All Terms Flashcards
(1045 cards)
1
Q
Investment
A
An investment is that it is deferred consumption. Any net outlay of cash made with the prospect of receiving future benefits might be considered an investment.
2
Q
Traditional Investments
A
Traditional investments include publicly traded equities, fixed-income securities, and cash.
3
Q
Real assets
A
Real assets are investments in which the underlying assets involve direct ownership of nonfinancial assets rather than ownership through financial assets, such as the securities of manufacturing or service enterprises.
4
Q
Farmland
A
Farmland consists of land cultivated for row crops (e.g., vegetables and grains) and permanent crops (e.g., orchards and vineyards).
5
Q
Financial Asset
A
A financial asset is not a real asset; it is a claim on cash flows, such as a share of stock or a bond.
6
Q
Infrastructure Investments
A
Infrastructure investments are claims on the income of toll roads, regulated utilities, ports, airports, and other real assets that are traditionally held and controlled by the public sector (i.e., various levels of government).
7
Q
Hedge Fund
A
A hedge fund is a privately organized investment vehicle that uses its less regulated nature to generate investment opportunities that are substantially distinct from those offered by traditional investment vehicles, which are subject to regulations such as those restricting their use of derivatives and leverage.
8
Q
Private equity
A
The term private equity is used in the CAIA curriculum to include both equity and debt positions that, among other things, are not publicly traded.
9
Q
Distressed Debt
A
Distressed debt refers to the debt of companies that have filed or are likely to file in the near future for bankruptcy protection.
10
Q
Mezzanine Debt
A
Mezzanine debt derives its name from its position in the capital structure of a firm: between the senior secured debt and equity.
11
Q
Structured Products
A
Structured products are instruments created to exhibit particular return, risk, taxation, or other attributes.
12
Q
Absolute return products
A
Absolute return products are investment products viewed as having little or no return correlation with traditional assets, and have investment performance that is often analyzed on an absolute basis rather than relative to the performance of traditional investments.
13
Q
Diversifier
A
A diversifier is an investment with a primary purpose of contributing diversification benefits to its owner.
14
Q
Illiquidity
A
Illiquidity means that the investment trades infrequently or with low volume (i.e., thinly).
15
Q
Lumpy Assets
A
Lumpy assets are assets that can be bought and sold only in specific quantities, such as a large real estate project.
16
Q
Efficiency
A
Efficiency refers to the tendency of market prices to reflect all available information.
17
Q
Inefficiency
A
Inefficiency refers to the deviation of actual prices from valuations that would be anticipated in an efficient market.
18
Q
Compensation Structure
A
Compensation structure refers to the ways that organizational issues, especially compensation schemes, influence particular investments.
19
Q
Structuring
A
Structuring refers to the partitioning of claims to cash flows through leverage and securitization.
20
Q
Regulatory
A
Regulatory factors in the context of investing refer to the role of government, including both regulation and taxation, in influencing the nature of an investment.
21
Q
Trading Strategies
A
Trading strategies refer to the role of an investment vehicle’s investment managers in developing and implementing trading strategies that alter the nature of an investment.
22
Q
Institutional Factors
A
Institutional factors refer to the financial markets (and their policies, such as restrictions on short selling, leverage, and trading) and financial institutions related to a particular investment, such as whether the investment is publicly traded.
23
Q
Incomplete markets
A
Incomplete markets refer to markets with insufficient distinct investment opportunities.
24
Q
Information asymmetries
A
Information asymmetries refer to the extent to which market participants possess different data and knowledge.
25
Moral Hazard
Moral hazard is risk that the behavior of one or more parties will change after entering into a contract.
26
Active Management
Active management refers to efforts of buying and selling securities in pursuit of superior combinations of risk and return.
27
Passive Investing
Passive investing tends to focus on buying and holding securities in an effort to match the risk and return of a target, such as a highly diversified index.
28
Innovation
Innovation is the application of creativity.
29
Active Return
Active return is the difference between the return of a portfolio and its benchmark that is due to active management.
30
Active Risk
Active risk is that risk that causes a portfolio's return to deviate from the return of a benchmark due to active management.
31
Benchmark
A benchmark is a performance standard for a portfolio that reflects the preferences of an investor with regard to risk and return.
32
Benchmark Return
A benchmark return is the return of the benchmark index or benchmark portfolio.
33
Absolute return standard
An absolute return standard means that returns are to be evaluated relative to zero, a fixed rate, or relative to the riskless rate, and therefore independently of performance in equity markets, debt markets, or any other markets.
34
Relative return standard
A relative return standard means that returns are to be evaluated relative to a benchmark.
35
Pure arbitrage
Pure arbitrage is the attempt to earn risk-free profits through the simultaneous purchase and sale of identical positions trading at different prices in different markets.
36
Return diversifier
If the primary objective of including the product is the reduction in the portfolio's risk that it is believed to offer through its lack of correlation with the portfolio's other assets, then that product is often referred to as a return diversifier.
37
Return Enhancer
If the primary objective of including an investment product in a portfolio is the superior average returns that it is believed to offer, then that product is often referred to as a return enhancer.
38
Buy side
Buy side refers to the institutions and entities that buy large quantities of securities for the portfolios they manage.
39
Plan sponsor
A plan sponsor is a designated party, such as a company or an employer, that establishes a health care or retirement plan (pension) that has special legal or taxation status, such as a 401(k) retirement plan in the United States for employees.
40
Endowment
An endowment is a fund bestowed on an individual or institution (e.g., a museum, university, hospital, or foundation) to be used by that entity for specific purposes and with principal preservation in mind.
41
Family office
A family office is a group of investors joined by familial or other ties who manage their personal investments as a single entity, usually hiring professionals to manage money for members of the office.
42
Foundation
A foundation is a not-for-profit organization that donates funds and support to other organizations for its own charitable purposes.
43
Private limited partnerships
Private limited partnerships are a form of business organization that potentially offers the benefit of limited liability to the organization's limited partners (similar to that enjoyed by shareholders of corporations) but not to its general partner.
44
Sovereign wealth funds
Sovereign wealth funds are state-owned investment funds held by that state's central bank for the purpose of future generations and/or to stabilize the state currency.
45
Separately managed accounts
Separately managed accounts (SMAs) are individual investment accounts offered by a brokerage firm and managed by independent investment management firms.
46
'40 Act funds
Mutual funds, or '40 Act funds, are registered investment pools offering their shareholders pro rata claims on the fund's portfolio of assets.
47
Master limited partnerships (MLPs)
Master limited partnerships (MLPs) are publicly traded investment pools that are structured as limited partnerships and that offer their owners pro rata claims.
48
Mutual funds
Mutual funds, or '40 Act funds, are registered investment pools offering their shareholders pro rata claims on the fund's portfolio of assets.
49
Sell side
Sell-side institutions, such as large dealer banks, act as agents for investors when they trade securities.
50
Large dealer banks
Large dealer banks are major financial institutions, such as Goldman Sachs, Deutsche Bank, and the Barclays Group, that deal in securities and derivatives.
51
Proprietary trading
Proprietary trading occurs when a firm trades securities with its own money in order to make a profit.
52
Back office operations
Back office operations play a supportive role in the maintenance of accounts and information systems used to transmit important market and trader information in all trading transactions, as well as in the clearance and settlement of the trades.
53
Front office operations
Front office operations involve investment decision-making and, in the case of brokerage firms, contact with clients.
54
Middle office operations
Middle office operations form the interface between the front office and the back office, with a focus on risk management.
55
Prime broker
The prime broker has the following primary functions: clearing and financing trades for its client, providing research, arranging financing, and producing portfolio accounting.
56
Fund administrator
The fund administrator maintains a general ledger account, marks the fund's books, maintains its records, carries out monthly accounting, supplies its monthly profit and loss (P&L) statements, calculates its returns, verifies asset existence, independently calculates fees, and provides an unbiased, third-party resource for price confirmation on security positions.
57
Financial data providers
Financial data providers supply funds primarily with raw financial market data, including security prices, trading information, and indices.
58
Financial platforms
Financial platforms are systems that provide access to financial markets, portfolio management systems, accounting and reporting systems, and risk management systems.
59
Financial software
Financial software may consist of prepackaged software programs and computer languages tailored to the needs of financial organizations. Some funds use open-source software, and others pay licensing fees for proprietary software.
60
Hedge fund infrastructure
The hedge fund infrastructure may have three main financial components: (1) platforms, (2) software, and (3) data providers.
61
Consulting conflicts of interest
Consulting conflicts of interest can emerge when consultants are compensated by money managers because this form of payment can detract from the ability to offer independent advice to clients and encourage the consultant to favor the money managers offering compensation.
62
Commercial bank
A commercial bank focuses on the business of accepting deposits and making loans, with modest investment-related services.
63
Custodians
Depositories and custodians are very similar entities that are responsible for holding their clients' cash and securities and settling clients' trades, both of which maintain the integrity of clients' assets while ensuring that trades are settled quickly.
64
Depositories
Depositories and custodians are very similar entities that are responsible for holding their clients' cash and securities and settling clients' trades, both of which maintain the integrity of clients' assets while ensuring that trades are settled quickly.
65
Depository Trust Company (DTC)
The Depository Trust Company (DTC) is the principal holding body of securities for traders all over the world and is part of the Depository Trust and Clearing Corporation (DTCC), which provides clearing, settlement, and information services
66
Investment bank
An investment bank focuses on providing sophisticated investment services, including underwriting and raising capital, as well as other activities such as brokerage services, mergers, and acquisitions.
67
Universal banking
Germany uses universal banking, which means that German banks can engage in both commercial and investment banking.
68
Limited liability
Limited liability is the protection of investors from losses that exceed their investment.
69
Passive investments
In the context of limiting liability, passive investments are positions in entities (such as operating firms or investment firms) over which the owner of the position does not exert substantial control and therefore may receive reduced liability exposures and/or passive investment tax treatments.
70
Probity
Probity is the quality of exercising strong principles such as honesty, decency, and integrity.
71
Limited liability company (LLC)
A limited liability company (LLC) is a distinct entity: (1) designed to offer its investors (“members”) protection from losses exceeding their investments absent fraud or other activities that could “pierce the veil” between the member's ownership interest in the LLC and the member's other holdings, and (2) that does not require that distributions and any other advantages of ownership be made in proportion to each member's capital contribution to the firm.
72
Special purpose vehicle (SPV)
A special purpose vehicle (SPV) is a legal entity at the heart of a CDO structure that is established to accomplish a specific transaction, such as holding the collateral portfolio.
73
Feeder fund
A feeder fund is a legal structure through which investors have access to the investment performance of the master trust.
74
Master trust
The master trust is the legal structure used to invest the assets of both onshore investors and offshore investors in a consistent if not identical manner, so that both funds share the benefit of the fund manager's insights.
75
Special purpose entity (SPE)
A special purpose vehicle (SPV) or special purpose entity (SPE) is a legal entity such as an LLC that serves a specific function (such as holding assets),often with the goal of being bankruptcy remote.
76
Master-feeder funds
Master-feeder funds are designed to provide efficient access to investors who are subject to different taxation but wish to invest in the same portfolio.
77
Management company operating agreement
A management company operating agreement is an agreement between members related to a limited liability company and the conduct of its business as it pertains to the law.
78
Partnership agreement
A partnership agreement is a formal written contract creating a partnership.
79
Private-placement memoranda
Private-placement memoranda (a.k.a. offering documents) are formal descriptions of an investment opportunity that comply with federal securities regulations.
80
Subscription agreement
A subscription agreement is an application submitted by an investor who desires to join a limited partnership.
81
Adverse selection
Adverse selection takes place before a transaction is completed, when the decisions made by one party cause less desirable parties to be attracted to the transaction.
82
Limited partnership agreement (LPA)
The limited partnership agreement (LPA) defines its legal framework and its terms and conditions.
83
Qualified majority
A qualified majority is generally more than 75% of LPs in contrast to the over 50% required for a simple majority.
84
Limited partner advisory committee (LPAC)
The LP advisory committee (LPAC)'s responsibilities are defined in the LPA and normally relate to dealing with conflicts of interest, reviewing valuation methods, and any other consents predefined in the LPA.
85
Primary market
A primary market refers to the methods, institutions, and mechanisms involved in the placement of new securities to investors.
86
Secondary market
A secondary market facilitates trading among investors of previously existing securities.
87
Limit orders
In major markets, limit orders can be placed by market participants to buy securities at specified maximum prices or sell securities at specified minimum prices.
88
Securitization
Securitization involves bundling assets, especially unlisted assets, and issuing claims on the bundled assets.
89
Bid-ask spread
The price difference between the highest bid price (the best bid price) and the lowest offer (the best ask price) is the bid-ask spread.
90
Market making
Market making is a practice whereby an investment bank or another market participant deals securities by regularly offering to buy securities and sell securities.
91
Market orders
Market participants that wish to have transactions executed without delay may place market orders, which cause immediate execution at the best available price.
92
Market takers
Participants that place market orders are market takers, which buy at ask prices and sell at bid prices, generally paying the bid-ask spread for taking liquidity.
93
Third markets
Third markets are regional exchanges where stocks listed in primary secondary markets can also be traded. In the United States, third markets allow brokers and dealers to set up trades away from an exchange by listing their prices on the NASDAQ Intermarket.
94
Systemic risk
Systemic risk is the potential for economy-wide losses attributable to failures or concerns over potential failures in financial markets, financial institutions, or major participants.
95
Fourth markets
Fourth markets are electronic exchanges that allow traders to quickly buy and sell exchange-listed stocks via the electronic.
96
Liquid alternative
Liquid alternatives are investment vehicles that offer alternative strategies in a form that provides investors with liquidity through opportunities to sell their positions in a market.
97
Hedge fund replication
Hedge fund replication is the attempt to mimic the returns of an illiquid or highly sophisticated hedge fund strategy using liquid assets and simplified trading rules.
98
Closed-end mutual fund
Closed-end mutual fund structures provide investors with relatively liquid access to the returns of underlying assets even when the underlying assets are illiquid.
99
Progressive taxation
Progressive taxation places higher-percentage taxation on individuals and corporations with higher incomes.
100
Section 1256 contracts
Section 1256 contracts include many futures and options contracts; have potentially enormous tax advantages in the United States. including having their income treated as 60% long-term capital gain and 40% short-term capital gain regardless of holding period.
101
Short selling
Short selling financial assets is the process of borrowing securities from a securities lender, selling the securities at their market price, and eventually purchasing identical securities in the market to extinguish the loan from the securities lender.
102
Street name
Street name refers to the brokerage practice of having the direct legal ownership of customer securities held in the name of the brokerage firm on behalf of the customers rather than having the legal ownership of the shares reside directly with the economic owners of the securities (i.e., the customers of the brokerage firm).
103
Rebate
A rebate is a payment of interest to the securities' borrower on the collateral posted.
104
Substitute dividends
Substitute dividends are cash flows paid by share borrowers to share lenders to compensate the lenders for the distributions paid by the corporation while the loan of stock is outstanding.
105
Dividend irrelevancy
Dividend irrelevancy is the proposition that, in the absence of imperfections such as income taxation that penalized dividends, the distribution of corporate dividends does not alter shareholder wealth.
106
Special stock
A special stock is a stock for which higher net fees are demanded when it is borrowed.
107
General collateral stocks
General collateral stocks, which are stocks not facing heavy borrowing demand, may earn a 2% rebate when Treasury bill rates are at 2%, whereas stocks on special may earn zero rebates or even negative rebates, wherein borrowers must pay the lenders money in addition to the interest that the lender is earning on the collateral.
108
Bought in
When the inventory of stock available to borrowers becomes extremely tight, short sellers may find their position bought in, meaning the broker revokes the borrowing privilege for that specific stock and requires the trader to cover the short position.
109
Short squeeze
A short squeeze occurs when holders of short positions are compelled to purchase shares at increasing prices to cover their positions due to limited liquidity.
110
Continuous compounding
Continuous compounding assumes that earnings can be instantaneously reinvested to generate additional earnings.
111
Discrete compounding
Discrete compounding includes any compounding interval other than continuous compounding such as daily, monthly, or annual.
112
Simple interest
Simple interest is an interest rate computation approach that does not incorporate compounding.
113
Log return
A log return is a continuously compounded return that can be formed by taking the natural logarithm of a wealth ratio: Rm = ∞ = ln(1 + R) where ln( ) is the natural logarithm function, Rm = ∞ is the log return, or continuously compounded return, and m is the number of compounding intervals per year.
114
Return computation interval
The return computation interval for a particular analysis is the smallest time interval for which returns are calculated, such as daily, monthly, or even annually.
115
Notional principal
Notional principal or notional value of a contract is the value of the asset underlying, or used as a reference to, the contract or derivative position.
116
return on notional principal
The return on notional principal divides economic gain or loss by the notional principal of the contract.
117
Fully collateralized
Fully collateralized means that a position (such as a forward contract) is assumed to be paired with a quantity of capital equal in value to the notional principal of the contract.
118
Partially collateralized
A partially collateralized position has collateral lower in value than the notional value.
119
Internal rate of return (IRR)
The internal rate of return (IRR) can be defined as the discount rate that equates the present value of the costs (cash outflows) of an investment with the present value of the benefits (cash inflows) from the investment.
120
Interim IRR
The interim IRR is a computation of IRR based on realized cash flows from an investment and its current estimated residual value.
121
Lifetime IRR
A lifetime IRR contains all of the cash flows, realized or anticipated, occurring over the investment's entire life, from period 0 to period T.
122
Since-inception IRR
A since-inception IRR is commonly used as a measure of fund performance rather than the performance of an individual investment.
123
Borrowing type cash flow pattern
A borrowing type cash flow pattern begins with one or more cash inflows and is followed only by cash outflows.
124
Complex cash flow pattern
A complex cash flow pattern is an investment involving either borrowing or multiple sign changes.
125
Multiple sign change cash flow pattern
A multiple sign change cash flow pattern is an investment where the cash flows switch over time from inflows to outflows, or from outflows to inflows, more than once.
126
Scale differences
Scale differences are when investments have unequal sizes and/or timing of their cash flows.
127
Aggregation of IRRs
Aggregation of IRRs refers to the relationship between the IRRs of individual investments and the IRR of the combined cash flows of the investments.
128
Modified IRR
The modified IRR approach discounts all cash outflows into a present value using a financing rate, compounds all cash inflows into a future value using an assumed reinvestment rate, and calculates the modified IRR as the discount rate that sets the absolute values of the future value and the present value equal to each other.
129
Reinvestment rate assumption
The reinvestment rate assumption refers to the assumption of the rate at which any cash flows not invested in a particular investment or received during the investment's life can be reinvested during the investment's lifetime.
130
Dollar-weighted returns
Dollar-weighted returns are averaged returns that are adjusted for and therefore reflect when cash has been contributed or withdrawn during the averaging period.
131
Time-weighted returns
Time-weighted returns are averaged returns that assume that no cash was contributed or withdrawn during the averaging period, meaning after the initial investment.
132
Distribution to paid-in (DPI) ratio
The distribution to paid-in (DPI) ratio, or realized return, is the ratio of the cumulative distribution to investors to the total capital drawn from investors, and can loosely viewed as a non-annualized measure of income (actually, distributions) in the numerator to total investment in the denominator.
133
Total value to paid-in (DPI) ratio
The total value to paid-in (TVPI) ratio, or total return, is a measure of the cumulative distribution to investors plus the total value of the unrealized investments relative to the total capital drawn from investors, and is the sum of the income (DPI) and capital gain or loss (RVPI).
134
Residual value to paid-in (DPI) ratio
The residual value to paid-in (RVPI) ratio, or unrealized return, at time T is the ratio of the total value of the unrealized investments at time T to the total capital drawn from investors during the previous time periods, and can be loosely viewed as a measure of capital gain or loss, with a ratio of one indicating that, ignoring prior distributions, the investment has neither gained or lost value relative to the total contributions.
135
Public Market Equivalent (PME) Method
The Public Market Equivalent (PME) method uses a publicly traded securities index that is believed to have a similar risk exposure to private equity as a return target and requires or finds the corresponding premium over public equity (e.g., 300 to 500 basis points) for a private equity investment using the investment's cash contributions (calls), distributions, and terminal value.
136
Accounting convention of conservatism
The accounting convention of conservatism holds that it is prudent to recognize potential expenses and liabilities as soon as possible but not to similarly anticipate potential revenues or gains, often resulting in an understatement of income and assets in the short run.
137
J-curve
The J-curve is the classic illustration of the early losses and later likely profitability of venture capital.
138
Financial Accounting Standard (FAS) 157
Financial Accounting Standard (FAS) 157, which was introduced in 2006, seeks to require asset managers to regularly value their investments at fair value, even when the valuation is not immediately observable from market prices.
139
Waterfall
The waterfall is a provision of the limited partnership agreement that specifies how distributions from a fund will be split and how the payouts will be prioritized.
140
Carried interest
Carried interest is synonymous with an incentive fee or a performance-based fee and is the portion of the profit paid to the GPs as compensation for their services, above and beyond management fees.
141
Catch-up provision
A catch-up provision permits the fund manager to receive a large share of profits once the hurdle rate of return has been achieved and passed.
142
Hurdle rate
A hurdle rate specifies a return level that LPs must receive before GPs begin to receive incentive fees.
143
Incentive fee
Carried interest is synonymous with an incentive fee or a performance-based fee and is the portion of the profit paid to the GPs as compensation for their services, above and beyond management fees.
144
Performance-based fee
Carried interest is synonymous with an incentive fee or a performance-based fee and is the portion of the profit paid to the GPs as compensation for their services, above and beyond management fees.
145
Preferred return
The term preferred return is often used synonymously with hurdle rate--a return level that LPs must receive before GPs begin to receive incentive fees.
146
Vesting
Vesting is the process of granting full ownership of conferred rights, such as incentive fees.
147
Clawback
A clawback clause, clawback provision, or clawback option is designed to return incentive fees to LPs when early profits are followed by subsequent losses.
148
Compensation scheme
The compensation scheme is the set of provisions and procedures governing management fees, general partner investment in the fund, carried-interest allocations, vesting, and distribution.
149
Catch-up rate
A catch-up provision contains a catch-up rate, which is the percentage of the profits used to catch up the incentive fee once the hurdle is met.
150
Management fees
Management fees are regular fees that are paid from the fund to the fund managers based on the size of the fund rather than the profitability of the fund.
151
Management fee offsets
Management fee offsets occur when all fees earned by general partners would reduce the management fee owed to the GP by the LPs.
152
Deal-by-deal carried interest
Deal-by-deal carried interest is when incentive fees are awarded separately based on the performance of each individual investment.
153
Fund-as-a-whole carried interest
Carried interest can be fund-as-a-whole carried interest, which is carried interest based on aggregated profits and losses across all the investments, or can be structured as deal-by-deal carried interest.
154
Hard hurdle rate
A hard hurdle rate limits incentive fees to profits in excess of the hurdle rate.
155
Soft hurdle rate
A soft hurdle rate allows fund managers to earn an incentive fee on all profits, given that the hurdle rate has been achieved.
156
Ex ante returns
Future possible returns and their probabilities are referred to as expectational or ex ante returns.
157
Ex post returns
Ex post returns are realized outcomes rather than anticipated outcomes.
158
Normal distribution
The normal distribution is the familiar bell-shaped distribution, also known as the Gaussian distribution.
159
Central limit theorem
The formal statistical explanation for the idea that a variable will tend toward a normal distribution as the number of independent influences becomes larger is known as the central limit theorem.
160
Lognormal distribution
A variable has a lognormal distribution if the distribution of the logarithm of the variable is normally distributed.
161
Mean
The most common raw moment is the first raw moment and is known as the mean, or expected value, and is an indication of the central tendency of the variable.
162
Variance
The variance is the second central moment and is the expected value of the deviations squared.
163
Skewness
The skewness is equal to the third central moment divided by the standard deviation of the variable cubed and serves as a measure of asymmetry.
164
Kurtosis
Kurtosis serves as an indicator of the peaks and tails of a distribution.
165
Excess kurtosis
Excess kurtosis provides a more intuitive measure of kurtosis relative to the normal distribution because it has a value of zero in the case of the normal distribution.
166
Leptokurtosis
If a return distribution has positive excess kurtosis, meaning it has more kurtosis than the normal distribution, it is said to be leptokurtic, leptokurtotic, or fat tailed, and to exhibit leptokurtosis.
167
Mesokurtosis
If a return distribution has no excess kurtosis, meaning it has the same kurtosis as the normal distribution, it is said to be mesokurtic, mesokurtotic, or normal tailed, and to exhibit mesokurtosis.
168
Platykurtosis
If a return distribution has negative excess kurtosis, meaning less kurtosis than the normal distribution, it is said to be platykurtic, platykurtotic, or thin tailed, and to exhibit platykurtosis.
169
Covariance
The covariance of the return of two assets is a measure of the degree or tendency of two variables to move in relationship with each other.
170
Correlation coefficient
The correlation coefficient (also called the Pearson correlation coefficient) measures the degree of association between two variables, but unlike the covariance, the correlation coefficient can be easily interpreted.
171
perfect linear negative correlation
A correlation coefficient of −1 indicates that the two assets move in the exact opposite direction and in the same proportion, a result known as perfect linear negative correlation.
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Perfect linear positive correlation
A correlation coefficient of +1 indicates that the two assets move in the exact same direction and in the same proportion, a result known as perfect linear positive correlation.
173
Spearman rank correlation
The Spearman rank correlation is a correlation designed to adjust for outliers by measuring the relationship between variable ranks rather than variable values.
174
Beta
The beta of an asset is defined as the covariance between the asset's returns and a return such as the market index, divided by the variance of the index's return, or, equivalently, as the correlation coefficient multiplied by the ratio of the asset volatility to market volatility.
175
Autocorrelation
The autocorrelation of a time series of returns from an investment refers to the possible correlation of the returns with one another through time.
176
First-order autocorrelation
First-order autocorrelation refers to the correlation between the return in time period t and the return in the immediately previous time period, t−1.
177
Partial autocorrelation coefficient
A partial autocorrelation coefficient adjusts autocorrelation coefficients to iso- late the portion of the correlation in a time series attributable directly to a particular higher-order relation.
178
Jarque-Bera test
The Jarque-Bera test involves a statistic that is a function of the skewness and excess kurtosis of the sample: JB = (n/6)[S2 + (K2/4)] where JB is the Jarque-Bera test statistic, n is the number of observations, S is the skewness of the sample, and K is the excess kurtosis of the sample.
179
GARCH
GARCH (generalized autoregressive conditional heteroskedasticity) is an example of a time-series method that adjusts for varying volatility.
180
Heteroskedascity
Heteroskedasticity is when the variance of a variable changes with respect to a variable, such as itself or time.
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Homoskedasticity
Homoskedasticity is when the variance of a variable is constant.
182
ARCH
ARCH (autoregressive conditional heteroscedasticity) is a special case of GARCH that allows future variances to rely only on past disturbances, whereas GARCH allows future variances to depend on past covariances as well.
183
Autoregressive
Autoregressive refers to when subsequent values to a variable are explained by past values of the same variable.
184
Conditionally heteroskedastic
Conditionally heteroskedastic financial market prices have different levels of return variation even when specified conditions are similar (e.g., when they are viewed at similar price levels).
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Informational market efficiency
Informational market efficiency refers to the extent to which asset prices reflect available information.
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Semistrong form informational market efficiency
The concept of semistrong form informational market efficiency (or semistrong level) refers to market prices reflecting all publicly available information (including not only past prices and volumes but also any publicly available information such as financial statements and other underlying economic data).
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Strong form informational market efficiency
The concept of strong form informational market efficiency (or strong level) refers to market prices reflecting all publicly and privately available information.
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Weak form informational market efficiency
Weak form informational market efficiency (or weak level) refers to market prices reflecting available data on past prices and volumes.
189
Inflation
Inflation is the decline in the value of money relative to the value of a general bundle of goods and services.
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Term structure of interest rates
Sometimes the term structure of interest rates is distinguished from the yield curve because the yield curve plots yields to maturity of coupon bonds, whereas the term structure of interest rates plots actual or hypothetical yields of zero-coupon bonds.
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Anticipated inflation rate
The anticipated inflation rate (π) is generally defined as a measure of the expected rate of change in the value of a currency measured through changes in overall price levels.
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Real interest rate
The real interest rate is the annualized rate earned on default-free fixed-income investments, after adjusting the nominal rate downward for the effect of inflation.
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Modified Fisher equation
The modified Fisher equation expresses the nominal interest rate as the combination of the after- tax real interest rate, r, and the anticipated rate of inflation (π), with an adjustment for the income tax rate, T.
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Fisher effect or Fisher equation
The Fisher effect (or Fisher equation) states that the nominal interest rate (i) is equal to the sum of the real interest rate (r) and the expected inflation rate (π), when interest rates are expressed as continuously compounded rates.
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Nominal interest rate
A nominal interest rate is the rate of return measured in terms of a given currency without a downward adjustment for the potential effects of positive inflation.
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Yield to maturity
The yield to maturity of a fixed income instrument is the rate that discounts all of the promised cash flows of the instrument into a summed present value that equals the instrument's market price.
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Unbiased expectations theory
The unbiased expectations theory hypothesizes that all fixed-income securities offer the same expected return over the same time interval (i.e., there are no risk premiums), therefore serving as a useful tool in risk-neutral modeling in which all interest rates are formed purely on interest rate expectations.
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Liquidity preference theory
The liquidity preference theory hypothesizes that longer-term fixed-income securities offer higher expected returns over the same time interval as shorter-term bonds, that risk premiums are positive and increasing in the bond's longevity, that all interest rates are formed based on both interest rate expectations and risk premiums, and that fixed-income management reflects a trade-off between risk and return.
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Market segmentation theory
The market segmentation theory hypothesizes that the preferred habitats of borrowers and lenders influence the expected returns of each maturity range, resulting in varying risk premiums and varying expected returns across maturity ranges that form humps and other non-monotonic shapes that are not eliminated by arbitrageurs (because the market is segmented).
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Implied forward rate
An implied forward rate, F(t, T), is the annual return between time t and T (with T > t) inferred from the term structure of interest rates.
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Arbitrage
Arbitrage is the attempt to earn riskless profits (in excess of the risk-free rate) by identifying and trading relatively mispriced assets.
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Term structure of implied forward rates
The term structure of implied forward rates is the relationship between implied forward rates and the starting point of each rate and is often superimposed on the term structure of spot rates.
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Arbitrage-free model
An arbitrage-free model is a financial model with relationships derived by the assumption that arbitrage opportunities do not exist, or at least do not persist.
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Relative pricing model
A relative pricing model prescribes the relationship between two prices.
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Key externality of arbitrage activities
A key externality of arbitrage activities is that they tend to drive similar assets toward similar prices which, in turn, improves global economic decisions.
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Absolute pricing model
An absolute pricing model attempts to describe a price level based on its underlying economic factors.
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Cash market
The spot market or cash market is any market in which transactions involve immediate payment and delivery: The buyer immediately pays the price, and the seller immediately delivers the product.
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Spot market
The spot market or cash market is any market in which transactions involve immediate payment and delivery: The buyer immediately pays the price, and the seller immediately delivers the product.
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Binomial tree
A binomial tree projects possible outcomes in a variable such as a security price or interest rate by modeling uncertainty as two movements: an upward movement and a downward movement.
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Recombining binomial tree
A recombining binomial tree has n + 1 possible final outcomes for an n period tree, rather than 2n outcomes.
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Risk-neutral model
A risk-neutral model is a framework for valuing financial derivatives in which risk preferences and probabilities of price changes do not alter the solution and are therefore irrelevant, and in which the analyst selects risk-neutrality as the model's underlying assumption with regard to risk preferences.
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Duration
The general definition of duration is the elasticity of a bond price with respect to a shift in its yield (or a uniform shift in the spot rates, corresponding to each prospective cash flow).
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Interest rate immunization
Interest rate immunization is the process of eliminating all interest rate risk exposures.
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Duration of a fixed coupon bond
The duration of a fixed-coupon bond is the weighted average of the longevities of the cash flows to a coupon bond where the weight of each of the bond's cash flows is the proportion of the bond's total value attributable to that cash flow.
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Asset pricing model
An asset pricing model is a framework for specifying the return or price of an asset based on its risk, as well as future cash flows and payoffs.
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Capital asset pricing model (CAPM)
The capital asset pricing model (CAPM) provides one of the easiest and most widely understood examples of single-factor asset pricing by demonstrating that the risk of the overall market index is the only risk that offers a risk premium.
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Market portfolio
The market portfolio is a hypothetical portfolio containing all tradable assets in the world.
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Market weight
The market weight of an asset is the proportion of the total value of that asset to the total value of all assets in the market portfolio.
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Single-factor asset pricing model
A single-factor asset pricing model explains returns and systematic risk using a single risk factor.
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Ex ante models
Ex ante models, such as ex ante asset pricing models, explain expected relationships, such as expected returns. Ex ante means “from before.”
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Idiosyncratic return
Idiosyncratic return is the portion of an asset's return that is unique to an investment and not driven by a common association.
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Idiosyncratic risk
Idiosyncratic risk is the dispersion in economic outcomes caused by investment-specific effects. This section focuses on realized returns and the modeling of risk.
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Systematic return
Systematic return is the portion of an asset's return driven by a common association.
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Systematic risk
Systematic risk is the dispersion in economic outcomes caused by variation in systematic return.
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Ex post model
An ex post model describes realized returns and provides an understanding of risk and how it relates to the deviations of realized returns from expected returns.
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Excess return
The excess return of an asset refers to the excess or deficiency of the asset's return relative to the periodic risk-free rate.
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Forward contract
A forward contract is simply an agreement calling for deferred delivery of an asset or a payoff.
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Reference rate
A reference rate is a market rate specified in contracts such as a forward contract that fluctuates with market conditions and drives the magnitude and direction of cash settlements.
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Forward rate agreement (FRA)
A forward rate agreement (FRA) is a cash-settled contract in which one party agrees to offer a specified or fixed rate (the FRA rate), such as an interest rate on a specified principal amount and over a specified time in the future (or a currency exchange rate at a specified time in the future) while the other party agrees to provide that rate.
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Swap
A swap is a string of forward contracts grouped together that vary by time to settlement.
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Financed positions
Financed positions enable economic ownership of an asset without the posting of the purchase price.
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Carrying cost
The carrying cost is the cost of maintaining a position through time and includes direct costs, such as storage or custody costs, as well as opportunity costs, such as forgone cash flows.
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Cost-of-carry model
A cost-of-carry model specifies a relationship between two positions that must exist if the only difference between the positions involves the expense of maintaining the positions.
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Cost of carry
In the context of futures and forward contracts, a cost of carry (or carrying cost) is any financial difference between maintaining a position in the cash market and maintaining a position in the forward market.
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Convenience yield
Convenience yield, y, is the economic benefit that the holder of an inventory in the commodity receives from directly holding the inventory rather than having a long position in a forward contract on the commodity.
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Storage costs
Storage costs of physical commodities involve such expenditures as warehouse fees, insurance, transportation, and spoilage.
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Marginal market participant
The marginal market participant to a derivative contract is any entity with individual costs and benefits that make the entity indifferent between physical positions and synthetic positions.
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Open interest
The outstanding quantity of unclosed contracts is known as open interest.
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Marked-to-market
The term marked-to-market means that the side of a futures contract that benefits from a price change receives cash from the other side of the contract (and vice versa) throughout the contract's life.
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Crisis at maturity
A crisis at maturity is when the party owing a payment is forced at the last moment to reveal that it cannot afford to make the payment or when the party obligated to deliver the asset at the original price is forced to reveal that it cannot deliver the asset.
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Initial margin
The collateral deposit made at the initiation of a long or short futures position is called the initial margin.
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Maintenance margin requirement
A maintenance margin requirement is a minimum collateral requirement imposed on an ongoing basis until a position is closed.
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Margin call
A margin call is a demand for the posting of additional collateral to meet the initial margin requirement.
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Rolling contracts
Rolling contracts refers to the process of closing positions in short-term futures contracts and simultaneously replacing the exposure by establishing similar positions with longer terms.
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Distant contracts
Contracts with longer times to settlement are often called distant contracts, deferred contracts, or back contracts.
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Front month contract
On an exchange, the futures contract with the shortest time to settlement is often referred to as the front month contract.
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Naked option
A short option position that is unhedged is often referred to as a naked option.
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Covered call
A covered call combines being long an asset with being short a call option on the same asset.
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Protective put
A protective put combines being long an asset with a long position in a put option on the same asset.
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Bear spread
An option combination in which the long option position is at the higher of two strike prices is a bear spread, which offers bearish exposure to the underlying asset that begins at the higher strike price and ends at the lower strike price.
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Bull spread
An option combination in which the long option position is at the lower of two strike prices is a bull spread, which offers bullish exposure to the underlying asset that begins at the lower strike price and ends at the higher strike price.
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Option spread
An option spread (1) contains either call options or put options (not both), and (2) contains both long and short positions in options with the same underlying asset.
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Option combination
An option combination contains both calls and puts on the same underlying asset.
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Option straddle
An option straddle is a position in a call and put with the same sign (i.e., long or short), the same underlying asset, the same expiration date, and the same strike price.
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Option strangle
An option strangle is a position in a call and put with the same sign, the same underlying asset, the same expiration date, but different strike prices.
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Ratio spreads
Spread positions termed ratio spreads can be formed in which the number of options in each position differ.
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Option collar
An option collar generally refers only to the long position in a put and a short position in a call.
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Risk reversal
A long out-of-the-money call combined with a short out-of- the-money put on the same asset and with the same expiration date is termed a risk reversal.
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Put-call parity
Put-call parity is an arbitrage-free relationship among the values of an asset, a riskless bond, a call option, and a put option.
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Black-Scholes call option formula
Black-Scholes call option formula expresses the price of a call option as a function of five variables: the price of the underlying asset, the strike price, the return volatility of the underlying asset, the time to the option's expiration, and the riskless rate.
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Rho
Rho is the sensitivity of an option price with respect to changes in the riskless interest rate.
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Standard deviation
The square root of the variance is an extremely popular and useful measure of dispersion known as the standard deviation.
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Volatility
In investment terminology, volatility is a popular term that is used synonymously with the standard deviation of returns.
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Elasticity
An elasticity is the percentage change in a value with respect to a percentage change in another value.
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Omicron
Omicron is the partial derivative of an option or a position containing an option to a change in the credit spread and is useful for analyzing option positions on credit-risky assets.
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Lambda
Lambda or omega for a call option is the elasticity of an option price with respect to the price of the underlying asset and is equal to delta multiplied times the quantity (S/c).
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Omega
Lambda or omega for a call option is the elasticity of an option price with respect to the price of the underlying asset and is equal to delta multiplied times the quantity (S/c).
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Semivariance
The semivariance uses a formula otherwise identical to the variance formula except that it considers only the negative deviations. Semivariance is therefore expressed as: Semivariance = 1/Σ[Rt E(R)]2 For all Rt < E(R) where T is the number of negative deviations.
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Semistandard deviation
Semistandard deviation, sometimes called semideviation, is the square root of semivariance.
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Semivolatility
Semivolatility is similar to semistandard deviation except that it is unambiguously based on only the number of observations below the mean or threshold (T*) and it subtracts 0.5, rather than 1.0, from that number.
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Shortfall risk
Shortfall risk is simply the probability that the return will be less than the investor's target rate of return.
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Target semistandard deviation
Target semistandard deviation (TSSD) is simply the square root of the target semivariance.
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Target semivariance
Target semivariance is similar to semivariance except that target semivariance substitutes the investor's target rate of return in place of the mean return.
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Tracking error
Tracking error indicates the dispersion of the returns of an investment relative to a benchmark return, where a benchmark return is the contemporaneous realized return on an index or peer group of comparable risk.
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Drawdown
Drawdown is defined as the maximum loss in the value of an asset over a specified time interval and is usually expressed in percentage-return form rather than currency.
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Maximum drawdown
Maximum drawdown is defined as the largest decline over any time interval within the entire observation period.
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Value at risk
Value at risk (VaR) is the loss figure associated with a particular percentile of a cumulative loss function.
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Conditional value-at-risk
Conditional value-at-risk (CVaR), also known as expected tail loss, is the expected loss of the investor given that the Var has been equaled or exceeded.
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Parametric VaR
A VaR computation assuming normality and using the statistics of the normal distribution is known as parametric VaR.
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Monte Carlo analysis
Monte Carlo analysis is a type of simulation in which many potential paths of the future are projected using an assumed model, the results of which are analyzed as an approximation to the future probability distributions.
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Benchmarking
Benchmarking, often referred to as performance benchmarking, is the process of selecting an investment index, an investment portfolio, or any other source of return as a standard (or benchmark) for comparison during performance analysis.
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Peer group
The peer group is typically a group of funds with similar objectives, strategies, or portfolio holdings.
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Performance attribution
Performance attribution, also known as return attribution, is the process of identifying the components of an asset's return or performance.
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Return attribution
Performance attribution, also known as return attribution, is the process of identifying the components of an asset's return or performance.
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Sharpe ratio
The Sharpe ratio has excess return as its numerator and volatility as its denominator: SR = [E(Rp) − Rf]/σp where SR is the Sharpe ratio for portfolio p,E (Rp) is the expected return for portfolio p, Rf is the riskless rate, and σp is the standard deviation of the returns of portfolio p.
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Well-diversified portfolio
In the field of investments, the term well-diversified portfolio is traditionally interpreted as any portfolio containing only trivial amounts of diversifiable risk.
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Treynor ratio
The Treynor ratio has excess return as its numerator and beta as the measure of risk as its denominator: TR = [E(Rp) − Rf]/βp where TR is the Treynor ratio for portfolio p; E(Rp) is the expected return, or mean return, for portfolio p; Rf is the riskless rate; and βp is the beta of the returns of portfolio p.
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Sortino ratio
The Sortino ratio subtracts a benchmark return, rather than the riskless rate, from the asset's return in its numerator and uses downside standard deviation as the measure of risk in its denominator: Sortino Ratio = [E(Rp) − RTarget ]/TSSD where E(Rp) is the expected return, or mean return in practice, for portfolio p; RTarget is the user's target rate of return; and TSSD is the target semistandard deviation (or downside deviation).
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Information ratio
The information ratio has a numerator formed by the difference between the average return of a portfolio (or other asset) and its benchmark, and a denominator equal to its tracking error: Information Ratio = [E(Rp) − RBenchmark]/TEp where E(Rp) is the expected or mean return for portfolio p, RBenchmark is the expected or mean return of the benchmark, and TEp is the tracking error of the portfolio relative to its benchmark return.
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Return on VaR (RoVaR)
Return on VaR (RoVaR) is simply the expected or average return of an asset divided by a specified VaR (expressing VaR as a positive number): RoVaR = E(Rp)/VaR.
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Jensen's alpha
Jensen's alpha may be expressed as the difference between its expected return and the expected return of efficiently priced assets of similar risk.
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M^2 approach
The M^2 approach, or M-squared approach, expresses the excess return of an investment after its risk has been normalized to equal the risk of the market portfolio.
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Average tracking error
Average tracking error refers to the excess of an investment's return relative to its benchmark. In other words, it is the numerator of the information ratio.
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Alpha
Alpha refers to any excess or deficient investment return after the return has been adjusted for the time value of money (the risk-free rate) and for the effects of bearing systematic risk (beta).
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Ex ante alpha
Ex ante alpha is the expected superior return if positive (or inferior return if negative) offered by an investment on a forward-looking basis after adjusting for the riskless rate and for the effects of systematic risks(beta) on expected returns.
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Ex post alpha
Ex post alpha is the return, observed or estimated in retrospect, of an investment above or below the risk- free rate and after adjusting for the effects of beta (systematic risks).
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Dependent variable
The dependent variable is the variable supplied by the researcher that is the focus of the analysis and is determined at least in part by other (independent or explanatory) variables.
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Independent variable
Independent variables are those explanatory variables that are inputs to the regression and are viewed as causing the observed values of the dependent variable.
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Simple linear regression
A simple linear regression is a linear regression in which the model has only one independent variable.
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Regression
A regression is a statistical analysis of the relationship that explains the values of a dependent variable as a function of the values of one or more independent variables based on a specified model.
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Intercept
The intercept is the value of the dependent variable when all independent variables are zero.
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Residuals
The residuals of the regression, eit, reflect the regression's estimate of the idiosyncratic portion of asset i's realized returns above or below its mean idiosyncratic return (i.e., the regression's estimates of the error term).
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Slope coefficient
The slope coefficient is a measure of the change in a dependent variable with respect to a change in an independent variable.
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Goodness of fit
The goodness of fit of a regression is the extent to which the model appears to explain the variation in the dependent variable.
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R-squared
The r-squared value of the regression, which is also called the coefficient of determination, is often used to assess goodness of fit, especially when comparing models. In a simple linear regression, the r-squared is simply the squared value of the estimated correlation coefficient between the dependent variable and the independent variable.
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T-statistic
The t-statistic of a parameter is formed by taking the estimated absolute value of the parameter and dividing by its standard error.
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T-test
A t-test is a statistical test that rejects or fails to reject a hypothesis by comparing a t-statistic to a critical value.
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Model misspecification
Model misspecification is any error in the identification of the variables in a model or any error in identification of the relationships between the variables.
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Omitted (more misidentified) systematic return factors
Omitted (or misidentified) systematic return factors is the failure to include relevant factors in an analysis of returns such as momentum or size.
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Misestimated betas
Misestimated betas is estimation error due to randomness or econometric errors such as failure to correct for heteroskedasticity.
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Nonlinear risk-return relation error
Nonlinear risk-return relation error is the failure to model nonlinearity such as quadratic or cubic effects.
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Beta creep
Beta creep is when hedge fund strategies pick up more systematic market risk over time.
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Beta expansion
Beta expansion is the perceived tendency of the systematic risk exposures of a fund or asset to increase due to changes in general economic conditions.
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Beta nonstationarity
Beta nonstationarity is a general term that refers to the tendency of the systematic risk of a security, strategy, or fund to shift through time.
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Full market cycle
A full market cycle is a period of time containing a large representation of market conditions, especially up (bull) markets and down (bear) markets.
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Abnormal return persistence
Abnormal return persistence is the tendency of idiosyncratic performance in one time period to be correlated with idiosyncratic performance in a subsequent time period.
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Return driver
The term return driver represents the investments, the investment products, the investment strategies, or the underlying factors that generate the risk and return of a portfolio.
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Alpha driver
An investment that seeks high returns independent of the market is an alpha driver.
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Beta driver
An investment that moves in tandem with the overall market or a particular risk factor is a beta driver.
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Equity risk premium
The equity risk premium (ERP) is the expected return of the equity market in excess of the risk-free rate.
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Equity risk premium puzzle
The equity risk premium puzzle is the enigma that equities have historically performed much better than can be explained purely by risk aversion, yet many investors continue to invest heavily in low-risk assets.
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Linear risk exposure
A linear risk exposure means that when the returns to such a strategy are graphed against the returns of the market index or another appropriate standard, the result tends to be a straight line.
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Asset gatherers
Asset gatherers are managers striving to deliver beta as cheaply and efficiently as possible, and include the large- scale index trackers that produce passive products tied to well-recognized financial market benchmarks.
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Passive beta driver
A passive beta driver strategy generates returns that follow the up-and-down movement of the market on a one-to-one basis.
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Process drivers
Process drivers are beta drivers that focus on providing beta that is fine-tuned or differentiated.
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Product innovators
At one end of the spectrum are product innovators, which are alpha drivers that seek new investment strategies offering superior rates of risk-adjusted return.
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Hypotheses
Hypotheses are propositions that underlie the analysis of an issue.
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Alternative hypothesis
The alternative hypothesis is the behavior that the analyst assumes would be true if the null hypothesis were rejected.
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Null hypothesis
The null hypothesis is usually a statement that the analyst is attempting to reject, typically that a particular variable has no effect or that a parameter's true value is equal to zero.
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Confidence interval
A confidence interval is a range of values within which a parameter estimate is expected to lie with a given probability.
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P-value
The p-value is a result generated by the statistical test that indicates the probability of obtaining a test statistic by chance that is equal to or more extreme than the one that was actually observed (under the condition that the null hypothesis is true).
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Significance level
The term significance level is used in hypothesis testing to denote a small number, such as 1%, 5%, or 10%, that reflects the probability that a researcher will tolerate of the null hypothesis being rejected when in fact it is true.
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Test statistic
The test statistic is the variable that is analyzed to make an inference with regard to rejecting or failing to reject a null hypothesis.
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Economic significance
Economic significance describes the extent to which a variable in an economic model has a meaningful impact on another variable in a practical sense.
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Type I error
A type I error, also known as a false positive, is when an analyst makes the mistake of falsely rejecting a true null hypothesis.
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Type II error
A type II error, also known as a false negative, is failing to reject the null hypothesis when it is false.
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Selection bias
Selection bias is a distortion in relevant sample characteristics from the characteristics of the population, caused by the sampling method of selection or inclusion.
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Self-selection bias
If the selection bias originates from the decision of fund managers to report or not to report their returns, then the bias is referred to as a self-selection bias.
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Survivorship bias
Survivorship bias is a common problem in investment databases in which the sample is limited to those observations that continue to exist through the end of the period of study.
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Data dredging
Data dredging, or data snooping, refers to the overuse and misuse of statistical tests to identify historical patterns.
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Data mining
Data mining typically refers to the vigorous use of data to uncover valid relationships.
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Backfill bias
Backfill bias, or instant history bias, is when the funds, returns, and strategies being added to a data set are not representative of the universe of fund managers, fund returns, and fund strategies.
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Backfilling
Backfilling typically refers to the insertion of an actual trading record of an investment into a database when that trading record predates the entry of the investment into the database.
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Backtesting
Backtesting is the use of historical data to test a strategy that was developed subsequent to the observation of the data.
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Overfitting
Overfitting is using too many parameters to fit a model very closely to data over some past time frame.
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Cherry-picking
Cherry-picking is the concept of extracting or publicizing only those results that support a particular viewpoint.
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Chumming
Chumming is a fishing term used to describe scattering pieces of cheap fish into the water as bait to attract larger fish to catch. In investments, we apply this term to the practice of unscrupulous investment managers broadcasting a variety of predictions in the hope that some of them will turn out to be correct and thus be viewed as an indication of skill.
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Outlier
An outlier is an observation that is markedly further from the mean than almost all other observations.
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Causality
The difference between true correlation and causality is that causality reflects when one variable's correlation with another variable is determined by or due to the value or change in value of the other variable.
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Spurious correlation
The difference between spurious correlation and true correlation is that spurious correlation is idiosyncratic in nature, coincidental, and limited to a specific set of observations.
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Natural resources
Natural resources are real assets that have received no or almost no human alteration.
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Split estate
A split estate is when surface rights and mineral rights are separately owned.
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Pure play
A pure play on an investment is an investment vehicle that offers direct exposure to the risks and returns of a specific type of investment without the inclusion of other exposures.
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Exchange option
An exchange option is an option to exchange one risky asset for another rather than to buy or sell one asset at a fixed exercise or strike price.
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Perpetual option
A perpetual option is an option with no expiration date.
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Low-hanging-fruit principle
The low-hanging-fruit principle states that the first action that should be taken is the one that reaps the highest benefits over costs.
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Intrinsic option value
An intrinsic option value is the greater of $0 and the value of an option if exercised immediately.
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Time value of an option
The time value of an option is the excess of an option's price above its intrinsic value.
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Land banking
Land banking is the practice of buying vacant lots for the purpose of development or disposition at a future date.
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Blue top lots
Blue top lots are at an interim stage of lot completion. In this case, the owner has completed the rough grading of the property and the lots, including the undercutting of the street section, interim drainage, and erosion control facilities, and has paid all applicable fees required.
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Finished lots
Finished lots are fully completed and ready for home construction and occupancy.
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Paper lots
Paper lots refers to sites that are vacant and approved for development by the local zoning authority but for which construction on streets, utilities, and other infrastructure has not yet commenced.
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Binomial option pricing
Binomial option pricing is a technique for pricing options that assumes that the price of the underlying asset can experience only a specified upward movement or downward movement during each period.
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Risk-neutral probability
A risk-neutral probability is a probability that values assets correctly if, everything else being equal, all market participants were risk neutral.
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Negative survivorship bias
A negative survivorship bias is a downward bias caused by excluding the positive returns of the properties or other assets that successfully left the database.
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Timberland investment management organizations (TIMOs)
Timberland investment management organizations (TIMOs) provide management services to timberland owned by institutional investors, such as pension plans, endowments, foundations, and insurance companies.
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Rotation
Rotation is the length of time from the start of the timber (typically the planting) until the harvest of the timber.
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Reduced integration in the forest products industry
Reduced integration in the forest products industry refers to the increased separation of ownership of trees, pulp mills, and sawmills and is a key reason for changes in timberland ownership.
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Cap rate
In real estate, the cap rate (capitalization rate) or yield is a common term for the return on assets (7.33% in this example).
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Agency risk
Agency risk is the economic dispersion resulting from the consequences of having another party (the agent) making decisions contrary to the preferences of the owner (the principal).
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Political risk
Political risk is economic uncertainty caused by changes in government policy that may affect returns, perhaps dramatically.
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Row cropland
Row cropland is annual cropland that produces row crops, such as corn, cotton, carrots, or potatoes from annual seeds.
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Permanent cropland
Permanent cropland refers to land with long-term vines or trees that produce crops, such as grapes, cocoa, nuts, or fruit.
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Agronomy
Agronomy is the science of soil management, cultivation, crop production, and crop utilization.
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Smoothing
Smoothing is reduction in the reported dispersion in a price or return series.
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Favorable mark
A favorable mark is a biased indication of the value of a position that is intentionally provided by a subjective source.
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Managed returns
Managed returns are returns based on values that are reported with an element of managerial discretion.
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Model manipulation
Model manipulation is the process of altering model assumptions and inputs to generate desired values and returns.
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Selective appraisals
Selective appraisals refers to the opportunity for investment managers to choose how many, and which, illiquid assets should have their values appraised during a given quarter or some other reporting period.
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Market manipulation
Market manipulation refers to engaging in trading activity designed to cause the markets to produce favorable prices for thinly traded listed securities.
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Stale prices
Stale prices are indications of value derived from data that no longer represent current market conditions.
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Contagion
Contagion is the general term used in finance to indicate any tendency of major market movements--especially declines in prices or increases in volatility--to be transmitted from one financial market to other financial markets.
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Hotelling's theory
Hotelling's theory states that prices of exhaustible commodities, such as various forms of energy and metals, should increase by the prevailing nominal interest rate--perhaps with a risk premium.
383
Commodity-linked note
A commodity-linked note (CLN) is an intermediate-term debt instrument whose value at maturity is a function of the value of an underlying commodity or basket of commodities.
384
Spoilage cost
Spoilage cost is the loss of value that may naturally occur through time during storage due to physical deterioration.
385
inventory shrinkage
Inventory shrinkage is loss of inventory through time due to theft, decline in moisture content, and so forth.
386
Perfectly elastic supply
With regard to supply, on one end of the spectrum is a perfectly elastic supply, in which any quantity demanded of a commodity can be instantaneously and limitlessly supplied without changes in the market price.
387
Inelastic supply
Inelastic supply is when supplies change slowly in response to market prices or when large changes in market prices are necessary to effect supply changes.
388
Backwardation
When the slope of the term structure of forward prices is negative, the market is in backwardation, or is backwardated.
389
Contango
When the term structure of forward prices is upward sloping (i.e., when more distant forward contracts have higher prices than contracts that are nearby), the market is said to be in contango.
390
Inelastic demand
Inelastic demand is a market condition in which the demand for a good does not increase or decrease substantially due to changes in price and therefore is a potential cause of higher price volatility and higher convenience yield.
391
Basis
The basis in a forward contract is the difference between the spot (or cash) price of the referenced asset, S, and the price (F) of a forward contract with delivery T.
392
Basis risk
Basis risk is the dispersion in economic returns associated with changes in the relationship between spot prices and futures prices.
393
Calendar spread
A calendar spread can be viewed as the difference between futures or forward prices on the same underlying asset but with different settlement dates.
394
Excess return of a futures contract
The return generated exclusively from changes in futures prices is known as the excess return of a futures contract.
395
Fully collateralized position
A fully collateralized position is a position in which the cash necessary to settle the contract has been posted in the form of short-term, riskless bonds.
396
Collateral yield
Collateral yield, is the interest earned from the riskless bonds or other money market assets used to collateralize the futures contract.
397
Roll return
Roll yield or roll return is properly defined as the portion of the return of a futures position from the change in the contract's basis through time.
398
Roll yield
Roll yield or roll return is properly defined as the portion of the return of a futures position from the change in the contract's basis through time.
399
Spot return
Spot return is the return on the underlying asset in the spot market.
400
Heterogeneous
A heterogeneous value differs across one or more dimensions.
401
Normal backwardation
In normal backwardation, the forward price is believed to be below the expected spot price.
402
Normal contango
In normal contango, the forward price is believed to be above the expected spot price.
403
Stock-out
Stock-out occurs when storage effectively drops to zero, resulting in consumption being entirely dependent on production and transportation networks, and typically occurs in markets with peak seasonal demand, such as natural gas or heating oil, or with annual crop cycles, such as grains.
404
Working curve
The theory of storage as illustrated in the Working curve positively relates the slope of the forward curve to current levels of inventory such that low inventory levels tend to be associated with a negative and nonlinear forward curve slope.
405
Humped curve
The crude oil futures market has often exhibited a humped curve, which in the typical case of commodity futures means that the market is in contango in the short term, but gives way to backwardation for longer-maturity contracts.
406
Nominal price
A nominal price refers to the stated price of an asset measured using the contemporaneous values of a currency.
407
Real price
A real price refers to the price of an asset that is adjusted for inflation through being expressed in the value of currency from a different time period.
408
Volatility asymmetry
A volatility asymmetry is a difference in values between two analogous volatilities, such as is the case with commodities, in which volatility tends to be higher when prices are rising than when they are falling.
409
Inflation risk
Inflation risk is the dispersion in economic outcomes caused by uncertainty regarding the value of a currency.
410
Investable index
An investable index has returns that an investor can match in practice by maintaining the same positions that constitute the index.
411
Production-weighted index
A production-weighted index weights each underlying commodity using estimates of the quantity of each commodity produced.
412
Standard & Poor's GSCI (S&P GSCI)
The Standard & Poor's GSCI (S&P GSCI) is a long only index of physical commodity futures.
413
Bloomberg Commodity Index (BCOM)
The Bloomberg Commodity Index (BCOM), formerly the Dow Jones-UBS Commodity Index, is a long-only index composed of futures contracts on 22 physical commodities.
414
Thomson Reuters ore Commodity Research Bureau (CRB) index
The Thomson Reuters Core Commodity Research Bureau (CRB) Index is the oldest major commodity index and is currently made up of 19 commodities traded on various exchanges.
415
Downstream operations
Downstream operations focus on refining, distributing, and marketing the oil and gas.
416
Upstream operations
Upstream operations focus on exploration and production; midstream operations focus on storing and transporting the oil and gas.
417
Midstream operations
Midstream operations and midstream MLPs—the largest of the three segments—process, store, and transport energy and tend to have little or no commodity price risk.
418
Double taxation
Double taxation is the application of income taxes twice: taxation of profits at the corporate income tax level and taxation of distributions at the individual income tax level.
419
Unrelated business income tax (UBIT)
Unrelated business income tax (UBIT) is the income generated through businesses unrelated to the tax-exempt purpose of the organization.
420
Investable infrastructure
Investable infrastructure is typically differentiated from other assets with seven primary characteristics:(1) public use, (2) monopolistic power, (3) government related, (4) essential, (5) cash generating, (6) conducive to privatization of control, and (7) capital intensive with long-term horizons.
421
Brownfield project
Investable infrastructure can also be an existing project, or brownfield project, that has a history of operations and may have converted from a government asset into something privately investable.
422
Greenfield project
Investable infrastructure can originate as a new, yet-to-be-constructed project, referred to as a greenfield project, which was designed to be investable.
423
Critical property of infrastructure
The critical property of infrastructure (i.e., the most important distinction between investable infrastructure and traditional investments) is in the nature of the revenues, with investable infrastructure generating a cash flow stream in a monopolistic environment rather than in a competitive environment.
424
Privatization
When a governmental entity sells a public asset to a private operator, this is termed privatization.
425
Public-private partnership (PPP)
A public-private partnership (PPP) occurs when a private sector party is retained to design, build, operate, or maintain a public building (e.g., a hospital), often for a lease payment for a prespecified period of time.
426
Social infrastructure
Social Infrastructure assets are assets that have end users who are unable to pay for the services or that are used in such a way that it is difficult to determine how many services were used by each person; examples include schools, public roads, prisons, administrative offices, and other government buildings.
427
Regulatory risk
Regulatory risk is the economic dispersion to an investor from uncertainty regarding governmental regulatory actions.
428
Regulated pricing
Regulated pricing occurs in most countries and the pricing for goods and services deemed essential is largely determined by price changes that must be approved by public entities and are most common in the energy sector.
429
Greenfield phase
The greenfield phase covers the initial stages of infrastructure, from (1) building and development (including the design), to (2) the construction of the project itself, and (3) the project's ramp-up period (i.e., its start-up).
430
Brownfield phase
The brownfield phase involves operations and takes place when assets are already constructed.
431
Political infrastructure risk
Political infrastructure risk includes regulatory risk and nonregulatory risks, such as the risk of expropriation.
432
Evergreen funds
Unlisted open-end funds, also called evergreen funds, allow investors to subscribe to or redeem from these funds on a regular basis.
433
Closed-end infrastructure funds
Closed-end infrastructure funds are typically structured like private equity funds, have a life of typically 10 to 15 years, and draw down investor capital commitments over a stated investment period of four to five years.
434
Gates
Gates are fund restrictions on investor withdrawals.
435
Excludable good
An excludable good is a good others can be prevented from enjoying.
436
Intangible assets
Intangible assets are economic resources that do not have a physical form.
437
Intellectual property
Intellectual property (IP) is an intangible asset that can be owned, such as copyrighted artwork.
438
Unbundled intellectual property
Unbundled intellectual property is IP that may be owned or traded on a standalone basis.
439
Mature intellectual property
Mature intellectual property is IP that has developed and established a reliable usefulness and will have a more certain valuation and a more clear ability to generate licensing, royalty, or other income associated with its use.
440
Negative costs
Negative costs refer not to the sign of the values but to the fact that these are costs required to produce what was, in the predigital era, the film's negative image.
441
Visual works of art
Visual works of art include paintings and have a rich history of prices and returns, but they do not represent a major component of institutional portfolios.
442
Aesthetic benefit
The aesthetic benefit is the nonfinancial benefit to owning art and includes the joy of viewing and otherwise controlling the art.
443
Mortgage
A mortgage loan can be simply defined as a loan secured by property.
444
Seven challenges to international real estate investing
Seven challenges to international real estate investing include: (1) a lack of knowledge and experience regarding foreign real estate markets, (2) a lack of relationships with foreign real estate managers, (3) the time and expense of travel for due diligence, (4) liquidity concerns, (5) political risk (particularly in emerging markets), (6) risk management of foreign currency exposures, and (7) taxation differences.
445
Commercial real estate properties
Commercial real estate properties include the following property sectors: office buildings, industrial centers, data centers, retail (malls and shopping centers, also referred to as “strips”), apartments, health-care facilities (medical office buildings and assisted-living centers), self-storage facilities, and hotels.
446
Residential real estate
Residential real estate or housing real estate includes many property types, such as single-family homes, townhouses, condominiums, and manufactured housing.
447
Private real estate equity
Private real estate equity investment involves the direct or indirect acquisition and management of actual physical properties that are not traded on an exchange.
448
Private real estate
Private real estate is also known as physical, direct, or non-exchange-traded real estate, and may take the form of equity through direct ownership of the property or debt via mortgage claims on the property.
449
Public real estate investment
Public real estate investment entails the buying of shares of real estate investment companies and investing in other indirect exchange-traded forms of real estate (including futures and options on real estate indices and exchange-traded funds linked to real estate).
450
Private real estate market
The private real estate market comprises several segments: housing or residential real estate properties, commercial real estate properties, farmland, and timberland.
451
Primary real estate market
Real estate assets are said to trade in a primary real estate market if the geographic location of the real estate is in a major metropolitan area of the world, with numerous large real estate properties or a healthy growth rate in real estate projects with easily recognizable names.
452
Lumpiness
Lumpiness describes when assets cannot be easily and inexpensively bought and sold in sizes or quantities that meet the preferences of the buyers and sellers.
453
Core real estate
Core real estate includes assets that achieve a relatively high percentage of their returns from income and are expected to have low volatility.
454
Styles of real estate investing
Styles of real estate investing refer to the categorization of real estate property characteristics into core, value added, and opportunistic.
455
Opportunistic real estate
Opportunistic real estate properties are expected to derive most or all of their returns from property appreciation and may exhibit substantial volatility in value and returns.
456
Value-added real estate
Value-added real estate includes assets that exhibit one or more of the following characteristics: (1) achieving a substantial portion of their anticipated returns from appreciation in value, (2) exhibiting moderate volatility, and(3) not having the financial reliability of core properties.
457
Real estate style boxes
Real estate style boxes use two categorizations of real estate to generate a box or matrix that can be used to characterize properties or portfolios.
458
Fixed-rate mortgage
A fixed-rate mortgage has interest charges and interest payments based on a single rate established at the initiation of the mortgage.
459
Residential mortgage loans
Residential mortgage loans are typically taken out by individual households on properties that generate no explicit rental income, since the houses are usually owner occupied.
460
Variable-rate mortgage
A variable-rate mortgage has interest charges and interest payments based on a rate that is allowed to vary over the life of the mortgage based on terms established at the initiation of the mortgage.
461
Amortization
Reduction in principal due to payments is known as amortization.
462
Fully amortized
An asset is fully amortized when its principal is reduced to zero.
463
Unscheduled principal payments
If the borrower makes unscheduled principal payments, which are payments above and beyond the scheduled mortgage payments, the mortgage's balance will decline more quickly than illustrated in the Residential Mortgages lesson in the Amoritzation Schedule for a Fixed-Rate Mortgage exhibit, and the mortgage will terminate early. In traditional mortgages, payments that exceed the required payment reduce the principal payment but do not lower required subsequent payments until the mortgage is paid off.
464
Prepayment option
The ability of the borrower to make or not make unscheduled principal payments is an option to the borrower: the borrower's prepayment option.
465
Index rate
An index rate is a variable interest rate used in the determination of the mortgage's stated interest rate.
466
Margin rate
A margin rate is the spread by which the stated mortgage rate is set above the index rate. (This should not be confused with the same term used to describe a rate associated with margin debt in a brokerage account.)
467
Interest rate cap
An interest rate cap is a limit on interest rate adjustments used in mortgages and derivatives with variable interest rates.
468
Balloon payment
A balloon payment is a large scheduled future payment.
469
Negative amortization
Negative amortization occurs when the interest owed is greater than the payments being made such that the deficit is added to the principal balance on the loan, causing the principal balance to increase through time.
470
Option adjustable-rate mortgage (option ARM)
An option adjustable-rate mortgage (option ARM) is an adjustable-rate mortgage that provides borrowers with the flexibility to make one of several possible payments on their mortgage every month.
471
Subprime mortgages
Uninsured mortgages with borrowers of relatively high credit risk are generally known as subprime mortgages.
472
Prime mortgages
Prime mortgages are offered to borrowers with lower levels of credit risk and higher levels of creditworthiness.
473
Commercial mortgage loans
Commercial mortgage loans are loans backed by commercial real estate (multifamily apartments, hotels, offices, retail and industrial properties) rather than owner-occupied residential properties.
474
Loan-to-value ratio (LTV ratio)
The loan-to-value ratio (LTV ratio) is the ratio of the amount of the loan to the value (either market or appraised) of the property.
475
Covenants
Covenants are promises made by the borrower to the lender, such as requirements that the borrower maintain the property in good repair and continue to meet specified financial conditions.
476
Cross-collateral provision
In order to mitigate the risk to which they are exposed, lenders commonly use a cross-collateral provision, wherein the collateral for one loan is used as collateral for another loan.
477
Recourse
Recourse is the set of rights or means that an entity such as a lender has in order to protect its investment.
478
Debt service coverage ratio
A related measure is the debt service coverage ratio (DSCR), which is the ratio of the property's net operating income to all loan payments, including the amortization of the loan.
479
Fixed charges ratio
The fixed charges ratio is the ratio of the property's net operating income to all fixed charges that the borrower pays annually.
480
Interest coverage ratio
Lenders typically examine the interest coverage ratio, which can be defined as the property's net operating income divided by the loan's interest payments.
481
Mortgage-backed securities (MBS)
Mortgage-backed securities (MBS) are a type of asset-backed security that is secured by a mortgage or pool of mortgages.
482
Collateralized mortgage obligations (CMOs)
Collateralized mortgage obligations (CMOs) extend this MBS mechanism to create different security classes, called tranches, which have different priorities to receiving cash flows and therefore different risks.
483
Pass-through MBS
A pass-through MBS is perhaps the simplest MBS and consists of the issuance of a homogeneous class of securities with pro rata rights to the cash flows of the underlying pool of mortgage loans.
484
Residential mortgage-backed securities
The residential mortgage-backed securities(RMBS) market is backed by residential mortgage loans.
485
Conditional prepayment rate
The annualized percentage of a mortgage's remaining principal value that is prepaid in a particular month is known as the conditional prepayment rate (CPR).
486
PSA benchmark
The Public Securities Association (PSA) established the PSA benchmark, a benchmark of prepayment speed that is based on the CPR and that has become the standard approach used by market participants.
487
Idiosyncratic prepayment factors
Factors affecting prepayment decisions other than interest rates or other systematic factors are known as idiosyncratic prepayment factors.
488
Refinancing burnout
Reduced refinancing speeds due to high levels of previous refinancing activity is known as refinancing burnout.
489
Commercial mortgage-backed securities
Commercial mortgage-backed securities (CMBS) are mortgage-backed securities with underlying collateral pools of commercial property loans.
490
Equity REITs
Equity REITs invest predominantly in equity ownership within the private real estate market.
491
Mortgage REITs
Mortgage REITs invest predominantly in real estate-based debt.
492
Real estate investment trust (REIT)
A real estate investment trust (REIT) is an entity structured much like a traditional operating corporation, except that the assets of the entity are almost entirely real estate.
493
Real estate development projects
Real estate development projects can include one or more stages of creating or improving a real estate project, including the acquisition of raw land, the construction of improvements, and the renovation of existing facilities.
494
Real option
A real option is an option on a real asset rather than a financial security.
495
Decision tree
A decision tree shows the various pathways that a decision maker can select as well as the points at which uncertainty is resolved.
496
Information node
An information node denotes a point in a decision tree at which new information arrives.
497
Backward induction
Backward induction is the process of solving a decision tree by working from the final nodes toward the first node, based on valuation analysis at each node.
498
Decision node
A decision node is a point in a decision tree at which the holder of the option must make a decision.
499
Real estate appraisal
A real estate appraisal is generally viewed as a formal opinion of a value provided by an appraiser and often used in financial reports and in decision-making including lending.
500
Profit approach
The profit approach to real estate valuation is typically used for properties with a value driven by the actual business use of the premises; it is effectively a valuation of the business rather than a valuation of the property itself.
501
Cost approach
The cost approach assumes that a buyer will not pay more for a property than it would cost to build an equivalent one.
502
Comparable sale prices approach
The comparable sale prices approach values real estate based on transaction values of similar real estate, with adjustments made for differences in characteristics.
502
Real estate valuation
Real estate valuation is the process of estimating the market value of a property and should be reflective of the price at which informed investors would be willing to both buy and sell that property.
503
Income approach
The income approach values real estate by projecting expected income or cash flows, discounting for time and risk, and summing them to form the total value.
504
Transaction-based real estate valuation methods
Transaction-based real estate valuation methods are based on relatively large data sets of actual transaction prices of properties within a specified time period and include the repeat-sales and hedonic methods.
505
State appraisal effect
A stale appraisal effect comes from the use of dated appraisals.
506
NCREIF Property Index (NPI)
The NCREIF Property Index (NPI) is the primary example of an appraisal-based real estate index in the United States and is published by the National Council of Real Estate Investment Fiduciaries (NCREIF), a not-for-profit industry association that collects data regarding property values from its members.
507
Calculation of the returns to the NPI
The calculation of the returns to the NPI is performed on a before-tax basis (and therefore do not include income tax expense) and is performed for each individual property and then value-weighted in the index calculation.
508
Discounted cash flow (DCF) method
The income approach is also known as the discounted cash flow (DCF) method when cash flows are discounted rather than accounting estimates of income.
509
Net operating income (NOI)
Net operating income (NOI) is a measure of periodic earnings that is calculated as the property's rental income minus all expenses associated with maintaining and operating the property.
510
Net sale proceeds (NSP)
The net sale proceeds (NSP) is the expected selling price minus any expected selling expenses arising from the sale of the property at time T.
511
Effective gross income
The effective gross income is the potential gross income reduced for the vacancy loss rate.
512
Fixed expenses
Fixed expenses, examples of which are property taxes and property insurance, do not change directly with the level of occupancy of the property.
513
Operating expenses
Operating expenses are non-capital outlays that support rental of the property and can be classified as fixed or variable.
514
Potential gross income
The potential gross income is the gross income that could potentially be received if all offices in the building were occupied.
515
Vacancy loss rate
The vacancy loss rate is the observed or anticipated rate at which potential gross income is reduced for space that is not generating rental income.
516
Variable expenses
Variable expenses, examples of which are maintenance, repairs, utilities, garbage removal, and supplies, change as the level of occupancy of the property varies.
517
Risk premium approach
The risk premium approach to estimation of a discount rate for an investment uses the sum of a riskless interest rate and one or more expected rewards—expressed as rates—for bearing the risks of the investment.
518
Net lease
In a net lease, the tenant is responsible for almost all of the operating expenses.
519
Depreciation
Depreciation is a noncash expense that is deducted from revenues in computing accounting income to indicate the decline of an asset's value.
520
After-tax discounting approach
In an after-tax discounting approach, the estimated after-tax cash flows (e.g., after-tax bond payments) are discounted using a rate that has been reduced to reflect.
521
Pre-tax discounting approach
The pre-tax discounting approach is commonly used in finance, where pre-tax cash flows are used in the numerator of the present value analysis (as the cash flows to be received), and the pre-tax discount rate is used in the denominator.
522
Equity residual approach
An alternative approach, often termed the equity residual approach, focuses on the perspective of the equity investor by subtracting the interest expense and other cash outflows due to mortgage holders (in the numerator) and by discounting the remaining cash flows using an interest rate reflective of the required rate of return on the equity of a leveraged real estate investment (in the denominator).
523
Private equity real estate funds
Private equity real estate funds are privately organized funds that are similar to other alternative investment funds, such as private equity funds and hedge funds, yet have real estate as their underlying asset.
524
Commingled real estate
Commingled real estate funds (CREFs) are a type of private equity real estate fund that is a pool of investment capital raised from private placements that are commingled to purchase commercial properties.
525
Syndications
Syndications are private equity real estate funds formed by a group of investors who retain a real estate expert with the intention of undertaking a particular real estate project.
526
Real estate joint ventures
Real estate joint ventures are private equity real estate funds that consist of the combination of two or more parties, typically represented by a small number of individual or institutional investors, embarking on a business enterprise such as the development of real estate properties.
527
Gearing
Gearing is the use of leverage.
528
Open-end real estate mutual funds
Open-end real estate mutual funds are public investments that offer a non-exchange traded means of obtaining access to the private real estate market.
529
Stale pricing
The use of prices that lag changes in true market prices is known as stale pricing.
530
Exchange-traded funds (ETFs)
Exchange-traded funds (ETFs) represent a tradable investment vehicle that tracks a particular index or portfolio by holding its constituent assets or a subsample of them.
531
Closed-end real estate mutual fund
A closed-end real estate mutual fund is an investment pool that has real estate as its underlying asset and a relatively fixed number of outstanding shares.
532
FTSE NAREIT US Real Estate Index Series
The FTSE NAREIT US Real Estate Index Series is a family of REIT-based performance indices that covers the different sectors of the U.S. commercial real estate space.
533
Safe harbor
In investments, a safe harbor denotes an area that is explicitly protected by one set of regulations from another set of regulations.
534
Consolidation
Consolidation is an increase in the proportion of a market represented by a relatively small number of participants (i.e., the industry concentration).
535
High-water mark
The high-water mark (HWM) is the highest NAV of the fund on which an incentive fee has been paid.
536
Asymmetric incentive fees
Asymmetric incentive fees, in which managers earn a portion of investment gains without compensating investors for investment losses, are generally prohibited for stock and bond funds offered as '40 Act mutual funds in the United States.
537
Managerial coinvesting
Managerial coinvesting in this context is an agreement between fund managers and fund investors that the managers will invest their own money in the fund.
538
Optimal contracting
Optimal contracting between investors and hedge fund managers attempts to align the interests of both parties to the extent that the interests can be aligned cost-effectively, with marginal benefits that exceed marginal costs.
539
Excessive conservatism
Excessive conservatism is inappropriately high risk aversion by the manager, since the manager's total income and total wealth may be highly sensitive to fund performance.
540
Perverse incentive
A perverse incentive is an incentive that motivates the receiver of the incentive to work in opposition to the interests of the provider of the incentive.
541
Annuity view of hedge fund fees
The annuity view of hedge fund fees represents the prospective stream of cash flows from fees available to a hedge fund manager.
542
Option view of incentive fees
The option view of incentive fees uses option theory to demonstrate the ability of managers to increase the present value of their fees by increasing the volatility of the fund's assets.
543
Incentive fee option value
The incentive fee option value is the risk-adjusted present value of the incentive fees to a manager that have been adjusted for its optionality.
544
At-the-money incentive fee approximation
The at-the-money incentive fee approximation expresses the value of a managerial incentive fee as the product of 40%, the fund's NAV, the incentive fee percentage, and the volatility of the assets (σ1) over the option's life.
545
Closet indexer
A closet indexer is a manager who attempts to generate returns that mimic an index while claiming to be an active manager.
546
Pure asset gatherer
A pure asset gatherer is a manager focused primarily on increasing the AUM of the fund. A pure asset gatherer is likely to take very little risk in a portfolio and, like mutual fund managers, become a closet indexer.
547
Lock-in effect
The lock-in effect in this context refers to the pressure exerted on managers to avoid further risks once high profitability and a high incentive fee have been achieved.
548
Managing returns
The terms managing returns and massaging returns refer to efforts by managers to alter reported investment returns toward preferred targets through accounting decisions or investment changes.
549
Massaging returns
The terms managing returns and massaging returns refer to efforts by managers to alter reported investment returns toward preferred targets through accounting decisions or investment changes.
550
Classification of hedge fund strategies
A classification of hedge fund strategies is an organized grouping and labeling of hedge fund strategies.
551
Fund of funds
A fund of funds in this context is a hedge fund with underlying investments that are predominantly investments in other hedge funds.
552
Multistrategy fund
A multistrategy fund deploys its underlying investments with a variety of strategies and sub-managers, much as a corporation would use its divisions.
553
Single-manager hedge fund
A single-manager hedge fund, or single hedge fund, has underlying investments that are not allocations to other hedge funds.
554
Fund mortality
Fund mortality, the liquidation or cessation of operations of funds, illustrates the risk of individual hedge funds and is an important issue in hedge fund analysis.
555
Hedge fund program
A hedge fund program refers to the processes and procedures for the construction, monitoring, and maintenance of a portfolio of hedge funds.
556
Absolute return strategies
Absolute return strategies are hedge fund strategies that seek to minimize market risk and total risk.
557
Diversified strategies
Diversified strategies are hedge fund strategies that seek to diversify across a number of different investment themes.
558
Equity strategies
Equity strategies are hedge fund strategies that exhibit substantial market risk.
559
Event-driven strategies
Event-driven strategies are hedge fund strategies that seek to earn returns by taking on event risk, such as failed mergers, that other investors are not willing or prepared to take.
560
Relative value strategies
Relative value strategies are hedge fund strategies that seek to earn returns by taking risks regarding the convergence of values between securities.
561
Off-balance-sheet risk
Event risk is effectively an off-balance-sheet risk—that is, a risk exposure that is not explicitly reflected in the statement of financial positions.
562
Short volatility exposure
Short volatility exposure is any risk exposure that causes losses when underlying asset return volatilities increase.
563
Convergent strategies
Convergent strategies profit when relative value spreads move tighter, meaning that two securities move toward relative values that are perceived to be more appropriate.
564
Relative return product
A relative return product is an investment with returns that are substantially driven by broad market returns and that should therefore be evaluated on the basis of how the investment's return compares with broad market returns.
565
Opportunistic
An investment strategy is referred to as opportunistic when a major goal is to seek attractive returns through locating superior underlying investments.
566
Headline risk
Headline risk is dispersion in economic value from events so important, unexpected, or controversial that they are the center of major news stories.
567
Fee bias
Fee bias is when index returns overstate what a new investor can obtain in the hedge fund marketplace because the fees used to estimate index returns are lower than the typical fees that a new investor would pay.
568
Representativeness
The representativeness of a sample is the extent to which the characteristics of that sample are similar to the characteristics of the universe.
569
Instant history bias or backfill
Instant history bias or backfill bias occurs when an index contains histories of returns that predate the entry date of the corresponding funds into a database and thereby cause the index to disproportionately reflect the characteristics of funds that are added to a database.
570
Liquidation bias
Liquidation bias occurs when an index disproportionately reflects the characteristics of funds that are not near liquidation.
571
Participation bias
Participation bias may occur for a successful hedge fund manager who closes a fund and stops reporting results because the fund no longer needs to attract new capital.
572
Strategy definitions
Strategy definitions, the method of grouping similar funds, raise two problems: (1) definitions of strategies can be very difficult for index providers to establish and specify, and (2) some funds can be difficult to classify in the process of applying the definition.
573
Style drift
Style drift (or strategy drift) is the change through time of a fund's investment strategy based on purposeful decisions by the fund manager in an attempt to improve risk-adjusted performance in light of changing market conditions.
574
Synthetic hedge funds
Synthetic hedge funds attempt to mimic hedge fund returns using listed securities and mathematical models.
575
Investability
The investability of an index is the extent to which market participants can invest to actually achieve the returns of the index.
576
Capacity
Capacity is the limit on the quantity of capital that can be deployed without substantially diminished performance.
577
Counterparty risk
Counterparty risk is the uncertainty associated with the economic outcomes of one party to a contract due to potential failure of the other side of the contract to fulfill its obligations, presumably due to insolvency or illiquidity.
578
Black-box model trading
Systematic fund trading, often referred to as black-box model trading because the details are hidden in complex software, occurs when the ongoing trading decisions of the investment process are automatically generated by computer programs.
579
Discretionary fund trading
Discretionary fund trading occurs when the decisions of the investment process are made according to the judgment of human traders.
580
Systematic fund trading
Systematic fund trading, often referred to as black-box model trading because the details are hidden in complex software, occurs when the ongoing trading decisions of the investment process are automatically generated by computer programs.
581
Fundamental analysis
Fundamental analysis uses underlying financial and economic information to ascertain intrinsic values based on economic modeling.
582
Technical analysis
Technical analysis relies on data from trading activity, including past prices and volume data.
583
Global macro funds
Global macro funds have the broadest investment universe: They are not limited by market segment, industry sector, geographic region, financial market, or currency, and therefore tend to offer high diversification.
584
Market microstructure
Market microstructure is the study of how transactions take place, including the costs involved and the behavior of bid and ask prices.
585
Thematic investing
Thematic investing is a trading strategy that is not based on a particular instrument or market; rather, it is based on secular and long-term changes in some fundamental economic variables or relationships—for example, trends in population, the need for alternative sources of energy, or changes in a particular region of the world economy.
586
Event risk
Event risk refers to sudden and unexpected changes in market conditions resulting from a specific event (e.g., Lehman Brothers bankruptcy).
587
Leverage
Leverage refers to the use of financing to acquire and maintain market positions larger than the assets under management (AUM) of the fund.
588
Market risk
Market risk refers to exposure to directional moves in general market price levels.
589
Managed futures
The term managed futures refers to the active trading of futures and forward contracts on physical commodities, financial assets, and exchange rates.
590
Commodity pool operator (CPO)
Investors can access the managed futures industry either by investing in a futures trading fund (via a managed account or a commingled fund) or through a commodity pool--a commingled investment vehicle that resembles a fund of funds and is managed by a commodity pool operator (CPO), who invests in a number of underlying CTAs.
591
Commodity Futures Trading Commission (CFTC)
In the United States, the Commodity Futures Trading Commission (CFTC) was initiated in 1974 as a federal regulatory agency for all futures and derivatives trading.
592
National Futures Association (NFA)
The National Futures Association (NFA) is an independent, industry-supported, self-regulatory body created in 1982.
593
Futurization
Futurization is the movement from traditional OTC contracts to multilateral cleared contracts in the futures market.
594
Commodity pools
Commodity pools are investment funds that combine the money of several investors for the purpose of investing in the futures markets.
595
Private commodity pools
Private commodity pools are funds that invest in the futures markets and are sold privately to high-net-worth investors and institutional investors.
596
Public commodity pools
Public commodity pools are open to the general public for investing in much the same way that a mutual fund sells its shares to the public.
597
Commodity trading advisers (CTAs)
Commodity trading advisers (CTAs) are professional money managers who specialize in the futures markets.
598
Managed account
A managed account (or separately managed account) is created when money is placed directly with a CTA in an individual account rather than being pooled with other investors.
599
Slippage
Slippage is the unfavorable difference between assumed entry and exit prices and the entry and exit prices experienced in practice.
600
In-sample data
In-sample data are those observations directly used in the backtesting process.
601
Out-of-sample data
Out-of-sample data are observations that were not directly used to develop a trading rule or even indirectly used as a basis for knowledge in the research.
602
Robustness
Robustness refers to the reliability with which a model or system developed for a particular application or with a particular data set can be successfully extended into other applications or data sets.
603
Validation
Validation of a trading rule refers to the use of new data or new methodologies to test a trading rule developed on another set of data or with another methodology.
604
Degradation
Degradation is the tendency and process through time by which a trading rule or trading system declines in effectiveness.
605
Mean-reverting
Mean-reverting refers to the situation in which returns show negative autocorrelation—the opposite tendency of momentum or trending.
606
Momentum
Momentum is the extent to which a movement in a security price tends to be followed by subsequent movements of the same security price in the same direction.
607
Moving average
A moving average is a series of averages that is recalculated through time based on a window of observations.
608
Random walk
A price series with changes in its prices that are independent from current and past prices is a random walk.
609
Trend-following strategies
Trend-following strategies are designed to identify and take advantage of momentum in price direction (i.e., trends in prices).
610
Systematic trading strategies
Systematic trading strategies are generally categorized into three groups: trend-following, non-trend-following, and relative value.
611
Simple moving average
The most basic approach uses a simple moving average, a simple arithmetic average of previous prices.
612
Weighted moving average
A weighted moving average is usually formed as an unequal average, with weights arithmetically declining from most recent to most distant prices.
613
Exponential moving average
The exponential moving average is a geometrically declining moving average based on a weighted parameter, λ, with 0 < λ < 1.
614
Whipsawing
Whipsawing is when a trader alternates between establishing long positions immediately before price declines and establishing short positions immediately before price increases and, in so doing, experiences a sequence of losses. In trend following strategies, whipsawing results from a sideways market.
615
Sideways market
A sideways market exhibits volatility without a persistent direction.
616
Breakout strategies
Breakout strategies focus on identifying the commencement of a new trend by observing the range of recent market prices (e.g., looking back at the range of prices over a specific time period).
617
Countertrend strategies
Countertrend strategies use various statistical measures, such as price oscillation or a relative strength index, to identify range-trading opportunities rather than price-trending opportunities.
618
Relative strength index (RSI)
The relative strength index (RSI), sometimes called the relative strength indicator, is a signal that examines average up and down price changes and is designed to identify trading signals such as the price level at which a trend reverses.
619
Pattern recognition system
A pattern recognition system looks to capture non-trend-based predictable abnormal market behavior in prices or volatilities.
620
Multistrategy CTAs
Multistrategy CTAs combine a variety of strategy focuses to provide a diversified set of potential return sources and risk-reward profiles.
621
Volatility targeting
Volatility targeting is where the size of the position is determined by the trader's conviction in the signal, the volatility of the particular futures market, and a volatility target that is determined by the trader.
622
Capital at risk
The risk loading times the equity or capital is sometimes termed the capital at risk.
623
Point value
The point value is the gain or loss in the contract from a one-point change (e.g., $1) in the futures prices.
624
Futures contract dollar risk
The futures contract dollar risk is a measure of the riskiness of the underlying asset of the futures contract during the most recent K trading periods.
625
Equal dollar risk allocation
Equal dollar risk allocation is a strategy that allocates the same amount of dollar risk to each market.
626
Equal risk contribution
Equal risk contribution is a strategy that allocates risk based on the risk contribution of each market, taking correlation into account.
627
Market capacity weighting
Market capacity weighting is an approach in which capital is allocated as a function of individual market capacity.
628
Alpha decay
Alpha decay is the speed with which performance degrades as execution is delayed.
629
Mount Lucas Management (MLM) Index
The Mount Lucas Management (MLM) Index is a passive, transparent, and investable index designed to capture the returns to active futures investing.
630
Natural hedger
A natural hedger is a market participant who seeks to hedge a risk that springs from its fundamental business activities.
631
Capacity risk
Capacity risk arises when a managed futures trader concentrates trades in a market that lacks sufficient depth (i.e., liquidity).
632
Model risk
Model risk is economic dispersion caused by the failure of models to perform as intended.
633
Transparency
Transparency is the ability to understand the detail within an investment strategy or portfolio.
634
Transparency risk
Transparency risk is dispersion in economic outcomes caused by the lack of detailed information regarding an investment portfolio or strategy.
635
Lack of trends risk
Lack of trends risk, which comes into play when the trader continues allocating capital to trendless markets, leading to substantial losses.
636
Liquidity risk
Liquidity risk, is somewhat related to capacity risk in that it refers to how a large fund that is trading in a thinly traded market will affect the price should it decide to increase or decrease its allocation.
637
Event-driven
The event-driven category of hedge funds includes activist hedge funds, merger arbitrage funds, and distressed securities funds, as well as special situation funds and multistrategy funds that combine a variety of event-driven strategies.
638
Corporate event risk
Corporate event risk is dispersion in economic outcomes due to uncertainty regarding corporate events.
639
Selling insurance
Selling insurance in this context refers to the economic process of earning relatively small returns for providing protection against risks, not the literal process of offering traditional insurance policies.
640
Long binary call option
A long binary call option makes one payout when the referenced price exceeds the strike price at expiration and a lower payout or no payout in all other cases.
641
Long binary put option
A long binary put option makes one payout when the referenced price is lower than the strike price at expiration and a lower payout or no payout in all other cases.
642
Activist investment strategy
The activist investment strategy involves efforts by shareholders to use their rights, such as voting power or the threat of such power, to influence corporate governance to their financial benefit as shareholders.
643
Corporate governance
Corporate governance describes the processes and people that control the decisions of a corporation.
644
Shareholder activism
Shareholder activism refers to efforts by one or more shareholders to influence the decisions of a firm in a direction contrary to the initial recommendations of the firm's senior management.
645
Proxy battle
A proxy battle is a fight between the firm's current management and one or more shareholder activists to obtain proxies (i.e., favorable votes) from shareholders.
646
Free rider
A free rider is a person or entity that allows others to pay initial costs and then benefits from those expenditures.
647
Agency theory
Agency theory studies the relationship between principals and agents.
648
Principal-agent relationship
A principal-agent relationship is any relationship in which one person or group, the principal(s), hires another person or group, the agent(s), to perform decision-making tasks.
649
Agency costs
Agency costs are any costs, explicit (e.g., monitoring and auditing costs) or implicit (e.g., excessive corporate perks), resulting from inherent conflicts of interest between shareholders as principals and managers as agents.
650
Agent compensation scheme
An agent compensation scheme is all agreements and procedures specifying payments to an agent for services, or any other treatment of an agent with regard to employment.
651
Form 13D
In the United States, Form 13D is required to be filed with the Securities and Exchange Commission (SEC) within 10 days, publicizing an activist's stake in a firm once the activist owns more than 5% of the firm and has a strategic plan for the firm.
652
Toehold
A toehold is a stake in a potential merger target that is accumulated by a potential acquirer prior to the news of the merger attempt becoming widely known.
653
Form 13F
In the United States, Form 13F is a required quarterly filing of all long positions by all US asset managers with over $100 million in assets under management, including hedge funds and mutual funds, among other investors.
654
Form 13G
In the United States, Form 13G is required of passive shareholders who buy a 5% stake in a firm, but this filing may be delayed until 45 days after year-end.
655
Wolf pack
A wolf pack is a group of investors who may take similar positions to benefit from an activists' engagement with corporate management.
656
Staggered board seats
Staggered board seats exist when instead of having all members of a board elected at a single point in time, portions of the board are elected at regular intervals.
657
Interlocking boards
Interlocking boards occur when board members from multiple firms—especially managers—simultaneously serve on each other's boards and may lead to a reduced responsiveness to the interests of shareholders.
658
Spin-off
A spin-off occurs when a publicly traded firm splits into two publicly traded firms, with shareholders in the original firm becoming shareholders in both firms.
659
Split-off
A split-off occurs when investors have a choice to own Company A or B, as they are required to exchange their shares in the parent firm if they would like to own shares in the newly created firm.
660
Merger arbitrage
Merger arbitrage attempts to benefit from merger activity with minimal risk and is perhaps the best- known event-driven strategy.
661
Stock-for-stock mergers
Stock-for-stock mergers acquire stock in the target firm using the stock of the acquirer and typically generate large initial increases in the share price of the target firm.
662
Traditional merger arbitrage
Traditional merger arbitrage generally uses leverage to buy the stock of the firm that is to be acquired and to sell short the stock of the firm that is the acquirer.
663
Cash-for-stock mergers
Cash-for-stock mergers occur wherein the acquirer pays cash for the shares of the firm being acquired.
664
Bidding contest
A bidding contest or bidding war is when two or more firms compete to acquire the same target.
665
Antitrust review
An antitrust review is a government analysis of whether a corporate merger or some other action is in violation of regulations through its potential to reduce competition.
666
Financing risk
Financing risk is the economic dispersion caused by failure or potential failure of an entity, such as an acquiring firm, to secure the funding necessary to consummate a plan.
667
Distressed debt hedge funds
Distressed debt hedge funds invest in the securities of a corporation that is in bankruptcy or is likely to fall into bankruptcy.
668
Bankruptcy process
The bankruptcy process is the series of actions taken from the filing for bankruptcy through its resolution.
669
Liquidation process
In a liquidation process (chapter 7 in U.S. bankruptcy laws), all of the assets of the firm are sold, and the cash proceeds are distributed to creditors.
670
Reorganization process
In a reorganization process (chapter 11 in U.S. bankruptcy laws), the firm's activities are preserved.
671
One-off transaction
A one-off transaction has one or more unique characteristics that cause the transaction to require specialized skill, knowledge, or effort.
672
Recovery value
The recovery value of the firm and its securities is the value of each security in the firm and is based on the time it will take the firm to emerge from the bankruptcy process and the condition in which it will emerge.
673
Capital structure arbitrage
Capital structure arbitrage involves offsetting positions within a company's capital structure with the goal of being long relatively underpriced securities, being short overpriced securities, and being hedged against risk.
674
Financial market segmentation
Financial market segmentation occurs when two or more markets use different valuations for similar assets due to the lack of participants who trade in both markets or who perform arbitrage between the markets.
675
Event-driven multistrategy funds
Event-driven multistrategy funds diversify across wide variety of event-driven strategies, participating in opportunities in both corporate debt and equity securities.
676
Special situation funds
Special situation funds invest across a number of event styles and are typically focused on equity securities, especially those with a spin-off or recent emergence from bankruptcy.
677
Classic relative value strategy trade
The classic relative value strategy trade is based on the premise that a particular relationship or spread between two prices or rates has reached an abnormal level and will therefore tend to return to its normal level.
678
Convergence
Convergence is the return of prices or rates to relative values that are deemed normal.
679
Classic convertible bond arbitrage trade
The classic convertible bond arbitrage trade is to purchase a convertible bond that is believed to be undervalued and to hedge its risk using a short position in the underlying equity.
680
Convertible bonds
Convertible bonds are hybrid corporate securities, mixing fixed-income and equity characteristics into one security.
681
Bond convertibles
Bonds with very high conversion premiums are often called busted convertibles, as the embedded stock options are far out-of-the-money.
682
Equity-like convertible
An equity-like convertible is a convertible bond that is far in- the-money and therefore has a price that tracks its underlying equity very closely.
683
Hybrid convertibles
Convertible bonds with moderately sized conversion ratios have stock options closer to being at-the-money and are called hybrid convertibles.
684
Moneyness is the extent to which an option is in-the-money, at-the-money, or out-of-the-money.
Moneyness
685
Delta
Delta is the change in the value of an option (or a security with an implicit option) with respect to a change in the value of the underlying asset (i.e., it measures the sensitivity of the option price to small changes in the price of its underlying asset).
686
Gamma
Gamma is the second derivative of an option's price with respect to the price of the underlying asset—or, equivalently, the first derivative of delta with respect to the price of the underlying asset.
687
Theta
Theta is the first derivative of an option's price with respect to the time to expiration of the option.
688
Delta-neutral
A delta-neutral position is a position in which the value-weighted sum of all deltas of all positions equals zero.
689
Implied volatility
The implied volatility of an option or an option-like position—in this case, the implied volatility of a convertible bond—is the standard deviation of returns that is viewed as being consistent with an observed market price for the option.
690
Realized volatility
Realized volatility is the actual observed volatility (i.e., the standard deviation of returns) experienced by an asset—in this case, the underlying stock.
691
Complexity premium
A complexity premium is a higher expected return offered by a security to an investor to compensate for analyzing and managing a position that requires added time and expertise.
692
Dilution
Dilution takes place when additional equity is issued at below-market values, and the per-share value of the holdings of existing shareholders is diminished.
693
Components of convertible arbitrage returns
The components of convertible arbitrage returns include interest, dividends, rebates, and capital gains and losses.
694
Dynamic delta hedging
Dynamic delta hedging is the process of frequently adjusting positions in order to maintain a target exposure to delta, often delta neutrality.
695
Net delta
The net delta of a position is the delta of long positions minus the delta of short positions.
696
Volatility arbitrage
Volatility arbitrage is any strategy that attempts to earn a superior and riskless profit based on prices that explicitly depend on volatility.
697
Anticipated volatility
Anticipated volatility is the future level of volatility expected by a market participant.
698
Vega
Vega is a measure of the risk of a position or an asset due to changes in the volatility of a price or rate that helps determine the value of that position or asset.
699
Vega risk
Vega risk is the economic dispersion caused by changes in the volatility of a price, return, or rate.
700
Variance swaps
Variance swaps are forward contracts in which one party agrees to make a cash payment to the other party based on the realized variance of a price or rate in exchange for receiving a predetermined cash flow.
701
Variance notional value
The variance notional value of the contract simply scales the size of the cash flows in a variance swap.
702
Vega notional value
The vega notional value of a contract serves to scale the contract and determine the size of the payoff in a volatility swap.
703
Volatility swap
A volatility swap mirrors a variance swap except that the payoff of the contract is linearly based on the standard deviation of a return series rather than the variance.
704
Marking-to-model
Marking-to-market refers to the use of current market prices to value instruments, positions, portfolios, and even the balance sheets of firms.
705
Marking-to-market
Marking-to-market refers to the use of current market prices to value instruments, positions, portfolios, and even the balance sheets of firms.
706
Price transparency
Price transparency is information on the prices and quantities at which participants are offering to buy (bid) and sell (offer) an instrument.
707
Pricing risk
Pricing risk is the economic uncertainty caused by actual or potential mispricing of positions.
708
Correlation risk
Correlation risk is dispersion in economic outcomes attributable to changes in realized or anticipated levels of correlation between market prices or rates.
709
Volatility risk
Volatility risk is dispersion in economic outcomes attributable to changes in realized or anticipated levels of volatility in a market price or rate.
710
Tail risk
Tail risk is the potential for very large loss exposures due to very unusual events, especially those associated with widespread market price declines.
711
Portfolio insurance
Portfolio insurance is any financial method, arrangement, or program for limiting losses from large adverse price movements.
712
Correlations go to one
The term correlations go to one means that during periods of enormous stress, stocks and bonds with credit risk decline simultaneously and with somewhat similar magnitudes.
713
Classic dispersion trade
The classic dispersion trade is a market-neutral short correlation trade, popular among volatility arbitrage practitioners, that typically takes long positions in options listed on the equities of single companies and short positions in a related index option.
714
Short correlation
The classic dispersion trade is referred to as a short correlation trade because the trade generates profits from low levels of realized correlation and losses from high levels of realized correlation.
715
Fixed-income arbitrage
Fixed-income arbitrage involves simultaneous long and short positions in fixed income securities with the expectation that over the investment holding period, the security prices will converge toward a similar valuation standard.
716
Duration
Duration is a measure of the sensitivity of a fixed-income security to a change in the general level of interest rates.
717
Intracurve arbitrage positions
These are examples of intracurve arbitrage positions because they are based on hedged positions within the same yield curve.
718
Yield curve
A yield curve is the relationship between the yields of various securities, usually depicted on the vertical axis, and the term to maturity, usually depicted on the horizontal axis.
719
Carry trades
Carry trades attempt to earn profits from carrying or maintaining long positions in higher-yielding assets and short positions in lower-yielding assets without suffering from adverse price movements.
720
Intercurve arbitrage positions
There are also intercurve arbitrage positions, which means arbitrage (hedged positions) using securities related to different yield curves.
721
Sovereign debt
Sovereign debt is debt issued by national governments.
722
Duration-neutral
A duration-neutral position is a portfolio in which the aggregated durations of the short positions equal the aggregated durations of the long positions weighted by value.
723
Parallel shift
A parallel shift in the yield curve happens when yields of all maturities shift up or down by equal (additive) amounts.
724
Riding the yield curve
The process of holding a bond as its yield moves up or down the yield curve due to the passage of time is known as riding the yield curve.
725
Rolling down
Rolling down the yield curve is the process of experiencing decreasing yields to maturity as an asset's maturity declines through time in an upward-sloping yield curve environment.
726
Modified duration
Modified duration is equal to traditional duration divided by the quantity [1 + (y/m)], where y is the stated annual yield, m is the number of compounding periods per year, and y/m is the periodic yield.
727
Asset-backed securities
Still another subset of fixed-income arbitrage trades is asset-backed securities (ABS), which are securitized products created from pools of underlying loans or other assets.
728
Effective duration
Effective duration is a measure of the interest rate sensitivity of a position that includes the effects of embedded option characteristics.
729
Mortgage-backed securities arbitrage
Mortgage-backed securities arbitrage attempts to generate low-risk profits through the relative mispricing among MBS or between MBS and other fixed-income securities.
730
Option-adjusted spread
A key concept in pricing fixed income securities with embedded prepayment options is the option-adjusted spread (OAS), which is a measure of the excess of the return of a fixed-income security containing an option over the yield of an otherwise comparable fixed-income security without an option after the return of the fixed- income security containing the option has been adjusted to remove the effects of the option.
731
Equity long/short funds
Equity long/short funds tend to have net positive systematic risk exposure from taking a net long position, with the long positions being larger than the short positions.
732
Equity market-neutral funds
Equity market-neutral funds attempt to balance short and long positions, ideally matching the beta exposure of the long and short positions and leaving the fund relatively insensitive to changes in the underlying stock market index.
733
Short-bias funds
Short-bias funds have larger short positions than long positions, leaving a persistent net short position relative to the market index that allows these funds to profit during times of declining equity prices.
734
Liquidity
Liquidity in this context is the extent to which transactions can be executed with minimal disruption to prices.
735
Taking liquidity
More generally, taking liquidity refers to the execution of market orders by a market participant to meet portfolio preferences that cause a decrease in the supply of limit orders immediately near the current best bid and offer prices.
736
Providing liquidity
Providing liquidity refers to the placement of limit orders or other actions that increase the number of shares available to be bought or sold near the current best bid and offer prices.
737
Market maker
A market maker is a market participant that offers liquidity, typically both on the buy side by placing bid orders and on the sell side by placing offer orders.
738
Asynchronous trading
Asynchronous trading is an example of market inefficiency in which news affecting more than one stock may be assimilated into the price of the stocks at different speeds.
739
Informationally efficient
Markets are said to be informationally efficient when security prices reflect available information.
740
Overreacting
Another potential source of abnormal profits for hedge funds is overreacting in which short-term price changes are too large relative to the value changes that should occur in a market with perfect informational efficiency.
741
Short interest
Short interest is the percentage of outstanding shares that are currently held short.
742
Underreacting
Another potential source of abnormal profits for hedge funds is underreacting in which short-term price changes are too small relative to the value changes that should occur in a market with perfect informational efficiency.
743
Speculation
Speculation is defined as bearing abnormal risk in anticipation of abnormally high expected returns.
744
Market anomalies
Investment strategies that can be identified based on available information and that offer higher expected returns after adjustment for risk are known as market anomalies, and they are violations of informational market efficiency.
745
Test of joint hypotheses
An empirical test of market efficiency is a test of joint hypotheses, because the test assumes the validity of a model of the risk-return relationship to test whether a given trading strategy earns consistent risk-adjusted profits.
746
Accounting accrual
An accounting accrual is the recognition of a value based on anticipation of a transaction.
747
Price momentum
Price momentum is trending in prices such that an upward price movement indicates a higher expected price and a downward price movement indicates a lower expected price.
748
Earnings momentum
Earnings momentum is the tendency of earnings changes to be positively correlated.
749
Earnings surprise
Earnings surprise is the concept and measure of the unexpectedness of an earnings announcement.
750
Standardized unexpected earnings
Standardized unexpected earnings (SUE) is a measure of earnings surprise.
751
Post-earnings-announcement drift
A post-earnings-announcement drift anomaly has been documented, in which investors can profit from positive surprises by buying immediately after the earnings announcement or selling short immediately after a negative earnings surprise.
752
Share buyback program
When a company chooses to reduce its shares outstanding, a share buyback program is initiated, and the company purchases its own shares from investors in the open market or through a tender offer.
753
Issuance of new stock
Issuance of new stock is a firm's creation of new shares of common stock in that firm and may occur as a result of a stock-for-stock merger transaction or through a secondary offering.
754
Net stock issuance
Net stock issuance is issuance of new stock minus share repurchases.
755
Insider trading
Illegal insider trading varies by jurisdiction but may involve using material nonpublic information, such as an impending merger, for trading without required disclosure.
756
Legal insider trading
Trading by insiders can be legal insider trading when it is performed subject to legal restrictions.
757
Multiple-factor scoring models
Multiple-factor scoring models combine the factor scores of a number of independent anomaly signals into a single trading signal.
758
Pairs trading
Pairs trading is a strategy of constructing a portfolio with matching stocks in terms of systematic risks but with a long position in the stock perceived to be relatively underpriced and a short position in the stock perceived to be relatively overpriced.
759
Limits to arbitrage
The limits to arbitrage refer to the potential inability or unwillingness of speculators, such as equity hedge fund managers, to hold their positions without time constraints or to increase their positions without size constraints.
760
Market impact
Market impact is the degree of the short-term effect of trades on the sizes and levels of bid prices and offer prices.
761
Uptick rule
An uptick rule permits short sellers to enter a short sale only at a price that is equal to or higher than the previous transaction price of the stock.
762
Mean neutrality
Mean neutrality is when a fund is shown to have zero beta exposure or correlation to the underlying market index.
763
Variance neutrality
Variance neutrality is when fund returns are uncorrelated to changes in market risk, including extreme risks in crisis market scenarios.
764
Operational due diligence
Operational due diligence is the process of evaluating the policies, procedures, and internal controls of an asset management organization.
765
Fee netting
Fee netting in the case of a multistrategy fund is when the investor pays incentive fees based only on net profits of the combined strategies, rather than on all profitable strategies.
766
Access
Access is an investor's ability to place new or increased money in a particular fund.
767
Liquidity facility
A liquidity facility is a standby agreement with a major bank to provide temporary cash for specified needs with pre-specified conditions.
768
Seeding funds
Seeding funds, or seeders, are funds of funds that invest in newly created individual hedge funds, often taking an equity stake in the management companies of the newly minted hedge funds.
769
Nontraditional bond funds
Nontraditional or unconstrained bond funds do not simply take long positions in investment-grade sovereign and credit securities, but may also invest in high-yield or emerging markets debt, often including leverage and short positions.
770
Unconstrained bond funds
Nontraditional or unconstrained bond funds do not simply take long positions in investment-grade sovereign and credit securities, but may also invest in high-yield or emerging markets debt, often including leverage and short positions.
771
Market-defensive funds of funds
Market-defensive funds of funds tend to have underlying and unhedged short positions.
772
Conservative funds of funds
Conservative funds of funds have underlying hedged positions.
773
Diversified fund of funds
Diversified funds of funds represent a broad mix of funds.
774
Strategic funds of funds
Strategic funds of funds tend to have underlying directional bets.
775
Equity kicker
An equity kicker is an option for some type of equity participation in the firm (e.g., options to buy shares of common stock) that is packaged with a debt financing transaction.
776
Venture capital (VC)
Venture capital (VC), the best known of the private equity categories, is early-stage financing for young firms with high potential growth that do not have a sufficient track record to attract investment capital from traditional sources, like public markets or lending institutions.
777
Cash burn rate
The cash burn rate of a business describes the speed with which cash is being depleted through time and can be used to project when the organization will deplete its cash and require outside funding.
778
Venture capital securities
Venture capital securities are the privately held stock, or equity-linked securities, that venture capitalists obtain when investing in business ventures that are striving to become larger and to go public.
779
Investment structures
Investment structures used by venture capitalists include convertible preferred equity, convertible notes, or debentures that provide for the conversion of the principal amount of the note or bond into either common or preferred shares at the option of the venture capitalist, or other positions such as warrants.
780
VC exits
VC exits typically focus on going public (i.e., conducting an initial public offering of the company's securities), but can also include sales to acquiring firms or even a leveraged recapitalization, where the proceeds from the debt are paid to the venture capitalist.
781
Convertible preferred stock
Convertible preferred stock is used by VC investors to provide higher priority than common stock along with an implicit call option to share in upside potential similar to the upside potential of equity.
782
Prudent person standard
The prudent person standard is a requirement that specifies levels of care that should be exercised in particular decision-making roles, such as investment decisions made by a fiduciary.
783
20-bagger
The terminology 20-bagger indicates a company that appreciates in value 20-fold compared to the cost of the VC investment.
784
Angel investing
Angel investing refers to the earliest stage of venture capital, in which investors fund the first cash needs of an entrepreneurial idea.
785
Seed capital stage
The seed capital stage is the first stage where VC firms invest their capital into a venture and is typically prior to having established the viability of the product.
786
Change in the prudent person standard
The change in the prudent person standard was to base analysis on a portfolio basis (rather than a standalone basis) and to test for prudence based on analysis (rather than outcome), allowing US pension funds for the first time to wholly endorse and engage in venture capital investing.
787
Alpha testing
Alpha testing is the process of analyzing a product or service to determine its ability to perform its tasks, potentially under laboratory-like conditions, to generate feedback for developers.
788
Second or late-stage venture capital
Second or late-stage (i.e., expansion stage) venture capital fills the cash flow deficiency once commercial viability is established.
789
Beta testing
This is often referred to as beta testing, in which a prototype is sent to potential customers free of charge to get their input into the product's viability, design, and user-friendliness.
790
First stage, start-up stage, and early stage venture capital
The first-stage, start-up stage, or early-stage of venture capital begins when the start-up company has a viable product that has been beta tested and involves testing of the second-generation prototype with potential end users and funding after seed capital but before commercial viability has been established.
791
Mezzanine venture capital
Mezzanine venture capital, or pre-IPO financing, is the last funding stage before a start-up company goes public or is sold to a strategic buyer.
792
Enterprise value
Enterprise value is the total value of the company, which adds the equity value of the firm to its outstanding debt and subtracts the cash on the firm's balance sheet.
793
EBITDA
EBITDA is a firm's earnings or operating income before interest, taxes, depreciation, and amortization and is therefore used as a measure of before-tax cash flow rather than being a net-of-debt measure.
794
EBITDA multiples
EBITDA multiples are general levels of the perceived ratio between the enterprise value of a firm's assets and its estimated or projected earnings before income taxes, depreciation, and amortization.
795
Exit plan
The exit plan describes how venture capitalists can liquidate their investment in the start-up company to realize a gain for themselves and their investors.
796
Compound option
A compound option is an option on an option. In other words, a compound option allows its owner the right but not the obligation to pay additional money at some point in the future to obtain an option.
797
Venture capital business plan
The venture capital business plan should clearly state the business strategy, identify the niche that the new company will fill, and describe the resources needed to fill that niche, including the expenses, personnel, and assets. It must be comprehensive, coherent, and internally consistent.
798
Milestone
A milestone is a set of goals that must be met to complete a phase and usually denotes when the entrepreneur will be eligible for the next round of financing.
799
Two keys to successful VC investing
The two keys to successful VC investing: (1) identifying underpriced options by locating potentially valuable projects for which substantial information regarding likely profitability can be obtained prior to commitment of substantial capital, and (2) abandoning worthless out-of-the-money options when they are expiring by ignoring sunk costs and judiciously assessing likely outcomes of success based on the objective analysis of new information.
800
Growth equity securities
Growth equity securities are newly originated securities that have a minority position in terms of control but a relatively high position in terms of liquidation priority, such as convertible preferred equities or debt.
801
Protective provisions in growth equity
Protective provisions in growth equity provide operational control such as investor consent rights on key transactions, with key growth transactions including changes in capital structure, major assets, tax or accounting policies, key employees, and significant operational activities.
802
Redemption rights
Redemption rights grant powers to investors to redeem their position in the company by specifying the triggers and actions that demark the remedies available to the investors.
803
Growth equity redemption value
A growth equity redemption value is typically set as the maximum of one of the following or the maximum of two or more of the following: (1) the original issuance price plus a preferred return, (2) a multiple of the original issuance price, and (3) the fair market value of the equity interest.
804
Growth equity redemption sources
Growth equity redemption sources can be required to include: (1) all “legally available funds,” (2) undertaking a “forced sale” or other capital raising transaction, (3) issuing a promissory note for the redemption value, and/or (4) using all other available means in order to effect a required redemption.
805
Growth equity default remedies
Growth equity default remedies include springing board remedies and forced sales.
806
Springing board remedy
A springing board remedy occurs when the investor designates a majority of the defaulting issuer's board of directors.
807
Forced sale remedy
A forced sale remedy occurs when an investor compels a liquidating transaction, such as sale of the entire company or other transactions, to generate cash to meet the redemption obligation.
808
Times revenue method
The times revenue method values an enterprise as the product of its projected annual revenue and a multiple derived from analysis of the value of similar firms.
809
Four principal considerations in redemption rights
Four principal considerations in redemption rights are (1) redemption triggers, (2) redemption value, (3) sources of funds, and (4) remedies for defaulted redemption.
810
Buyout
A buyout occurs when capital, often as a mix of debt and equity, is used to acquire an entire existing company (private or publicly traded) from its current shareholders and to operate the company as an independent organization—as opposed to an acquisition, in which the acquired company is folded into the buyer's existing company.
811
Buyouts
In the context of private equity, buyouts are the purchase of a public company by an entity that has a private ownership structure.
812
Leverage buyout (LBO)
A leveraged buyout (LBO) is distinguished from a traditional investment by three primary aspects: (1) an LBO buys out control of the assets, (2) an LBO uses leverage, and (3) an LBO itself is not publicly traded.
813
Management buy-in (MBI)
A management buy-in (MBI) is a type of LBO in which the buyout is led by an outside management team.
814
Buyout of a private company
A buyout of a private company is a form of private equity that is often executed in lieu of an IPO exit, from the perspective of the shareholders who are selling the company.
815
Management buyout (MBO)
A management buyout is a buyout that is led by the target firm's current management.
816
Buy-in management buyout
A buy-in management buyout is a hybrid between an MBI and an MBO in which the new management team is a combination of new managers and incumbent managers.
817
Secondary buyout
In a secondary buyout, one private equity firm typically sells a private company to another private equity firm.
818
Rescue capital
Rescue capital (or turnaround capital) refers to a strategy in which capital is provided to help established companies recover profitability after experiencing trading, financial, operational, or other difficulties.
819
Replacement capital
Replacement capital (also called secondary purchase capital) refers to a strategy in which capital is provided to acquire existing shares in a company from another PE investment organization.
820
Segmentation
Segmentation in this context denotes the grouping of market participants into clienteles that focus their activities within specific areas of the market, rather than varying their range of activities more broadly throughout all available opportunities.
821
Golden parachute
A generous compensation scheme, known as a golden parachute, is often given to top managers whose careers are being negatively affected by a corporate reorganization.
822
Evolution of the buyout market
An evolution of the buyout market has occurred that has been driven by substantial buyout activity and has resulted in a less segmented market that has grown into a more efficient, auction-driven asset market, in which greater competition has reduced abnormal profit opportunities.
823
Conglomerates
Conglomerates have many different divisions or subsidiaries, often operating in completely different industries.
824
Efficiency buyouts
Efficiency buyouts are LBOs that improve operating efficiency.
825
Entrepreneurship stimulators
Entrepreneurship stimulators are LBOs that create value by helping to free management to concentrate on innovations.
826
Buy-and-build strategy
A buy-and-build strategy is an LBO value-creation strategy involving the synergistic combination of several operating companies or divisions through additional buyouts.
827
Turnaround strategy
A turnaround strategy is an approach used by LBO funds that look for underperforming companies with excessive leverage or poor management.
828
Buyout-to-buyout deal
A buyout-to-buyout deal takes place when a private equity firm sells one of its portfolio companies to another buyout firm.
829
Merchant banking
Merchant banking is the practice whereby financial institutions purchase nonfinancial companies as opposed to merging with or acquiring other financial institutions.
830
Winner-take-all market
A winner-take-all market refers to a market with a tendency to generate massive rewards for a few market participants that apparently provide products or services that are only marginally better than their competitors.
831
Unicorn
A unicorn is a VC-backed firm that soars to $1 billion or more in private market capitalization over a relatively short period of time.
832
Private equity (PE) funds
Private equity funds are investment pools created to hold portfolios of private equity securities.
833
Venture capital (VC) fund
A venture capital fund is a private equity fund that pools the capital of large sophisticated investors to fund new and start-up companies.
834
Blind pool
A blind pool is when investors don't know the underlying portfolio companies before committing capital.
835
Dry powder
The amount committed but not yet called is an undrawn commitment or dry powder.
836
Undrawn commitment
The amount committed but not yet called is an undrawn commitment or dry powder.
837
Co-investment
The amount committed but not yet called is an undrawn commitment or dry powder.
838
Vintage year
The year a particular private equity fund commences operations is known as its vintage year.
839
Sourcing investments
Sourcing investments is the process of locating possible investments (i.e., generating deal flow), reading business plans, preparing intense due diligence on start-up companies, and determining the attractiveness of each start-up company.
840
Reinvestment position
A reinvestment provision is where the proceeds of realizations within the investment period or a similar time frame may be reinvested in new opportunities and not distributed to investors.
841
In-kind distributions
Distributions to investors can also take the form of securities of a portfolio company, known as in-kind distributions.
842
Cash flow J-curve
The cash flow J-curve is a representation of the evolution of the net accumulated cash flows from the investors to the fund, which are negative during the early years of existence before making a U-turn and becoming positive in the later years of the fund's life.
843
NAV J-Curve
The NAV J-curve is a representation of the evolution of the NAV of a fund versus the net paid in (NPI), which first decreases during the early years of the fund's existence and then improves in its later years.
844
Commitment risk
Commitment risk describes the situation in which an LP may become a defaulting investor if the proceeds of exiting funds are not sufficient to pay the capital calls of newly committed funds.
845
Committed capital
Committed capital is the cash investment that has been promised by an investor but not yet delivered to the fund.
846
Capital calls
Capital calls are options for the manager to demand, according to the subscription agreement, that investors contribute additional capital.
847
Clawback escrow agreement
There is often a clawback escrow agreement, in which a portion of the manager's incentive fees are held in a segregated account until the entire fund is liquidated.
848
Subscription lines
Subscription lines are lines of credit used by the GP to make investments in portfolio companies.
849
Key personnel clause
A key personnel clause is a provision that allows investors to withdraw their assets from the fund, immediately and without penalty, when the identified key personnel are no longer making investment decisions for the fund.
850
Hurt money
The capital contribution by GPs is known as hurt money.
851
Bad-leaver clause
LPs may include a bad-leaver clause, which is a for-cause removal of the GP that, if exercised (normally following a simple majority vote of the LPs), causes investments to be suspended until a new fund manager is elected or, in the extreme, the fund is liquidated.
852
Good-leaver clause
A good-leaver clause enables investors to cease additional funding of the partnership with a vote requiring a qualified majority (generally more than 75% of LPs).
853
Auction process
An auction process involves bidding among several private equity firms, with the deal going to the highest bidder.
854
Club deal
In a club deal, two or more LBO firms work together to share costs, present a business plan, and contribute capital to the deal.
855
Business development companies (BDCs)
Business development companies (BDCs) are publicly traded funds with underlying assets typically consisting of equity or equity-like positions in small, private companies. BDCs use a closed-end structure and trade on major stock exchanges, especially the NASDAQ.
856
Private investments in public equity (PIPE)
Private investments in public equity (PIPE) transactions are privately issued equity or equity-linked securities that are placed outside of a public offering and are exempt from registration.
857
Traditional PIPEs
The large majority of PIPE transactions are traditional PIPEs, in which investors can buy common stock at a fixed price.
858
Structured PIPEs
Structured PIPEs include more exotic securities, like floating-rate convertible preferred stock, convertible resets, and common stock resets.
859
Toxic PIPE
A toxic PIPE is a PIPE with adjustable conversion terms that can generate high levels of shareholder dilution in the event of deteriorating prices in the firm's common stock.
860
Death spiral
The process of lower conversion prices, greater dilution, and lower share prices repeats in a downward death spiral.
861
Publicly traded PE firms
Publicly traded PE firms offer investors exposure to PE and earning carried interest from high returns to those firms generated from the underlying fund investments.
862
Blind pool equity fund
A blind pool equity fund aggregates capital obtained from its partners into a single fund (i.e., the main fund) that has a stated investment mandate but that generally does not involve limited partners in deal sourcing.
863
Co-investment
Co-investment refers to the practice of investors being invited by the sponsors of private equity funds (typically GPs) to make investments into one or more pre-specified portfolio companies using structures other than a main private equity fund.
864
Three alternative co-investing structures
Three alternative co-investing structures involve: (1) the LP invests directly into one or more of the portfolio companies of the main fund, (2) one or more LPs use a GP-controlled fund created apart from the main fund for the purposes of investing in one or more of the same portfolio companies selected for the main fund, and (3) making investments in co-investment programs in which the specific investments are identified and decisions of whether to co-invest are made on an ongoing and deal-by-deal basis.
865
Top-up fund
A top-up fund is used to co-invest in one or more future investments of the main fund.
866
Annex fund
An annex fund is used to co-invest in one or more pre-existing investments.
867
Lock-step provision
A lock-step provision in a co-investment agreement specifies that the terms and conditions of the co-investor-GP relationship is the same as the terms and conditions of the LP-GP relationship.
868
Bridging
In the context of private equity financing, bridging is when the GP makes an investment in the main fund while agreeing to sell that investment at a subsequent time to co-investors such that coinvestors receive bridge-financing from the main fund between the time the investment is made and the time that the co-investor(s) takes ownership. Side letters are detailed in the Co-investments lesson in Section 4.4, Evolution of Investing in Private Equity.
869
Promote
In the context of private equity, promote is a fee based on profits that is similar to carried interest but is typically associated with more specific duties such as the creation and marketing of a specific investment opportunity.
870
Interval funds
Interval funds are semi-liquid, semi-illiquid closed-end funds that do not trade on the secondary market but offer the opportunity for investors to redeem or exit their investments at regularly scheduled intervals.
871
Drawdown fund
A drawdown fund is a type of private equity fund (that can be used for private credit) in which investor commitments are called as needed (e.g., to fund investments or meet expenses), in essence providing partnership-like liquidity features in a fund structure.
872
Loan-to-own investment
A loan- to-own investment occurs when the investor focuses on the value of the borrower's assets and the value of the company that could be repossessed if the borrower was unable to service the loan, not necessarily evaluating the ability of the company to pay back the principal and interest as scheduled.
873
Fulcrum security
Fulcrum securities are the more junior debt securities that are most likely to be converted into the equity of the reorganized company.
874
Credit spread
A credit spread is the excess of the yield on a debt security with credit risk relative to the yield on a debt security of similar maturity but no credit risk.
875
Covenant-lite loans
Covenant-lite loans are loans that place minimal restrictions on the debtor in terms of loan covenants.
876
Incurrence covenants
Incurrence covenants typically require a borrower to take or not take a specific action once a specified event occurs.
877
Maintenance covenants
Maintenance covenants are stricter than incurrence covenants in that they require that a standard be regularly met to avoid default.
878
Negative covenants
Negative covenants are promises by the debtor not to engage in particular activities, such as paying dividends or issuing new debt.
879
Indenture
An indenture is the contract between the borrower and the lender that sets out the terms of the borrowing.
880
Affirmative covenants
Affirmative covenants are requirements for the borrower to comply with, such as to maintain a debt service coverage ratio that requires a minimum income relative to the size of the current year principal and interest payments.
881
Recovery rate
The recovery rate is the percentage of the credit exposure that the lender ultimately receives through the bankruptcy process and all available remedies.
882
Unitranche
A unitranche is when a large piece of debt is issued that includes both senior and junior debt at a blended interest rate in a single debt issue.
883
Haircut
In finance, the term haircut usually refers to a percentage reduction applied to the value of securities in determining their value as collateral.
884
Chapter 11 bankruptcy
Chapter 11 bankruptcy attempts to maintain operations of a distressed corporation that may be viable as a going concern.
885
Chapter 7 bankruptcy
Chapter 7 bankruptcy is entered into when a company is no longer viewed as a viable business and the assets of the firm are liquidated. Essentially, the firm shuts down its operations and parcels out its assets to various claimants and creditors.
886
Plan of reorganization
A plan of reorganization is a business plan for emerging from bankruptcy protection as a viable concern, including operational changes.
887
Blocking position
A blocking position exists when a creditor or group of creditors holds more than one-third of the dollar amount of any class of claimants and utilizes those holdings to prevent a plan of reorganization.
888
Absolute priority rule
An absolute priority rule is a specification of which claims in a liquidation process are satisfied first, second, third, and so forth in receiving distributions.
889
Cramdown
A cramdown is when a bankruptcy court judge implements a plan of reorganization over the objections of an impaired class of security holders.
890
Debtor-in-possession financing
When secured lenders extend additional credit to the debtor company, it is commonly known as debtor- in-possession financing (DIP financing).
891
Leveraged loans
Leveraged loans are syndicated bank loans to non-investment-grade borrowers.
892
Syndicated
The term syndicated refers to the use of a group of entities, often investment banks, in underwriting a security offering or, more generally, jointly engaging in other financial activities.
893
Direct lending
Direct lending (also called market-based lending, shadow banking, or nonbank lending) is a transaction in which investors extend credit to borrowers outside of the traditional banking system.
894
Peer-to-peer lending
Peer-to-peer lending is originating loans directly to consumers and is done by both institutional and retail investors who have an opportunity to originate consumer loans, often through an Internet-based underwriting and brokerage platform.
895
Warrant
A warrant is a call option issued by a corporation on its own stock.
896
Weighted average cost of capital
The weighted average cost of capital for a firm is the sum of the products of the percentages of each type of capital used to finance a firm times its annual cost to the firm.
897
PIK toggle
A PIK toggle allows the underlying company to choose whether it will make required coupon payments in the form of cash or in kind, meaning with more mezzanine bonds.
898
Sponsored lending
Many private credit funds participate in sponsored lending, whereby the borrowing firm is backed by an investment from a private equity fund or buyout fund sponsor.
899
Bridge financing
Bridge financing is a form of gap financing—a method of debt financing that is used to maintain liquidity while waiting for an anticipated and reasonably expected inflow of cash.
900
Stretch financing
In stretch financing, a bank lends more money than it believes would be prudent with traditional lending standards and traditional lending terms.
901
Intercreditor agreement
An intercreditor agreement is an agreement with the company's existing creditors that places restrictions on both the senior creditor and the mezzanine investor.
902
Acceleration
Acceleration is a requirement that debt be repaid sooner than originally scheduled, such as when the senior lender can declare the senior debt due and payable immediately.
903
Blanket subordination
A blanket subordination prevents any payment of principal or interest to the mezzanine investor until after the senior debt has been fully repaid.
904
Springing subordination
A springing subordination allows the mezzanine investor to receive interest payments while the senior debt is still outstanding.
905
Takeout provision
A takeout provision allows the mezzanine investor to purchase the senior debt once it has been repaid to a specified level.
906
Default rate
The annual default rate is the annual portion of debt issues that default by failing to pay principal and interest as scheduled or that experience a technical default when a company is unable to comply with the covenants, or.
907
Loan loss rate
The annual loan loss rate is the annual default rate multiplied by the losses on the debt that aren't recovered through bankruptcy.
908
Vulture investors
Vulture investors help the economy by cleaning up after bankruptcies, recycling bad debt and turning poorly run companies into new investments with greater potential profits and job growth.
909
Structuring
In the context of alternative investments, structuring is the process of engineering unique financial opportunities from existing asset exposures.
910
Complete market
A complete market is a financial market in which enough different types of distinct securities exist to meet the needs and preferences of all participants.
911
State of the world
A state of the world, or state of nature (or state), is a precisely defined and comprehensive description of an outcome of the economy that specifies the realized values of all economically important variables.
912
Tranche
A tranche is a distinct claim on assets that differs substantially from other claims in such aspects as seniority, risk, and maturity.
913
Sequential-pay collateralized mortgage obligation
The sequential-pay collateralized mortgage obligation is the simplest form of CMO.
914
Contraction risk
Contraction risk is dispersion in economic outcomes caused by uncertainty in the longevity—especially decreased longevity—of cash flow streams.
915
Extension risk
Extension risk is dispersion in economic outcomes caused by uncertainty in the longevity—especially increased longevity—of cash flow streams.
916
Interest-only (IO)
Interest-only (IO) tranches receive only interest payments from the collateral pool.
917
Planned amortization class (PAC) tranches
Planned amortization class (PAC) tranches receive principal payments in a more complex manner than do sequential pay CMOs.
918
Principal-only (PO)
Principal-only (PO) tranches receive only principal payments from the collateral pool.
919
Targeted amortization class (TAC) tranches
Targeted amortization class (TAC) tranches receive principal payments in a manner similar to PAC tranches but generally with an even narrower and more complex set of ranges.
920
Floating-rate tranches
Floating-rate tranches earn interest rates that are linked to an interest rate index, such as the London Interbank Offered Rate (LIBOR), and are usually used to finance collateral pools of adjustable-rate mortgages.
921
Inverse floater tranche
An inverse floater tranche offers a coupon that increases when interest rates fall and decreases when interest rates rise.
922
Structural credit risk models
Structural credit risk models use option theory to explicitly take into account credit risk and the various underlying factors that drive the default process, such as (1) the behavior of the underlying assets, and (2) the structuring of the cash flows (i.e., debt levels).
923
Call option view of capital structure
The call option view of capital structure views the equity of a levered firm as a call option on the assets of the firm.
924
Put option view of capital structure
The put option view of capital structure views the equity holders of a levered firm as owning the firm's assets through riskless financing and having a put option to deliver those assets to the debt holders.
925
Cap
A cap is a series of caplets, and its price is equal to the sum of the prices of the caplets, which, in turn, can be valued using various term-structure models and a procedure similar to the Black-Scholes option pricing model.
926
Caplet
A caplet is an interest rate cap guaranteed for only one specific date.
927
Interest rate floor
In an interest rate floor, one party agrees to pay the other when a specified reference rate is below a predetermined rate (known as the floor rate, which is analogous to the strike price of a European put option).
928
Floor
A floor is a series of floorlets, and its price is equal to the sum of the prices of the floorlets.
929
Floorlet
A floorlet is an interest rate floor guaranteed for only one specific date.
930
Collateralized debt obligation (CDO)
A collateralized debt obligation (CDO) applies the concept of structuring to cash flows from a portfolio of debt securities into multiple claims; these claims are securities and are referred to as tranches.
931
Equity tranche
The equity tranche has lowest priority and serves as the residual claimant.
932
Mezzanine tranche
A mezzanine tranche is a tranche with a moderate priority to cash flows in the structured product and with lower priority than the senior tranche.
933
Senior tranche
The senior tranche is a tranche with the first or highest priority to cash flows in the structured product.
934
Attachment point
The first percentage loss in the collateral pool that begins to cause reduction in a tranche is known as the lower attachment point, or simply the attachment point.
935
Detachment point
The higher percentage loss point at which the given tranche is completely wiped out is known as the upper attachment point, or the detachment point.
936
Lower attachment point
The first percentage loss in the collateral pool that begins to cause reduction in a tranche is known as the lower attachment point, or simply the attachment point.
937
Upper attachment point
The higher percentage loss point at which the given tranche is completely wiped out is known as the upper attachment point, or the detachment point.
938
Bull call spread
A bull call spread has two calls that differ only by strike price, in which the long position is in the lower strike price and the short position is in the higher strike price.
939
Bull put spread
A bull put spread has two puts that differ only by strike price, in which the long position is in the lower strike price and the short position is in the higher strike price.
940
Credit risk
Credit risk is dispersion in financial outcomes associated with the failure or potential failure of a counterparty to fulfill its financial obligations.
941
Default risk
Default risk is the risk that the issuer of a bond or the debtor on a loan will not repay the interest and principal payments of the outstanding debt in full.
942
Reduced-form credit models
Reduced-form credit models focus on default probabilities based on observations of market data of similar-risk securities.
943
Exposure at default
Exposure at default (EAD) specifies the nominal value of the position that is exposed to default at the time of default.
944
Loss given default
Loss given default (LGD) specifies the economic loss in case of default.
945
Probability of default
Probability of default (PD) specifies the probability that the counterparty fails to meet its obligations.
946
Risk-neutral approach
A risk-neutral approach models financial characteristics, such as asset prices, within a framework that assumes that investors are risk neutral.
947
Risk-neutral investor
A risk-neutral investor is an investor that requires the same rate of return on all investments, regardless of levels and types of risk, because the investor is indifferent with regard to how much risk is borne.
948
Calibrate a model
To calibrate a model means to establish values for the key parameters in a model, such as a default probability or an asset volatility, typically using an analysis of market prices of highly liquid assets.
949
Credit derivatives
Credit derivatives transfer credit risk from one party to another such that both parties view themselves as having an improved position as a result of the derivative.
950
Derivatives
Derivatives are cost-effective vehicles for the transfer of risk, with values driven by an underlying asset.
951
Hazard rate
Hazard rate is a term often used in the context of reduced- form models to denote the default rate.
952
Price revelation
Price revelation, or price discovery, is the process of providing observable prices being used or offered by informed buyers and sellers.
953
Multiname instruments
Multiname instruments, in contrast to single-name instruments, make payoffs that are contingent on one or more credit events (e.g., defaults) affecting two or more reference entities.
954
Single-name credit derivatives
Single-name credit derivatives transfer the credit risk associated with a single entity. This is the most common type of credit derivative and can be used to build more complex credit derivatives.
955
Unfunded credit derivatives
Unfunded credit derivatives involve exchanges of payments that are tied to a notional amount, but the notional amount does not change hands until a default occurs.
956
Funded credit derivatives
Funded credit derivatives require cash outlays and create exposures similar to those gained from traditional investing in corporate bonds through the cash market.
957
Interest rate swap
In a plain vanilla interest rate swap, party A agrees to pay party B cash flows based on a fixed interest rate in exchange for receiving from B cash flows in accordance with a specified floating interest rate.
958
Swap rate
The fixed rate of an interest rate swap is referred to as the swap rate.
959
Swap rate curve
The swap rate curve displays the relationship between swap rates and the maturities of their corresponding contracts, having a concept analogous to that of the yield curve.
960
Credit default swap (CDS)
A credit default swap (CDS) is an insurance-like bilateral contract in which the buyer pays a periodic fee (analogous to an insurance premium) to the seller in exchange for a contingent payment from the seller if a credit event occurs with respect to an underlying credit-risky asset.
961
Credit protection buyer
In a CDS, the credit protection buyer pays a periodic premium on a predetermined amount (the notional amount) in exchange for a contingent payment from the credit protection seller if a specified credit event occurs.
962
Credit protection seller
The credit protection seller receives a periodic premium in exchange for delivering a contingent payment to the credit protection buyer if a specified credit event occurs.
963
Total return swap
In a total return swap, the credit protection buyer, typically the owner of the credit risky asset, passes on the total return of the asset to the credit protection seller in return for a certain payment.
964
CDS premium
The CDS spread or CDS premium is paid by the credit protection buyer to the credit protection seller and is quoted in basis points per annum on the notional value of the CDS.
965
CDS spread
The CDS spread or CDS premium is paid by the credit protection buyer to the credit protection seller and is quoted in basis points per annum on the notional value of the CDS.
966
Standard ISDA agreement
The standard ISDA agreement serves as a template to negotiated credit agreements that contains commonly used provisions used by market participants.
967
Cash settlement
In a cash settlement, the credit protection seller makes the credit protection buyer whole by transferring to the buyer an amount of cash based on the contract.
968
Physical settlement
Under physical settlement, the credit protection seller purchases the impaired loan or bond from the credit protection buyer at par value.
969
Referenced asset
The referenced asset (also called the referenced bond, referenced obligation, or referenced credit) is the underlying security on which the credit protection is provided.
970
Mark-to-market adjustment
The process of altering the value of a CDS in the accounting and financial systems of the CDS parties is known as a mark-to-market adjustment.
971
Assignment
A novation or an assignment is when one party to a contract reaches an agreement with a third party to take over all rights and obligations to a contract.
972
Novation
A novation or an assignment is when one party to a contract reaches an agreement with a third party to take over all rights and obligations to a contract.
973
American credit options
American credit options are credit options that can be exercised prior to or at expiration.
974
Binary options
Binary options (sometimes termed digital options) offer only two possible payouts, usually zero and some other fixed value.
975
European credit options
European credit options are credit options exercisable only at expiration.
976
Credit-linked notes (CLNs)
Credit-linked notes (CLNs) are bonds issued by one entity with an embedded credit option on one or more other entities.
977
CDS indices
CDS indices are indices or portfolios of single-name CDSs.
978
Bankruptcy remote
Bankruptcy remote means that if the sponsoring bank or money manager goes bankrupt, the CDO trust is not affected.
979
Ramp-up period
The ramp-up period, is the first period in a CDO life cycle, during which the CDO trust issues securities (tranches) and uses the proceeds from the CDO note sale to acquire the initial collateral pool (the assets).
980
Revolving period
The second phase in the CDO life cycle is normally called the revolving period, during which the manager of the CDO trust may actively manage the collateral pool for the CDO, potentially buying and selling securities and reinvesting the excess cash flows received from the CDO collateral pool.
981
Sponsor of the trust
The sponsor of the trust establishes the trust and bears the associated administrative and legal costs.
982
Reference portfolio
The underlying portfolio or pool of assets (and/or derivatives) held in the SPV within the CDO structure is also known as the collateral or reference portfolio.
983
Weighted average rating factor (WARF)
The weighted average rating factor (WARF), as described by Moody's Investors Service, is a numerical scale ranging from 1 (for AAA-rated credit risks) to 10,000 (for the worst credit risks) that reflects the estimated probability of default.
984
Amortization period
During the amortization period, the manager of the CDO stops reinvesting excess cash flows and begins to wind down the CDO by repaying the CDO's debt securities.
985
Arbitrage CDOs
Arbitrage CDOs are created to attempt to exploit perceived opportunities to earn superior profits through money management.
986
Balance sheet CDOs
Balance sheet CDOs are created to assist a financial institution in divesting assets from its balance sheet.
987
Diversity score
A diversity score is a numerical estimation of the extent to which a portfolio is diversified.
988
Tranche width
The tranche width is the percentage of the CDO's capital structure that is attributable to a particular tranche.
989
Weighted average spread (WAS)
The weighted average spread (WAS) of a portfolio is a weighted average of the return spreads of the portfolio's securities in which the weights are based on market values.
990
Cash-funded CDO
A cash-funded CDO involves the actual purchase of the portfolio of securities serving as the collateral for the trust and to be held in the trust.
991
Synthetic CDO
In a synthetic CDO, the CDO obtains risk exposure for the collateral pool through the use of a credit derivative, such as a total return swap or a CDS.
992
Cash flow CDO
In a cash flow CDO, the proceeds of the issuance and sale of securities (tranches) are used to purchase a portfolio of underlying credit-risky assets, with attention paid to matching the maturities of the assets and liabilities.
993
Market value CDO
In a market value CDO, the underlying portfolio is actively traded without a focus on cash flow matching of assets and liabilities.
994
Internal credit enhancement
An internal credit enhancement is a mechanism that protects tranche investors and is made or exists within the CDO structure, such as a large cash position.
995
Subordination
Subordination is the most common form of credit enhancement in a CDO transaction, and it flows from the structure of the CDO trust.
996
Overcollateralization
Overcollateralization refers to the excess of assets over a given liability or group of liabilities.
997
Reserve account
A reserve account holds excess cash in highly rated instruments, such as US Treasury securities or high-grade commercial paper, to provide security to the debt holders of the CDO trust.
998
External credit enhancement
An external credit enhancement is a protection to tranche investors that is provided by an outside third party, such as a form of insurance against defaults in the loan portfolio.
999
Distressed debt CDO
A distressed debt CDO uses the CDO structure to securitize and structure the risks and returns of a portfolio of distressed debt securities, in which the primary collateral component is distressed debt.
1000
Collateralized fund obligation (CFO)
A collateralized fund obligation (CFO) applies the CDO structure concept to the ownership of hedge funds as the collateral pool.
1001
Single-tranche CDO
In a single-tranche CDO, the CDO may have multiple tranches, but the sponsor issues (sells) only one tranche from the capital structure to an outside investor.
1002
Financial engineering risk
Financial engineering risk is potential loss attributable to securitization, structuring of cash flows, option exposures, and other applications of innovative financing devices.
1003
Risk shifting
Risk shifting is the process of altering the risk of an asset or a portfolio in a manner that differentially affects the risks and values of related securities and the investors who own those securities.
1004
Copula approach
A copula approach to analyzing the credit risk of a CDO may be viewed like a simulation analysis of the effects of possible default rates on the cash flows to the CDO's tranches and the values of the CDO's tranches.
1005
Equity-linked structured products
Equity-linked structured products are distinguished from structured products by one or more of the following three aspects: (1) They are tailored to meet the preferences of the investors and to generate fee revenue for the issuer; (2) they are not usually collateralized with risky assets; and (3) they rarely serve as a pass-through or simple tranching of the risks of a long-only exposure to an asset, such as a risky bond or a loan portfolio.
1006
Wrapper
A wrapper is the legal vehicle or construct within which an investment product is offered.
1007
Tax deferral
Tax deferral refers to the delay between when income or gains on an investment occur and when they are taxed.
1008
Tax deduction
Tax deduction of an item is the ability of a taxpayer to reduce taxable income by the value of the item.
1009
Exotic option
Although there is no universally accepted definition of an exotic option, a useful definition is that an exotic option is an option that has one or more features that prevent it from being classified as a simple option, including payoffs based on values prior to the expiration date, and/or payoffs that are nonlinear or discontinuous functions of the underlying asset.
1010
Simple option
A simple option has (1) payoffs based only on the value of a single underlying asset observed at the expiration date, and (2) linear payoffs to the long position of the calls and puts based on the distance between the option's strike price and the value of the underlying asset.
1011
Principal-protected structured product
A principal-protected structured product is an investment that is engineered to provide a minimum payout guaranteed by the product's issuer (counterparty).
1012
Structured product without exotic options
A structured product without exotic options has a payoff diagram defined exclusively in terms of the payoff to the value of a single underlier at termination and is (1) a continuous relationship, (2) a one-to-one relationship, and (3) a relationship composed entirely of two linear segments. Thus, a structured product based.
1013
Participation rate
The participation rate indicates the ratio of the product's payout to the value of the underlying asset.
1014
Cash-and-call strategy
A cash-and-call strategy is a long position in cash, or a zero- coupon bond, combined with a long position in a call option.
1015
Asian option
An Asian option is an option with a payoff that depends on the average price of an underlying asset through time.
1016
Path-dependent option
A path-dependent option is any option with a payoff that depends on the value of the underlying asset at points prior to the option's expiration date.
1017
Active option
An active option in a barrier option is an option for which the underlying asset has reached the barrier.
1018
Barrier option
A barrier option is an option in which a change in the payoff is triggered if the underlying asset reaches a prespecified level during a prespecified time period.
1019
Knock-in option
A knock-in option is an option that becomes active if and only if the underlying asset reaches a prespecified barrier.
1020
Knock-out option
A knock-out option is an option that becomes inactive (i.e., terminates) if and only if the underlying asset reaches a prespecified barrier.
1021
Spread option
A spread option has a payoff that depends on the difference between two prices or two rates.
1022
Look-back option
A look-back option has a payoff that is based on the value of the underlying asset over a reference period rather than simply the value of the underlying asset at the option's expiration date.
1023
Quanto option
A quanto option is an option with a payoff based in one currency using the numerical value of the underlying asset expressed in a different currency.
1024
Absolute return structured product
An absolute return structured product offers payouts over some or all underlying asset returns that.
1025
Principal protected absolute return barrier note
A principal protected absolute return barrier note offers to pay absolute returns to the investor if the underlying asset stays within both an upper barrier and a lower barrier over the life of the product.
1026
EUSIPA
The EUSIPA (European Structured Investment Products Association) was founded in 2009 as a nonprofit association “to promote the interests of the structured retail investment products market.”
1027
EUSIPA Derivative Map
The EUSIPA Derivative Map categorizes structured products with two major classifications: investment products and leverage products.
1028
Investment products in the EUSIPA derivative map
The Investment Products in the EUSIPA Derivative Map includes three major sub-categories: capital protection products, yield enhancement products, and participation products.
1029
Capital protection structured products
Capital protection structured products tend to offer long call-option-like pay-offs: downside protection, upside potential, and below-market interest income.
1030
Yield enhancement structured products
Yield enhancement structured products tend to offer short put-option-like payoffs with full downside exposure, capped upside potential, and above-market interest income (i.e., yield enhancement).
1031
Participation structured products
Participation structured products tend to offer exposures (bull or bear) to the underlying index (or assets) that are not capped in terms of potential profits or losses (i.e., in either the bull or bear scenarios).
1032
Leverage structured products
Leverage structured products have three subcategories: leverage without knock-outs, leverage with knock-outs, and constant leverage.
1033
Power reverse dual-currency note
At its core, in a power reverse dual-currency note (PRDC), an investor pays a fixed interest rate in one currency in exchange for receiving a payment based on a fixed interest rate in another currency.
1034
Dynamic hedging
Dynamic hedging is when the portfolio weights must be altered through time to maintain a desired risk exposure, such as zero risk.
1035
Boundary condition
A boundary condition of a derivative is a known relationship regarding the value of that derivative at some future point in time that can be used to generate a solution to the derivative's current price.
1036
Partial differential equation approach (PDE approach)
The partial differential equation approach (PDE approach) finds the value to a financial derivative based on the assumption that the underlying asset follows a specified stochastic process and that a hedged portfolio can be constructed using a combination of the derivative and its underlying asset(s).
1037
Analytical
The solution is analytical because the model can be exactly solved using a finite set of common mathematical operations.
1038
Numerical methods for derivative pricing
Numerical methods for derivative pricing are potentially complex sets of procedures to approximate derivative values when analytical solutions are unavailable.
1039
Building blocks approach
The building blocks approach (i.e., portfolio approach) models a structured product or other derivative by replicating the investment as the sum of two or more simplified assets, such as underlying cash-market securities and simple options.
1040
Static hedge
A static hedge is when the positions in the portfolio do not need to be adjusted through time in response to stochastic price changes to maintain a hedge.
1041
Payoff diagram level
The payoff diagram level determines the amount of money or the percentage return that an investor can anticipate in exchange for paying the price of the product.
1042
Payoff diagram shape
The payoff diagram shape indicates the risk exposure of a product relative to an underlier.
1043
Overconfidence bias
An overconfidence bias is a tendency to overestimate the true accuracy of one's beliefs and predictions.
