business of buying and selling securities operating as both a broker and dealer depending on the transaction. Technically, a broker is only an agent who executes orders on behalf of clients, whereas a dealer acts as a principal and trades for his or her own account. Because most brokerages act as both brokers and principals, the term broker-dealer is commonly used to describe them.

Agent
1. An individual or firm that places securities transactions for clients. 2. A person licensed by a state to sell insurance. 3. A securities salesperson who represents a broker-dealer or issuer when selling or trying to sell securities to the investing public. Essentially, this is the person who makes a transaction on behalf of their employer or client.

Analyst
A financial professional who has expertise in evaluating investments and puts together buy, sell, and hold recommendations on securities. Also known as a financial analyst or security analyst. Analysts are typically employed by brokerage firms, investment advisors, or mutual funds. Analysts do the grunt work for brokers, preparing the research that brokers use. The most prestigious certification an analyst can receive is the Chartered Financial Analyst (CFA) designation. Analysts usually specialize in specific industries or sectors to allow for comprehensive research.

Buy

1. A recommendation to purchase a specific security. 2. To acquire an asset in exchange for currency.

Exact definitions vary by brokerage, but in general this rating is better than neutral but worse than strong buy

Buy and Hold

A passive investment strategy with which an investor buys stocks and holds them for a long period regardless of fluctuations in the market.

Conventional investing wisdom tells us that, with a long time horizon, equities render a higher return than other asset classes such as bonds. There is, however, a debate over whether a buy and hold strategy is superior to an active investing strategy. There is no easy answer to this question as both sides have valid arguments. Buy and hold, however, is advantageous as far as tax implications are concerned.

Dividend Reinvestment Plan DRIP

A plan offered by a corporation allowing investors to reinvest their cash dividends by purchasing additional shares or fractional shares on the dividend payment date.

A DRIP is an excellent way to increase the value of your investment. Most DRIPs allow you to buy shares at a significant discount to the current share price and commission free. Most DRIPS don't allow reinvestments much lower than $10. Sometimes this is abbreviated as "DRP."

Automatic Investment Plan

An investment program that allows you to contribute small amounts of money (as little as $20 a month) in regular intervals. Funds are automatically deducted from your checking/savings account or your paycheck, and invested in a retirement account or mutual fund.

This is one of the best ways to save money. By "paying yourself first" many people find they invest more in the long run. Their investments are treated as another part of their regular budget. It also helps to force you to pay for investments automatically, so don't forget and spend all your money on impulse.

Compounding

The ability of an asset to generate earnings that are then reinvested and generate their own earnings.

Making interest on interest, the power of compounding interest is truly magical. At 15% interest for 25 years, $10,000 would grow to $330,000!

Mutual Fund

A security that gives small investors access to a well-diversified portfolio of equities, bonds and other securities. Each shareholder participates in the gain or loss of the fund. Shares are issued and can be redeemed as needed.

The fund's net asset value (NAV) is determined each day. Each mutual fund portfolio is invested to match the objective stated in the prospectus. It has been shown in study after study that a majority of mutual funds fail to beat the market. Also, picking mutual funds purely on the basis of past performance usually does not work.

Asset Allocation Fund - AAF

A mutual fund that splits its investment assets among stocks, bonds and other investment vehicles in an attempt to provide a consistent return for the investor. Also referred to as a "diversification fund". In other words, this is a mutual fund that diversifies your assets among different investment products such as stocks, international stocks, corporate bonds, money market securities and cash. This type of fund offers wide diversification in one fund, as opposed to investing in several funds to obtain this.

Blend Fund
A mutual fund composed of various asset classes (such as stocks, bonds and money market securities), allowing investors to diversify their holdings by owning just a single fund. Also called "hybrid funds". The risk of blend funds is somewhere between that of growth funds and value funds. Thus, by applying both of these fund strategies, a blend fund might, for instance, invest in both high-growth Internet stocks (like growth funds) and cheaply priced automotive companies (like value funds). As such, blend funds are difficult to classify in terms of risks, and their performance can vary considerably. However, blend funds are usually less risky than stock mutual funds and somewhat more risky than bond funds or money market mutual funds.

Diversification
A risk management technique that mixes a wide variety of investments within a portfolio. It is designed to minimize the impact of any one security on overall portfolio performance. Diversification is possibly the greatest way to reduce the risk. This is why mutual funds are so popular.

Portfolio

The group of assets - such as stocks, bonds and mutuals - held by an investor. To reduce their risk, investors tend to hold more than just a single stock or other asset. Think of the portfolio as a pie: each piece is divided up into specific assets such as bonds, equities, etc.

Portfolio Insurance

1. A method of hedging a portfolio of stocks against the market risk by short selling stock index futures. 2. Brokerage insurance such as the Securities Investor Protection Corporation (SIPC). 1. This hedging technique is frequently used by institutional investors when the market direction is uncertain or volatile. By short selling index futures they offset any downturns, but they also hinder any gains. 2. SIPC is an insurance that provides brokerage customers up to $500,000 coverage for cash and securities held by a firm.

Hedge

Making an investment to reduce the risk of adverse price movements in an asset. Normally, a hedge consists of taking an offsetting position in a related security, such as a futures contract. An example of a hedge would be if you owned a stock, then sold a futures contract stating that you will sell your stock at a set price, therefore avoiding market fluctuations. Investors use this strategy when they are unsure of what the market will do. A perfect hedge reduces your risk to nothing (except for the cost of the hedge).

Delta Hedging

An options strategy that aims to reduce (hedge) the risk associated with price movements in the underlying asset by offsetting long and short positions. For example, a long call position may be delta hedged by shorting the underlying stock. This strategy is based on the change in premium (price of option) caused by a change in the price of the underlying security. The change in premium for each basis-point change in price of the underlying is the delta and the relationship between the two movements is the hedge ratio. For example, the price of a call option with a hedge ratio of 40 will rise 40% (of the stockprice move) if the price of the underlying stock decreases. Typically, options with high hedge ratios are usually more profitable to buy rather than write since the greater the percentage movement - relative to the underlying's price and the corresponding little time-value erosion - the greater the leverage. The opposite is true for options with a low hedge ratio.

Delta

The ratio comparing the change in the price of the underlying asset to the corresponding change in the price of a derivative.

This is sometimes referred to as the hedge ratio. For example, with respect to call options, a delta of 0.7 means that for every dollar the underlying stock increases the call option will increase by $0.70. Put option deltas on the other hand will be negative because, as the underlying security increases, the value of the option will decrease. So a put option with a delta of -0.7 will decrease by $0.70 for every $1.00 the underlying increases in price. As an in-the-money call option nears expiration, it will approach a delta of 1.00, and as an in-the-money put option nears expiration, it will approach a delta of -1.00.

Derivative

A security, such as an option or futures contract, whose value depends on the performance of an underlying security or asset. Futures contracts, forward contracts, options, and swaps are the most common types of derivatives. Derivatives are generally used by institutional investors to increase overall portfolio return or to hedge portfolio risk.

Forward Contract
A cash market transaction in which delivery of the commodity is deferred until after the contract has been made. Although the delivery is made in the future, the price is determined on the initial trade date.

Most forward contracts don't have standards and aren't traded on exchanges. A farmer would use a forward contract to "lock-in" a price for his grain for the upcoming fall harvest.

Commodity
Any bulk good traded on an exchange or in the cash market. Some examples include grain, oats, gold, oil, beef, silver, and natural gas.

Commodity Swap

A swap where exchanged cash flows are dependent on the price of an underlying commodity. This is usually used to hedge against the price of a commodity. In this swap, the user of a commodity would secure a maximum price and agree to pay a financial institution this fixed price. Then in return, the user would get payments based on the market price for the commodity involved. On the other side, a producer wishes to fix his income and would agree to pay the market price to a financial institution, in return for receiving fixed payments for the commodity. The vast majority of commodity swaps involve oil.

Currency Swap

A swap that involves the exchange of principal and interest in one currency for the same in another currency. Currency swaps were originally done to get around the problem of exchange controls.

Currency Overlay

The outsourcing of currency risk management to a specialist firm, known as the overlay manager. This is used in international investment portfolios to separate the management of currency risk from the asset allocation and security selection decisions of the investor's money managers. The overlay manager's hedging is "overlaid" on the portfolios created by the other money managers, whose activities continue unaffected.

Hard Currency Soft Money

A currency, usually from a highly industrialized country, that is widely accepted around the world. The U.S. Dollar and the British Pound are good examples of a hard currency.

1. The "one-time" funding from governments and organizations for a project or special purpose. 2. Paper currency, as opposed to gold, silver, or some other coined metal.

A good example of soft money is the campaign funding that politicians get during election years. The money received is not recurring and it is to be used explicitly for election related expenses.

Soft Currency

Another name for "weak currency." There is very little demand for this type of currency and values often fluctuate. Currencies from most developing countries are considered to be soft currencies.

Hard Money

1. Government and organizations refer to this as funding that is repetitive, not a one time grant or gift. 2. Describes gold/silver/platinum (bullion) coins.

1. Governments and organizations prefer hard money because it is a predictable stream of funds, rather than a one shot deal.

Bullion

Gold and silver that is officially recognized as high quality (at least 99.5% pure), and is in the form of bars rather than coins. Traditionally, bullion has been a good hedge against inflation.

Inflation

The rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling. As inflation rises, every dollar will buy a smaller percentage of a good. For example, if the inflation rate is 2%, then a $1 pack of gum will cost $1.02 in a year. Most countries' central banks will try to sustain an inflation rate of between 2-3%.

Deflation
A general decline in prices, often caused by a reduction in the supply of money or credit. Deflation can be caused also by a decrease in government, personal or investment spending. The opposite of inflation, deflation has the side effect of increased unemployment since there is a lower level of demand in the economy, which can lead to an economic depression. Declining prices, if they persist, generally create a vicious spiral of negatives such as falling profits, closing factories, shrinking employment and incomes, and increasing defaults on loans by companies and individuals. To counter deflation, the Federal Reserve (the Fed) can use monetary policy to increase the money supply and deliberately induce rising prices, causing inflation. Rising prices provide an essential lubricant for any sustained recovery because businesses increase profits and take some of the depressive pressures off wages and debtors of every kind.

Hyperinflation

Extremely rapid or out of control inflation. There is no precise numerical definition to hyperinflation. This is a situation where price increases are so out of control that the concept of inflation is meaningless. The most famous example of hyperinflation occurred in Germany between January 1922 and November 1923. By some estimates, the average price level increased by a factor of 20 billion!

Disinflation

A slowing of the rate at which prices increase. Typically, this occurs during a recession as sales drop and retailers are not able to pass on higher prices to customers. Disinflation is not to be confused with deflation, where prices actually drop.

Inflationary Psychology
The relationship between inflation and individuals' behavior. For example, in times of higher than average inflation, consumers have a higher likelihood of borrowing to buy things because they are assuming goods will cost more tomorrow than they do today. Consequently, this increased buying only exacerbates inflation.

Stagnation
A period of little or no growth in the economy. Economic growth of less than 2-3% is considered stagnation. Sometimes used to describe low trading volume or inactive trading in securities. A good example of stagnation was the U.S. economy in the 1970s.

Stagflation
A condition of slow economic growth and relatively high unemployment - a time of stagnation - accompanied by a rise in prices, or inflation. Stagflation occurs when the economy isn't growing but prices are - not a good situation for a country to be in. This happened to a great extent during the 1970s, when world oil prices rose dramatically, fueling sharp inflation in developed countries. For these countries, including the U.S., the effects of inflation were considerably made worse because of this stagnation.

Consumer Price Index - CPI

A measure of price changes in consumer goods and services such as gasoline, food and automobiles. Sometimes referred to as "headline inflation". CPI is one of the frequently used statistics to identify periods of inflation or deflation. It usually has a big impact on stocks the day it is released.

Personal Consumption Expenditures - PCE

A measure of price changes in consumer goods and services. It consists of the actual and imputed expenditures of households and includes data pertaining to durables, nondurables, and services. It is essentially a measure of goods and services targeted towards individuals and consumed by individuals. Also referred to as "consumption." Similar to the consumer price index (CPI), PCE is a report (actually a part of the personal income report) put out by the Bureau of Economic Analysis of the Department of Commerce. There are two broad indexes of consumer prices in the United States: the CPI and the chain price index for personal consumption expenditures (PCEPI). They are similar in many respects, but there are some important differences which can lead to large gaps between CPI and PCEPI inflation rates at times. The PCEPI uses a chain index which takes into account consumers' changing consumption due to prices, while the CPI uses a fixed basket of goods with weightings that do not change over time. The PCE is a fairly predictable report that has little impact on the markets.

Indicator
Anything used to predict future financial or economic trends. In the context of technical analysis, an indicator is a mathematical calculation based on a securities price and/or volume. The result is used to predict future prices. In an economic context, an indicator could be a measure such as the unemployment rate which can be used to predict future economic trends

Monetary Policy

The actions of a central bank, currency board, or other regulatory committee, that determine the size and rate of growth of the money supply, which in turn affects interest rates. In the United States, the Federal Reserve is in charge of monetary policy.

Discount Rate

1. The interest rate that an eligible depository institution is charged to borrow short-term funds directly from a Federal Reserve Bank. 2. The interest rate used in determining the present value of future cash flows. 1. This type of borrowing from the Fed is fairly limited. Institutions will often seek other means of meeting short-term liquidity needs. The Federal funds discount rate is one of two interest rates the Fed sets, the other being the overnight lending rate, or the Fed funds rate. 2. For example, let's say you expect $1,000 dollars in one year's time. To determine the present value of this $1,000 (what it is worth to you today) you would need to discount it by a particular rate of interest (often the risk-free rate but not always). Assuming a discount rate of 10%, the $1,000 in a year's time would be the equivalent of $909.09 to you today (1000/[1.00 + 0.10]).

Net Present Value - NPV

An approach used in capital budgeting where the present value of cash inflows is subtracted by the present value of cash outflows. NPV is used to analyze the profitability of an investment or project. NPV analysis is sensitive to the reliability of future cash inflows that an investment or project will yield. Formula:

NPV compares the value of a dollar today versus the value of that same dollar in the future, after taking inflation and return into account. If the NPV of a prospective project is positive, then it should be accepted. However, if it is negative, then the project probably should be rejected because cash flows are negative.

Capital Budgeting

The process of determining whether or not projects such as building a new plant or investing in a long-term venture are worthwhile.

Popular methods of capital budgeting include net present value (NPV), internal rate of return (IRR), discounted cash flow (DCF), and payback period. Also known as investment appraisal.

Cost of Capital

The required return necessary to make a capital budgeting project worthwhile, such as building a new factory. Cost of capital would include the cost of debt and the cost of equity. The cost of capital determines how a company can raise money (through a stock issue, borrowing, or a mix of the two). This is the rate of return that a firm would receive if they invested their money someplace else with similar risk.

Cost of Equity
The return that stockholders require for a company. The traditional formula is the dividend capitalization model:

Let's look at a very simple example: let's say you require a rate of return of 10% on an investment in the TSJ Sports Conglomerate. The stock is currently trading at $10 and will pay a dividend of $0.30. Through a combination of dividends and share appreciation you require a $1.00 return on your $10.00 investment. Therefore the stock will have to appreciate by $0.70, which, combined with the $0.30 from dividends, gives your your 10% cost of equity. The capital asset pricing model (CAPM) is another approach to determining cost of equity.

Capital Asset Pricing Model CAPM

A model describing the relationship between risk and expected return that is used in the pricing of risky securities.

The CAPM says that the expected return of a security or a portfolio equals the rate on a risk-free security plus a risk premium. If this expected return does not meet or beat the required return then the investment should not be undertaken. The security market line (SML) plots the results of the CAPM. There are books and research papers written entirely on the CAPM and how to determine the risk premium for various securities.

Capital Market Line - CML

A line used in the Capital Asset Pricing Model to illustrate the rates of return for efficient portfolios depending on the risk free rate of return and the level of risk (beta) for a particular portfolio.

The CML is derived by drawing a tangent line on the intercept point on the efficient frontier where the expected return equals the risk-free rate of return. The CML is considered to be superior to the efficient frontier since it takes into account the inclusion of a risk free asset in the portfolio. The capital asset pricing model (CAPM) demonstrates that the market portfolio is essentially the efficient frontier. This is achieved visually through the security market line (SML).

Standard Deviation

1. A measure of the dispersion of a set of data from its mean. The more spread apart the data is, the higher the deviation. 2. In finance, standard deviation is applied to the annual rate of return of an investment to measure the investment's volatility (risk). A volatile stock would have a high standard deviation. In mutual funds, the standard deviation tells us how much the return on the fund is deviating from the expected normal returns. Standard deviation can also be calculated as the square root of the variance.

Variance

A measure of the dispersion of a set of data points around their mean value. It is a mathematical expectation of the average squared deviations from the mean. Variance measures the variability (volatility) from an average. Volatility is a measure of risk, so this statistic can help determine the risk an investor might take on when purchasing a specific security.

ZZZZ Best
A company owned by Barry Minkow in the 1980s. Through such means as forgery and theft, Minkow appeared to be building a multimillion dollar corporation. ZZZZ Best went public in December of 1986, eventually reaching a market capitalization of over $200 million (U.S. Dollars).

The amazing thing is that Barry Minkow was only a teenager at the time! He was eventually sentenced to 25 years in prison.

Caveat Emptor

Another way to say, "let the buyer beware." In other words, consumers need to know their rights and be vigilant in avoiding scams.

Zombies
Companies that continue to operate even though they are insolvent. Also known as living dead. It's advisable to avoid investing in zombies at all costs; their life expectancies are highly unpredictable.

Insolvency

When a company can no longer meet its debt obligations with another firm or institution. An insolvency proceeding is when the company that is on "the hook" for the debt attempts to get some of their money back through liquidation.

Bankruptcy

The state of a person or firm unable to repay debts. If the bankrupt entity is a firm, the ownership of the firm's assets is transferred from the stockholders to the bondholders. Shareholders are the last people to get paid if a company goes bankrupt. Secure creditors always get first grabs at the proceeds from liquidation.

Bankruptcy

The state of a person or firm unable to repay debts. If the bankrupt entity is a firm, the ownership of the firm's assets is transferred from the stockholders to the bondholders. Shareholders are the last people to get paid if a company goes bankrupt. Secure creditors always get first grabs at the proceeds from liquidation. Bankruptcy The state of a person or firm unable to repay debts. If the bankrupt entity is a firm, the ownership of the firm's assets is transferred from the stockholders to the bondholders. Shareholders are the last people to get paid if a company goes bankrupt. Secure creditors always get first grabs at the proceeds from liquidation.

Lady Macbeth Strategy

A corporate-takeover strategy with which a third party poses as a white knight to gain trust, but then turns around and joins with unfriendly bidders. Lady Macbeth, one of Shakespeare's most frightful and ambitious characters, devises a cunning plan for her husband, the Scottish general, to kill Duncan, the King of Scotland. The success of Lady Macbeth's scheme lies in her deceptive ability to appear noble and virtuous, and thereby secure Duncan's trust in the Macbeths' false loyalty.

Hostile Takeover

A takeover attempt that is strongly resisted by the target firm. Hostile takeovers are usually bad news, as the employee moral of the target firm can quickly turn to animosity against the acquiring firm.

Takeover

A corporate action where an acquiring company makes a bid for an acquiree. If the target company is publicly traded, the acquiring company will make an offer for the outstanding shares. A welcome takeover is usually referring to a favorable and friendly takeover. Friendly takeovers generally go smoothly because both companies consider it a positive situation. In contrast, an unwelcome or hostile takeover can get downright nasty!

Acquisition
When one company purchases a majority interest in the acquired. Acquisitions can either be friendly or unfriendly. Friendly acquisitions occur when the target firm agrees to be acquired, unfriendly acquisitions don't have the same agreement from the target firm.

Merger

The combining of two or more companies, generally by offering the stockholders of one company securities in the acquiring company in exchange for the surrender of their stock. Basically, when two companies become one. This decision is usually mutual between both firms.

De-merger
A corporate strategy to sell off subsidiaries or divisions of a company. For example, in 2001 British Telecom did a de-merger of its mobile phone arm, BT Wireless, in an attempt to boost the performance of its stock. British Telecom took this action because it was struggling under high debt levels from the wireless venture.

Reverse Triangular Merger

When the subsidiary of the acquiring corporation merges with the target firm. In this case, the subsidiary's equity merges with the target firm's stock. As a result of the merger, the target would become a wholly-owned subsidiary of the acquirer and shareholders of the target would get shares of the acquirer. This form of acquisition is often used for regulatory reasons.

Tracking Stock

A stock issued by a parent company in order to create a financial vehicle that tracks the performance of a particular division or subsidiary. When a parent company issues a tracking stock, all revenues and expenses of the applicable division are separated from the parent company's financial statements and bound to the tracking stock. Often this is done to separate a high-growth division from large losses shown by the financial statements of the parent company. The parent company and its shareholders, however, still control operations of the subsidiary.

Carve-out (Equity Carve-Out)

1. Sometimes known as a partial spinoff, a carve out occurs when a parent company sells a minority (usually 20% or less) stake in a subsidiary for an IPO or rights offering. 2. Where an established brick-and-mortar company hooks up with venture investors and a new management team to launch an Internet spinoff. In most cases the parent company will spinoff the remaining interests to existing shareholders at a later date when the stock price is much higher. Also known as a "carveout" or an "equity carve out."

Split-Up
Exchanging the stock of two or more subsidiary companies for all of the parent company's stock, followed by the liquidation of the parent company. A split-up is an effective way to break a company into two or more independent companies.

Consolidated Financial Statements

The combined financial statements of a parent company and its subsidiaries. Because consolidated financial statements present an aggregated look at the financial position of a parent and its subsidiaries, they enable you to gauge the overall health of an entire group of companies as opposed to one company's stand alone position.

Parent Company
A company that controls other companies by owning an influential amount of voting stock. Companies can become parent companies by many different means. The two most common ways are through (1) acquisitions of smaller companies and (2) the spin-off or creation of subsidiaries.

Subsidiary

A company whose voting stock is more than 50% controlled by another company, usually referred to as the parent company.

As long as the parent company has more than 50% of the voting stock in the subsidiary, it has control. In the case of a foreign subsidiary, the company the subsidiary is incorporated under must adhere to the laws of the country in which it operates, although the parent company still carries the foreign subsidiaries financials on their books (consolidated financial statements).

Wholly Owned Subsidiary

A subsidiary whose parent company owns 100% of its common stock. In other words, the parent company owns the company outright and there are no minority owners.

Initial Public Offering - IPO

Also referred to as a "Public Offering."

The first sale of stock by a private company to the public. IPOs are often smaller, younger companies seeking capital to expand their business.

IPOs can be a risky investment, for the individual investor it is tough to predict what the stock will do on its initial day of trading. Also known as going public.

Underwriting
1. The process by which investment bankers raise investment capital from investors on behalf of corporations and governments that are issuing securities (both equity and debt). 2. The process of issuing insurance policies.

The word "underwriter" is said to have came from the practice of having each risk taker write his name under the total amount of risk that he was willing to accept at a specified premium. In a way, this is still true today, as new issues are usually brought to market by an underwriting syndicate in which each firm takes the responsibility (and risk) of selling their specific allotment.

Syndicate
A group of bankers, insurers, etcetera, who work together on a large project. A syndicate only works together temporarily. They are commonly used for large loans or underwritings to reduce the risk that each individual firm must take on.

Spread

1. The difference between the bid and the ask prices of a security or asset. 2. An options position established by purchasing one option and selling another option of the same class, but of a different series.

1) The spread for an asset is influenced by a number of factors, such as: a) Supply or "float" (the total number of shares outstanding available to trade). b) Demand or interest in a stock. c) Total trading activity in the stock. 2) For a stock option, the spread would be the difference between the strike price and the market value.

Market Value
1. The current quoted price at which investors buy or sell a share of common stock or a bond at a given time. 2. The market capitalization plus the market value of debt. Sometimes referred to as "total market value".

1. In the context of securities, market value is often different from book value because the market takes into account future growth potential. Most investors who use fundamental analysis to picks stocks look at a company's market value and then determine whether or not the market value is adequate or if it's undervalued in comparison to it's book value, net assets or some other measure.

Quote

The last price at which a security or commodity traded at, meaning the most recent price at which a buyer and seller agreed on a price and transacted some amount of the asset. This is also referred to as an asset's "quoted price".

Quotes such as stock and bond prices change constantly throughout the trading day as new transactions occur one after another in a constant stream of trades. When you look up a stock quote for a given company, you are looking at the most recent price at which a trade was successfully executed at for that particular security.

Blue Chip

A security from a well-established and financially-sound company that has demonstrated its ability to pay dividends in both good and bad times.

These stocks are usually less risky than other stocks. The stock price of a blue chip usually closely follows the S&P 500. The name "blue chip" came about because in the game of poker the blue chips were traditionally the most expensive ones. Blue Chip A security from a well-established and financially-sound company that has demonstrated its ability to pay dividends in both good and bad times.

These stocks are usually less risky than other stocks. The stock price of a blue chip usually closely follows the S&P 500. The name "blue chip" came about because in the game of poker the blue chips were traditionally the most expensive ones.

Shareholder
Any person, company, or other institution that owns at least 1 share in a company. A shareholder may also be referred to as a stockholder.

Shareholders are the owners of a company. They have the potential to profit if the company does well, but that comes with the potential to lose if the company does poorly.

Corporation
A legal entity that is separate and distinct from its owners. Corporations enjoy most of the rights and responsibilities that an individual possesses; that is, a corporation has the right to enter into contracts, loan and borrow money, sue and be sued, hire employees, own assets and pay taxes. The most important aspect of a corporation is limited liability. That is, shareholders have the right to participate in the profits, through dividends and/or the appreciation of stock, but are not held personally liable for the company's debts.

A corporation is created (incorporated) by a group of shareholders who have ownership of the corporation, represented by their holding of common stock. Shareholders elect a board of directors (generally receiving one vote per share) who appoint and oversee management of the corporation. Although a corporation does not necessarily have to be for profit, the vast majority of corporations are setup with the goal of providing a return for its shareholders. When you purchase stock you are becoming part owner in a corporation. Corporations are often called "C Corporations".

Globalization

The tendency of investment funds and businesses to move beyond domestic and national markets to other markets around the globe and thereby increase the interconnectiveness of different markets.

In general, globalization is seen as making the world one community. The advantages and and disadvantages of globalization has been debated and scrutinized heavily in recent years. Proponents say that it helps Second and Third World nations catch up much faster through increased employment and technological advances. Opponents of globalization say that it reduces national sovereignty and allows rich nations to ship domestic jobs overseas where labor is much cheaper.

General Agreement on Tariffs and Trade - GATT

An agreement signed in 1947, whose purpose was to promote global trade between members through a reduction in tariffs.

The formation of GATT--and its subsequent amendments up to 1994--laid the framework for the creation of the WTO in 1995.

Index

A statistical measure of change in an economy or a securities market. In the case of financial markets, an index is essentially 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 changes is more important that the actually numeric value. For example, knowing that a stock exchange is at, say, 5,000 doesn't tell you much. However, knowing that the index has risen 30% over the last year to 5,000 gives a much better demonstration of performance. The plural of index can be spelled either indexes or indices.

The Standard & Poor's 500 is one of the world's best known indexes, and is the most commonly used benchmark for the stock market. Technically, you can't actually invest in an index. Rather, you invest in a security such as an index fund or ETF that attempts to track an index as closely as possible.

Futures

A financial contract that obligates the buyer (seller) to purchase (sell and deliver) financial instruments or physical commodities at a future date, unless the holder's position is closed prior to expiration.

Futures are often used by mutual funds and large institutions to hedge their positions when the markets are rocky, preventing large losses in value. The primary difference between options and futures is that options provide the holder the right to buy or sell the underlying asset at expiration, while futures contracts holders are obligated to fulfill the terms of their contract.

Arbitrage

The simultaneous purchase and selling of an asset in order to profit from a differential in the price. This usually takes place on different exchanges or marketplaces. Also known as a "riskless profit".

Here's an example of arbitrage: Say a domestic stock trades also on a foreign exchange in another country, where it hasn't adjusted for the constantly changing exchange rate. A trader purchases the stock where it is undervalued and short sells the stock where it is overvalued, thus profiting from the difference. Arbitrage is recommended for experienced investors only.

Market Value Added - MVA

The difference between the market value of a company and the capital contributed by investors (both bondholders and shareholders). In other words, it is the sum of all capital claims held against the company plus the market value of debt and equity.

The higher the MVA, the better. A high MVA indicates the company has created substantial wealth for the shareholders. A negative MVA means that the value of the actions and investments of management is less than the value of the capital contributed to the company by the capital markets, meaning wealth or value has been destroyed.

Economic Value Added - EVA

A measure of a company's financial performance based on the residual wealth calculated by deducting cost of capital from its operating profit (adjusted for taxes on a cash basis). (Also referred to as "economic profit".) The formula for calculating EVA is as follows: = Net Operating Profit After Taxes (NOPAT) - (Capital * Cost of Capital)

This measure was devised by Stern Stewart & Co. Economic value added attempts to capture the true economic profit of a company.

Market Capitalization

The total dollar value of all outstanding shares. It's calculated by multiplying the number of shares times the current market price. This term is often referred to as market cap.

Market Cap is a measure of a company's size. Brokerages vary on their exact definitions, but the current approximate classes of market capitalization are: Mega Cap: Market cap of $200 billion and greater Big/Large Cap: $10-$200 billion Mid Cap: $2 billion to $10 billion Small Cap: $300 million to $2 billion Micro Cap: $50 million to $300 million Nano Cap: Under $50 million In some parts of the world this can be spelt as market capitalisation.

Common Stock
A security that represents ownership in a corporation. Holders of common stock exercise control by electing a board of directors and voting on corporate policy. Common stockholders are on the bottom of the priority ladder for ownership structure. In the event of liquidation common shareholders have rights to a company's assets only after bond holders, preferred shareholders, and other debt holders have been paid in full.

If the company goes bankrupt the common stockholders will not receive their money until the creditors and preferred shareholders have received their respective share of the leftover assets. This makes common stock riskier than debt or preferred shares. The upside to common shares is that they usually outperform bonds and preferred shares in the long run.

Leveraged Buyout - LBO

A strategy involving the acquisition of another company using borrowed money (bonds or loans). The acquiring company uses its own assets as collateral for the loan in hopes that the future cash flows will cover the loan payments.

There is usually a ratio of 90% debt to 10% equity. Because of this high debt/equity ratio, the bonds are usually not investment grade and are referred to as junk bonds.

Management Buyout - MBO

When the managers and/or executives of a company purchase controlling interest in a company from existing shareholders.

In most cases, the management will buy out all the outstanding shareholders and then take the company private because it feels it has the expertise to grow the business better if it controls the ownership. Quite often, management will team up with a venture capitalist to acquire the business because it's a complicated process that requires significant capital.

Venture Capitalist
An investor who provides capital to either start-up ventures or support small companies who wish to expand but do not have access to public funding.

Venture capitalists usually expect higher returns for the additional risks taken.

Angel Investor
A financial backer providing venture capital funds for small start-ups or entrepreneurs. Typically, angel investors are friends or family members. Another good reason to mark their birthdays on your calendar!

Seed Capital

The initial equity capital used to start a new venture or business.

This initial amount is usually quite small because the venture is still in the idea or conceptual stage. Also, there's a high risk that the venture will fail.

Operating Leverage

A measurement of the degree to which a firm or project relies on fixed rather than variable costs.

The higher the degree of operating leverage, the greater the potential danger from forecasting risk. That is, if a relatively small error is made in forecasting sales, it can be magnified into large errors in cash flow projections. If the majority of costs for a company or project are fixed, then the costs will remain high while sales are dropping.

Variable Cost

A cost that changes in proportion to a change in a company's activity or business.

A good example of variable cost is the fuel for an airline. This cost changes with the number of flights and how long the trips are.

Sunk Cost
A cost that has been incurred and cannot be reversed. Also referred to as "stranded cost." A worn-out piece of equipment bought several years ago is a sunk cost because the cost of buying it cannot be reversed.

Outlay Cost
Any concrete costs that can be identified in the past, present, or future. These costs do not include forgone profits or benefits. For corporations, outlay costs for new projects will include start-up, production, maintenance, and extraneous costs. Also referred to as explicit costs.

Opportunity Cost
1. The cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the benefits you could have received by taking an alternative action. 2. The difference in return between a chosen investment and one that is necessarily passed up. Say you invest in a stock and it returns a paltry 2% over the year. In placing your money in the stock, you gave up the opportunity of another investment - say, a riskfree government bond yielding 6%. In this situation, your opportunity costs are 4% (6%2%).

1. The opportunity cost of going to college is the money you would have earned if you worked instead. On the one hand, you lose four years of salary while getting your degree; on the other hand, you hope to earn more during your career, thanks to your education, to offset the lost wages. Here's another example: if a gardener decides to grow carrots, his or her opportunity cost is the alternative crop that might have been grown instead (potatoes, tomatoes, pumpkins, etc.). In both cases, a choice between two options must be made. It would be an easy decision if you knew the end outcome; however, the risk that you could achieve greater "benefits" (be they monetary or otherwise) with another option is the opportunity cost.

Implicit Cost

A cost that is represented by lost opportunity in the usage of a company's own resources, excluding cash.

These are intangible costs that are not easily accounted for. For example, the time and effort that an owner puts into the maintenance of the company rather than working on expansion.

Explicit Cost

A cost that is represented by lost opportunity in actual cash payments.

These are tangible costs which can be easily accounted for. For example: wages, rent and materials

Greenshoe Option

An option that allows the underwriting of an IPO to sell additional shares to the public if the demand is high.

The name comes from the fact that the Green Shoe Company was the first to issue this type of option.

Eating Stock

Purchasing stock not because you desire it but because you are forced to do so.

Underwriters who can't find enough investors to purchase IPO shares are sometimes forced to eat stock. The underwriter is forced to purchase the shares that could not be sold to the public.

Red Herring
A preliminary registration statement that must be filed with the SEC describing a new issue of stock (IPO) and the prospects of the issuing company.

There is no price or issue size stated in the red herring, and it is sometimes updated several times before being called the final prospectus. It is known as a red herring because it contains a passage in red that states the company is not attempting to sell their shares before the registration is approved by the SEC.

Prospectus
1. A formal legal document describing details of a corporation. The prospectus is generally created for a proposed offering (usually an IPO), but they can still be obtained from existing businesses as well. The prospectus includes company facts that are vitally important to potential investors. 2. In this case of mutual funds, a prospectus describes the fund's objectives, history, manager background, and financial statements.

The prospectus is a document that makes investors aware of the risks of an investment.

Sandbag

A stalling tactic used by management to deter a company that is showing interest in taking them over.

The company stalls in hopes that a more favorable company will take them over.

Lobster Trap
A strategy used by a target firm to prevent a hostile takeover. In a lobster trap, the company passes a provision preventing anyone with more than 10% ownership from converting convertible securities into voting stock.

Examples of convertible securities include convertible bonds, convertible preferred stock, and warrants.

Poison Pill

A strategy used by corporations to discourage a hostile takeover by another company. The target company attempts to make its stock less attractive to the acquirer. There are two types of poison pills: 1. A "flip-in" allows existing shareholders (except the acquirer) to buy more shares at a discount. 2. The "flip-over" allows stockholders to buy the acquirer's shares at a discounted price after the merger.

1. By purchasing more shares cheaply (flip-in), investors get instant profits and, more importantly, they dilute the shares held by the competitors. As a result, the competitor's takeover attempt is made more difficult and expensive. 2. An example of a flip-over is when shareholders have the right to purchase stock of the acquirer on a 2-for-1 basis in any subsequent merger. This is similar to the macaroni defense, except it uses equity rather than bonds.

Suicide Pill

A defensive strategy by which a target company engages in an activity that might actually ruin the company rather than prevent the hostile takeover. Also known as the "Jonestown Defense."

This is an extreme version of the poison pill.

Whitemail
A strategy that a takeover target uses to try and thwart an undesired takeover attempt. The target firm issues a large amount of shares at below-market prices, which the acquiring company will then have to purchase if it wishes to complete the takeover.

If the whitemail strategy is successful in discouraging the takeover, then the company can either buy back the issued shares or leave them outstanding.

Bankmail

An agreement made between a company planning a takeover and a bank, which prevents the bank from financing any other potential acquirer's bid.

Bankmail agreements are meant to stop other potential acquirers from receiving similar financing arrangements.

Greenmail
A situation in which a large block of stock is held by an unfriendly company. This forces the target company to repurchase the stock at a substantial premium to prevent a takeover. It is also known as a "Bon Voyage Bonus" or a "Goodbye Kiss".

Not unlike blackmail, this is a dirty tactic, but it's very effective.

Shark Repellent
Any number of measures taken by a corporation to discourage an unwanted takeover attempt.

Examples of shark repellent include Golden Parachute contracts with executives, a defensive merger with another company, a super-majority provision, and so on.

Pac Man

A form of defense used in a hostile takeover situation. The target firm turns around and tries to take over the company that has made the hostile bid.

Just think - all those years of playing Atari games could save a company someday.

Macaroni Defense
An approach taken by a company that does not want to be taken over. The company issues a large number of bonds with the condition they must be redeemed at a high price if the company is taken over.

Why is it called Macaroni Defense? Because if a company is in danger, the redemption price of the bonds expands like Macaroni in a pot!

Sleeping Beauty

A company that is prime for takeover but has not been approached by an acquiring company.

A company may be considered a sleeping beauty because it has large cash reserves, undervalued real estate, or huge potential.

Scorched Earth Policy

An anti-takeover strategy that a firm undertakes by liquidating its valuable and desired assets and assuming liabilities in an effort to make the proposed takeover unattractive to the acquiring firm.

In extreme cases, this strategy might end up being a 'suicide pill'. The scorched earth policy is actually a classic military strategy: generals would instruct troops to burn any land/crops/trees as they retreated so there would be no supplies to refresh the advancing army.

Saturday Night Special

A slang term used to refer to a surprise takeover attempt. The term alludes to the fact that many takeover bids are announced over the weekend in order to avoid too much publicity.

Blank Check Preferred Stock

A method companies use to simplify the process of creating new classes of preferred stock to raise additional funds from sophisticated investors without obtaining separate shareholder approval.

To do this a company must amend its articles of incorporation to create a class of unissued shares of preferred stock whose terms and conditions may be expressly determined by the company's board of directors. This kind of stock can also be created by a public company as a takeover defense in the event of a hostile bid for the company (poison pill).

Articles of Incorporation
A set of documents filed with a government body for the purpose of legally documenting the creation of a corporation. Also referred to as the "corporate charter."

Articles of incorporation typically contain pertinent information such as the firm's address, profile, distribution of corporate powers, and the amount/type of stock to be issued. Some states will offer more favorable environments and thus attract a greater proportion of firms seeking incorporation.

Participating Preferred Stock

A type of preferred stock that, under certain conditions, gives holders the right to receive earnings payouts over and above the specified dividend rate.

Participating preferred stock is rarely issued, but one way in which it is used is as a poison pill. In this case, current shareholders are issued stock that gives them the right to buy more shares at a bargain price in the event of an unwanted takeover bid.

Unbundling

The process of taking over a large company with several different lines of business, and then, while retaining the core business, selling off the subsidiaries to help fund the takeover.

In other words, unbundling occurs when a company purchases another for its most valuable divisions (its crown jewels) with little desire for the other aspects of the business.

Crown Jewels

The most valuable unit of a corporation because of profitability, asset value, future prospects, etc.

The crown jewels are often the target of takeover attempts.

Yard

Slang for one billion units in currency.

The term also refers to "milliard," which is a European term for 1,000 million (a billion). If a person wanted to buy one billion U.S. dollars, he or she might say, "I would like to buy a yard of U.S. dollars." By using the word "yard" in place of "billion," the person ensures that the counter-party will not misunderstand billion for "million" or "trillion."

Woody

Slang to describe when the market has a strong and quick upward movement.

For example, you'll hear "the market has a woody," when the market is performing well... seriously, we don't make this stuff up.

Winner's Curse
A financial theory that the winning participants within an auction will typically pay an overvalued price for the winning item.

The problem of the winner's curse occurs during any auction process when bidders must estimate the true or final value of a desired good. Generally, bidders are considered to be risk averse and the average bid is expected to be lower than the final value. However, due to estimation errors, the winning bid is usually much higher because the highest overestimation made by any of the bidders will win the auction. The significance of this theory is most evident in IPO pricing schemes. Because this observation contradicts the common assumption of rational investors, it allows underwriters to price new issues differently.

Window Dressing
A strategy used by mutual fund and portfolio managers near the year or quarter end to improve the appearance of the portfolio/fund performance before presenting it to clients or shareholders.

Performance reports and a list of the holdings in a mutual fund are usually sent to clients every quarter. To window dress, the fund manager will sell stocks with large losses and purchase high flying stocks near the end of the quarter. These securities are then reported as part of the fund's holdings. Another variation of window dressing is investing in stocks that don't meet the style of the mutual fund. For example, a precious metals fund might invest in stocks that are in a hot sector at the time, disguising the fund's holdings, so clients really have no idea what they are paying for. Window dressing may make a fund appear more attractive, but you can't hide poor performance for long.

Fund Manager

The person responsible for investing a mutual fund's assets, implementing its investment strategy, and managing the day-to-day portfolio trading.

The whole point of investing in a mutual fund is to leave stock picking to professionals. Therefore, the fund manager is one of the most important factors to consider when looking at a mutual fund. Researching a fund manager's past performance in the last 5+ years will tell you a lot; have they had consistent performance, or have they bounced around from fund to fund? Do they have a history of underperforming?

Portfolio Manager
The person responsible for investing a mutual fund's assets, implementing its investment strategy, and managing the day-to-day portfolio trading.

The portfolio manager is one of the most important factors to consider when looking at a mutual fund.

Gunslinger
A high-strung portfolio manager who, looking for high returns, invests in very high-risk stock.

Stay away from these guys, or they could end up shooting you in the foot!

Hedge Fund
An aggressively managed fund portfolio taking positions in both safe and speculative opportunities.

Most hedge funds are limited to a maximum of 100 investors. And for the most part, hedge funds (unlike regular mutual funds) are unregulated because it is assumed that the people investing in them are very sophisticated and wealthy investors. Don't be fooled by the name: hedging is actually the practice of attempting to reduce risk, and the main goal of a hedge fund is to get a maximum rate of return, using strategies involving options, short selling, and leverage. On the other hand, because they often use futures, swaps, and arbitrage strategies, you could argue that hedge funds diversify away some of the investor risk of the stock market.

Winding Up

A process that entails selling all the assets of a business entity, paying off creditors, distributing any remaining assets to the principals, and then dissolving the business.

Essentially, "winding up" is just another term for liquidation.

Wild Card Play

Having the right to deliver on a futures contract at the last closing price, even though the contract is no longer trading.

This is similar to the wild card option

Wild Card Option

An option associated with treasury bond or treasury note futures contracts that permits the short position to delay the delivery of the underlying.

This provision allows the short futures contract holder to announce his or her intention to deliver the underlying securities on any notice day before a specified time, which is later than the regular trading hours, in which invoice prices are normally fixed. The security that is delivered is usually the cheapest to deliver on that specific day.

Widow-and-Orphan Stock
Relatively low-risk stocks from well-known firms that pay high dividends. Widow-and-Orphan stocks are generally chosen during bear markets and ignored during bull markets. This is because these companies are perceived to be able to maintain their dividend payment schedule through difficult financial times.

White Elephant

Any investment that nobody wants because it is unprofitable.

The term 'White Elephant' is derived from Thailand, where an Albino (white) elephant was given to unfavored people by the ruler. Because these elephants were sacred and not permitted to work, it was a burden to the owner as it would eat up all the owner's money until he/she became destitute.

Falling Knife
A stock whose price has fallen significantly in a short period of time. Don't try to catch a falling knife or you'll end up getting hurt!

Whistle Blower
An employee who has inside knowledge of illegal activities occurring within his or her organization and reports these to the public.

Although whistle blowers are protected under federal law from employer retaliation, there have been cases where punishment for whistle blowing has occurred.

Insider Trading
The buying or selling of a security by someone who has access to material, nonpublic information about the security.

Insider trading can be illegal or legal depending on when the insider makes the trade: it is illegal when the material information is still nonpublic--trading while having special knowledge is unfair to other investors who don't have access to such knowledge. Illegal insider trading therefore includes tipping others when you have any sort of nonpublic information. Directors are not the only ones who have the potential to be convicted of insider trading. People such as brokers and even family members can be guilty. Insider trading is legal once the material information has been made public, at which time the insider has no direct advantage over other investors. The SEC, however, still requires all insiders to report all their transactions. So, as insiders have an insight into the workings of their company, it may be wise for an investor to look at these reports to see how insiders are legally trading their stock.

Open-Market Transaction

An order placed by an insider, after all appropriate documentation has been filed, to buy or sell restricted securities openly on an exchange.

This is simply an order placed by an insider to buy or sell shares according to the rules and regulations set out by the SEC. The importance of an open market order is that the insider is voluntarily buying or selling shares at or close to the market price.

Black Friday
A day of stock market catastrophe. Originally, September 24th, 1869 was termed Black Friday. The crash was sparked by gold speculators including Jay Gould and James Fist attempting to corner the gold market. Their attempt failed and the gold market collapsed, causing the market to tank.

The term "black" has been used to describe other disastrous days in financial markets. For example, Tuesday, October 29th, 1929, a day the market fell precipitously, has been coined Black Tuesday, signaling the start of the Great Depression. Additionally, the largest one-day drop in stock market history occurred on Black Monday, October 19th, 1987, when the DJIA plummeted more than 22%.

Black Monday
The most notorious day in financial history (October 19, 1987). The DJIA fell 508 points, almost 22%.

Since Black Monday, there have been multiple mechanisms built into the market to prevent panic selling such as trading curbs and circuit breakers