I can smell an animal from almost two miles away. Think of the buffalo: shower before you start studying next time.
Vocabulary
12B-1 Fee
Definition
So along came the Investment Advisers Act of 1940, which basically recognized that mutual funds did, in fact, have expenses that were more than bonuses to the senior partners.
The 12b-1 fee system allowed a fairly set and standard amount of fees to be charged to customers, so that a given mutual fund could recoup the money it had to spend mailing annual reports and performance data and tax information and all kinds of other things to its customers.
The 12b-1 fee system was basically a pass-through set of charges, such that the customer paid for her own paperwork…incentivizing mutual funds to actually do a good job communicating with their constituency.
144a
Definition
144a is a law set up by the Securities & Exchange Commission (SEC). The rule limits when you can trade shares and stocks of a company where you're the owner, investor, or other insider.
According to the rule, if you're a high-flying insider and your company goes public, you might have to wait six months and then some before you can begin trading your stocks or shares.
1939 Trust Indenture Act
Definition
This federal law was created as part of the Securities Act of 1939 and was meant to protect investors who sunk their money into corporate bonds.
What you need to know:
The law meant that if you bought any bond over $5 million, you'd have to get information about the bond and an agreement signed by you and the bond issuer (the corporation selling the bond). It also meant that issuers offering bonds over $5 million had to appoint a trustee not connected with the company to make sure there were no conflicts of interest. This trustee would take a look at the signed documents and would mediate if needed.
Basically, if you were throwing around $5 million like nobody's business (and back in 1939, $5 mil was a lot of dough), this law was meant to protect your cash from any shady dealings a corporation might try to pull.
1940 Investment Advisors Act
Definition
Wondering why you're reading these definitions instead of working on your short game? This is why.
After people claiming to be "investment advisors" scammed a lot of innocent folks in the 1930s (and before), this act created a bunch of rules you have to follow to become a registered investment advisor. After this rule was created, you couldn't just open up shop and claim to be an investment advisor—you needed to pass a test and get a piece of paper to prove it.
1940 Investment Company Act
Definition
This act was driven by various flavors of corruption and inefficiency involving banks and investors. It forced the separation of investment banking activities (think: used company salesmen) from investing activities of mutual funds and other merchant banking beasts of the day.
Thanks to this act, fund companies offering investment products and funds to the public have to play by a bunch of rules when it comes to filings, fees, and revealing financial information. So you can stroll into a fund company's offices and know they won't be trying to pull the wool over your eyes... too much.
200 Day, 50 Day Moving Averages
Definition
Moving averages are a series of snap shots of stocks' closing prices over a 50- or 200-day period when the market actually ran (or walked... or crawled).
The charts you see on traders' websites that show a bunch of lines going up and down? Those are the moving averages. Look closely and you'll see a line following the closing prices of a stock and another line either above or below that line. If a stock's price is headed up, there might be what traders call a support line under it. This one shows how low the price will drop before bouncing back up. If a stock is heading to tank-ville, there will be a line drawn above the averages. That one shows how far the stock will jump before it's pulled back down.
The idea is that you can use this info to get an idea of how the stock's doing and how it might do in the future.
Of course, trying to predict how stocks will do over the long term is a lousy idea. Even financial types in big jets who are paid to predict how stocks will do are right only about as often as the Psychic Friends Network. Stocks don't always follow averages: when they don't they surge past the resistance or support lines, it's called a break out.
401(k) And Roth 401(k)
Definition
Want to retire with dignity and not have to rely on spam sandwiches and off-brand prune juice? Retirement savings are pretty much a must.
If you work in the good ol' U.S. of A. in a typical job, part of your hard-earned cash is going towards Social Security, which is supposed to give you some moolah for when you retire. The problem: it's not really enough for most folks who get used to the idea of things like decent food and hot water. That's why retirement accounts were created: so that you can put even more of your hard-earned money away to pay for retirement.
The most popular type of retirement accounts are the 401k and Roth 401k.
- The Roth 401k was created back in 1978. It's a "qualified" plan, meaning that you don’t automatically get it just for showing up. Instead, you and the company you work for are going to have to sign a bunch of papers and properly structure the thing.
- The 401k is a "defined contribution plan," meaning that the money put in by the employer and worker are defined. It is not a "defined benefit plan" where your boss would be on the hook for investment return minimums.
A lot of people choose 401k because most employers will match contributions. For every buck you put in, your employer may give you another buck—until you retire. It's like a twofer on your investing dollar before you even start investing the dough, and it's probably the closest you're going to get to free money from your boss.
401k vs. Roth 401k
So what's the difference between a 401k and a Roth 401k?
With a 401k, you get your retirement account from your boss, and the money you put in gets taken out of your paycheck before you pay income taxes. Let's say that you make $40,000 a year and invest $5,000 in your 401k. Instead of being taxed on $40,000 you're taxed on $35,000, like that $5,000 never happened. Presto—a lower tax bill. But (of course there's a but), while you don't pay the taxes now, when you retire, you're taxed on the money you take out of the 401k, so the IRS won't be sobbing into their pillow at night. Like Vegas, the house always wins.
With a Roth 401k, you can set up your account with a bank or financial advisor, so it's an option if your boss doesn't offer retirement benefits. The Roth 401k also doesn't give you any tax advantages now. If you make $40,000 this year and contribute $5,000, you still pay income taxes on $40,000. Sorry. But when you're a golden oldie and ready to invest in salsa classes, you can take money out of your Roth 401k without having to worry about paying taxes then. So more cash for you when you're grey.
403(b) Plan
Definition
Think: 401k Plan...Lite. That is, for companies with fewer than 25 employees.
409a Valuation
Definition
409a valuations set the price of the common stock generally after preferred stock has been purchased by the investing angel or venture capitalist. Preferred stock might have been purchased for a dollar a share—but once preferred stock has been sold by the company, it has to be paid back first before common stock has any value.
So imagine an extreme situation where a company which just started last week raises $80 million in preferred stock. The odds that the full $80 million is ever even paid back is probably low so it wouldn't be crazy to see the common stock valued at almost zero/nothing. Employees get stock options in common stock—not preferred—so somebody has to set the strike price for the options on their common. That's the purpose of the 409a valuation—it sets the price at which common stock options can be bought and thus converted from options into actual stock ownership.
Accredited Investor
Definition
The difference between an accredited college and an unaccredited college can be the difference between Princeton and the School of Feel Good Energy your Great-Aunt Bertha set up in her garage last year.
Accredited investors work on a similar idea: a bunch of someones have come along and agreed that accredited investors have certain qualifications. So accredited investors are simply investors who qualify to do a certain investment. Usually, "accredited" means that they have...credit. Or assets. Or wampum. Or knowledge. Which means that they're big boys and girls who are able to invest a large amount of money in a risky venture.
Officially, they're investors who have an income of at least $200,000 for the past two years ($300,000 for joint accredited investors), or have a net worth of at least $1,000,000 (individually or jointly), or are executives, partners, or directors of the entity issuing securities. Institutional investors such as mutual funds, hedge funds, and pension funds also fit the bill.
Accrual Accounting
Definition
Accrual accounting refers to the practice of tallying up revenues and costs when a transaction occurs rather than when cash changes hands.
Example
Let's say you pay for a new tattoo with a credit card. If Tattoo Joe uses the accrual method of accounting, he adds the money he charged you to his accounts before your Tylenol even wears off—even if MasterCard takes months to pay up.
The opposite of accrual accounting is cash accounting, where money is only counted when it changes hands. That means Tattoo Joe would only add the price of your tattoo to his coffers after MasterCard had actually transferred the money to his account.
Active Management
Definition
Active management is usually used with investment companies offering mutual funds and similar types of investments. They hire groups of Type-A money people in fancy suits. These portfolio managers and analysts drink a lot of coffee, read a lot of money-related reports and forecasts, and look at a lot of charts to try to figure out how to pick stocks and investments that outperform their return targets.
Passive management, BTW, is the opposite. Usually it's a thing with ETFs and index funds, where a bunch of stocks are picked because they are all linked to a specific area (like tech, for example). Nobody spends time trying to figure out what to buy. Instead, the investments are sometimes rebalanced to make sure they still match up what they're supposed to represent. One money guy with a computer can usually handle investments in a passive management style.
Adjustable Rate Preferred Stock
Definition
Okay, first see preferred stock for the gist.
Preferred stock is preferred because stockholders with these puppies are paid before common stockholders if a company goes belly-up. If your stock says "preferred stock—ARPS," then the rate paid out depends on a specific set standard or yardstick (usually T-bills). So if T-bills (or whatever the benchmark the company uses) suddenly pay out more, your stock will, too.
And that's how it's adjustable.
Adjustable-Rate Mortgage (ARM)
Definition
The key letter in ARM is A, and it stands for adjustable, as in Adjustable Rate Mortgage.
Most mortgages have a fixed interest rate. That means you pay 5% interest (or whatever your rate is) during the first year you have your mortgage, during the third year, and all the way to the final day you have that loan and can throw your big ""We Paid it Off"" party.
With an adjustable rate mortgage, your rate can change. Why would you want to get an ARM rather than a fixed rate mortgage? Well, maybe you like the element of surprise. More likely, you can save a few bucks at the start of the mortgage loan. If interest rates are expected to rise, you can get a better rate (at first) with an ARM than you can with a fixed rate mortgage. By the time your ARM rates go up and you have to pay more, maybe you'll have gotten that promotion at work.
Lots of folks choose ARMs, because they seem like a better deal on paper, but you'll want to run side-by-side comparisons to figure out whether they'll cost you more in the long run. You'll also want to make sure you can afford your home loan—even if interest rates go up. If you're just barely making payments now and your monthly mortgage costs go up $300, what are going to do? That's the sort of situation that causes people to lose their homes.
ARMs have a couple parts. They usually start with a low interest rate and have a guaranteed period of time for that interest rate, so you know your interest rate won't go up right away. An ARM also usually comes with an index (like LIBOR) against which it is adjusted, a step up percentage (how much the interest rate will likely grow each period), and maybe a cap (the maximum rate it can be raised in a given period). That all ensures that the rate won't balloon out of control.
Some ARMs are interest-only for the first few years. The monthly amount you pay is really low, but you're also not paying down the principal or the amount you borrowed. Which means the total amount you owe to the bank is not going down any. The upside is that your payments will be affordable at first, and you'll have time to increase your income or get a great job (and hopefully give interest rates a chance to drop).
Adjustment Bond
Definition
An adjustment bond can choose to pay interest—or not—at will. If the responsible party for the bond punts a payment, they don't go into default—they just keep rollin' over the debt they owe.
Now you might be thinking, “Why would anyone want an adjustment bond when there are bonds that promise to pony up cash faithfully?”
Good question. Adjustment bonds are usually issued when a company is facing bankruptcy or is restructuring. If you’re popping antacids like Tic Tacs because you have bonds that might be useless if a company goes under, you (and other bondholders) might get adjustment bonds if the company is really struggling. It eases some of the pressure on the company by letting them pay off what they owe, and it means you might get at least some of your cash (and some of your expected returns) back. It’s better than nothing, which is what you’d get with a bankruptcy and no adjustment bonds.
Administrative Order On Consent (AOC)
Definition
The administrator is the person in each state who's in charge of making sure that securities laws are followed and investors are protected. If an administrator thinks something shady is going on, he can issue an order to deny, suspend, or revoke the sketchy financial individual's license so that investors are protected.
When the administrator pulls rank like that, it's called an administrative order.
Advance/Decline Ratio
Definition
It's an index. Just an index... but one that is widely quoted in the financial press. Specifically, an advance/decline ratio is the number of stocks which are up vs. the number which are down (hence the catchy "advance" and "decline" talk).
Money guys and financial reporters use this ratio when trying to decide whether the market is about to change. When the ratio is high, there's a lot of buying (maybe even too much), and when it's low, that could be a sign of overbuying. You can imagine, though, how this index has wide ranges for error; i.e., every stock could be down one penny and the ratio would be 0 - which would be like "as bad as it's ever been"— when, in fact, the day was basically as flat as the opposing team on Glee.
Aftermarket Securities Transactions
Definition
Traders in New York City work until 4:00PM. They have busy schedules and fancy dinners to get to, you know. But what happens if you get a burning desire to buy securities after 4 o'clock? What happens if you live in a different time zone and think the world shouldn't revolve around NY time? If you're buying or selling stocks outside of regular hours, you're making an aftermarket securities transaction.
And yes, if you're investing in another country's securities, you're making an aftermarket securities transaction if you buy or sell securities outside of the business hours of that country’s stock exchange.
Money never sleeps.
Agency Trade
Definition
Unlike a trade initiated directly by the customer, an agency trade is when a broker-dealer, such as T.D. Ameritrade or Charles Schwab, initiates a trade on behalf of the client. The broker usually gets the wholesale (cheaper) brokerage price on the commission and terms. In other words, it's the agency's trade (and they have strong negotiating leverage), even if it is on behalf of the client's account (who has relatively weak negotiating leverage).
Agent
Definition
Real estate agents represent their clients to negotiate the terms of the buying and selling of a house. Stockbrokers are agents who represent their clients for the purchase and sale of stocks and investments.
Agents have specialized knowledge and negotiate deals on behalf of their clients, also called the principal, who feel like they need someone looking out for them. Some agents have a broader power of representation, such as having power of attorney. Other agents represent their clients for a specific reason, or for a single transaction. Basically, an agent is a third party who is somehow getting a piece of the money pie.
All Or None - AON
Definition
The order: 100 shares at $15. All or None (AON).
If your broker can't find 100 shares of whatever stock you want at $15, she buys nothing. You've basically told her to go whole hog or abandon ship. Example: Imagine if Warren Buffett decided to buy 10% of Netflix (yes, it would mean the world was ending, but that's a different story). NFLX stock would almost certainly shoot up a ton.
So let's say his brokers were told that it was an all or none order. If his brokers are able to grab the 10% before anyone gets wind of the deal, Sir Warren ends up with a big chunk of a company stock that's about to go sky-high in price. But if the broker gets about 2.3% and then start hemming and hawing very politely, he's stuck. He either has to pay more for the 7.7% (he wanted to get to 10%—and now that everyone's onto him, those NFLX shares are more expensive) or he can turn around and sell the 2.3% so that he has no part of Netflix.
AON deals are done when an investor has enormous Assets Under Management, and the notion is that, unless he has a huge stake in something, it's not worth it for him to have any stake in it. Hence the AON positioning with brokers.
Alligator Spread
Definition
This could refer to a gourmet lunch in Louisiana or a centerfold of glossy pages in PlayGator magazine.
In finance, an alligator spread refers to a situation where huge commissions gobble up any profits that could have happened with a trade. Usually, it happens when put options and call options are used to give the investor a chance to buy at a specific price later on.
Alternative Minimum Tax (AMT)
Definition
It might sound like a tax invented for Coachella, but it's really a tax created to make sure that the rich pay their fair share. It has nothing to do with "alternative" or "minimum" anything, really. Created by Congress and the IRS, AMT adds stuff back to the "adjusted gross income" line of your IRS tax return. If you’re really rich, you might find that you can't claim the same deductibles you did before—and you'll end up paying more taxes.
AMT ignores one basic thing: the rich don’t fill out the "adjusted gross income" line of their tax forms. They have people who do that for them... people who incidentally know tax laws really well and can find loopholes anyway. Thanks to the fact that AMT is complex and not really doing much, there was much grumbling about it (as there is with any tax).
In response, President Obama signed a law in 2013 that was supposed to be a patch to fix some of the problems. People kept grumbling anyway and voted for Trump.
American Stock Exchange - AMEX
Definition
The AMEX is a stock exchange, which is a place where securities can be bought or sold. The AMEX happens to be the third-largest stock exchange in the U.S. and it's a private intentionally non-profit company.
About 15% of all trades in the U.S. are made through the AMEX, and its competitive brethren are NYSE and NASDAQ.
Annuity
Definition
An annuity is a contract written by an insurance company, which guarantees income for the rest of your life in return for a set of payments up front. Note the "ann" in the word, which is also coincidentally the opening of the word "annual"—as in the payments happen annually. These payments either come in one plop or are "accumulated" over time.
In theory, it has less risk than just buying a bunch of stocks. But there is a price to pay for that risk mitigation...usually in the form of lower returns to annuitants.
Anti-Dilution Covenants
Definition
Dilution happens when a company issues a bunch of additional shares or options, which can lower the amount of ownership or the value of investments for current shareholders. (Not to be confused with delusion—similar, but not quite the same.)
An anti-dilution covenant sounds like something out of Indiana Jones, but it's really just the tiny fine print that helps protect you if you own shares. If you own convertible shares or preferred stock, you might see this little clause somewhere in the paperwork. If the company issues more shares (diluting your ownership), the clause lets you get more shares if you're an early investor.
Anti-Money Laundering Laws
Definition
See Anti-Money Laundering - AML
Arbitrage
Definition
Talk about a great word to use at cocktail parties (especially if you can say it with a vaguely Euro posh accent). Arbitrage is the business of finding something for cheap and then turning around and selling it for more to another customer, keeping the profits...basically, it's the art of taking advantage of the spaces that open up within markets.
Let's say that the kid down the block is selling lemonade for $0.50 a glass, but the local construction workers are willing to pay $1.00 a glass. You buy from the kid, upsell to the construction guys, and pocket the $0.50 difference each time.
Back in the good old days, arbitrage was considered easy money. Thanks to online and electronic trading, though, it's gotten a lot less profitable. For one thing, any 14-year-old with an Internet connection can find a cheaper deal online, so there's less opportunity. There's also less need for the middle man. The construction workers probably have an app on their phone that lets them find the cheapest lemonade around, meaning they don't need your help.
Another current problem with arbitrage is the commissions and other costs and fees. Every trade you make online is going to cost you something, so there needs to be a big difference between buy and sell prices for you to make a profit.
Asset Allocation
Definition
Think about the assets you have. Maybe you have biceps like Channing Tatum or a smile like Beyoncé. Great, but not really relevant to this discussion.
Now think about your financial assets...like cash, real estate, stocks, and so on. Asset allocation is all about where you put your financial assets so that they make sense for you. If you're young, you might want to put a lot of your assets into stocks because you have lots of time for them to grow, and you want to make money more aggressively. If you're getting close to old geezerhood, you might want to invest in bonds or more stable investments because you and your ticker can't handle the shock of sudden market downturn.
The point is that asset allocation is all about putting your assets into the right combos to balance the risk of losing money against the possibility of making more dough. When you're older, you'll want lower risk, and when you're young and cute (and can put those Channing Tatum arms and Beyoncé smile to work), you'll want a better possibility of earning more. Generally: YMMV.
Assets Under Management
Definition
It's the amount of dough the money manager manages. Why does it matter? Because the fees that the manager earns are based on the size of those assets.
And the public market investing business really scales...that is, if a company is managing 20 billion dollars and has 40 analysts and employees and charges 1% average fee, they are charging $200 million a year to manage that money. Then the market goes up and some more money comes in and a year later, they're managing 30 billion. Their fee might go down to 0.9% on that next 10 billion so the average fee income might be like a shade under $300 million. And yet they still have 40 analysts and employees. HUGELY more profitable, the more assets there are under management.
Nice work if you can get it...and are good at it.
Authorized Stock
Definition
When a company goes public and gets incorporated, they change legal status. Part of it means having lots of meetings and signing more paperwork than most of us see in a lifetime. One of those pieces of paperwork is a charter, which outlines a bunch of rules—including the total number of shares a company can issue. This number of shares is called authorized stock, 'cause it's the total number of shares the company is authorized by its charter to issue.
Example
Let's say Company XXX wants to buy Company Y. Company XXX has an authorized limit of 100 million shares. It currently has 85 million shares and 5 million options, yet unvested, outstanding. Technically it has 90 million shares outstanding. It wants to print shares to buy Company Y. But company Y wants 20% of the primary shares of Company XXX or 17 million shares. Company XXX cannot print the shares to buy Y. Why? Because it needs to get approval to change the charter—doable only by a majority vote of the outstanding shares at the time.
Back End Load
Definition
We'll skip the inappropriate jokes and just say that back end load refers to mutual fund b-shares, where you pay fees and commissions when selling your fund, not when you buy or when you hold (see b-shares). Here, "load" is commission and "back end" means that it's paid at the end of the holding period (when you sell).
Balance Of Payments
Definition
An accounting record of transactions between one country and other countries during a specific period of time.
This term is used to refer to the levels of international trade between countries, tracking money in and money out. Say China is selling the U.S. a heap more lugnuts and t-shirts than we're selling them cars and iPhones; then the balance of payments would be unfavorable to the U.S. (and favorable toward China). In general, you want to be selling a lot more than you're buying.
Balloon Maturity
Definition
When a balloon loan comes due. At this point, you have to make your big final payment (balloon loans let you pay a little bit at a time and then a bigger lump sum at the end).
Banker’s Acceptance - BA
Definition
Kind of like a Treasury bill but with fewer calories, a banker's acceptance is a promise of future payment, where a banker accepts the responsibility of paying a creditor at a later date on behalf of a borrower. The banker takes the risk in case the payer disappears into thin air. They're often used in international trade transactions since they're a safe way to exchange money in the short term.
A banker's acceptance can also be traded at a slight discount to the face value and held until maturity, sort of like a bond.
Bankruptcy
Definition
A legal process in court that lets you basically say "whoops, sorry—I can't repay what I owe."
When you declare bankruptcy, you're basically getting an excuse not to pay off a bunch of your debts, including credit card debts. Once you go through the process, credit card companies, debt collectors, and other companies can't come up to you to get their money back. You may be asked to liquidate some of the things you have in order to pay back some of what you owe. And some stuff—such as custody payments—cannot be forgiven in a bankruptcy.
It's not a get out of jail free card, either. Bankruptcy basically ruins your credit rating for years and makes it hard for you to get a home loan, credit card, and other types of financing. So why would anyone do it? If you're really over your head in debt, bankruptcy can help you get a fresh start and can help protect you so you don't get your home taken away.
It's pretty much a last resort if you're in financial hot water.
Basis Point
Definition
One hundredth of one percent. It's the measure bankers use to talk about mortgages: they talk about mortgage rates going up or down a certain number of basis points.
Example
If mortgage rates are quoted today at 6.274% and next week at 6.284%, they have gone up one basis point. If they move two weeks later to 6.074%, they've gone down 20 basis points from the original quote.
Bearer Bonds
Definition
You know that saying "possession is nine-tenths of the law"? That's how bearer bonds work. If you have the paper issuing the bond in your hot little hands, you own the bond (whether you stole it or bought it): there is no record of who bought or sold the bond.
Bearer bonds aren't common today, in part because investors don't like the idea that they can be stolen.
Best Efforts
Definition
"Best efforts" is a goofy legal term that describes a kind of goodwill, or "we tried really hard...really" when trying to execute a sale, a transaction, or anything that requires brokerage work. It just means that the person doing the work can't sit around on his butt and do nothing. She has to...try.
Beta
Definition
Beta is a measure used to describe volatility or risk of a portfolio or share. Usually, Wall Street types use the market as a whole to measure how risky or volatile something is.
Blue-Sky Laws
Definition
There are thousands of rules about selling and marketing securities. These laws are there to protect you, but... they're confusing.
For one thing, each state has its own separate laws and there are federal rules to follow, too. Blue-Sky laws are the collective state regulations involving the marketing and sale of securities in a specific state. If you want to make new issues and secondary offerings available in, say, Idaho, you have to register according to the relevant Idaho laws. Some states' regulations are stricter than others.
Board Of Directors
Definition
The board of directors is the central nervous system for company management. They get paid to provide oversight on things like compensation, ethical things, accounting, governance, and deciding who is picking up the cake for Janet from accounting's birthday party. Its primary function is to hire (and fire) the CEO who then in turn hires, more or less, everyone else. The board members are elected by votes drawn from the pool of Common Stock investors.
Bond
Definition
No longer the hippest spy in the world (Matt Damon took that spot), the word bond comes from Latin, meaning just "an agreement."
Financially, a bond is an obligation to pay back money. In return for renting that money for some period of time and for the risk of that borrower not being able to pay back the money, bonds charge rent or interest.
Bonds have levels of seniority and other features which can make them "feel like" stocks or other kinds of investments. For example, it is not uncommon in large public companies to have 8 or 9 layers of bonds with fancy names like preferred, senior, junior, convertible, subordinated, or debenture.
Each of these flavors of bonds has a slightly different taste with the one common protein that they are all different forms of debt obligation.
You would likely have been raised in a barn and gotten your transportation to your soccer games in a horse and covered wagon if bonds or debt didn't exist. Almost nobody buys a home without debt. Most people buy cars with debt. Most students pay for their college education with debt. And that plastic in your wallet? Yeah, it's debt. The one unifying string that has woven the financial fabric of this country has been financial trust.
Because our laws around financial obligations are so strict, for hundreds of years, this country has developed a deep sense of trust in another party's promise to repay. That promise is taken seriously by everyone and anyone with whom you will do business in your future as you try to buy toys, shelter, and self-actualization (a convertible Porsche).
Bond At A Discount
Definition
A bond that is selling for less than its stated value. Summer sale for investors.
Bond At Premium
Definition
A bond that is selling for more than its stated value.
Why would it sell for more than its value? Investors might be certain the bond will pay off, or its credit rating may have been upgraded since the bond had been issued. Or it's possible that interest rates have dropped and that bond looks more appealing than the ones being issued now.
Bond Rating
Definition
S&P, Moody's, and Fitch are all rating agencies that gather up information about bonds and the companies that issue them. They release ratings about the relative strengths of individual bonds so that investors can make better decisions.
Rating agencies look at things like the financials of a bond issuer, debt loads, and indicators. If a bond is ranked high, there is a low chance of default, meaning that the company or issuer will probably pay you what they're supposed to and you won't lose your money. Lower ratings mean bigger risks.
In the S&P world, BBB is the highest rating for an "investment grade" bond. Anything lower than BBB is considered a junk bond.
Caveat emptor. (That's Latin for "read the fine print.")
Book Entry
Definition
You might think that "book entry" would have to do with writing stuff down in an actual book... but... the opposite is true. Book entry is the way that securities get registered today in an electronic form. No physical paper is used and no actual bond certificates or stock certificates are issued in most cases.
Book Value
Definition
A balance sheet term. It's what things are worth at liquidation. If you own a company with stuff like machines, equipment, and inventory (stuff you sell), you'll figure out what things are worth now and how much they decline in value each year. Book value helps you understand how much everything is worth right now if you suddenly need to liquidate (or are just applying for a business loan).
Example
Caterpillar Tractor bought a smelting stove to melt iron at high temperatures. They paid $10 million for it. It should last 20 years and then they can sell it for scrap for $2 million. Using advanced calculus, we can ascertain that it will have depreciated $8 million in the 20 years that they use it. Using arithmetic depreciation, it will have declined in value $8 million / 20 = $400,000 per year in value. By year 10 of having owned the smelting stove, it will have depreciated $4 million. The book value of that stove will be held on the balance sheet of CAT as $6 million.
Borrow
Definition
When you borrow, someone fronts you something (cash, a book, a good shirt for your date on Friday night). "The borrow" is the cost of borrowing shares if an investor has to borrow the shares from the brokerage (it's called short selling a stock). The borrow is usually expensive because of the high interest rates charged.
Bought Deal
Definition
When an underwriter buys shares directly from the issuer first and then files the prospectus and the IPO. These are usually big deals, so the company ends up selling all of their shares. The underwriter, since they are buying up all the shares, can usually negotiate a sweet deal. Because of that, they can turn around and sell them at a good price (attracting more investors) while still making a profit.
Breakpoints
Definition
Waltz into a store willing to buy a lot, and you can usually expect a discount or a freebie. The more you spend, the more discounts stores are usually willing to pile on to keep you buying. It works the same way with mutual funds. Buyers of mutual funds can get discounts once they get past breakpoints (the minimum levels where certain discounts are activated). Go past a certain breakpoint, and the commission on the buy might be slashed by 1%. Go above another breakpoint, and the commission will go even lower or disappear entirely.
Example
Buying shares of One Eyed Man Mutual Fund Company's flagship fund might cost 5.5% commission if you buy less than $25,000 worth. If you buy $500,000 worth of the fund, the commission might just be 1%. Over a million bucks, the commission might be free—the broker will be paid out of the management fee of the company, i.e. One Eyed.
Brochure Rule
Definition
This rule came as part of the 1940 Investment Act, and it requires that folks selling securities provide written documentation of what they are selling, i.e. a brochure. That way, if things ever go to court, there's no "he said, she said" in front of the very angry Judge Judy. All the pertinent facts are written down. Preferably not in crayon.
Business Cycle
Definition
Just like circle of life, business has its ups and downs. The economy looks to be tanking and then recovers, only to nose-dive again at some later date. The whole process is a cycle: the business cycle.
Not exactly what Mufasa was singing about, but you get the idea.
Buy And Hold
Definition
Buy and Hold is a style of investing. Basically, you buy stocks and then hold them. Convoluted idea, we know.
Warren Buffett, the Big Cheese in the investing business, is a big believer in buy and hold. Stockbrokers are less excited about this strategy, because they make their money when people trade, sell, and buy stocks. If everyone held onto stocks, stockbrokers might make less and might have to wear last year's Tom Ford designs. Tragic.
To be successful at the buy and hold strategy, you will generally focus on putting just a few companies in your investment portfolio—fewer than 12 for most people. Then you avoid selling or trading those shares. To make money, though, you need to choose the "right" shares, and this is where things get tricky. What sort of business is around and profitable forever? Google and Apple might seem like sure bets now, but what happens 30 years (or more) down the line? Warren Buffet and others have found success by investing in things that people "always" buy—like Coca Cola.
One of the big advantages of the buy and hold strategy is that it gives stocks lots of time to grow in value. Another big plus is that you don't realize gains, which means you don't have to pay capital gains taxes to the IRS. The big drawback is that your stock portfolio is going to go through lots of ups and downs, which will seem extra scary because you only have a limited number of stocks. When it all tanks, you won't be selling. You'll just be sweating it out, hoping that prices head back up. If you need the money in the short term and your portfolio doesn't recover in time, you might panic. This is really a strategy for the young or youngish who are thinking about stashing money away for retirement or even their kids.
C Corporation
Definition
A type of business structure designed to separate the owners' legal and financial liability from that of the company. Unlike S Corporations where profits are taxed at the level of the shareholder, C Corps have their profit taxed at the corporate level...and again at the shareholder level after profits are distributed. Wait, why would a corporation want to be double-taxed? Well, it offers the most protection to stakeholders. If the corporation goes belly up, they're not on the hook. Most big corporations, like McDonald's, are C Corporations. It's the McCorporation Structure.
Call Option
Definition
A type of option that gives the buyer the right to purchase something for a set price for a predetermined, finite period. A call represents a bet that the underlying asset (the thing you have the right to buy) will see its price increase.
So say you like shares of Hopefully Going Up Co., which are currently trading at $20 per share. You might buy a call option with a strike price of $25 per share and an expiration one month from now. If a month from now, the stock has risen to $30 per share, you can exercise your option, buy shares at $25 per share, immediately sell them at the going rate of $30 per share and pocket the $5 per-share profit (minus whatever it cost you to purchase the call in the first place).
If shares of Hopefully Going Up Co. sink to $18 per share, you can just let your call option expire. You aren't required to buy the stock. Using call options lets traders make bets without forcing them to buy the underlying asset outright. This lowers the expense of placing the bet, and thus lowers the risk.
The opposite of a call option is a put option. A put gives the right to sell an asset at a certain price during a set period of time. It's a bet that the price of the underlying asset will go down, a way to short the asset.
Call Provision
Definition
See Call Protection. The call provision is just the details and fine print that tell you whether the issuer can call a bond early (and how they can do that).
Callable Preferred
Definition
Just see callable. Preferred stock certificates also have fine print that means companies can call their shares at specific times.
Capital Appreciation
Definition
Yes, we all appreciate having capital. But this term applies when the value of capital goes up or, well, appreciates. Important note: you don't have to do anything for capital to go up in value. Let's say you buy a stock for $20, and after a year its value is $25. It has appreciated $5 a share. You didn't have to do anything, and you don't have to sell, trade, or do anything now. You can just sit back and appreciate the appreciation.
Capital Asset Pricing Model (CAPM)
Definition
A Capital Asset Pricing Model (or CAPM) is a model that prices securities in terms of the relative risk and return offered. You can do complex equations to figure the CAPM value for something (if you're into that sort of thing). The important thing to remember: CAPM recognizes that investors need to be rewarded for risk and for the value of their money in terms of time.
Capital Gains
Definition
If you schlep to work each day, you have to pay income tax. If you invest money, make money through investments, you have to pay capital gains taxes. The rate on capital gains taxes is typically lower than income taxes. In theory, that's because the IRS wants to reward you for investing rather than spending. Call us skeptical...it still looks like more taxes to us.
Capital Markets People
Definition
The people who have their hot little mitts involved in the world-wide trading activities of certain sectors (like tech, healthcare, or real estate).
Capital Surplus
Definition
See Paid-In Surplus.
On a balance sheet, a company is supposed to list all its stock and capital. But what happens when the company issues or sells stock at above face value? The extra they are paid is not an earning or a capital stock. So it goes on its separate line as paid-in surplus or capital surplus.
Cash Flow
Definition
Cash is like water, always moving. It's flowing and ebbing, sometimes just trickling, its way around. Cash flow just refers to the process of money moving in and out of a business. It involves cash inflows, or money flowing into your business from customers and sales. There's also (unfortunately) cash outflows, like the cash you have to pony up to fix that radiator again. (Also, salaries, utilities, raw materials, etc.)
CBOE (Chicago Board Of Options Exchange)
Definition
The Chicago Board of Options Exchange. Want to buy options? No need to go to the Windy City. The CBOE is an exchange that lets you buy and sell options. They sell more than a million contracts a day, since they are pretty much the biggest options exchange around. All the options sold there are the basic calls and puts and all are American-style (which means you don’t have to wait until the day of expiration to exercise your option). Created in 1973, the CBOE is also busy creating e-trading and other financial tech products.
Certificate Of Deposit (COD)
Definition
A secured-by-the-bank promissory "IOU" note, usually with a fixed maturity date and fixed interest rate.
CDs are generally shorter term "paper," and most volume in CDs mature within the next three years or less.
Chinese Wall
Definition
This concept was named after the Great Wall because it was thought to be impenetrable. The Chinese Wall refers to the divisions between the financial guys at a company and other departments at that same company. The idea is that the sides are divided up so that information can't leak through enough to allow insider trading.
In reality, the Chinese Wall is more like Swiss cheese: insider trading and information sharing between departments and companies happens all the time (even when it shouldn't).
Churning
Definition
Back in colonial times, before America was the good old U.S.A., colonists would churn cream into butter. Back then, churning involved moving a plunger in a wood bucket over and over and over again. Not exciting, but that's what happens when there's no better technology.
Today, churning is something illegal that brokers do. Churning in the financial sense means making tons of trades in a client's account to get more commissions. It's illegal but sometimes it can be difficult to detect or stop. If you fall prey to a broker who's involved in churning, you'll end up overpaying in commissions, and you might even have to pay extra taxes because of all those trades.
Closed Indenture
Definition
A loan that has maxed out or is up to the maximum amount of funds that can be borrowed. The bank is closed, folks; you'll need to find another way to pay for your dentures.
Closed-Market Transaction
Definition
Unlike open-market transactions where investors buy/sell on the open market ("Google is doing well; let's buy some.") these kinds of transactions happen when an insider buys or sells directly from or to a company.
Usually, these sorts of transactions happen when an employee is trading company shares or stock options with the company itself. There are all sorts of rules that insiders and companies have to follow in these types of transactions to make sure that everything is on the up-and-up. These transactions don't usually affect market prices for stocks and securities on the open market.
COGS (Cost Of Goods Sold)
Definition
COGS refers to the "Cost of Goods Sold," which are all the expenses a company needs to pay to get their products out the door. So the company that makes your shoes might have to pay for material to make the shoes, the process of making the shoes, the price tags and boxes for the shoes, delivery, and everything else that it takes to get the shoes to the store or to your doorstep. Those costs, all together, are the COGS of your Nikes.
Coincident Indicator
Definition
When stuff happens that is generally aligned with other stuff that happens at the same time.
Helpful, we know.
Here's an example: when the weather turns cold, people buy more gas—they are coincident.
Collateral Trust Bonds
Definition
When a company takes shares they own of another company, tosses them in an escrow account, and uses those stocks as collateral for raising money.
Example
Let's say you own a company that makes hair-removal products and you stumble across a formula guaranteed to get rid of knuckle hair forever. (Just think of all those hairy dudes and grannies you could help!) Only one little hiccup: you need cash to make and market the product.
Your company owns Apple stock. So you throw the Apple stock into an escrow account and go to the bank. The bank uses the stock as collateral to give you a loan. Now you have the cash for your new product. Ta-da!
Commercial Paper
Definition
These are unsecured, very short-term to maturity bonds (270 days, max) which typically have low yields, low risk, and high liquidity, meaning that you can sell all of them and turn 'em into hard cash in minutes. They're usually sold by large institutions and corporations to meet debt obligations in the short term.
Commissions
Definition
You didn't think that stockbrokers worked out of the goodness of their hearts, did you?
Yachts and fancy cars don't pay for themselves, you know.
Rather than being paid a salary like any Joe Schmo, stockbrokers are paid commissions, which means they are paid a small percentage of every trade they make. It can really add up, especially if someone uses unethical or illegal activities to trade more.
Commissions are really the lifeblood of stockbrokers. What gets commissions and how it gets commissions is an R-rated story (see wrap account; churning; sell-side analyst). But one key theme is that commission rates have come down. There's a lot more shares trade today versus 30 years ago, but commission rates are a fraction (we're talking 0.5–3%) of what they were in 1980.
Commitment Letter
Definition
"Dear Rebecca. It’s been fun and all, but asking me to move in with you was a real turn-off. So, uh…have a nice life."
Yeah, that would be a, uh…“fear of commitment” letter.
So…what’s a commitment letter? All right, well… you need dough. But you don't need it today. You need it in 6 months, when construction is finished on your cabin by the lake. At that point, you’ll convert your very expensive building loan into a normal mortgage.
Well, you can go to the bank and, for a small(ish) fee, get a commitment letter...which stipulates that, assuming nothing material changes between now and then, you will get a loan for $152,000 at 5% fixed interest for 30 years.
The bank is then committed to giving you that loan…when, eventually, you need it. That way, you don’t have to worry about your bank, uh…breaking up with you.
Which is nice, because it’s tough getting the “it’s not you, it’s me” speech from a guy in a bow tie.
Common Stock
Definition
Common stock is a share of ownership in a company that gives you voting rights, but does not guarantee you’ll be paid a dividend.
If the company goes belly up, common stock is paid after preferred stock, which means there might not be much left in the tank for you after everyone else has been paid.
Competitive Bid
Definition
When a company decides to go public and launch an IPO, they need someone to sell their stock; these sellers are underwriters. But how can a company choose the right underwriters for their IPO? Sometimes, through a competitive bid. Different underwriters submit closed bids and details of the terms they are offering, and the company compares the bids to find the cheapest or best underwriters.
Complex Trust
Definition
Not a simple trust? Yeah. A complex trust has stipulations for all kinds of other activities: how much must be given away to charity, what activities and/or people the trustees have to deal with, and so on. A trust can flip-flop between simple and complex if certain conditions aren't met, such as not paying distributions to beneficiaries in a timely manner. Some trusts are simple and some are complex... but they're all complicated.
Consent To Service Of Process
Definition
It’s like when you intone ironically “So sue me!”
And they do. Or at least they can.
"Consent to service of process" is a legal acceptance of financial responsibility when you set up your company in whatever form in a given state. That is, when you consent to being served lawsuit papers at your address of record, it makes it all the easier for...whoever...to sue you.
They don't have to hunt you down in the woods, or wait for you to show up at your P.O. Box, or try to I.D. you in a “Where’s Waldo” drawing. All they have to do is send what’s called a process server (registered mail, basically) who identifies you, and then takes a selfie of him serving you papers, i.e. handing you an envelope stating that you are being served.
The state had to require this consent, because too many deadbeat companies absconded with unpaid bills, unserved responsibilities in contracts, and other omissions that finally force the government to say “enough!”
If you want to do business in our neck of the woods, then you’ll consent to being sued…easily.
Don’t worry though...it only hurts the first time.
Consumer Price Index
Definition
An index that measures prices based on the value of certain good and services in an attempt to meter and measure inflation rates
Contempt Of Court
Definition
Yeah, we all know what this one means.
Being held in contempt of court means you've been stupid enough to violate a court order, court injunction, or a subpoena. When a court tells you that you need to do something... you need to do it. Or hire a really good lawyer who can find lots of reasons why you're the exception to the rule.
Contraction
Definition
You might want to look into prune juice or some fiber.
When the economy or a market grows a lot, it eventually contracts or slows down (or hits a slump). It's basically the "what goes up must come down" idea in economics.
Conversion Ratio
Definition
This one has nothing to do with how many heads the minister dips in the river.
The term refers to the number of shares a bond is "convertible into." If you have a convertible bond, this ratio tells you how many shares of common stock you will get if you decide to convert the bond into stocks.
Example
Let's say a $1,000 bond converts into 100 shares. At ten bucks a share, the conversion is break-even-ish. If it's more than ten bucks a share, you're sitting pretty.
Conversion Rights
Definition
The rights to convert. It's usually something people talk about when talking about a bond converting into common stock.
Convertible Bonds
Definition
A bond that can be converted into a set number of (usually) common stock shares.
Example: A $1,000 par bond is convertible into 20 shares of common stock. What is the base conversion price? $50 a share. That's 20 shares times 50 bucks to convert. But at exactly that number, the risk/reward may not be favorable, because equities can (and do) go down a lot all the time. Whereas the bond at a grand a unit is likely pretty steady and safe. So the actual conversion price, in practice, is probably a bit higher than the 50 bucks minimum.
Cooling
Definition
If you're a big spender, you want a cooling off period before you spend big bux. Lack of a cooling period may be why you've made some impulse buys in the past (like the leopard print pantsuit or that trip to Vegas you swore you'd never talk about). When a company publishes an offering memorandum outlining its plans to sell bonds or stock, there is a cooling off period required by law; it prevents investors from rushing in to buy without thinking.
Corporate Bonds
Definition
Companies put cash in their bank accounts in a few basic ways. 1) They sell equity or ownership or shares of themselves like in an IPO. 2) They can make money from selling their product; that is, a single shingle sells for $19.95 and they keep $4.82 in profits from it. Times ten million...is a lot of cash. And 3) they sell bonds. Or rather, debt. That is, they pay rent for borrowing money just as governments do.
What do Microsoft, Coke, and your deadbeat uncle all have in common? They all have debt outstanding.
Most companies (like...well over 99% of them) boringly pay off their interest…and when the bonds come due however many years or decades later, they pay the principal and they’re done.They’ve presumably used the money wisely. But the more interesting bond stories revolve around the times when companies' best-laid plans go awry, and they snuggle up real close next to bankruptcy.
Example time.
If our roofing company, We've Got Shingles, has 90 million bucks in pre-tax profits, they might have 1.6 billion dollars of bonds with an interest rate of 5%. The interest costs are 80 million a year, so the company is only making 10 million dollars...juuuust enough to cover the interest.
Should profits fall, the company would go into default, miss an interest payment...and then, in theory, the bondholders could repossess the company. The bondholders could take control of it, sell off assets to pay themselves back and, well…the company usually then dies. So...that’s not good.
And that’s why the bonds are called junk. Or, in more proper parlance, “high yield.”
They live waaaaay to the right on the risk spectrum, because that whole snuggling up right next to bankruptcy is not something Wall Street people like doing. Childhood intimacy issues, probably.
So, while a very safe U.S. Government 10-year bond might pay 3%, a similar but very junky corporate bond might pay 12% or more to adjust for the vastly higher degree of risk.
Corporation
Definition
A form of business organization in which the business acquires a legal status separate from its owners; this limits the liability or risks of the owners by placing their other assets beyond the reach of court action and creditors. Corporations divide ownership into units represented by shares of stock that can be transferred or exchanged. Corporations are also generally characterized by the separation of ownership from management; thus, shareholders often play very little role in the practical management of the corporation.
Bottom line: if you sue a corporation, you can’t go after Richie McRich who owns the corporation, too.
Coupon
Definition
They're on the back of cereal boxes and at coupons.com en masse.
Oh, coupons also apply to bonds. If you have a bond, the coupon is the money you make from the interest on that bond. A normal vanilla bond pays its interest twice a year, which means that twice a year—for as long as you have the bond (until it expires)—you get cash.
Example
You have a $500,000, 8% coupon bond. Twice a year, you get $20,000 for your investment. Not bad.
Coupon Bond
Definition
A bond which pays a coupon or interest at regular intervals as long as you hold onto the bond. See zero coupon, too, which pays no coupon until the very end.
Coverdell Education Savings Account (CESA)
Definition
Coverdell accounts are similar to other college savings programs like 529 accounts. All of them offer the ability to save money tax-deferred (as long as the money is then used only for college costs. And yes, ramen noodles count as an expense), but the CESA has a much broader definition of "eligible post-secondary school," making it easier to get training in a field outside the "traditional" college system. Very good deal if you qualify.
Crash Of 1929
Definition
In the 1920s, the stock market was booming, and people were using their stock investments to buy houses and the like. Then, in October 1929, it tanked. People's investments were wiped out, and... hello, Great Depression.
Credit Rating Agency Reform Act Of 2006
Definition
This act was meant to improve the quality of company-credit ratings. It was enacted in the hope that we could avoid the subprime mortgage crisis that almost brought down the finances of the entire country. It worked—in the same way that a scale works in an embarrassing episode of The Biggest Loser.
The idea was that the big 3 agencies—Moody's, S&P and Fitch—were colluding with each other and rating every security as "A-okay." The big-3 then produced a product that wasn't reflective of the real risks inherent in the marketplace. Basically, they had been labeling "pink slime" and hot-dog meat as Grade-A sirloin.
The act made it much easier for smaller firms to compete for business by doing quality research and not being afraid to give bad ratings to bad money-butchers.
Credit Risk
Definition
Will the borrower pay or end up a deadbeat who doesn't pay their debts? That's credit risk: the risk that the promise to pay won't be honored.
Lenders are really worried about credit risk and have all sorts of ways to figure out whether you're a good risk or a bad one. They might take a peek at your credit score, for example, or run an employment verification to get some intel on you.
Cumulative Preferred Stock
Definition
The dividend on the preferred stock must be paid before the company can pay the common shareholders a cent.
If it's not paid, then it just builds and builds (a.k.a. accumulates). Usually, dividends are not paid if the company runs into trouble. Once the company gets over the hump and starts paying dividends again, it has to pay up all the missed dividends owed to the preferred stockholders (that amount is the cumulative preferred stock) before paying the common stock folks.
In theory, the company could stiff the preferred holders forever, but that never happens because the common shareholders would revolt and throw those jerks out of their cushy jobs.
Cumulative Voting
Definition
It's about how companies' boards of directors are voted in or out. In cumulative voting, shareholders get one vote for each director, but they can accumulate all of them and pool all of the votes behind just one director if they want.
Example
You have 500 shares of XYZ Corp., and there are 5 directors up for election. That means you have 2,500 votes (500 shares x 5 directors) to allocate, and you can put them all behind your cousin Billy.
Current Ratio
Definition
Current ratio is just a measure of what we got against what we owe, based on current (short-term) assets and liabilities (ones we only have to worry about for the next year).
We have to worry about two things here: the ratio itself and how big the numbers are.
If we have a really small business and our liabilities are larger than our assets, we might be scrambling to pay what we owe and we could get into a lot of trouble. If we're handling big moolah (assets of $10 million or more), we've got more pressure if we have lots of debt... even if we have more assets. If sales dip or a lot of our sales are on credit, we could have a hard time paying what we owe.
Example
Say current assets are $10,000,000 and current liabilities are $3,000,000. We like to see 3-1 or better for this ratio. It just means we’re paying our bills faster than we’re collecting them and it says a lot about our cash liquidity.
Current Yield
Definition
Think of it as "market yield": You can figure out the current yield by dividing the amount you make from an investment by the current market price. It gives you a sense of what sort of money you'd be making if you bought a bond or investment and held onto it for a year.
Example
The subordinated debentures for Cablevision have a coupon of 7%. That is, when Cablevision sold $100M of those bonds, they were on the hook for $7M a year in interest. Cablevision couldn't help that Wall Street didn't like their new programming deals, which didn't include C-SPAN, and the bonds sold off heavily—down to 90 cents on the dollar. Anyone who now buys a bond unit (usually solid in increments of $1,000) for $900 still receives the 7% coupon from the good people at Cablevision. It's just that now that $70 in interest is paid out over the initial cost of $900 instead of $1,000. 70/1000 = 7%; 70/900 = 7.8%
Custody
Definition
When you have custody, you have the actual physical assets, whether they are in the form of cash or securities.
If a client has given their investment adviser full discretion to withdraw customer cash and securities, the investment adviser is considered to have custody.
Cyclical Stock
Definition
Stocks that move with economic cycles. These tend to be stocks in companies that can be affected by the economy at large. In many cases, they're from companies that make or sell discretionary items.
Example
If your company sells cheap-o vacation plans and the economy tanks, fewer people are going on vacation—because they're working overtime. As a result of that, your stock prices might drop.
D&A (Depreciation & Amortization)
Definition
Depreciation and Amortization (D&A). It's a method of valuing assets—usually ones that are declining in value.
Day Order
Definition
The order is what you give your broker, telling them to buy or sell specific securities on your behalf. A day order is good for only the day in which it was placed. If it's not filled for some reason, it's no good the next day.
Debenture
Definition
Nothing to do with your grandpappy's dentures, a debenture is a bond-like loan certificate that's backed only by the promise the issuer makes that it will pay back the dough.
Like other investments, it pays interest, but it's risky because there's nothing backing it up.
If the company lied about paying you back? Not much you can do about it.
Debt-to-EBITDA
Definition
Debt-to-EBITDA is a ratio that compares what a company owes in debts to the EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).
This number is used by bankers and investors to see how leveraged a company is. The higher the number, the more likely it is that a company will struggle to pay up its debt. Debt of more than 3 or 4 times cash flow is considered very high on most planets.
Debt-to-Equity Ratio
Definition
A very closely-watched metric by analysts.
The percentage is calculated by dividing a company's debt by the equity of stockholders and other owners. In general, a high D/E ratio is considered dangerous because it means the company has borrowed a lot. Lots of borrowing increases the chances of default and ultimate bankruptcy.
Defensive Stocks
Definition
See: Defensive Investment Strategy.
Defined Contribution Plans
Definition
Retirement plans that are funded through employee salary deferrals. The employee (also called the "participant") is offered a choice of investments, usually in the form of mutual funds. The employee is responsible for the performance of the account—the employer has no responsibility for the investment choices or how well they do. So if the employee ends up with nada because of poor investment choices, the employer has nothing to do with it.
Depression
Definition
Usually, what happens right around April 15th each year.
From a macro perspective, a depression is defined differently by different groups, but most agree that it's a more severe and prolonged version of a recession, with GDP in sustained decline and unemployment at high rates.
When it happens, everyone has less money to spend and things become a cycle—since people aren’t spending money, businesses don’t need to make as much stuff and they lose revenues so some of them shut down, which means fewer jobs and even less spending. During a depression, the government might step in with programs that are meant to provide jobs and get people spending again.
Dilution
Definition
If you pour a bunch of cream into black coffee, you dilute the coffee—it's tastier, yes, but it's not just coffee anymore.
Same deal with stocks. The more shares a company has outstanding, the more the company is owned by other people and the more diluted it is—which means that each person with stock owns a tinier chunk of the pie.
Short version: dilution is the reduction in relative ownership levels or percentages caused by the creation of new shares.
Example
If a company has 50 million shares outstanding and grants 10 million options with a low strike price, it has diluted itself about 20% because the options will be exercised and—presto!—the company now has 60 million shares outstanding. Early stage start-up companies usually have stock option plans so most "suffer" dilution because they're trying to raise cash for growing the company.
Disclosure
Definition
When you tell someone something that would otherwise be private. Or embarrassing. Or both.
Typically in finance, disclosure means releasing important information about a company which could affect investors' decision-making. The SEC has pretty strict guidelines for what must be disclosed in order for a company to be listed on the big U.S. exchanges.
Discount Rate
Definition
Investments always carry risk. How much risk they carry is where the discount rate comes in; when fancy numbers are run on discounted cash flow, it lets money types figure out present value.
Basically, you get a higher discount rate for riskier investments.
Discounted Cash Flow
Definition
A dollar today is worth more than a dollar tomorrow. So... money in the future carries a discounted value from what money is worth today. How much it's discounted is called the discount rate, and DCF in particular refers to the way many companies are valued on Wall Street.
Basically, you can decide how much an investment might be worth to you by trying to figure out how much cash flow a business might experience in the future. Finance types use lots of equations and numbers for discount cash flow analysis to figure out exactly how much more (or less) cash flow a company might experience in the future.
It's a science, not an art.
Example
When you buy shares of Facebook at the IPO, there isn't enough cash flow today to justify a very high valuation. But the expectation is that, in the future, the company will generate gobs of cash. Of course, there's risk that the company won't generate the cash and then it'll come in the future, so you have to discount back the value of those streams of cashola.
Discretionary Account
Definition
An account where the manager of that account can do whatever she wants with it.
Well, within reason.
The manager can't just withdraw everything and go "find themselves" in the Amazon. What it does mean, though, is that they get to call the shots. An amazing once-in-a-lifetime opportunity crops up, but your broker can't get in touch with you? Too bad, so sad—unless you have a discretionary account. In that case, the broker can buy that amazing opportunity for you without your say-so.
Discretionary Order
Definition
A type of securities order where the broker can decide when and at-what-price to pull the trigger on a client's order.
A client can call his broker and tell her to use her discretion as to when to buy the 1,000 shares of MCD the client wants. The broker will try to get the client the best deal because they have a fiduciary responsibility to not suck at their jobs and do the right thing.
Diversification
Definition
Investment in a range of stocks in order to mitigate volatility and risk
Dividend Exclusion Rule
Definition
Corporations in America used to suffer from "double taxation"—that is, they'd sell their lugnuts, be taxed on profits, and if they did a really good job, they could pay a dividend. Then the dividend which went out to the shareholders they worked for would be taxed again. So that nice dollar of profit turned into a quarter pretty fast.
Then the DER came in and allowed corporations to deduct the dividend they paid from their tax bill so that the dividends were taxed once—at the level of the shareholder to whom they were distributed.
Dollar-Cost Averaging (DCA)
Definition
A strategy for mutual fund investing.
You invest a fixed dollar amount each month in the fund. The theory behind this discipline runs that, if you buy when the price is declining, you will buy more shares each period, so that when the rebound happens, your overall investment will be worth more.
Of course, it takes a big leap of faith to keep buying in the face of persistent declines. Your broker will tell you that "it's a great investment," but if it's so great, why is it falling? Is it a good deal for you, or for the broker? You make the call. But if you believe that, over time, markets go up, then adding more of something when it's "cheap" is usually a good idea.
See: Average Down.
Dow Theory
Definition
Dow Theory views the transportation industry as a leading indicator for where the rest of the market is going. The belief is that the market, on both the up and the down side, plays hopscotch with the transportation index, such that in understanding Dow Theory, investors get a guided tour of the crystal ball of the future of where the stock market is heading.
Due Diligence
Definition
Sure, you could buy stocks, start up a company, or make all kinds of money decisions without actually looking into anything.
But when you don't do your homework, you're more likely to end up a whole pile of crappy investments. Due diligence just means hitting the books (or Google) to make sure that a company or business is all that it seems.
Eastern Accounts
Definition
Eastern and Western Accounts are two different team methods in which underwriters or stock brokers or investment bankers sell securities to their constituency. And that’s a $5 word for…mutual funds…hedge funds…and just generally wealthy people. "Team" is only a notional thing on Wall Street…and the line between the two types of teams gets drawn clearly in a Western v. Eastern style of selling.
Think: the Mississippi River. A Western account is a divided account. What does that mean? Well, like the Old West, this style agreement is, more or less, "every man, woman or other for him-her-or-itself"... and since, in most deals, there are multiple syndicate partners, “who is responsible to sell” is what really matters.
So in any given deal, when the partners sign up to bid for the business to take whatever.com public...it is those partners in a Western style account who are each on the hook to sell whatever amount of shares or dollar volumes they have committed to sell. In other words...you break it, you bought it. Or rather, you bid for it, you own it.
In a Western account, the allegory is the cowboy who has his own set of 28 cows he feeds, clothes, manages, and provides a social life for, all on his own. At the other end of the country...lives the Eastern style of account arrangement. Not sure what it is about East Coasters; maybe it’s the history of unions there, but they all seem to want to work together. Go figure.
Eastern account syndicates oblige members to sell not only their own allotment, but also the amount that is not sold by other syndicate members. That is, each individual member is not only on the hook to sell the shares they have committed to sell, but they are also responsible for selling the shares of the other players in their syndicate.
You can imagine that, for a company nervous about getting all of their shares placed properly, they would lean hard on the investment bank to adopt an Eastern style team sales approach instead of a Western one. Regardless of Eastern or Western style deals…the most important element in an offering getting properly placed is that the bankers get paid.
As long as the contract is set up so that the banker only makes money if a successful deal happens, usually everyone selling securities is kept fat and happy. The same may not necessarily be said for the people who bought them...
EBITDA
Definition
Earnings Before Interest, Taxes, Depreciation, and Amortization.
Seems like a five-eyeballed purple fish out of a nuclear plant river. Why on earth would anyone track this arcane piece of financial data?
Well, in theory, EBITDA strips out noise—noise that isn't germane to the business being analyzed. The idea is that EBITDA takes out information about financing and accounting differences, so it's easier to compare companies. Investors use this number to figure out whether a company is a good investing bet or not. EBITDA can be useful, but it can also be fudged—just like any other financial data.
The notion was popularized by high cap ex industries (like the cable industry) which generated very high unit margins but never had any capital available to give back to shareholders because the industry was busy buying content and itself (i.e. consolidating). Many investors liken EBITDA to "cash flow" as a proxy for the unfettered operational cash earning power of the entity itself.
The dotcom meltdown of the early 2000s happened in part because the EBITDA numbers for dotcom companies were great... even though that didn't stop those companies from flopping. EBITDA can make companies with a lot of debt look far more promising than they are, so always check more than EBITDA when deciding what to invest in, kay?
Effective Date
Definition
The effective date is the date when a security can be sold to the public (because its registration has become effective).
Usually it happens about 20 days after the security registration has been filed with the SEC.
Efficient Markets Theory
Definition
There should just be a big picture of Warren Buffett here. It should be “The Man” explaining the efficient markets theory…which states that it’s impossible to beat the market over a sustained period. It should be Buffett who explains that all relevant information comes public, in public stocks, and that the market more or less immediately incorporates that information in its pricing. Hence, nobody can ever beat the market.
So…why should Buffett be giving this little definition? Because the efficient markets theory is wrong.
Buffett has beaten the market...for decades in a row now, in every way, shape and form. So…you have a really memorable, huge figure in finance...and then pipsqueak professors who are kind of a laughingstock whenever the wealthy power crowds gather in Omaha for their national convention.
The, uh...Woodstock of Finance, if you will. Fortunately, most people keep their clothes on for this one…
Employee Stock Options
Definition
Your employer might want to sweeten your benefits package by offering you stock options—it's a way of enticing you to work for below-market levels of cash salary. If your company makes it big, it can pay off. Otherwise, it's basically just fake money.
Your employee stock options (ESOs) give you the right to buy your company stock for a specific price by a specific date. It’s similar to a regular ol' stock option, but with two big differences:
- ESOs can't usually be traded on public exchanges like other options.
- You will usually need to be an employee for a specific period of time before you can exercise your options.
Equipment Trust Certificate
Definition
Well, it’s basically an asset-backed bond…i.e. a bond that is backed by the equipment or machinery that a company owns.
When you buy this sort of bond, the idea is that, in case the company can't pay back the bond...the equipment or machinery they own can be sold to pay for it—that way, the lender doesn’t lose money.
Probably.
Think of the equipment as collateral itself. Wanna buy a turbo-charged driving lawnmower that mows dozens of acres of land into a finely landscaped golf course...because you’re bored and like to cut grass?
You can buy it for six grand down and a $14k loan against that lawnmower, such that if you ever stop making payments, Caterpillar can repossess it and sell it on eBay. Although, if they do, they, uh...probably won’t be invited to play on your course.
Equity
Definition
Equity can refer to two things:
- The amount of value you have in assets minus any debts. If you have a $200,000 house and owe $100,000 on your mortgage, you have $100,000 in equity. It's an important number if you’re trying to borrow against that amount.
- Ownership (of stock). If you own 3 shares of Acme Corporation, you have equity in the company that made the Road Runner famous. Equity means owning a sliver of the big fat pie called Corporate America.
ERISA
Definition
Employee Retirement Income Security Act.
It's a federal law that protects you if you have an employee retirement account. It doesn't mean that your boss has to provide you with an employee retirement account and it doesn't set minimums for how much you can make or invest. But if your boss does offer an employee retirement account, this law sets some ground rules.
Thanks to ERISA, your boss must provide you with some basic information about your investments and must be reasonable when making up your retirement fund. These rules also establish how long you must work before you get any benefits. Basically, the law means your boss can't legally take your money into a retirement account and then drain the cash to take off to Fiji with the hot guy from the mail room.
Estate Tax
Definition
You know how people say the two things you can't escape are death and taxes? Well, it turns out you can't escape taxes even after you die. Whatever you leave behind is taxed—heavily.
In fact, estate tax has become a political football with spikes in it. Politicians define wealth in vastly different means and manners based on the geography of their constituency. In fact, five million dollars in Des Moines, IA is probably wealth. But five million dollars in Silicon Valley barely buys you a home without asbestos in the roof. The reality is that the U.S. has no uniform wealth index, and the notion of how estates get taxed now exists as a volatile and angering discussion set, particularly when politicians suggest that anything above a million dollars should be taxed at some 70-80%; meaning that a generation's hard work scrimping and saving ends up being taken over by the government when the people who earned that money die.
Because this issue exists as such a hot-button, expect us to add all kinds of pithy notes to this glossary term as we go.
See: QPRT.
ETF (Exchange Traded Fund)
Definition
ETFs (exchange-traded funds) are a bunch of stocks in one investment that are linked to an index (like the Dow or the S&P 500).
When an ETF is set up, someone buys up stocks in the companies listed in a specific index in the same amount as the index itself. Your ETF is based on the FUN* index that's made up of stocks in ten candy and video game companies? Great, your ETF will have stocks in those ten companies. Here's where things get interesting: the thing about an ETF is that no changes are made to the fund as the index changes. Over time, some companies might fold or might be replaced on the index. Some companies might tank. No matter. Your ETF will remain pretty much true to the index on the day your fund was created—no big changes.
By the way, ETFs may look like mutual funds (they are a collection of stocks, after all) but they trade like stocks on the markets.
Index Funds vs. ETFs
One key elemental thing worth understanding is the difference between index funds and exchange traded funds.
Index funds are NAV beasts; that is, each day, an uber-bean-counter adds up the stocks and/or bonds in a fund and calculates its value. Periodically (monthly-ish), the fund manager rebalances the fund. Let's say that a company in the S&P 500 is acquired by another or goes bankrupt. Well, it has to be replaced in the index. Or let's say a stock has a monster run and gets huge—should Apple still be 16% of the QQQQ index? It depends on the original documentation of the fund and the fund manager's job is to rebalance" over time.
ETFs do pretty much the opposite. No uber bean-counter, no rebalancing. Like your uncle Dennis's comb-over, the style stays the same.
*not a real index; sorry, dudes
Eurodollar Bonds
Definition
Bonds denominated in Euros. Pretty simple. It's more of an adjective than a term.
Executor
Definition
The guy who cuts your head off if you betray the king?
In finance, the executor is your "personal representative" after you lose your head. This person pays all your remaining bills, files the papers with the courts, figures out taxes, and distributes the remaining money to the beneficiaries, typically requiring them to spend a dark and stormy night in a haunted mansion.
Exempt
Definition
If something is exempt in your finances, it means you don’t have to pay taxes on it. For example, if you have a home loan, you don’t have to pay taxes on the interest rate on your mortgage.
Exempt Security
Definition
A security that does not have to meet the registration requirements of The Securities Act of 1933.
Usually, exempt securities are backed by or insured by a government or government institution, banks or depository institutions, insurance companies authorized to do business in the state, railroads and public utilities securities, options or warrants, employee benefit plans, equipment trust certificates, and nonprofits.
The idea, generally, is that these securities are less of a risk for investors so the SEC doesn't have to get involved.
Expansion
Definition
Expansion of your waistline is one thing; expansion in the economy is...a similar thing.
During times of expansion in the economy, there's lots of spending, lots of business activity, and lots of stuff being made (including waistline-expanding food). This period of expansion usually means good things for the stock market because business is booming. After a few months or a few years of it, though, the economy slows down and contracts.
Face Amount
Definition
On a given debt security, there is a "face" or cover which has a value printed on it. Essentially, the face amount is how much the security is worth. It's how much will get paid back when the instrument matures or is "called back" prematurely.
Often, debt instruments are bought at discounts or premiums from or to the face amount.
Face Value
Definition
What's your face worth?
Guess it depends on your face.
Face value also refers to the numbers on the front of a bond, other debt-like certificate, or stock. It's also known as par value. As the actual value of the bond or stock goes up and down, you can compare it to the face value for kicks (and to figure out how the investment's doing).
FACs
Definition
Bonds for sale! Get your fresh, hot bonds here!
FACs are a guarantee a company gives to pay whatever is written on the face of the bond. It's a way to lure in investors.
Catchy.
Federal Reserve Board
Definition
The Federal Reserve board is the seven people who basically govern the entire Federal Reserve System.
Want a seat on the board? You need to get elected by the President of the U.S. and approved by the Senate. Once you do get to the board, though, you wield a lot of power. The board makes big economic decisions that affect us all. For example, they decide how much banks need to keep in reserve (that's the amount banks need to keep in cash at the federal bank to make sure they don't run out). They also decide the interest rate the Federal Reserve charges when loaning money to banks.
These kinds of decisions affect the interest rates you pay and how well the economy overall is doing.
P.S. It was created with three mandates: control inflation, enable full employment, and promote stability within the banking system.
FFBC (First Financial BanCorp)
Definition
First Financial BanCorp (FFBC) is a bank holding company, which means they control a bunch of smaller banks.
Fiduciary
Definition
The person who's in charge of taking care of assets or something else on behalf of others.
In a trust, the fiduciary manages the trust on behalf of the beneficiary, for example. They must act in the best interests of the beneficiary; they can’t grab the cash and head for the Caymans.
FIFO (First In First Out)
Definition
It sounds like Great Aunt Elmo's pet poodle, but FIFO actually means "First in First Out." It's an accounting term which refers to the method of accounting for inventory. With this method, if you have a bunch of inventory you're selling off, you'd recognize the older inventory first (or the cost of that inventory).
Example
Let's say you live in a high inflation time and you have stocked yacht bolts (they last forever) in your warehouse. The 1,000 bolts you made 10 years ago cost $2 each; the 500 bolts you made last year cost $5. FIFO accounting would have you recognize the $2 bolts first until you had sold all of them out of your warehouse, and then you'd start accounting for the cost as $5 each instead of $2. That's even if you can't tell the $5 and $2 bolts apart.
Firm Commitment
Definition
When the underwriters involved in an IPO make a firm commitment, they're saying that they are responsible for any unsold shares.
They can't just say "Oops, we missed a few." Well, they can, but it's illegal.
Fiscal Policy
Definition
Want to start a discussion around Thanksgiving dinner that will make you face-plant into the mashed potatoes? Bring up fiscal policy. Everyone has an opinion about it.
So what is it?
It's basically the plans and strategies created and used by Congress, the president, and other higher-ups to help out the economy. When the economy is tanking, there's a lot of talk about fiscal policies and what's being done to help things along.
Fixed Annuity
Definition
An annuity where the earnings on the investment are at a fixed rate. Very similar to the interest on a bond or a savings account.
If you have a retirement fund and then take the money and set up an annuity so that you have a yearly or monthly income from that money, a fixed annuity will give you no surprises: you'll get the same rate and earnings on your investment.
Fixed Coupon On A Bond
Definition
Bonds pay interest twice a year—that interest is called a "coupon" because, in the good ol' days, people would clip the coupon from the bond, mail it in, and get a check from the bondholder a few weeks later. The coupon itself is "fixed" in that if, say, a $1,000 savings bond pays 4%, it'll pay a fixed coupon amount of $20, twice a year.
Fixed Dividend
Definition
A dividend paid out on a stock that stays fixed (i.e., the same) each year. Even if the company suddenly hires a reality TV star as CEO and starts tanking, your dividend stays the same. Preferred stocks often have fixed dividends.
Flat Yield Curve
Definition
Happens in blue moons and when the cost of renting money is the same for a short period of time or a long period of time.
A normal yield curve goes... up. That is, the cost of borrowing money in the short term is cheaper than the cost of borrowing money in the long term. It's important to understand with bonds. If you're investing in bonds, a flat yield curve happens when the yield on long-term and short-term bonds is pretty much the same. When that happens, there's no point in investing for the longer term—you're not making any more money. When you see a flat yield curve on investments, it can mean that the economy's headed into a recession.
Time to pay attention and get ready to batten the hatches.
Example
You're looking at U.S. Treasury bonds and you're wondering whether to invest long-term or short-term. The three-year bond has a yield of 6%. You look at the 20-year bond. The yield is 6.2%. Uh-oh. That's a flat yield curve. Time to make sure your investments would do okay in a recession.
Floor
Definition
The lowest limit that parties in a particular transaction are willing to accept.
For example, if you set a rock-bottom interest rate or stock price on a transaction, that's the floor.
FNMA (Federal National Mortgage Association)
Definition
The Federal National Mortgage Association, a.k.a. Fannie Mae.
It's jointly owned by the government and the public, with the goal of encouraging banks to offer more mortgages. Like Freddie Mac, Fannie Mae buys mortgages, bundles them up, and sells them as investments. Fannie Mae, though, buys its mortgages mostly from commercial banks (Freddie Mac deals with the smaller fry).
So how does this make mortgages more affordable for you? It keeps cash flowing through the housing and mortgage market and reduces the risk of default (in theory) so banks are more likely to lend money to you when you want to buy a house.
Foreign Bonds
Definition
Bonds backed by foreign assets.
Forward Split
Definition
A forward split occurs when a stock splits so that the shareholders own more shares after the split than before.
A 2:1 split is an example of a forward split; your holdings double in size. If you owned 100 shares before the split, after the split, you will own 200 (each share will become two).
Just remember that the company isn't worth any more after the split. For your shares to be worth more, the pie has to grow. All that a split does is cut the same pie into more slices.
Why would a company want to forward split shares if the price isn't going to be affected? If the stock prices are high, a stock split can mean that each individual share is less expensive, so more people can afford to buy. The more people buy, the better for the company. With more people buying, there's more interest in the stock, which means more trading and a better stock price.
Win win.
Free Cash Flow
Definition
Free cash flow is the money coming in and out of a company that's not all tied up in costs related to fixed assets (like machinery and land). Basically, the cash coming in and out of a business only tells part of the story. The money that's not tied up in fixed costs is important because it shows how much of your earnings are tied up in costs. If you're earning tons but spending all of it on overhead costs, you're not coming out ahead, are you?
Example
You may be generating $100 million in earnings each month at your business, but you may be paying $10 million for leasing a factory, buying a new office, and paying for licenses for your products. The free cash flow is $90 million (your earnings minus your capital costs or expenditures).
Front End Load
Definition
See A-shares and deferred load. The term applies to mutual funds: if you buy a front-end load mutual fund, you're paying commissions up front, so the load or weight on the investment return happens at the beginning.
Initially, you're making less on your investment because part of your cash is going towards the pesky commissions, but since they're out of the way, once your investment takes off, you don't have to pay.
Fulcrum Fee
Definition
A fulcrum fee is an additional fee that's added when an adviser does well and gets a better-than-expected return. On the other side of the coin, the fulcrum fee reduces the fee the adviser would get if the adviser ends up losing a client money.
It's basically a performance-based fee for advisers that acts as a financial stick and carrot.
Full Faith And Credit
Definition
Full faith and credit is the United States' guarantee to pay all interest and principal on every bond that the government issues.
The U.S. can make this guarantee because it can tax its people more or crank up the printing presses to Warp Factor 8 and literally print money to pay everybody back. Note that there's no guarantee that the money would actually be worth anything; you're only assured that you'll get pieces of paper in full payment of the obligation.
Fully Bought Deal/Bought Deal
Definition
When an investment bank takes a company public in a bought deal or fully bought deal, they promise to buy all the shares of that IPO. (A nanosecond later, they will generally turn around and re-sell them at a mark-up to cardiologists in the mid-west who all want to buy 100 shares of whatever.com is hot.)
Fully Diluted Shares
Definition
When a company is mature, it often has more than just its primary shares outstanding.
- Employees have stock options that could convert into shares if they are exercised.
- The company may have debt that carries warrants that convert into shares if the debt isn't paid off by a given date.
- There could be business deals that carry options as part of the compensation given to the buyer.
Each of these adds to the total number of shares outstanding—usually without making the total value of the company any different. So we have a pie which then has more slices taken out of it—so the fully diluted number of shares of a given company, then, if counted, often puts a lower value per share on the total shares of the company as primary owners have been "diluted" by all of the other forms of shares converting back into primary.
Fundamental Analysis
Definition
When it's a blast doing, uh, damental analysis.
Bad puns aside, fundamental analysis is what you do when you invest in a company and look into some basic stuff to find out whether the stocks or bonds are a good deal or a bad idea. Fundamental analysis involves looking at stuff like the core business operations of the company, revenue growth, profit margins, cash flow, and other things that could affect your investment. It's very different (and at least a little more reliable) than using astrology to tell you how you should invest as an Aries or Cancer.
Funded Debt
Definition
Long-term debt, pretty much. Funded debt is a company's debt—like bonds or notes payable—that won't come due for a while (5 years or more, in some cases).
General Partner
Definition
In a DPP (Direct Participation Program) or limited partnership, a general partner makes all the operating decisions. Not because she necessarily wants to (although it's likely he does), but because it's legally required that she do so.
General partners will have some financial interest in the limited partnership, but a lot of their compensation is based on their management and investment responsibilities. General partners also have unlimited liability, in contrast to limited partners, whose liability is limited to the amount invested.
So if the limited partnership or DPP is sued, the limited partners can only be sued for a limited amount while the general partner can in theory be taken to the cleaners. Don't worry too much, though; there are plenty of extra legal protections they can put in place (and insurance they can buy) to protect them from lawsuits. The rich men and women will be just fine.
Gift Tax
Definition
Awww, those IRS people. They ruin everyone’s fun.
You can’t even give things away anymore without it being taxed. Anyone have some tea we can spill into a harbor? Boston gift tax party anyone? No? Oh, well.
So, overly simply, as of 2019, you’re allowed to gift 15 grand a year with the expectation that this number will rise a bit year after year...and on that 15 grand or less, there is no tax owed.You have to declare to the IRS people that you gifted but you don't have to write them an incremental check.
And all kinds of little tweaks to the definitions of givers and receivers have made estate transfer easier in this country. For example, a family can gift in multiple directions from multiple sources. Like, each year, Mama Bear can gift 15k to Baby Bear, then 15k to sulky Teenager Bear, then another 15k to the Elder Bear, for a total of 45k gifted from Mama Bear.
Then Daddy Bear can do the same for each kid...such that they can gift, in one year, 90 thousand dollars total in gifts with no tax. And there are other twists. Like...they aren’t limited to gifting cash. They can gift art, jewelry, mountain-vats of honey or porridge...or private stock.
So hmm, you may reasonably wonder, "How would they determine the value of private stock, or really any of the above non-actively-traded-and-valued things?" There isn’t a daily market for shares in private companies...so how does the IRS assess value?
Well, usually value is taken at whatever the last round was invested at, even if it was 5 years ago and the company has gone up a ton in value. But if it has, it’s likely the company will have been required to get a new 409a valuation, which is basically just a few high-priced lawyers assessing what the company is worth based on other, similar companies that were sold or funded recently. That is, it's the best guess of lawyers and accountants.
And the same applies to appraisals of jewelry and art and the like. So you can imagine that, if a family wanted to transfer as much as they possibly could to their kids, the impetus could involve a whole lot of downward pressure on valuations, such that the 15k that was tax-free gift-able...might really be worth something more like 20k, 30k, 50k even...were it to sell that day.
That said, private valuations carry all kinds of risk to the giftees as well. They can (and often do) die, leaving the recipient with a whole lot of Kleenex to wipe away the tears of relative poverty. Maybe discounting private things makes sense. The key is that it’s 15k of value that can be transferred.
So what happens if Mama Bear gives Baby Bear 20k in cash one year, for a top-of-the-line, Dr. Brown’s Porridge Warmer? Well, either Baby Bear can just pay income tax on the 5 grand difference and, in fact, it’s Mama Bear who would technically be legally responsible for paying that tax, but Baby Bear can do it if she wants, or she can write Mama Bear a check for 5k back. It’s the net number that the IRS cares about.
And if they find that it balances out…well, then everything is juuuuuust right.
GNMA (Government National Mortgage Association)
Definition
Government National Mortgage Association, a.k.a., Ginne Mae.
Like Freddie Mac and Fannie Mae, Ginnie Mae is a government-owned agency that's linked to the mortgage industry. Where it's different is that Ginnie Mae focuses on making housing more affordable. The agency backs bonds that are backed by mortgages and ensures that investors who have bought these bonds continue to make money—even if some folks stop making their mortgage payments.
Ginnie Mae-backed bonds are another way you can invest.
Good 'Til Canceled - GTC
Definition
When a client places an order to buy or sell a security, they set limits around the order, either with a given price or a given minimum amount or something else. There must be a time axis placed on a good order as well, e.g., "this order is binding as long as you fill it by the end of the day, or the end of the month, or until I call you and cancel it."
It’s a way in which securities’ buy and sell orders are placed. Like: “I’ll buy up to 10,000 shares of Coke at $42 a share, and this order is GTC...i.e. it’s good, or effective, until I tell you otherwise.”
Could this order sit on the books of Schwab or Fidelity or another broker for 8 months before executing? Sure could...if it isn’t canceled. Then it’s effective, and it sits around waiting for that shoulder tap to finally get on the stock conveyor belt and get on gettin’ on...uh, being sold.
And...that’s it.
Just think: the TV show, Futurama. It was good…real good...until it was canceled. And now it exists only in the pasturama.
Grantor Trust
Definition
A grantor trust is a vehicle through which rich people grant their children, well… stuff. The trick with a grantor trust is that the grantor (the one who created the trust itself) still has control over the trust; i.e. who gets what, when, and how.
The trust is then deemed to be kinda-sorta "revocable" (they can take back or reallocate a lot of the rights or establish a "must-stay-in-haunted-mansion-overnight-to-receive-funds" clause). Or worse, that the trust is then taxable to the grantor.
Why would someone set up a Grantor Trust instead of an Irrevocable Trust, which avoids taxes? Well, it might make sense if the grantor wasn't exactly Parent of the Year and their kids ended up just... not all that trustworthy or worldly. Then the Grantor Trust is sadly probably the way to go.
Gross Margin
Definition
The gross margin for a business can be calculated using this handy equation:
(Revenue – Cost of Goods Sold) ÷ Revenue
Why would you want to figure out the gross margin—and is it really that gross?
The "ew" factor probably depends on how much you like math. As for why we need to figure out the gross margin, it's a handy tool for trying to decide how much of your revenues are tied up in the costs of making the product or service you're selling. If the margin is really high, it means that the costs of making the stuff you're selling are cutting into your revenues.
Gross National Product - GNP
Definition
See: Gross Domestic Product - GDP.
High Alpha Investor
Definition
"Alpha" in investing is synonymous with "smart." If you have lotsa Alpha, then you are "smarter than the market."
So a high Alpha investor is someone who beat the market while taking low risk—i.e. not a lot of leverage, not super volatile stocks or categories, etc. It's a new-ish term in "Modern Portfolio Theory" (which is a thing, apparently), that signifies that this fund manager or mutual fund is pretty awesome, and we can quantify that awesomeness with a number. Which we call alpha.
High Octane Stock
Definition
Have you seen those silly car commercials where an actor with a super-deep voice talks about octane and horsepower? High octane stocks follow the same idea—lots of power and speed.
These are volatile stocks that people think have lots of chance for fast growth.
Vroom vroom.
High Yield
Definition
High yield bonds pay high interest—usually because they have to. These bonds are considered risky because the company linked to them isn't doing so great. They might be in huge debt or have a history of not paying up.
To attract any investors, they have to offer a better interest rate. Sometimes called "junk" bonds, high yield bonds might seem like a good deal—look at those high interest rates!—but remember that if you buy the bond and the company goes under, you lose all your cash and get nothin'.
Not such a great deal, then, eh?
Example
In a prevailing interest rate world where T-Bills are yielding around 3%, grade B bonds might yield 5% and "junk" or high yield bonds might yield 8% and much, much more... and often carry ratings of CCC or worse.
Holder
Definition
The person who owns stock options is the holder of them. It's easier to just say "owner," but finance types thought a special word was needed. As always.
Immediate Or Cancel Order - IOC
Definition
A type of securities trade order you send to a broker or brokerage when trading securities. You're basically telling them "now or never."
If the broker can't buy a million shares of Google or whatever it is right this hot minute, you don't want them to bother trying later. Good if you have zero patience or want to take advantage of the current market prices.
Incentive Stock Option - ISO
Definition
See: Stock Option. See: Non-Qualified Stock Option - NSO.
Incentive stock options are used by startups and growing companies to hire workers. These companies can't usually pony up the cash to pay a great salary. Rather than seeing the best guys go to Big Conglomerate, Inc., they offer stock options to sweeten the pot and hopefully make workers overlook the low pay. The idea is that, if the company takes off, the stock options will be worth more than just a salary, even a hefty one.
Example.
A Silicon Valley startup says "We'll pay you $45,000 a yea,r even though you're used to making $100,000. But we'll give you 300,000 ISOs (incentive stock options) at a 4-cent-a-share strike price. If we make it big, you make millions."
Worth it to you? Maybe. You can retire rich. But if the company doesn't do as well as hoped, you'll have put in years of work for lousy pay.
Income Statement
Definition
The infamous P&L or profit and loss statement.
This statement is supposed to show a company's revenues, expenses, and earnings. The idea is that it's supposed to be a clear-cut set of numbers that shows what's coming in and what's heading out. Is the company making money? Is it bleeding cash?
The reality is that accountants can do all kinds of fun accounting stuff to fudge the numbers and hide what's really going on, so those black-and-white numbers don't always tell the full story.
In cases like Enron, WorldCom, and other financial disasters, income statements are telling a mostly fictional story.
Indenture
Definition
An indenture is the paperwork behind a loan. It says that you are "indentured" (or bound and legally obligated) to pay off the loan or you lose the house or property you used as collateral for the loan.
Index Fund
Definition
See ETF vs. Index Fund.
An index fund is just a big fat basket of stocks or bonds geared to reflect a market "strategy" (i.e., whatever logic that consumers will buy). If you believed in sin doing well over time, you might try to find an index with tobacco, alcohol, gun sales, and gambling. The more generic funds are those baskets that reflect a popular index like NASDAQ or the S&P 500 or the Dow.
Here’s the composition of the Dow-Jones Industrials which are 30 big fat cap companies that are supposed to reflect the industrial strength of this country and the world (you have probably heard of a few):
3M
American Express
Apple
Boeing
Caterpillar
Chevron
Cisco
Coca-Cola
Walt Disney
EI Du Pont
Exxon Mobil
General Electric
Goldman Sachs
Home Depot
IBM
Intel
Johnson & Johnson
JP Morgan
McDonald’s
Merck
Microsoft
Nike
Pfizer
Procter & Gamble
Travelers
United Technologies
United Health
Verizon
Visa
Wal-Mart
Individual Account
Definition
An account owned by one, individual person.
If you're an introvert who likes to say "No touch, mine!" an individual account might be just right for you. It's also a great account for anyone who wants to be able to have cash in their account without worrying whether their bae has spent all the money on NFL tickets again.
Joint accounts and business accounts are not individual accounts.
Inflation
Definition
Something that old people love to talk about.
Whenever granny says "Back when I was young, a new Ford cost $1,000," she's talking about inflation, the gradual increase in prices over the years. Thanks to inflation, money drops in value, so the $20 you stow under your bed today will be worth less in five years. By the time you're old enough to complain about it, that $20 won't buy much.
But, hey, at least you'll be able to complain about it.
Inflation-Adjusted Return
Definition
See: Real Return.
The average annual wage in 1905 was a thousand dollars. But you could buy a pint of milk for a penny, a horse for 10 bucks, and a house for five grand.
While that thousand bucks a year doesn't sound like much today, on an inflation-adjusted basis, the average wage today hasn't changed all that much—the average $40,000 a year on a percentage-basis buys you about the same as what turn-of-the-last-century dollars would get you just a year before the big San Francisco quake.
So when you look at investment performance, it has to be judged against whatever inflation did during that period (highly correlated to bond rates), and you then get a real return number that hopefully means something. In the modern era, i.e., last 50 years or so, inflation has averaged, eh, about 3% a year, maybe a bit less. The S&P 500 has averaged a return, ignoring taxes, and assuming dividends reinvested, of about 9% or so. And corporate bond rates have averaged, for BBB or better, something like 5% or so...just to frame the notion for how investing can keep you ahead of the inflation Grim Reaper of poverty.
"If you don't invest, you will not be best."
Insider
Definition
Insiders are the people who are in the know when it comes to a company and its secrets. Insiders in a company include its officers and directors, large stockholders of the company, and anyone else who would be in possession of important information that the average person doesn't have. Insiders also include immediate family members of all the above.
The important thing about insiders is that they have access to insider information, and if you somehow overhear or learn of this information, you have to be really careful not to use it in trading or you could end up in a legal mess—or in jail.
Insiders themselves have to obey a bunch of rules to make sure they don't use the knowledge they have to gain a trading advantage.
Insider Trading Act Of 1988
Definition
Everyone knows that if you make a huge bet on a roulette wheel, and it happens to stop at the exact moment it hits your number, well, you're probably cheating. And for a long time, everyone knew that people who had important information or "insider info" would probably be the first people to put their fingers into the proverbial roulette wheel to their own profit.
Well, that got out of hand.
The stakes became silly, making it to where any Joe Shmoe who happened to work in the right office building could suddenly own their own island nation if they made the right trade at the right time using insider information.
This act turned the previous slap-on-the-wrist into an orange jump-suit.
Insider Trading And Securities Fraud Enforcement Act Of 1988
Definition
The Securities and Exchange Act of 1934 (the '34 Act) made it illegal to use inside information to trade stocks. Since people could make a lot of money with insider information and thought they wouldn't get caught (who's going to know I overhead the CEO of Big Company talking about a merger in a Denny's washroom?), some folks pretty much ignored the law.
The 1988 law was basically Congress saying, "We're really serious about this." The 1988 legislation added some hefty penalties if you get caught.
People still trade on insider information though, so... yeah.
Interest Coverage
Definition
If a company borrows money, how easily can it pay the interest on the loans?
To answer that question, you have to figure out the interest coverage, which means using this handy equation:
Earnings Before Interest Taxes / Annual Interest Expense
If you're investing in a company, you want the number to be high, which would mean the company can handle its interest payments easily.
Interest Rate Options
Definition
You can go to one of the exchanges in the U.S. and buy interest rate options. Offered on T-notes, T-bonds, and other interest rate instruments, these options let you make money if interest rates go up or down.
Internal Rate Of Return (IRR)
Definition
IRR refers to the growth rate of capital invested in a given project.
Example
Let's say we go into the emu farming business. (Emu = big fat angry stupid ostrich that knows what it did and should respect our restraining order). If we buy 100 acres and 200 emu for $5 million, we believe we'll generate $1 million a year for 20 years. That's a big payback or a high IRR for this initial $5 million investment.
But it will never forgive their unjustified behavior. Shameful.
Interstate Offering
Definition
When companies issue an offering of stocks or securities, they can sell shares in their state or in more than one state. If they choose door #2, it's an interstate offering and it will mean more paperwork. The company will need to register with every state and with the SEC.
Intrinsic Value (of An Option)
Definition
Intrinsic value of an option is the difference between the strike price and the value of the stock involved. So if you have a call option for Google stock with a strike price of $200 but Google is trading at $250, the intrinsic value is $50.
Inverse Correlation
Definition
You go up, I go down. You go left, I go right. You go jazz, I go heavy-metal.
This term means that any given variables are at odds. If the price of leather pants goes down when cows get fat, the two variables (price of leather pants and size of cows) are inversely correlated.
Inverse Head-and-Shoulder-Chart
Definition
A chart that looks like shoulders and a head upside down... if you squint really hard or have had too many martinis at the company lunch.
When the chart is showing sales, company earnings, or stock market prices, a chart of this shape shows that a downward trend has reversed:
The first upside down shoulder shows a drop, then prices or sales go up. Then there's a huge drop followed by an increase (that's the head) and then a smaller drop followed by an increase (that's the second shoulder).
The idea is that this is the time to breathe a sigh of relief that the downturn is getting better.
Investment Adviser
Definition
An investment adviser is any person who takes your money to give you investment advice or who handles securities analysis. Anyone who promises or advertises themselves as offering investment advice for money is also an investment adviser... even if they're terrible at it.
Investment Adviser Representative
Definition
An investment adviser representative is someone who works for or is linked to an investment advisor. The fine folks who brought you the Uniform Securities Act also have this technical explanation of what an investment adviser representative does:
- Makes any recommendations or otherwise gives investment advice regarding securities
- Manages accounts or portfolios of clients
- Determines which recommendation or advice regarding securities should be given
- Provides investment advice or holds herself or himself out as providing investment advice
- Receives compensation to solicit, offer, or negotiate for the sale of or for selling investment advice
- Supervises employees who perform any of the foregoing
Investment Advisers Act Of 1940
Definition
The federal law that decides what investment advisers can and can't do (spoiler alert: they can't legally take your money and spend it all on their car collection). The Securities and Exchange Commission (SEC) enforces this law and resolves any issues about what it actually means.
Investment Bankers
Definition
Investment bankers help companies raise money, sell used companies, and offer money and merger advice to companies. These peeps have cushy, well-paid jobs... in case you were looking for career advice.
Investment Contract
Definition
The Uniform Securities Act and the Federal Securities Act of 1933 decided that the word "security" wasn't enough, so they created this word, which means the same thing.
Investment Fund
Definition
A "pool of assets" which were bought or invested in. They exist in a legal form called—yes, you guessed it—a fund. These funds are what investment-bankers create, mutual-fund managers obsess over, and everyone else squints at while muttering nonsense about "the Dow" in an effort to appear intelligent.
Investment Grade
Definition
Ratings agencies like Moody's think teachers shouldn't have all the fun—so they grade bonds. The higher the grade, the better the bond is doing and the more likely you are to make money.
According to the S&P system, bonds with grades of BBB or higher are investment grade, which means your investments might make you money. Anything below that means the bonds haven't done their homework and are maybe playing hooky.
Investment Objective
Definition
Well, we all wanna make money, right? Duh.
That's everyone's overall investment objective, but scratch a little further, and you'll find that everyone's investment goal or objective is a little different. Some people want to make lots of money fast because retirement is right around the corner. Some people want to make money slow because they don't feel comfortable with risk. Some folks want to make money, sure, but want to invest only in ethical companies.
It's a registered adviser's job to figure out how much someone wants to make and how they want to make money with investments. Knowing this stuff helps the adviser choose the right options for their client.
IRA (Individual Retirement Account)
Definition
Individual Retirement Accounts (IRAs) are accounts you can pay into now so that your money can grow. By the time you’re having senior moments, this money is supposed to be there for you so that you can pay for stuff.
There are two types of IRAs: Roth IRAs and traditional accounts. The big difference is how you pay taxes on your money.
- With a traditional IRA, you don’t have to pay taxes on the money you put in now, but you are taxed later on when you withdraw money from the account.
- The Roth IRA means you don’t get tax breaks now, but when you’re old and grey and need the money, you won’t generally have to pay taxes on the money you withdraw.
The IRS gets a chunk of your cash either way, but you get to decide when you pay up.
Irrevocable Trust
Definition
When rich people want to pass on their assets to their heirs without having both the grim reaper and taxes take away all of their hard earned dough, they usually set up an irrevocable trust.
Basically, a legal account is set up so that rich parents contribute money to it under various tax-avoiding rules like "no more than $24,000 per kid per parent per year" and "no more than $10 million total" and so on.
That trust is then irrevocable—that is, it can only be given away to the kid. It can't be taken back if the kid turns out to be a total loser or marries an entire of commune of goat-people.
Serious. Business.
Issuer
Definition
The company behind the stock or bond. Also, the company that gets the money by selling its stock or shares.
Example
IBM wants to raise debt to buy a competitor. It issues bonds—and it is the issuer who is on the hook to pay it back. Facebook wants to raise money to further suck away the time of middle-aged people everywhere? Facebook sells shares of its stock: it is the issuer of that stock.
Joint Account
Definition
A bank account or credit card account owned by two or more people.
Example
Mary Kate and Ashley are sisters with a joint checking account. They each put in $500 each month. They are both responsible for the account. If in March, Ashley doesn’t put in $500 and writes a check for $1,000 on the account when the account only has $900, Mary Kate is equally responsible for the charges of the bounced check. If Ashley skips town, the bank will make Mary Kate pay up.
Joint Tenants With Right Of Survivorship
Definition
The JTWROS account is a brokerage account where the other account holder automatically gets everything in the account when the other account-holder dies.
Here's a hint: If you married someone significantly more attractive than you and twenty years younger, don't get this brokerage account.
Jumbo (Negotiable) CDs
Definition
"Jumbo" meaning that the minimum amount for this certificate of deposit (a very safe government backed bond) is a hundred grand.
Junior Obligation Bond
Definition
If push comes to shove and a company goes bottom-up, the company issuing bonds will pay the "senior bondholders" before the "junior bondholders."
Keynes
Definition
Through the 1960s, British economist John Maynard Keynes was popular with economists. Today? He's lost some fans.
In his book, General Theory of Employment, Interest and Money (1936), Keynes wrote that the Depression was caused by a huge decline in total economic spending (he called this total spending in the economy "aggregate demand"). Keynes also wrote that once employment dropped, a new balance with low employment was created and the Depression might continue on and on unless the government started spending.
According to Keynes, the big solution was to have the government spend and spend to get things moving economically—even if it meant the government got into debt. This went against the ideas that economists had before, i.e. that the economy would eventually correct itself, no interference needed.
Not everyone likes Keynes' ideas, but President Roosevelt and the rest of the administration eventually did create the New Deal, which took on a broadly Keynesian quality, characterized by major and unprecedented government interventions into the economy. Keynesian ideas went on to dominate academic and government thinking about political economy through the 1960s.
Lagging Indicator
Definition
Lagging economic indicators include consumer inflation for services (as measured by the CPI), the cost of labor, the length of employment (specifically, the measure includes the inverse of the average length of employment), the average prime interest rate that banks are charging, the total value of industrial and commercial loans, the size of consumer credit (as compared to personal income) and the ratio of inventories to sales.
OK, back up. Here’s the economy: Kind of a roller coasters ups and downs but generally goes up, over time, anyway. More people. More demand for toothpicks. More bed sheets. More hair growth formula. More buyers of a one-bedroom with a view of another one-bedroom with a view of...whatever.
Wall Streety people and economists, yeah, those guys, are always trying to figure out where we are in these roller coaster cycle ups n’ downs. Are we here? Are we here? Are we here?
Yeah, very Carmen SanDiego.
So a leading indicator is basically the canary in the mineshaft and if you don't know the term PETA stopped this. But it used to be that miners would bring canaries with them into mine shafts because canaries are, if they live to tell the tale, extremely sensitive to gas. Uh, different gas.
And when there would be any kind of harmful leak, like from gas lanterns, or from diesel engines, or from fissures in the earth, the canary would die, or at least stop singing. And then the miners would skedaddle it out of there.
So the canary was the leading indicator of a deadly gas leak and miners would follow it.
Investors are always anxious to figure out what leading indicators are saying about where the economy is going. Investors kind of live two quarters into the future... and if they believe we’ll have a meaningful slowdown in the economy, they’ll usually begin selling well ahead of then.
That is, the economy, or belief in economic growth, is a leading indicator - often of where the broader stock market is heading. One famous canary no longer really in use are help wanted lines in the newspaper. And yes, once upon a time, those things were on paper, way before the founders of Glassdoor, Indeed and the others were even invented.
So help wanted lines were a leading indicator. If they were shrinking, the economy was likely to be softening as demand for incremental new hires was dissipating; And it went the other way too.
Today, we look more often at things like bond yields - albeit with skepticism, because the Fed can raise and lower bond rates for a variety of reasons -- defending the dollar internationally - like, they’d raise rates to do that…
Or with political back pressure, they might lower them to give the stock markets a chance to waft upwards. Lower rates mean lower bond yields, thus making things like equity dividends a much more attractive means of raising cash to pay the rent.
New housing starts are another big leading indicator - volatile space - but if the smart people of the world are greenlighting loans for builders to build new homes, then a whole lot of people believe that the demand will be there for those homes a year or two later.
Ok so those are leading indicators.
What are lagging ones? And why would we even care about a lagging indicator?
Like a lagging indicator of your death is worms eating your body. And you, really just not caring. Well, lagging indicators really serve as a truth telling mechanism to see if we got our leading indicators right.
That is, a lagging indicator might tell us that we’ve just finished a big economic boom, and are really 5 quarters into a sort of soft recession, as we see declines in profits from gate fees at Disneyland and Disney world and we might see unemployment rates going up at an active clip, and we might see interest rates following, with the gov hoping to stimulate economic activity again.
All of these indicators, however, only exist in a weird kind of vacuum, because so many cities and even states have their own ecosystem, economically speaking. The planet called Silicon Valley over the last couple of decades, has generally grown like a bamboo shoot on hot sweaty days, with only blips of economic cyclicality.
Other areas, like Detroit, can’t seem to grow no matter how much stimulus the Feds apply.
The key takeaway, as with any economic indicator, is that real investor-type Wall Street people really don’t care all that much about what the economy is doing when they put money to work for their clients, and after all those economists with PhDs need at least something to do with their time.
Lead Manager
Definition
The lead underwriter in an IPO. If a company wants to start selling stocks to the public, it needs underwriters to handle all the details. Sometimes, a bunch of underwriters work together in what is known as a syndicate. The head honcho of a syndicate or group of underwriters is the lead manager.
Usually, the lead manager is a bank or underwriting firm rather than one person.
Leading Indicators
Definition
You know when you walk up to a food cart selling egg-salad sandwiches and there's a dead squirrel nearby and the owner keeps swatting at flies? Those are all "leading indicators" that you'll get food poisoning.
The same goes in the world of finance. If there was some "measurable economic factor" that is currently happening, it probably has something to do with the market's current movement.
Level Load
Definition
"Hey guys, we gotta pay someone to tell people this fund exists, or we won't sell any shares."
Level load is a fancy term meaning "the cut of the profit in each transaction that goes to the salesman." Also called a "12b-1 fee," it's where none of the brokers or salespeople make a big up-front commission, but instead opt to get a little bit of the net-asset-value each year in exchange for their attention and advisory.
On the upside? Your broker isn't bouncing you around to this mutual fund or that mutual fund to get a commission. On the downside? They may not be bouncing you around enough to make the kind of investment returns you wanted.
"Level load" basically means that you know you'll be paying X% a year for the fund advice.
Liabilities
Definition
The boring technical definition: A liability is the future sacrifices of economic benefit that the entity is obliged to make to other entities as a result of past transactions or other past events, the settlement of which may result in the transfer or use of assets. A liability is legally defined by the following characteristics:
Any type of borrowing from persons or banks for improving a business or personal income that is payable during short or long time;
A duty or responsibility to others that entails settlement by future transfer or use of assets, provision of services, or other transaction yielding an economic benefit, at a specified or determinable date, on occurrence of a specified event, or on demand;
A duty or responsibility that obligates the entity to another, leaving it little or no discretion to avoid settlement; and,
A transaction or event obligating the entity that has already occurred
OK, but more Shmoopily fun...What is a liability? It's what you owe.
You bought 4 million gumballs on credit for your party pack for the parade; the money is owed to Gumballs 'R' Us in 90 days.
Short-term liability. Next...
You borrowed 83 million dollars to set up your new Dental Drive-thru service, due in 12 years at 7% interest a year.
Long-term liability.
Why long-term? Because it comes due in over a year. And that’s basically it. Liability comes in two flavors - short and long-term and it’s one of the key elements of the balance sheet, as it lives in this space riiiight over here…
So yeah, that’s liability.
Now, considering how many gumballs you’ve consumed in the past month, you really should get yourself to a good drive-thru dentist...
LIBOR
Definition
London Interbank Borrowing. LIBOR is the "best" interest rate in Britain. It's the interest rate that the safest customers get when they borrow money from British banks. And the rest of the world's banks peg their rates (with lube) after the Brits' LIBOR rates.
And no, it’s not the result of a lion mating with a bore. Or any other semi-rodenty thing. Write this down: LIBOR stands for
London
Inter
Bank
Offering
Rate
It is basically just the British “Fed” rate, reflecting the absolute lowest interest rate at which the British banking system will loan money to its best, most well-heeled customers. Like Sainsbury’s, BP, Barclays, and the guy who plans Royal weddings. So LIBOR is the best or cheapest rate at which the British banking system will lend money.
Most loans come at some premium to LIBOR - i.e. riskier loans might come at something like LIBOR plus 50 basis points or something like that. So that if LIBOR is currently quoted at 2.25 percent, then the LIBOR plus 50 loan is loaned out at 2.75 percent.
And that’s basically it. No need for any wild animals to get...wild.
Life Insurance
Definition
Life insurance is kind of a weird term, especially considering that the entire "life insurance" industry is regulated differently from other investment, corporate, or religious entities.
Life insurance "policies" were originally created to protect the soon-to-be-widowed wives of professional loggers and lumberjacks. Members of a fraternity of lumberjacks would pay a couple cents out of their dollar to a pool, knowing that if they were crushed by a log tomorrow, their family would get a check from the fraternity for something. Something > nothing.
Check out our section on life insurance for all the details.
LIFO - Last In, First Out
Definition
See: FIFO, First In, First Out. Then multiply by negative one.
Limit Order
Definition
You want to sell 1,000 shares of Colonel Electric. It was demoted after they cut their dividends.
The shares have been trading wildly between $15 and $25 a share. You don’t want to feel like a moron for having sold them at $15, when six weeks later they kiss $25. With tongue.
So what do you do? You put in a limit order.
That is, you put a limit of a minimum price of $25/share for Colonel Electric, such that those shares will simply sit in your account, maybe forever, until somebody out in the wild blue yonder of Stockland is willing to pay $25 or more for the shares where you have put a minimum price limit of $25/share in your order.
So here’s to hoping they sell, and don’t get further demoted. Sergeant Electric is just a place you don’t want to go.
Limited Liability
Definition
Liability means that your butt is legally on the line in case of a lawsuit. If you own a business, creating a corporation from that business (also known as "incorporating") means that you become a limited liability company; your assets (and the assets of any company owners) are separate from the assets of the company.
If somebody sues the company, they can't gun for your house, retirement fund, or personal assets, in most cases.
Example
You own a spa business and run it out of your house. One day, blue-haired Mrs. Smith slips on freesia massage oil in the lobby and breaks her arm. Her son is a lawyer and sues your business. If you’re not a limited liability, the lawsuit can try to get your house, dog, retirement fund, car, and everything you're worth. If your business is a limited liability legal structure, sonny is out of luck: he and his mom can only go after your business assets and the insurance money used to insure your business.
Limited Liability Company - LLC
Definition
LLC: Limited Liability Company, or LUHLC, as professionals in the business pronounce it. Why do you want one? Because limiting liability is a good thing if you are the one potentially liable for that stooge who slips on a banana peel in your lobby waiting area, and then sues you. And wins.
If you start building your own company as an individual, and not as an LLC, and you get sued for whatever, and you lose, you could lose everything you own. That is, the lawyers will come after your house, your car, your poodle, your signed Mila Kunis photograph collection. And legally, they will be entitled to take all of it.
If you have existed under the legal structure of an LLC, however, the most you can be liable for is the assets of the business itself. Yes, they’ll take the company computer, the remaining 17 months of lease on the company building, and all your staplers and Post-It's but legally, they won’t be able to go after your home, your car, your poodle or your autograph collection. Mila is safe. Phew.
So LLCs are a good thing. They cost only a few hundred bucks to set up these days. So before you start up a lava lamp company of your own, think about setting one up first. Mila and your poodle, Gregory will thank you for it.
Limited Partnership - LP
Definition
A limited partnership is not the qualitative assessment of Moe, Larry and or Curly. Woop. Woop. And yes, woop.
Rather, a limited partnership is an investment company run by a general partner with clear lines of demarcation as it relates to risk, fiduciary duty, and management responsibilities.
When you think Limited Partnership, think: things like a Venture Capital partnership. Like one where you have half a dozen experts who come together with long track records of identifying early stage growth companies usually deep in technology….
Together, they are the general partners of the partnership. The generals. They are responsible for the day to day management of the firm and in theory, have unlimited personal liability should something go terribly wrong
The limited partners are their investors. The people who give them money to make more money. General partners raise money for their funds by getting Limited Partners to invest in them. So what is limited about it? Well, the liability to the investors.
As long as those investing in the limited liability partnership don't operate the firm or manage it or deal with day to day issues that come up. Then those limited partners are fully shielded from any liability should uh, something go terribly terribly wrong, although if you're a limited partner in a company that's designed a nuclear-powered blender that spins just a little too fast, we're not sure how much that'll be worth in the grand scheme.
Liquid Market
Definition
A market where there are lots of buyers and sellers so investors can cash their investments in quickly.
Currency markets (especially the U.S. currency and Euro markets) are very liquid. If you have a pile of one currency, it's super easy and fast to convert it into a different currency. Fortune 500 company stocks would also be a liquid market because there are usually lots of buyers for that kind of stock. If you wanted to, you could sell your stocks quickly and have cash in hand.
Liquidity Preference Multiples
Definition
This is a common term in venture capital funding of start-ups. When an investor first funds the company, they typically get their preferred stock first—ahead of when the common shareholder would get his stock.
But often in deals where the founder wants a much higher valuation than the venture capitalist wants to pay because he thinks his company will be worth billions… then the founder offers a liquidity preference multiple; that is, the venture capitalist who put in $3 million at funding, gets a 3x liquidity preference or $9 million back before the founder who owns common shares gets a dime.
So basically, the person who invested the most gets preference.
Liquidity Preferences
Definition
This is a common term in venture capital funding of start-ups. When an investor first funds the company, they typically get their preferred stock first—ahead of when the common shareholder would get his stock. There are other forms of liquidity preferences—i.e., rights that inure to the investor over the investee—like various provisions that would force the founder to sell his company should a certain price be hit within a given time window.
It also involves (we know, we know, lots of definitions, but people use this term in different ways in different settings) the idea that investors prefer securities which are more easily turned into quick cash. So if something has a longer maturity date (like a long term bond or other thing where the money is tied up for a while), then they'll want some sort of extra benefit or premium for tying their money up for so long.
Macroeconomics
Definition
The study of economics from the perspective of the window of a jet at 37,000 feet.
Macroeconomics looks at the behavior of entire societies, in contrast to microeconomics, which focuses on individual households, individual firms, and presumably bacteria.
The key concepts of macroeconomics are aggregate demand and aggregate supply.
Maloney Act
Definition
This law was passed in 1935 and it allowed some self-regulatory organizations to help the SEC is regulating the big, bad financial world and OTC market. It's the law that gave FINRA its powers. Before this law, there was no self-policing allowed.
Margin
Definition
See margin debt. You're borrowing from your broker to invest money. The margin refers to the amount of money you have to pony up so that the broker pays up the rest.
Example
If Schwab is offering up to 50% margin and you opened an account with them for $100,000, you can buy up to $200,000 worth of securities. Your $100,000 would represent 50% of the purchase price of $200,000 in stock.
Margin Accounts
Definition
Brokerage accounts structured such that the owner of an account can pledge as collateral investments they hold in the account in order to borrow money "from themselves" for a modest fee, payable to the brokerage.
Markdowns
Definition
In stock sales, retail markets, and pretty much anything you can buy, somebody bought it before you did and paid... $X. Then they stuck a price tag on it that said something like $2X or $5X or $10,001X and sold it to you at a profit. They "marked up" the price they originally paid.
A markdown is the opposite, where a retailer says "no one's buying this stinky fish at this price, and I've got to get rid of it now or never, so I'll mark the price down until someone bites."
It also refers to the amount taken away from the final price of a security when it's sold to a dealer on the over-the-counter market. It's most often seen in the municipal bonds market, when no one wants to buy the stinky-fish debt of a random small town.
C'mon people, this bond isn't that bad. And it's on the cheap! Look at that markdown.
Market Maker
Definition
Let's say you have a certain stock and you want to sell. You call your broker, but he's got some bad news: "No one's buying thiscomapnysucks.com right now. I don't know why. Sorry."
What do you do? You need a market maker. This institution or individual buys and sells shares of a certain company or industry in order to literally create a market for guys like you—people who want to buy and sell. He accepts a lot of risk, but since he's creating the market, he also gets to name his price. Market makers can also charge commissions.
Example
Some guy at the NYSE put up a few million dollars of his own money to buy and sell shares of GM. He has various rules he must follow, and as long as he is a good boy, he can offer GM at $34.12 (where he is a seller) and bid for GM at $34.02 where he is a buyer—and live off of the dime per share spread. He'll need a lot of dimes to pay his bills.
Market Manipulation
Definition
Manipulating a market is a nasty thing to do—and it's is illegal to boot in the United States.
There are a lot of different schemes. A popular one is to deflate the price of a stock by making lots of sales at below market value. That makes it look like lots of investors are getting rid of their stock, which might make some investors think the stock is about to tank. They sell their stock, pushing the value of the stock down for realsies.
Another common method of manipulating the market is to buy and sell lots of stock at matching prices. So sell a bunch of stock for $50 a share and then buy it for $50 a share. Repeat over and over. The idea is to make it look like lots of people are snapping up the stock and there's a lot of interest, which can push the price up.
Market Order
Definition
When you have a broker and are buying or trading shares, you get to order them around or give them instructions about what and when to buy (and sell).
There are different flavors of orders. A market order means you're asking your broker to buy a certain amount of a certain security at the current market price. The idea is that the broker is expected to buy or sell now, but the trick is that some securities will go up and down in price a lot, so the price you think you're selling for might not end up being the price the broker can get for you.
Example
Ellen calls her broker and says, "Gimme 1,000 shares of Coke at market." The broker looks at her screen and says, "Okay, KO is trading at $68.42." That's how much Ellen pays per share.
Market Risk
Definition
There are lots of risks when you invest money; two of the most common categories of risk are
- unsystematic risk
- systematic risk (also known as market risk)
Unsystematic risk refers to risks linked to a specific stock or security. So you buy stocks in your dad's ice cream company, and the company goes bankrupt (who knew pork rind ice cream would prove so unpopular?). That's unsystematic risk, and you can help reduce some of your risk by diversifying your investments and at least investing in some companies that are likely to do well.
Market risk affects a whole market, and it happens because of things like terrorist attacks, natural disasters, political upheaval, and zombie apocalypses. There's no real way to protect yourself against market risk.
Just take your vitamins and hope you don't get bitten by the walking dead, we guess.
Market Valuation
Definition
A given company has a set number of shares outstanding at any one time. Multiply that number by the price of each share, and you have the market valuation.
Example
Shmapple has a billion shares outstanding and its stock trades for $104.32 this moment. That makes the market valuation of Shmapple $104.32 billion. It's the value that the market's assessment puts on the company as a whole by offering to buy or sell shares in the company at that given price.
Markups
Definition
In stock sales, retail markets, and pretty much anything you can buy, somebody bought it before you did and paid $X. Then they stuck a price tag on it that said something like $2X or $5X or $10,001x and sold it to you at a profit. They "marked up" the price they originally paid. It's called Capitalism. And I've heard it has "invisible hands," so let's keep that in mind when you get pinched inappropriately. It wasn't me, I swear.
Matched Purchases
Definition
A scam that can get you in a lot of hot water—if you're caught.
This scheme requires at least two people: one of you sells a stock or security at an agreed-upon price, and the other buys at an agreed-upon price. Then you switch, so that the stock exchanges hands between you—again and again. Lots of trading happens but no one loses money.
The goal is to make other investors (those suckers) think that there's lots of interest in a stock, which will hopefully cause people to buy. That in turn drives the price up, and in the end, you and your co-schemer have stock that's worth more. You can then sell the stock for real to someone else at the inflated price and keep the profit.
You can also go to jail, so choose wisely.
Maturity
Definition
What you gain with age (and something that seems to have eluded us here at Shmoop).
Also, the date when a debt becomes due for paying up.
Example
You buy a $1,000 bond with a maturity date of May 5. You’re basically buying a little bit of a company's debt. So what happens on May 5? That's the date you’ll get your 1G back—and you’ll have the interest you've earned on the bond, too.
Mean
Definition
The opposite of nice.
In finance, it's basically a fancy word for "average."
Median
Definition
Here's a series of numbers: 2, 3, 5, 5, 5, 7, 7, 8.
The median is 5.
Why? Click here.
Minimum Net Capital
Definition
The concept refers to leverage, meaning you can't borrow the moon (any more).
A given brokerage might have a minimum net capital rule of 40%; that is, if you have $1 million in stocks and bonds in that account, you can borrow up to $600,000. Your minimum net capital would then be $400,000 or 40%. The law exists to avoid that little thing that happened in the 20s with the stock market.
Misappropriation
Definition
Misappropriation can have multiple meanings, but in finance, it usually means that client funds are used in an unauthorized or inappropriate way.
Example
If you give your money to a brokerage firm and a broker at the firm uses the cash to buy a condo for his girlfriend, that is misappropriation. According to FINRA Rule 3070, if the brokerage gets wind of the problem, they must report the issue and take action.
Mode
Definition
This video says it all. Check it out:
Modern Portfolio Theory - MPT
Definition
Back in the ancient 1950s, Harry Markowitz created this theory to create an investment portfolio or investment system for folks who were nervous about risk.
The highlights? Diversification is good. (And some risk is needed to reap the rewards.) Balancing risk with proper diversification and tracking the results is good stuff. See: Portfolio.
Key Concept: Diversification. Is. Good. Dig it.
That’s modern. Like when Unk and Nuh-uh invested from their cave, they just invested in good rocks or spears and really didn’t worry about much else. Math hadn’t really been invented yet, so…like who knew the diff?
Then, in 1952, along came Harry Markowitz, who tried to science and math the crap out of the stock market.
What he came up with was modern portfolio theory, which basically said that there was a smarter way to invest than just, uh...putting your life savings into Blockbuster because you...like the logo. Using all sorts of advanced metrics that we won’t torture you with here, the theory he devised was that rather than throwing your money against a wall to see what sticks you could use extensive, elaborate data to determine the best way to maximize your returns, depending on how much risk you were willing to, uh… risk.
In general, MPT skews toward less risky investments in general. But it all comes down to risk/reward in the end. If, for whatever reason, you feel supremely confident that Radio Shack is about to make a massive comeback you might be able to justify taking more risk.
But, to be clear: Radio Shack was just a bad example. So, don’t try this at home.
Monetary Policy
Definition
By serving as an intermediary bank, setting reserve requirements, and making short-term loans to banks, the Fed plays a crucial role in overseeing the nation's banks and money supply. Our checks (a huge part of our money supply) are efficiently processed, banks are prevented from lending more of our money than is safe, and banks are provided assistance in meeting the federal regulations that ensure a stable and safe financial system. But the Fed also uses some of these same tools to more generally influence the performance of the economy. By adjusting the discount rate and reserve requirement, the Fed can make adjustments in the nation's money supply during periods of recession and inflation.
Money Laundering
Definition
It seems innocent enough: You toss your favorite jeans in the wash and don’t check the pockets. The $5 you had in there after lunch comes out clean and a little crumpled. No harm, no foul.
But that’s not the sort of money laundering the government is worried about. Money laundering means trying to hide money you make illegally by cooking the books, setting up fake businesses, and basically committing a bunch of fraud. The idea is that you create fake companies, fake accounts, or fake customers, so it looks like the money is coming from a legal business when it’s really coming from shady deals.
If you’ve seen Breaking Bad, you know that Walter White got into some seriously shady stuff—including money laundering. He created businesses and even hired an attorney (we're looking at you, Saul) to help him hide where the money was coming from. It's no meth cooking, but... not great.
Money Market
Definition
The money market is an odd name for short term bond paper. Many people want to park money for just a few months or so; as a result there is always huge demand for short term money which is relatively safe and highly liquid. It's called "money market" because it was sold as being the same as your checking account—money in the bank.
Money markets are insured by the FDIC (the Federal Deposit Insurance Corporation) and have low interest rates.
Moody's
Definition
One of the big three agencies that rates securities.
Want to buy Star Wars Corporation stock and are wondering whether it’s a good deal? The idea is that Moody’s has done all the boring research for you and lets you know whether the security is a high risk or a good risk.
The problem? Back in the 2000s, some people accused Moody’s and the other big agencies of giving everyone a passing grade. That led to the Credit Rating Agency Reform Act of 2006.
Mortgage Bond
Definition
You own a few apartment buildings. They carry mortgages on their own. One day, you decide to merge those mortgages into one piece of debt, using the apartment buildings as collateral—that merged big fat debt is a mortgage bond.
MSRB
Definition
The Municipal Securities Rulemaking Board.
It's where muni bonds go to be governed. Most of the MSRB's activities revolve around proper disclosure of risks, venues in which muni bonds can be properly sold, and various tax allocations for investors.
Very complicated and serious. No smiling allowed.
Municipal Bond
Definition
A bond issued by a municipality.
That's it.
Cities use them to raise money for parking facilities, water treatment, streets, and so on. Muni bonds are often backed by the assets they are being used to fund. They're a nice little thing to invest in, especially since they're exempt from federal taxes.
Mutual Funds
Definition
A mutual fund is a collection of stocks and/or bonds which are professionally managed for the benefit of investors in them.
Mutual funds exist because individual investors generally have neither enough money nor experience to properly diversify a portfolio. 12 shares of Coca Cola, 18 shares of Disney, 32 shares of GE, etc. are very expensive to buy individually. A professional money manager aggregates lots of small buyers into a big fat pot of money, which then effectively gets "volume discounts" for the purchases and sales of shares.
Mutual funds are usually sold with a "load," which is a fancy term for sales charge, along with a fee for managing the fund. There is a fabulous myth marketed aggressively to retail buyers that consumers get a great deal on "no load" funds. Traditionally, mutual funds were sold through brokers who charged between 1.5 and 7% commission, depending on the size of the purchase and the perceived "quality" or track record of the fund. Mutual funds were in the business of managing money, not selling it, so they were happy with their roles as buyers and sellers of stocks and bonds and they let brokers broker.
Then brokers got into the mutual fund business for a variety of reasons, mainly because they thought they could make money doing it. But there was a hole in the market because many mutual funds underperformed indexes—in theory, more than half anyway—and brokers felt they had leverage.
Mutual funds fought back. Think: Star Wars with finance geeks in glasses fighting with pens—and began to broker their own funds. Fidelity was the most successful of funds becoming "supermarkets" of financial services. Schwab was the most successful broker who went into the funds businesses and/or wholesaled other funds.
And through another lens:
What are mutual funds? Half a century and change ago, a bunch of investors wanted to mutually pool their assets to make investments together. They mutually agreed to abide by a relatively simple set of rules and then gather funds to go invest.
Why would they do this? Scale. You’ve heard of the notion that you get a discount when you buy in volume or bulk, right? If not, check these guys out. 84 pounds of dog food for 5 bucks. Even Fido can appreciate a good deal when he sees it.
Dog food discounts we get but why would anyone need to buy in bulk when investing in stocks and bonds? Because back in The Day, the only way investors could invest in the stock market was to buy an individual stock directly. Same deal with a bond.
A typical stock might sell for 40 bucks a share. The problem was that if an investor didn’t buy a round “lot” of these shares, she was charged a massive commission - almost like a penalty for not being rich enough to buy a Costco-type portion of shares.
A round lot is any order that comes in blocks of 100 shares, i.e., 200 shares is a round lot; 500 shares is a round lot; 738 shares is not a round lot. Some high-level calculus there. A typical round lot commission might be 5 per cent, an odd lot commission might be 15 per cent, so it made it even harder for the small buyer to get invested in the markets.
Illustrative example time.On a purchase of 100 shares at $40, that’s 4 grand. That’s even a lot of money today. But think about what 4 grand bought you in 1952. More than a few hula hoops and poodle skirts. Inflation adjusted, it’s almost 40 grand today.
It bought a home. A super nice one.
And yes, this. So how is the Average Josefina able to plunk down 40 grand to buy just one stock? She’s not.
You know your grandma Goose’s catch phrase, right? Well the same applies to investing. 4 grand could be a life’s savings and if a simple ‘retail’ investor put all of her money in one stock and that stock tanked, then she was SOL, or sweetly out of luck.
So mutual funds allowed that little guy investor with very small amounts of money and for most it was a minimum of about $250, which still applies today, to pool his money with thousands of other investors and get exposure to a basket of stocks.
The fancy $5 word is ‘diversification’ and when assets are pooled, that 4 grand of mutual fund ownership might look something like this:
If a thousand investors each put 4 grand, on average, into an investment pot, that gives them 4 million dollars of buying power and allows them easy access or liquidity to have their 4 grand invested in a wide range of stocks and bonds, in whatever form they want. And with a larger pot of money to put to work, might they also get the ear of the company’s CEO for 15 minutes a quarter?
Would that make them invest the dough more readily? Well, maybe.
At the end of the year, let’s say that 4 million was invested well and it has a value of 4.4 million bucks.
When the 1000 partners formed the fund, they agreed that they would divide the fund into slices of pie in the same way that ownership of a company is divided into shares. Remember that Apple has over 5 billion shares outstanding. They trade at 250 bucks per share, give or take, and multiplying the 2 together gives them a total value today of over a tril.
Well, the mutual fund might have 200,000 shares outstanding, so that at $4 million of value, to get the net asset value per share, you’d divide that total pie value by the number of slices in it to get 4 million over 200,000... or $20 per share.
If the fund goes up 10 percent, the number of shares outstanding in this scenario hasn’t changed, so the net asset value per share would be $22 a share. A gain of 10 percent.
In real life, however, investors buy additional shares in a mutual fund and redeem them. Why?
Well, they buy because rich Uncle Larry died and left them a million bucks and they already have the cool man cave stereo.
And they might sell because the fund had lousy performance and they’re P.O.’d, or they might sell because the fund had great performance, and since they know that most investments regress to the mean, i.e., become just average over time, they want to take their chips off the table today and put the dough elsewhere.
So let’s say a new investor comes in and wants to invest, $6000 in the fund, which closed at the end of today at exactly $20 a share. Let’s also say that, on this given day, everybody was happy with their investment. Nobody wanted to sell and nobody wanted to buy. Well, unlike buying shares in Apple, Walter doesn’t need another already-existing investor to sell him the shares. He can buy $6,000 divided by $20...or 300 shares of the fund. Those shares didn’t come from a disgruntled (or gruntled) other investor.
They were sold directly by the fund itself.
The analogous situation would be if Apple sold shares directly to the public - those things happen, they’re called IPOs and secondary offerings, but they’re not a daily event. Mutual funds selling shares to the public IS a daily event, however, and after this transaction, the investor now has 300 shares of this fund, a fund which now has 200,300 shares outstanding.
The value of the fund went up the $6,000 that was put in. So the fund’s value is now 200,300 times $20...or $4,006,000.
And Walter now owns 300 divided by 200,000...or 0.15% of the fund. Which is money we’re sure he’ll spend wisely.
He’s having fun. You’ll just have to trust us.
Naked Option
Definition
Warning. You’re going to be disappointed in this video. It’s not nearly as hot as you probably hoped.
Naked options are just options that you sell without having enough of the underlying security to cover your, uh...butt if the price changes. They are an investment that stands on their own, but with extreme amounts of risk.
You invest $10,000 in Coca-Cola stock at $40, buying 250 shares. The stock goes up $2 in a year, and you’ve made a whopping 5% on your money, or about $500. You bought the stock, not the option.
But let's say you had bought $10,000 worth of naked Coca-Cola call options, with a strike price of $42.50, expiring in 4 months. The stock remains at $42.50. Well, guess what. You’ve lost all of your money.
Had the stock gone to $45, however, that $10,000 invested in those call options, which bought you exposure to some 20,000 shares, would have made you something like $2.50 a share of in the money value on those options...times 20,000 shares, or 50 grand. Yeah. Way more than your boring experience of just owning the stock.
In reality, professional investors rarely just buy naked options alone, because they are so risky and volatile. But every now and then, somebody bets the ranch on 22 black. It comes up. They make 36x their money in a very short period of time. And everyone asks them for the best way to angle their thumb when they’re trying to flip a “head” on a quarter…
NASDAQ
Definition
What are NASDAQ and the NYSE? NNNNNAAASSSSDDDDAAAQQQQQ. It stands for:
National
Association
Of
Securities
Dealers
Automated
Quotation-systems
And yeah, it feels like they got cheated out of an ‘S’ there at the end. Like NASDAQS. But, uh, that’s what happens when life’s on a budget.
So NASDAQ is an electronified version of the original wall, as in the street, Wall Street. Yeah, that where well dressed folks would come with cash in hand, scream out a stock and a price and then trade shares. They would trade for whatever was trending at the time:
Like eyeball massagers, or wooden swimsuits, or motorized surfboards.
All real, by the way.
NASDAQ is the much more modern version of its predecessor NYSE, which is anything but nice when you lose money there.
The N Y S E stands for:
New
York
Stock
Exchange
And it too was an outgrowth of the well-dressed folks at the wall.
There are two key structural differences in the two trading systems — the NYSE is an actual place. It has a physical location, address, etc. And this is what it looks like:
NASDAQ is a concept. A religion. A network. It’s not really a place, at least not a geographic place. The other big difference is the manner in which shares are traded - the NYSE is an auction based system. One individual is a buyer of AMZN at $1,983.25. He screams (electronically) that number and then buys from whoever is willing to sell at that price.
Individuals buy from individuals. That’s an auction market.
But NASDAQ is a dealer market. That is, somebody deals in a stock.
They go out into the market and buy, say, a million shares of whatever.com that was bought in the market conveniently for exactly 10 bucks even. That dealer now ‘makes a market’ in that stock - i.e., the dealer is kind of a market unto herself and she moves with the market to manage the spread on the trades.
Like....she might have a narrow spread where she’s a buyer of the stock at 10.02 a share and a seller of it at 10.07 a share.
Or, if it is a really wild, volatile stock on a wild and volatile day, she might be a buyer at only 9.90 and a seller at 10.30...a 40 cent spread.
You can do the fancy math that, if she keeps her ‘inventory’ steady at a million shares, and trades a million that day with that spread, she makes 40 cents times a million or 400 grand for that day’s efforts.
However, after staring at a screen all day, she’s going to have to spend at least some of that money on eyecare. Thank goodness for eyeball massagers…
National Securities Markets Improvement Act - NSMIA
Definition
Dateline: 1996. The enactment took away a lot of the bureaucracy between and among state and federal financial laws, which were sometimes in conflict and often redundant, repetitive, requiring the same thing over and over and over and over again. This act streamlined things and saved trees from the MulchMonster.
So it's 1996. What’s going on in the world? One thing: the internet. Everything is getting wired, and not just on Espresso. Computers everywhere are talking to each other.
With massive structural change in the way in which people do business, 1996 brought about the advent of myriad new securities laws, which were needed as an update or sequel to the Acts in the 1930s and 1940.
One key change in this era was that borders among investors evaporated. Afghanistan was as close by as Peoria when it came to a click on an investor keyboard sitting in their office at home. The notion of borders among states, which was already vague, became infinitely opaque, and essentially any covered security, i.e. an investment made in any element of the public realm became by default a kind of nationally registered security, rather than something that only had to follow the rules of one state or another.
The SEC, the national organization for managing securities laws, took control over virtually all securities laws, and striated the rules so that they were more granular.
What does all this mean?
Well, it means that the investing world was becoming the wild wild west again, only it had the dot-com extension on the end of it. The broader goal here was to simplify rules as much as possible, without impinging on the liquidity of investors wanting to invest, you know, in their underwear.
In practice, the state-centric blue sky laws were transferred to the Federal government in the form of the SEC to promote fairness in dealing. Specific provisions of the law defined which "covered" securities are exempt from state regulations. These include any securities traded on national exchanges, such as the Nasdaq, and the New York Stock Exchange, as well as mutual fund shares.
Bottom line? The world is getting smaller. The notion of local securities laws is kind of going away, and everyone is a fan of that whole underwear investing thing.
Negotiated Deal
Definition
A type of contract signed between a company and the bankers acting as underwriters during an IPO. The contract outlines the standards and rules for the bankers. It's part of the big amounts of paperwork that go into issuing securities.
Net Asset Value (NAV)
Definition
NAV is the method with which mutual fund shares are valued or priced at the end of each trading day. We're making up the composition of a mutual fund. It has 1,470 shares of GOOG and 300 shares of AMZN and 500 shares of IBM and well, you get the idea.
At the end of each day, the ask prices in the bid ask spread, i.e. the ask is the price at which somebody will sell these shares are added up. Yep, total’d. In this case there are 114 different names in the portfolio and $7 million bucks in cash, all of which total 82.3 million dollars in value at the end of the day.
There are 2 million shareholders, exactly, at this moment. So the NAV at today's close? Well, it's $82.3M divided by 2 million, or $41.15 per share. That $41.15 is the NAV of the mutual fund.
And what happens when more investors join? Like let’s say somebody invests a million dollars at the end of today, well, then the fund goes from having 7 million bucks in cash to 8 million.
And that investor just bought one million divided by $41.15 per NAV share, so that the mutual fund company printed out of thin air an incremental 24,301 shares, bringing its total to 2,024,301.
The total value of the fund is now $83.3M from the $82.3M yesterday, and the shares outstanding are now 2,024,301. Yeah, the NAV didn’t change...just the shares outstanding.
Nominal Yield
Definition
The coupon, or percentage that the bond makes, is the nominal yield of a bond—and it always stays the same. The bond may trade up or down, but the nominal yield stays the same.
By the way, "nom" means "name" in Latin. We showed up in class that day.
Example:
A bond has a $1,000 par value, 8% coupon, and is due 2034. In trade, the bond might be worth $800 a year from now, $1,200 six months from now, and so on. The nominal yield, though, is 8%. Is now, and always will be.
Non Exempt
Definition
See exempt. Basically, this word means that something has to follow the rules and toe the line.
In investments, non-exempt might mean that something has to get registered with the SEC.
In other settings, it might mean that you won't get a tax break. For example, the interest on your mortgage is exempt from taxes, meaning you don't have to pay taxes on the interest. But the interest on your boat? Not so much. Sorry, yachters.
Non-Cumulative Preferred Stock
Definition
Preferred stock that does not require the issuer to pay any missed dividends before it pays dividends to the common stockholders. The company can say "Yeah, here's a juicy 10% dividend, but if we decide it's not in our best interest to pay you, too bad."
It's not usually the best kind of investment, since you're at the mercy of how the company is feeling about dividends and might end up in a "tough luck" kind of situation.
Non-Punitive Orders
Definition
Some orders issued by state administrators are punitive; e.g. if a broker steals money from clients, you can be sure that the state administrator will want to bring the pain. But other orders aren't related to crimes or punishment (or Crime and Punishment); those ones are non-punitive.
Example
An agent decides to withdraw their license or cancel it. (She's decided to open a cat B&B instead of being in the rough-and-tumble world of finance.) The state administrator issues an order that cancels or withdraws the license. It's non-punitive because the agent hasn't committed a crime.
At least not a financial one.
Non-Qualified Stock Option - NSO
Definition
Qualified: Think qualified for favorable, long-term gains tax treatment. If you have qualified stock options, aka incentive stock options, or ISOs - and they are relatively rare, they are generally only given to the very first, i.e. single-digit number of employees joining a company then those employees get the benefit of being able to buy out their stock options, and having them become fully owned common stock shares.
This ability is a huge benefit, not just for the meaningful vibe of being able to feel like and actually be a co-owner of the company, but because it usually means that the employee-investors will qualify for much cheaper tax rates when they eventually do sell. If the employee does not buy out the options, there is no difference in tax treatment. That is, these options are treated just like the less qualified non-stock options, or NSOs.
The number which can be granted to a company are limited, and if a company violates this number by granting too many, the company is taxed heavily, as it is viewed by the IRS as having used "falsely" cheap stock to pay key employees. Catchily, that's called the Cheap Stock Rule.
The granting of these kinds of compensatory stock options can only be given to employees-slash-insiders of the company. They have to be granted at a fair market value strike price, i.e. whatever the 409a valuation calculated by lawyers and bean counters said that the company was worth, that’s the valuation the strike price has to reflect for the common stock.
These types of stock options carry a maximum life of 10 years. And then there are the 10% rules. That is, for at least 10% of the shareholders, the exercise price of these options has to be 10% greater or more than the fair market value of the company at the time. Because these options receive such favorable tax treatment, their strike price has to carry a premium.
And lastly, the maximum cap or value of these stock options, for any individual, cannot exceed $100,000 as exercised or bought out in any one year. In other words, they are designed only for very early employees with companies carrying very low valuations.
Okay, so that’s qualified stock options. The other end of the world? Non-qualified stock options. Those options can, in fact, also be bought out, but upon that transaction, employees are taxed as if they are direct compensation, and those taxes are levied as ordinary income, i.e. the very high tax rates.
So in practice, most employees getting qualified stock options buy them out immediately... and usually there is a negotiation before that employee is hired, such that their commitment to the company is made clear by their tacit agreement to buy out their qualified options.
For employees with non-qualified stock options, the buyout usually doesn’t happen, and those options are viewed as gentle lottery ticket potential big wins way down the line, should the company do well.
Example time.
OK, so you and your roommate both joined Shmoopflix early. You both received the same grant of 100,000 options at a $1 a share strike price.
How was this dollar calculated? Lawyers and bean counters were hired, for a small fee, to make their own valuation assessment of the company, and when they completed that review, they determined that, if the company were sold today, its common shares would command a dollar each on the open market, or eBay, wherever the company was sold.
That number is called the 409a valuation, and the strike price of those options applies to both qualified or ISOs, and non-qualified stock options. Unfortunately, because you only majored in econ, your package gave you non-qualified stock options, whereas your roommate was an engineer, so she received qualifieds.
Not a big deal at the time. You didn't really care.
Other than the one little thing, which was that your roommate borrowed $100,000 to buy out all of her options at the time. A risky move, because if the company had gone bankrupt or done poorly, that hundred grand would have been zero…fast. However, because they were ISOs, she did not pay any tax on the exercise.
So then along comes an IPO, and the stock rocks, and the 4 years pass, and Shmoopflix is, conveniently for this example problem, hovering around $31 a share. It is 30 bucks in the money. And then you both go to sell.
Your roommate pays a 25-ish% long-term gains tax on the 30 dollars times 100,000...or 3 million bucks. That is, she pays 750 grand in taxes, to net 2.25 million. You, however, pay 50% ordinary income tax on the 3 million bucks in gains to net 1.5 million.
You paid a lot of tax - so it's a good problem to have … but wow - the little word NON on your non-qualified options plan cost you 750 thousand bucks of winnings. Ouch.
So this sounds like Silicon Valley magic, where everyone gets rich and becomes a millionaire by the time they finish their bar mitzvah. Oh so not the case. In fact, most startup companies in Silicon Valley go fully bankrupt. So, had a tax-avoiding, more greedy-than-fearful employee bought out all of their options, qualified or not, and then the company was sold for ⅔ of the value of its preferred stock investment, the common stock would be wiped out. Worthless. And all of the money the employees spent buying out their options would be gone.
So the business of betting big on startups is not one for the faint of heart, but going in, the presumption is that you’ve carefully watched this video, and others on Shmoop finance, and you know the witch and warlock dance between risk and reward.
Make sense? Make dollars.
Non-Voting Stock
Definition
Stock that doesn't give you any rights to vote on company decisions as a shareholder.
Normal Yield Curve
Definition
Check this out for a jolly-good story to help you visualize the general mathematical concept.
In finance, the normal curve is a reflection of how the price of borrowing money works over time. That is, money due and payable sooner is usually cheaper because risks are perceived as less. Over time, there's more uncertainty; to account for that, those who lend money will charge higher prices to rent that money.
It's normal. The curve shapes from low to high in a twisted smiley kind of way.
Odd Lot Theory
Definition
The theory here is that when you see a lot of trades with odd lots (small lots of less than 100 shares and in odd numbers), you should run in the opposite direction.
The idea is that odd lots are usually traded by small retail investors (so average Joes who think they're the Wolf of Wall Street because they read some of Investing for Dummies that one time on vacation). Most pros think that small retail investors don't know Jack and that you should do pretty much the opposite of what these guys are doing.
Offer
Definition
See bid-ask.
This is the price at which a seller is willing to sell you a security. The offer might have some wiggle room so you can make another offer, or the seller might be pretty sure they're not willing to negotiate.
Open-End Indenture
Definition
It has nothing to do with dentures or figuring out which end to put them in, so stop asking.
And open-end indenture is just a license to borrow. Assuming that some very basic covenants are covered, like the previous year's financial performance providing enough operating cash flow to cover interest costs x many times, the company (or municipality) can then go out to the market and raise yet more debt—open endedly. (Hence, the catchy name.)
Basically, it's a good place to be and means you can get your hands on more cash.
Operating Margin
Definition
Key word here: "operating." It's cousin is "gross." Not aesthetically... just financially.
Example
Let's say you sell lemonade for a buck a drink. Your cost per cup is a dime: the water, sugar, the paper cup itself, and the lemon. (Some people count the labor of the dude serving it, but in this futuristic world, you have a decanting robot machine.) Your gross margin here is 90%. But then you have rent, insurance, marketing, some human management, and a bunch of other costs to operate the business. You had pre-tax operating profit of $500 on revenues of $5,000 last month. Your operating margin was 10%.
Remember: Margin is a percentage, not a dollar sign-y number.
Operating Profit
Definition
This is the profit earned from a company's everyday main business. It doesn't include the money made from other investments, interest, or profit from owning a state in subsidiary companies.
To figure out your operating profit, you take your total money made, then subtract your cost of goods and services, operating expenses, depreciation, and amortization.
Is the number larger than one? If so, you're making money. Congrats.
OPEX (Operating Expenses)
Definition
Just a fun way of saying operating expenses. (Hey, something about finance has to be fun, right?)
The term refers to the cost of running a business. It can include the cost of staples and ink or the cost of paying employee wages. When companies start getting into trouble, they sometimes think about trimming back on their OPEX. This can result in a leaner, meaner company—or in disaster. Cut operating expenses too far and you won't have enough staff and stuff to offer your customers a good product or service.
Option
Definition
Options give you the right to buy (or sell) a security at a specific price on or by a certain date. You're not locked into buying or selling, though—hence, option.
Options come in lots of flavors (employee stock options and naked options, to name two), but the important thing to remember is that they don't give you the same benefits as actual stocks. You won't get dividends or voting rights with options—just the right to buy (or sell) stocks later on. You can trade options just like other investments, though, if people want 'em.
Example
A stock you're interested in is selling at $100 a share. You want to buy 1,000 shares of the stock but don’t have $100,000 to pony up. So you buy the option to buy within the month for $110,000 for 1,000 shares (the extra $10,000 is because the stock might go up in price). You pay $5,000 for the right to do that.
In a month's time, if 1,000 shares of stock are worth $170,000, you have a great deal. You can buy 1,000 shares for $110,000 ($115,000 with the $5G you spent on the option). If the stock drops in value and 1,000 shares are now worth $60,000, you don’t have to buy. You're not locked in. So you've lost $5,000 that you paid for the option, but you've saved a lot of headache.
Option Holder
Definition
Uh... someone who holds an option?
Yup.
Example
In the tech world today, an option holder is usually an early stage employee at a company that didn't have much cash to pay them a decent salary in the lean early years. So the company made up for it by granting them stock options which they hold until the company is sold or goes public. Ms. Employee can then sell those options in the open stock market.
OTC Bulletin Board
Definition
It's really just a blog that posts prices of stocks that have traded OTC: over the counter.
Many OTC stocks aren't well covered or reflected by the financial press, so it serves as a single source place where investors can go to check prices.
Over-The-Counter - OTC
Definition
Buy drugs? The um…non-prescription kind? Nyquil. Tylenol. Preparation H? Yeah. Then you’ll buy them over the counter.
Prescription drugs? Those are different. Much more highly inspected. Regulated. Structured.
Well, stocks work the same way. When you trade over the counter, you’re generally trading within a network of other dealers all trading stocks.
Think of it like…everyone on Facebook had a trading account. Nothing really is supervised or regulated or controlled. It’s just a transaction happening among two strangers in the night… exchanging glances.
Get a fair deal on this trade? Well, on the exchanges, Amazon was offered for $1,502 a share; but on the OTC deck network, it’s offered at $1,507. Maybe you’ll have overpaid 5 bucks a share for Amazon if you buy it here rather than on NASDAQ, which is a normal securities exchange.
Stocks, bonds, commodities, derivatives: They all trade OTC and also on exchanges. So why are there both methods of trading in the first place?
Well…demand. If everybody was happy with the trades they made from 9:30 to 4 New York time, then there wouldn't be a whole lot of demand for trading outside of those hours.
But there is.
So there is.
And OTC trading accommodates after hours trading, which can be a really big deal when a company announces earnings at 4:30 pm New York time, and the Street either loves or hates the numbers they’ve printed.
The stock can move a lot in a short period, so a lot of investors are happy to be able to either dump or scarf up positions in whatever.com at 4:32 pm after the numbers have been published, not wanting to wait the dozen and change hours until the market opens again in the morning.
The basic idea behind OTC trading is that the world of OTC is kind of the wild wild west of stock exchanges. Unlike trading on the NYSE, where companies have to meet a very high standard to be accepted for trading on the exchange.
To qualify for OTC trading, companies basically have to spell their name properly. And even then, there’s, uh...a lot of flexibility...
#TK FIX CONC
Overbought
Definition
What happens to a market when there are too many buyers.
According to financial journalists, it means that there need to be more sales.
But some financial pros think there's no such thing as overbought, since lots of buying affects market prices and eventually leads to selling...so it all sorts itself out in the end.
Paid In Capital
Definition
Well, first you start with the original $1,000 Grandma gave you, or rather, invested in you, to buy 10% of your lemonade business. And note that it’s very important for defining paid-in-capital that Grandma is buying a slice of your pie, representing 10% ownership of your company.
She’s not giving you a low interest rate loan. despite her career as a collection agent for the mob. So the thousand dollars is equity, aka ownership.
That capital is paid in, and it’s likely that, in order to build the 16,000 lemonade stand stores, you will need to attract other investors, who will then pay in more capital to own incremental percentages of you, as your own original 100% ownership of the business when you founded it gets diluted down to some much smaller number than the 90% you own after Grandma’s grand.
But things go well. And it turns out, amazingly, that you didn’t need to sell any more equity in your company.
You were able to grow by taking short-term loans, which you then paid off by charging $5 a cup for the absynthe kicker. It was a huge hit among third graders. So after four years, you found yourself with $196,000 in cash in your bank account.
Yes, you had $5,000 worth of cups in inventory, a bunch of sugar, and other things.
Yes, they are probably convertible quickly into cash, but if you converted them quickly, you would also suffer a massive discount in pricing, because semi-used cups, or at least ones that have been previously sold, even if they are in their original packaging, probably don’t sell for much on eBay.
So for your purposes in assessing your own capital surplus, you’re going to ignore inventory and all of the other elements, that in a big or real company you’d have to account for, or at least consider when you thought about how liquid your company was. And... that’s not a reference to the product you actually sell.
So of that $196,000, $195,000 of that cash was capital surplus, or just capital, aka cash that came in in the form of after-tax profits as you grew your company from a nothing to...a something.
Now that’s how you make the most of your, uh…seed money...
Par Value
Definition
The stated value of a bond or share—it's the face value, the dollar amount right there on the bond.
Most bonds are sold in increments of $1,000, so if you want to sound like you know what you're talking about, you'd refer to "par of a grand."
Parity
Definition
What happens when two things are the same. A equals B.
So if two currencies are trading at parity, one dollar of one country's currency gets you one dollar of the other country's currency.
Participating Preferred Stock
Definition
PPS is a popular term in venture capital circles.
Think of it as common stock on steroids. When you hold this type of stock, you have preferred stock that also participates in the profits of the company. If the company goes belly-up and has to sell its assets, you might get back the purchase price of your stock plus any extra money common shareholders get from sales of inventory and other assets.
Passive Investor
Definition
Passive management style, or PMS to mutual fund managers, refers a management style for index funds, ETFs, and other investment vehicles where a group of, say, 500 stocks are picked to represent a given area, and then... nobody touches them.
Someone (or someones) tracks their performance; sometimes they drop some stocks and pick up others at year-end, or, if a company is bought or goes bankrupt, a replacement is found. Basically, one guy and a laptop can handle passive investment vehicles.
Someone who buys into those funds is a passive investor.
Passive Management Style
Definition
Passive management style, or PMS to mutual fund managers, refers a management style for index funds, ETFs, and other investment vehicles where a group of, say, 500 stocks are picked to represent a given area, and then... nobody touches them.
Someone (or someones) tracks their performance. Sometimes they drop some stocks and pick up others at year-end, or, if a company is bought or goes bankrupt, a replacement is found. Basically, one guy and a laptop can handle passive investment vehicles.
Patriot Act Of 2001
Definition
There are books (and books and books) written on the Patriot Act, but here's the deal for finance:
The Patriot Act was drafted in reaction to 9/11 and was designed to track money going to foreign terrorist groups. It allowed the government to monitor many different activities revolving around global wire transfer of money and other things that could impinge on the safety and well-being of Americans. Basically, companies have to actively report a bunch of the activities that they never had to in the past as they relate to dealing with countries we don't necessarily want to invite over to next year's Thanksgiving dinner.
Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism. Talk about an acronym.
The relevant part when it comes to money is Title III of the Act. It's called the "International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001" (seriously, who names these things?). That part of the act requires banks to report suspected money-laundering activities and to create tougher rules to prevent money laundering in the first place. It also makes it tougher to do some types of high-falutin' banking between U.S. banks and financial institutions around the world.
Person
Definition
Seems obvious, but within the investment industry the term "person" has a specific meaning. A "person" is any natural person past the legal age of majority or any entity (like a corporation) that can enter into a legally binding contract.
Pooled Investment
Definition
Any time a bunch of investors throw their dough in to invest as a collective group, it's called a pooled investment. (We're talking mutual funds, index funds, ETFs... the list goes on.)
Why do it? It spreads risk and adds liquidity. Just make sure there's water in the pool before you start throwing those securities in. We'd rather avoid another incident.
Power Of Attorney (Trading Authorization)
Definition
Little Old Maybell Bluehair just can't think straight anymore, at least when it comes to managing her considerable money. Husband #4 was loaded and had a weak heart... and ate one too many cheeseburgers. Maybell trusts her grand-nephew Beauregard to make trades on her behalf, and has given him "trading authorization" to manage her account; that is, he can make trades without pre-clearing each one with her.
His status is analogous to having "power of attorney" in doing various legal things in life. Like…you might sign over power of attorney to your legalese-proficient uncle to handle negotiating the terms of your juggling contract, because, with your busy schedule, you need some help keeping all your, um…balls in the air.
And you have the option between granting general or limited power of attorney. If you want your uncle to handle all of your finances, general POA makes sense But if you want him to handle your contracts only, then a limited POA would be more appropriate.
So yeah, trading authority is the Wall Street-y version of Power of Attorney. You might really want to put a few grand into the stock market, but as far as you know, the “stock market” is just a market where they keep produce…stocked.
So you turn over authority to make the actual decisions, and perform the actual trades, to someone you trust to more efficiently handle your money. Because if everything’s left up to little ol’ Miss Bluehair, her entire life savings would be invested in Sweaters for Cats, Inc.…
Pre-Emptive Rights
Definition
Rights that allow you to do something first.
For example, if you have pre-emptive rights to buy shares, you'd get the chance to buy 'em before they were released to the general public. It's like the Disneyland FASTPASS but with fewer puke bags.
Preferred Stock
Definition
Stock of a company that has a higher position on the food chain than common stock. If the company liquidates and there's any money left after all the creditors are paid, holders of preferred stock get paid before the common shareholders.
Bonus question: how much do they get paid? Answer: up to the amount of the par value of the preferred stock.
P.S. Preferred stock was also the name of a cologne in the 1990s. Those were the days.
Premium Pricing
Definition
This refers to the method used to figure out how much a stock option should cost.
The "premium" is what you pay to buy an option on a security, whether you own that security or not. (Look up short-selling and marvel at the all the fun ways you can get yourself in serious trouble.) The "option writer" figures out the price by looking at a whole slew of data to find the option's theoretical value, like the stock's underlying price, the length the buyer wants to hold the option, and the strike price (the point that the option will execute).
If the stock just bounces around never hits the option's strike price, the writer still keeps all that delicious premium.
Prepayment Risk
Definition
Close your eyes and imagine a high-inflation, high-interest-rate world that is slowly crumbling—that is, The Federal Reserve Board is openly flirting with lowering interest rates.
You bought a bond from a corporation, which was going to pay 10% a year for 15 years. Spectacular returns expected. With one hitch: The issuing corporation had the right to buy back its bonds after 3 years for the price of 102 or 2% over par (the bond's actual face value.) Now with prevailing rates tumbling, that corporation thinks it can refinance that debt for 7% instead of 10%, so it makes sense to get rid of those older bonds and, well, start all over.
So, instead of 10 years of feasting on 10% a year returns, they hand you back your principal plus that extra 2%, and you're done.
That's prepayment risk—the risk that you'll have this awesome huge-yielding bond that you thought was going to last forever... only to just get your money back at a slight premium and the fat monthly checks go away.
Price-to-Earnings Ratio
Definition
It's a measure of a company's valuation, usually relative to that of the overall stock market.
Example
If a company, let's call it Theoretical Company Blah, will earn $1 a share this year and the stock of TCB trades at $20, then it has a 20x or 20:1 price-to-earnings ratio. The "gotcha" here is that companies often carry cash and/or debt, so if TRB has $10 a share in debt and $4 a share in cash, then its price-to-earnings ratio is still 20—but it likely has more volatility in its movements, since the debt is gasoline on a fire when things go well or poorly.
Primary Market
Definition
A primary market is a market where baby stock issues go to be bought for the first time.
Debt, equity, and other securities start trading on the primary market and then, after they are initially priced (during the Initial Public Offering), they can trade on the secondary market.
It's a magical place with bright-eyed, bushy-tailed securities and lots of yelling.
Primary Offering
Definition
Pretty much an IPO.
A company goes public and starts selling shares of its stock so that you get to own a little bit of the company. The shares have not yet been sold on the secondary market—they're farm-fresh.
Primary Shares
Definition
Freshly-minted common shares sold to investors from a company. See Secondary Shares.
Principal
Definition
The original amount of money you put down for a deposit or investment.
The higher the principal, the more you will pay in interest on a loan or the more potential returns you could get on an investment.
Example
You borrow $10,000 to buy a car. You pay off the loan in two years, and your total payments are $15,000. That means that in addition to the principal of the loan ($10,000), you’ve paid $5,000 in interest.
Principal Trade
Definition
This is when the principal in the trade (the owner, more or less) trades for its own profit.
It's something broker-dealers do all the time to make money for their own business by keeping the difference between the bid and ask prices. A client may be certain she wants to buy 100 shares of Amazon at $400—but the principal is the one selling those shares to her. It's like "betting against the house" because presumably the principal (usually a brokerage) knows more about the (short-term) expectations of a given stock than the retired school teacher to whom it is selling.
So when things are a principal trade, they get special attention when selling to Ma and Pa Kettle, little old ladies, and cardiologists from Milwaukee.
Principal-Only
Definition
Think of a bond as having two parts:
- the principal that will be paid on the maturity date
- the interest that's paid in coupon payments regularly
Usually, it's all tied up in a pretty package, but you can separate the two and sell the bond without the coupon payments as principal-only.
Private Placement
Definition
Also known as a Reg D offering, a private placement is an offering for unregistered securities which is made to accredited investors (not the general public) and no more than 35 non-accredited investors during any 12-month period.
Definition
A sale of securities sold to private parties.
Progressive Tax
Definition
The wealthier you are, the harder you get dinged with a progressive tax. The rates increase as your wealth does.
Income tax is a good example of this: If you don’t make a ton slinging lattes, you get a lower tax rate. If you make a cozy seven figures as a lawyer, you get charged at a higher rate.
Prospectus
Definition
A legal document issued by a company that lays out everything an investor may need to know in order to make an informed decision.
This report is required by the Securities and Exchange Commission for investments that are being sold. The idea is that clients get this information so that they can make a good decision.
Proxy
Definition
Somebody who is authorized to act as an agent on behalf of another.
If you own shares in a company, for example, you can get someone to vote by proxy. Rather than casting your vote as a shareholder, you get someone to cast it for you. Maybe because you're too busy frolicking on your yacht.
Prudent Man Rule
Definition
Years ago, this term was used after some courts decided that fiduciaries had to act in a reasonable way when deciding what to invest in. The courts eventually decided that prudent men invest in bonds and only bonds, so anyone investing in stocks was not prudent.
Since then, states have become a little more relaxed and use the prudent investor rule, which allows for different types of investments.
Prudent Man Standards
Definition
Being prudent just means being respectful, careful, measured…
And the prudent person standards are set up to protect shady brokers from getting little old ladies investing in very risky vehicles like penny stocks, wild-cat oil-well digging, and the investing equivalent of lottery tickets.
For details on what is not prudent, see The Wolf of Wall Street. You gotta know what you're doing, people, and you can't plead ignorance if something gets screwed up.
Prudent Person Rule
Definition
Years ago, this term was used after some courts decided that fiduciaries had to act in a reasonable way when deciding what to invest in. The courts eventually decided that prudent men invest in bonds and only bonds, so anyone investing in stocks was not prudent.
Since then, states have become a little more relaxed and use the prudent investor rule, which allows for different types of investments.
Punitive Orders
Definition
If an investment pro violates SEC rules or does something illegal, the state administrator can issue a punitive order, which is a type of punishment. This type of order can deny a license to work in the state, can be a suspension of a license, or can involve some sort of torturous dunk tank.
Put
Definition
A stock option that lets you sell your stock at a specific date by a specific date. You’re essentially ponying up money now for the right to sell a stock later. If the price of stock goes down, you can profit from put options.
Put Option
Definition
See call option.
Whereas calls are the right to buy a security at a given time range and at a given price, a put is the right to sell a security at a given time range and at a given price (e.g., you may pay $5 a share for the right to sell IBM any time between now and November at $130 a share).
Using options effectively reduces your market risk... and allows you to take over the world.
Putable Bonds
Definition
If bonds have a put feature, it means that the owner of that bond has the right to sell the bond back to the issuer at a given price within a given time range before maturity—of the bond, not the people doing the trades... or writing these definitions.
Quick Ratio
Definition
"Quick! How liquid are we?"
The quick ratio is a measure of how well (or not-so-well) a company is positioned to be able to quickly pay off its debts. The ratio looks like this:
(Cash + sellable securities + money people owe the company) / (liabilities)
So basically, it compares your total liquid assets to how much you owe. It's important to note that you don't count your current inventory as part of your assets, as it's typically hard to sell everything you have right this moment.
The higher the quick ratio, the healthier the liquidity position.
Random Walk Theory
Definition
Hipsters' favorite finance term. Especially if the walk is in Williamsburg.
Random walk is a belief that the market is unpredictable and you can't beat it. The market just walks where it wants to, bro—there's no rhyme or reason to it.
Don't tell Warren.
Range
Definition
Home, home on the... yeah.
The term also refers to the prices in which, say, an IPO is expected to be priced. That is, you'll find on the cover of the Red Herring IPO marketing document an "expected range of $12–$14," for example.
The term can also apply to, say, the 52-week trading range in which Stock X has traded between $15 and $24 a share.
The term also means the difference between the highest and lowest numbers in a group.
The term also refers to the thing you cook on...
Actually, the term means too many things. It should stop hogging all the definitions.
Real Estate Investment Trust - REIT
Definition
Let’s start with the basics. The letters. REIT:
Real
Estate
Investment
Trust
It’s basically a mini-mutual fund for real estate investments. Think: a chain of old age homes, which might carry a market value of a million bucks each, but which throw off 80 grand a year in net cash profits.
In melding together a whole bunch of old age homes, at least in theory, the volatility of any one home, um...dying, and then affecting the credit worthiness of the entire portfolio of real estate holdings...is lowered.
With scale, a REIT can then borrow money more liquidly, or easily, and it can leverage its legal obligations and meds-buying process, along with volume deals on diapers and dentures, across a much bigger swath of buyers.
REITs have been around a while. Ironically, they came into existence as an extension of the cigar excise tax in 1960, and extend as far in ownership as warehouses, commercial office buildings, shopping malls where piercings happen, and apartment complexes of all shapes and sizes.
To qualify as a REIT, a company must invest at least 75% of its assets in real estate, and/or be holding cash or US treasury bonds with the intent of investing in real estate. It has to receive at least 75% of its gross profits from real estate rentals. It has to pay out at least 90% of its taxable profits as dividends to its shareholders annually.
It has to have at least 100 shareholders, and have its ownership diversified, such that at least half of its ownership shares are held by 5 or more individuals. REITs are publicly available for Joe Schmo to invest in. They tend to pay very high dividend rates, and grow asset values at a modest premium to inflation.
That is, they don’t grow much. So most of their payback to investors is “bond-like”. And...that’s a REIT. Now, keep an eye out for those bulk diaper deals for Grandpa. And good luck, uh...dealing with the bulky diapers...
Rebalancing
Definition
Rebalancing usually refers to the process of tweaking an index fund so that it conforms to the goals of the investors.
Let's say a fund specifically cited that it seeks to maintain 20% of the fund in energy-related investments. But in a given quarter, energy might have done horribly—say it dropped 25%, so now the fund's energy holdings are only 15% of the whole fund.
The managers must "rebalance" the fund by buying a lot more energy stocks so that the fund "re-conforms" to its stated goal of having 20% of the fund in energy stocks.
If you don't rebalance, the whole fund will tip over and spill everywhere. And for the last time, we're not going to pick up your stocks off the floor.
Recourse Note
Definition
Debt for the truly desperate.
A recourse note allows the person making the loan to not only take the asset pledged as collateral for it, but also to go after the person who borrowed the money... personally. With baseball bats and pitch forks.
So even if you only pledged your car as collateral, they could go after your house, your jewelry, your pet pug Mort... leaving nowhere to hide when they come after you. With baseball bats and pitch forks.
Red Herring
Definition
Alas, nothing to do with CSI IPO. A red herring is a preliminary prospectus, which companies have to submit to the SEC outlining all the company details before a public offering. It's written partly in red ink, hence the nickname.
Regional Exchanges
Definition
Regional exchanges (like the Chicago and Pacific Stock Exchanges) are to the big exchanges (like the NYSE) what the minor leagues are to the majors.
They focus on servicing companies in their region and often deal in securities related to their core commercial interests. That is, Chicago is the broker for Midwest-grown commodities like wheat and corn and dead meat.
Registered Bonds
Definition
See bearer bond.
Then see Barry Bonds, just for a break.
Registered just means that a bond's owner has given the bond's issuer their name, social security number, soul, and so on.
This way, if the bond is ever lost or stolen, the owner can go back to the issuer and still get paid. In the case of a bearer bond, it's basically "possession is 100% of the law"—that is, if you "bear" that bond or have it… you own it. It's like a second cousin of cash.
The tellers at the bank prefer that you "grin" when you "bear it."
Registered Representative
Definition
A person who acts as an account executive and is allowed to sell securities. It's basically just another word for a stockbroker.
To become a registered representative, you have to pass the Series 7 and Series 63 securities exams and show that you have a good enough moral character to register with the Financial Industry Regulatory Authority (FINRA).
And no, those things aren't mutually exclusive.
Registration Statement
Definition
Before launching an IPO, your company has to file a literal crap-ton of paperwork with the state and the SEC. One of the documents is the registration statement, which includes your prospectus and other vital stats.
Regressive Tax
Definition
In a progressive tax, the rich pay more taxes. A regressive tax is the opposite—one that affects poor people more. It's not because they are taxed at a higher rate, but because their tax burden is greater.
Sales taxes, for example, are regressive taxes. When you buy detergent, you might have to pay 8.75% in sales tax—and you'll pay that 5% whether you’re rich or not. The extra buck or two might not matter if you're raking in $100G a year, but it can be bruising if that's your budget for lunch. The less you have, the bigger a problem that sales tax is.
Regulation A
Definition
Any offering with a value of less than $5 million in any 12-month period may not have to go through the full SEC treatment (just an abbreviated registration), and may be a Regulation A offering.
Regulation D - Reg D
Definition
This rule lets companies sell to private investors rather than to the general public. Regulation D offerings don't need to be registered with the SEC, but they do need to toe the line in other ways. The offering can be made to any number of accredited investors, for example, but to only up to 35 unaccredited investors. Rule 144 lockup provisions may also apply to this type of offering. Or said another way...
It’s another diet regulation drink, which gets companies selling stocks or bonds out of the small forest they have to kill to print all the paperwork required by the SEC in a full rollout public offering. Regulation D is sort of the special situation common in these letter regulations… which in this case simply restricts the company issuing the securities to only sell to qualified private investors.
What is “qualified”?
Well, it generally means that those private investors are already wealthy: net worth of n millions of dollars; they have continuing income well into the hundreds of thousands of dollars per year. They're educated…yes, broadly defined, and it doesn’t just mean they’ve taken a $14 Shmoop course. And most importantly, they will have signed a big boy or big girl letter, which states that if this risky offering goes completely bust, then...no tears. Or lawsuits.
In a Reg D filing, there is usually an allocation for sales beyond the above accredited private investors and some amount of the stock can be sold to non-accredited investors. And in current Reg D land, that number is limited to 35.
So why would the SEC allow a highly risky private investment be made to a meaningful number of non-accredited investors - people who might be non-millionaires, uneducated, or unsophisticated in the wiles of the financial jungle? Because in many early-stage startup companies, the founder has a few dozen family members who are all anxious to find the next Amazon and even though they are a plumber and a carpenter and a cook, they have 5 grand of savings with which they want to buy a lottery ticket.
So the SEC makes accommodation for this investment in Reg D, and oh by the way, this actually happened when Jeff Bezos founded and started Amazon. So dreams really do come true...
Relative Strength Index
Definition
How do you measure the strength of a stock? Try the relative strength index (RSI).
Imagine lots of charts and graphs (fun, right?). The price of a stock is graphed over a period of days, months, or years. Everything is put on a scale of 0–100, and analysts start paying attention when the stock prices go above the 70 mark or below the 30 mark. The idea is that too many peaks and valleys or lots of ups and downs is bad news.
Repurchase Agreement
Definition
Think: very short-term debt instruments.
That is, things like T-Bills and other government forms of debt paper are sold—and then bought back the next day. The annualized interest rates on these instruments is usually very small, but the instruments are very liquid. So people use these agreements to pay short term bills and take care of large corporate projects for short periods of time.
It's the fruit fly of the securities kingdom.
Reset Date
Definition
The date when the rate adjustment of a dividend happens.
"The preferred shares of BUBB will pay an interest rate no less than 50 basis points more than whatever the 10 year T-Bill is yielding on the last trading day of each quarter."
That last trading day is the reset date.
Residual Claim To Assets
Definition
The claim to leftover assets.
If you have common shares, you have a residual claim to assets. This means that if the company goes bankrupt and sells its assets, the creditors and others are paid first. If there's anything left over, you have rights to that leftover (residual) stuff.
Spoiler alert: By the time everyone's paid off, there's usually nothing left.
A few percent of $0 is still $0. That's just how math works.
Retirement Accounts
Definition
Life is fleeting, nothing lasts forever, and all that jazz.
Eventually, you too will get old, and no matter how cute you are now, you'll have to deal with hip aches and bratty kids. When you can no longer work, you'll want money to pay for food, heat, and adult diapers. You can invest money for that time with a retirement account—like a pension fund, 401k, or IRA.
These funds make your money grow faster (and a lot, if you start early); they offer tax breaks, to boot.
Reverse Split
Definition
When a stock is tanking, it risks getting laughed off the exchanges (i.e., being delisted). When this happens, the company can try a reserve split, which means that shares are merged together. If you hold 100 shares at a dollar each, you suddenly own just ten shares—but each is worth $10. It doesn't mean your investment is worth more, but the per-share value has less overall suckage.
Reversionary Interest
Definition
The key word here is "revert."
For example:
"For $10,000, you can use the walkway between my house and the beach for 10 years; after that time period, that right to use my (amazing) walkway reverts back to me and only me, and you're left using that other walkway—the one covered in rusty nails and rabid wolves. This forces you to negotiate again, and all the circumstances are different. For instance, now I want $20,000 instead of $10,000."
Reversionary interests apply to vanilla investments too. That is, "Cousin Billy Joe, you get the interest on these bonds and the rent from these apartments until your mama Cousin Louloubelle dies; at that point, the dough from these two vehicles reverts back to me."
Revocable Trust
Definition
"Kids, I am giving you 8,000 shares of whatever.com. It's going to sit in this revocable trust until you are 30. If, by that time, you have not married an admitted Packers fan, then the shares are revoked and I'll find some other Packer fan to give 'em to."
Revocable trusts are different from irrevocable most importantly from a tax perspective. In an irrevocable trust, the basis of the investment is fixed and the trust can be funded decades before your progeny would receive it; in a revocable trust, the IRS views it as not-really-a-gift, so taxes are levied after the dough from that trust is converted/sold/used.
Rights Offering
Definition
Think: "a right to buy." And buy at a discount.
Companies may be fearful of a hostile takeover or some other big bad event, and they want to give existing shareholders preferential treatment over external non-shareholders. So they might say, "Okay, pals, for the next 60 days, you have the right to buy an additional share of our stock which is currently trading for $312/share… for $300 a share (note the discount, wink wink) and you need to currently own 5 shares for every 1 that you'll then buy." That is, the company is offering those rights to buy at a discount—and the shareholders can sell those rights to other non-shareholders for cash.
In essence, it's kind of a funky, one-time dividend.
(See warrants, too.)
Risk-Adjusted
Definition
A fund may have doubled in a given year—yep, it went up 100% in one year. You paid $10 a share for that fund, and now it's worth $20 a share.
Did the managers do a good job? Well, there's an easy "of course!" in there because you doubled your money in one year—how can that possibly be bad? Well, what if the managers only invested your money in a series of California State Lottery tickets and it just happened that one of those tickets won and paid off huge, so that while 99.9% of your portfolio went bankrupt (or ended up being worth zero when the Scratcher returned a frowny face), 0.1% made a 100,000x return.
On a risk-adjusted basis, the fund was bad; the managers took insane and irresponsible amounts of risk. They returned a dandy absolute number but could very easily have had your $10 a share investment be worth $0.00 a share a year later.
Not good investment management practice.
Road Show
Definition
Before a company issues an IPO, they sometimes hit the road like a rock star—except with fewer wrecked hotel rooms... usually.
Road shows take company management around the country to give presentations to possible investors, analysts, and groupies. The idea is to drum up interest so that when the IPO happens, people will buy shares.
Think Cirque du Soleil but with charts and suits.
Roth IRA
Definition
It's a retirement package that taxes you for investments when you invest 'em.
Example
Say it's 2019, and you make a contribution of $2,000. You're taxed at the 50% marginal rate, so you had to earn $4k to keep that $2k. But at least you have that $2k. You then invest it in your Roth IRA and it compounds at 10% a year in an index fund. You take it out 22 years later and it has doubled 3 times—that is, it became worth $4k in 7.2 years, then $8k in another 7.2 years then $16k in another 7.2 years—at which time you retire and want the dough for the cruise to Boca.
You take out the $16k—untaxed. You got to compound all those years with no tax paid on the gains. In a normal IRA, you'd be taxed on those gains.
Roth Love.
Round Lot
Definition
A hundred shares of stock. (It can also refer to shares that can be neatly divided by 100.)
Usually, exchanges require you to buy at least 100 shares of stock before they talk to you (same with brokers), and they like to do trades in rounded numbers ending in zeroes.
Maybe they're not as good at math as they claim to be.
Rule 144
Definition
If you want to sell unregistered or restricted stocks and securities, the SEC wants you to follow some rules. For example, you might have to hold onto the stocks for a while before trading or selling (that's Rule 144).
See lockup provision.
Rule Of 72
Definition
A nifty little equation that lets you use the number 72 to figure out how long it will take for you to double the value of your investment. Just divide 72 by the annual rate of return on an investment to find out how many years will take for it be worth twice as much.
Example
You buy $1,000 worth of a stock (50 shares at $20 a share), which compounds at 8% per year. The Rule of 72 tells you how many years it'll take to double the principal compounded value of that stock—to get the magic number, you take that 8 and divide it into 72. In this case, at an 8% compound rate, it'll take you 9 years to double your money.
S Corporation
Definition
See sole proprietorship, limited liability corporation, and C corporation.
An S corporation is a type of incorporation for a company which "fits" for companies with 100 shareholders or less. In this case, a company's profits aren't taxed twice when paying out profits to shareholders.
Example
Kendra's Kazoo Factory has 50 shareholders and made $5M in profits, pre-tax, last year. Normally her company would pay $1.5M in taxes and then only have $3.5M to pass through to the 50 employees. Those employees then pay their personal individual income tax on that $3.5M. Figure it's about 40% is and the $3.5M turns into $2M after taxes. So we've taken $5M in profits and turned it into $2M by giving over $3M to the Taxman.
But in an S Corporation type of incorporation, there's no corporate slice of $1.5M meat—instead, all $5M is passed through to the 50 employees who then pay their 40%ish tax and the $5M turns into $3M instead of $2M.
Definitely a better deal for the people who worked hard to earn that money.
S&P (Standard & Poor's) 500
Definition
The Standard & Poor's 500 is a U.S. stock market index that's based on 500 major companies in the U.S. If you want to know how the U.S. stock market is doing, check the S&P 500.
For more, head on over to our Learning Guides.
Sale
Definition
In "the markets," a sale is both "the market" as well as "someone buying something."
Also, keep a look out for the word "sale" predicated by the word "yard." And then text us. We need a slightly-used desk chair.
Sarbanes Oxley
Definition
The Sarbanes-Oxley Act (SOX) of 2002 was created after the accounting scandals at Enron and WorldCom showed just how much numbers could be fudged.
Under Sarbanes-Oxley, there are stricter penalties for fraud and more rules about transparency and the reporting of accounts.
Second Market
Definition
A platform where shares of non-public companies can be traded.
Secondary Offering
Definition
First, there's an initial public offering. Any time a company sells shares after that, it's a secondary offering.
You can only be first once, but you can be second all you want.
Section 457 Plan
Definition
It's an extra benefit to government employees, courtesy of Uncle Sam. Employees under this plan are allowed to defer (not avoid) taxes on income.
Example
Ms. Havisham decides to take the amount she lost on a failed wedding out of her paycheck each year—$10,000—and put that money in a 457 plan. There are no taxes on that $10,000 until she takes it out of that plan, at which point it's taxed normally.
These plans are set up to help government employees better prepare for a quality retirement, i.e. not one in which they are living in the back seat of their old station wagon.
Secured Bond
Definition
A secured bond is backed by an asset. It guarantees that if the company gets into trouble and can't pay you back, they will sell the asset and use the money to pay the principal and interest on their bonds.
Securities Act 1933
Definition
Before this law, securities trading was the Wild West. Companies could lie about their shares and financials and do all kinds of other unethical things. This was the first major securities law, and it required companies to register before their shares could be sold to the public.
Suddenly, overseeing the securities market in the U.S. became possible.
Securities Amendments Act Of 1975
Definition
Before 1975, trading stocks was very much a regional thing. New York was the sun, and the rest of the world more or less just... orbited.
The 1975 Act created a national market clearing system so that a share of IBM traded for generally the same price in California, Georgia, New Hampshire, and New York. This way, smaller, less-liquid regions aren't penalized with higher transaction costs than the wolves on Wall Street.
Fairness FTW.
Securities And Exchange Commission - SEC
Definition
The SEC, or Securities Exchange Commission, has nothing to do with a realtor getting 6% when they sell your house. “Commission” here is about “committing” to do right by investors.
Why do we have a whole commission or army of lawyers dedicated to the fair exchange of securities?
Because there was an era, brutally demonstrated in the 1920s, when fast-talking, sleazy wheelers and dealers ripped off everyone from Ma ‘n Pa Kettle to, uh, Aunt and Uncle Teapot.
They would prey upon the uneducated, the uninformed, the gullible, painting stories of great riches that the would-be investors could have, if they just sold their 20,000 acre farm and parted with 10 grand to buy this beautiful park that real estate developers wanted to turn into highrise condos. But, in fact, many of those lands were actually... swamp lands. The only folks who might be moving in were beavers, deer flies and alligators.
And it wasn’t just real estate securities that were abused. Fake companies…
The Duffer Golf Association…
The Lego Bridge Building Company…
Bumper Stickers R Us, sprung up everywhere with crazy promises that sounded plausible to those with barely a 3rd grade education. But...total scams.
The American public, tired of reading about uneducated investors losing all their money to fast-talking salespeople, lobbied congress to create the SEC in 1934, with its core purpose to regulate the buying and selling of securities in America.
Yup...pretty much “the investing police.” Myriad laws and structures were put in place, mainly around full and fair disclosure of whatever security a money-raising company was selling. That is, if it really was swamp land, you had to disclose that it was swamp land.
You couldn’t claim it was something it wasn’t, using fancy vocabulary that a normal ordinary person couldn’t understand. You couldn’t, uh...polish a turd and call it a marble. The broader goal here was not to give Americans advice on what to buy or sell, but rather just to have full and fair disclosure of the facts, so that when a buyer did buy and got taken, all the facts she needed to make a rational and reasonable conclusion were right there in front of her.
So...anyone for a game of marbles?
Security
Definition
The generic term for anything that you can invest in: stocks, bonds, mutual funds, REITS—all of them are securities.
Selling Away
Definition
Selling away means your broker-dealer suggests stocks and securities not held or sold by their firm.
Usually, securities regulators from upon it since it generally means the broker-dealer is taking business away from the firm.
Selling Group
Definition
In any given offering of debt, equity, or marbles, there is usually more than one bank who markets the IPO (or secondary, or whatever).
On a big IPO like Alibaba's, there was Goldman, Morgan, Merrill, and an ocean of smaller banks around the world. Together, these comprise "the selling group." Fat Mike, Skinny Mike, and Ed from up the street would comprise the marbles' selling group.
Senior Debt
Definition
In companies who borrow a lot, there's usually a whole stack of debt. Layers upon layers of borrowings were done over years to build stuff and stave off peasant rebellions.
For instance, the cable industry borrows famously in many different "inventive" ways. Senior debt is the safest of that group; it sits on top of junior debt, which sits on top of debentures or unsecured debt.
In the event that the peasants do overrun corporate headquarters and the company goes belly-up for whatever reason, the senior debt is paid back first. And there's always the chance that junior debt won't get paid back at all.
Seniority
Definition
See: senior debt.
There's a pecking order in liquidation if things go... awry. Having seniority is good. Juniority? Not so good. Senior bonds get paid first.
Serial Maturity
Definition
How long has that box of Cheerios been in the cupboard?
Yeah, it's not about that.
In debt offerings with serial maturity, a portion of the total outstanding debt is retired or bought back by the issuer each period or "serial time."
Example
Shmoopazon is a public company, which just sold $1 billion worth of bonds. It is going to buy back $100 million of them every 6 months after 3 years have passed. It picks by lottery which bonds it'll buy back, usually in $25,000 units, and if your number is called, well, lots of soup for you. You get your principal cash back, plus usually a small premium, plus whatever interest would have accrued in the previous period. You can then spend that money on Grape Nuts, which is a very mature cereal.
SG&A (Sales, General & Administrative)
Definition
Sales, general and administrative expenses.
It's a line on an income statement and stands for the money used to manage a business, deliver products or services, and market the company. These costs are important to the overall expenses of a business, but they don't fit with the costs of production.
Shares Outstanding
Definition
The number of shares of a company that are out there in the world, owned by investors and shareholders. Any shares bought back by the company are not included in this number, which will change over time as the company raises more funds.
Example
Company X has issued a hundred million shares to employees, investors, and the general public. The company bought back ten million shares. They have ninety million shares outstanding.
Sharing In Profits/Losses Of Clients
Definition
An agent can only share in a client's account profits or losses if the agent has been allowed to do so by a principal or if the agent contributed to the account, in which case, the agent can only take part in the profits and losses to the extent that they took part in the account.
These limits and rules ensure that the agent can't help themselves to an account's profits whenever they want.
Sharpe Ratio
Definition
The Sharpe ratio is a calculation used by investors to figure out the link between risk and return.
Short Sale
Definition
Selling something that you don't currently own because you think the price will go down. You borrow the security and sell it. If you're right, the price drops and you buy it back later for less. Put another way: Your Granddad always said, "buy low, sell high." This is just "sell high, buy low."
The net result is the same.
Example
You see sales of Lost company for $40 a share. You think the price is about to head down so you borrow ten shares and sell 'em for $40. You make $400. A week later the shares are selling for $10. You buy the stock for $10. That's 10 shares for $100 and you give back what you've borrowed. The $300 difference is your profit.
Simple Trust
Definition
See complex trust.
The key differentiator is that a simple trust must distribute any income it made during the year. (A complex trust can retain 'em.)
Income is different from just capital or real estate or whatever appreciating in value—that stuff gets retained in the simple trust. And the beneficiary can not be a charity—it has to be a taxable someone or something.
Yeah, we know: not that simple.
Sinking Fund
Definition
A company with bonds outstanding will buy back some of the bonds each year, gradually paying off the debt. They do this by handing over chunks of money to a trustee who uses the cash to buy some of the bonds on the open market.
Investors love sinking funds because the company is putting money toward the bonds, so it's much less likely that they'll default (not pay). Low risk = happy investor.
Example
Company X has $100 million a year in extra cash. It has 10 bonds outstanding, each with a $50 million face value. The company takes half of its free cash flow (that's $50 million a year) to buy back the bonds. On the company's balance sheet, that's one less debt. The company's financials look rosier already.
Soft Dollars
Definition
This is basically the opposite of cold, hard cash.
Brokers need to get paid (how else are they going to keep their Maseratis running?) but they need not always be paid in cash. In many cases, brokers will pay for things like trading stations or research on their own nickels—and then "give" those to their clients.
In return, the client trades with that broker or buys shares through them. Ordinarily, the client would pay a commission, but, in this case, the client gets soft things from that broker like research from the analysts who the brokers employ to opine on the direction of shares of public companies.
Soft dollars are also much better for stuffing mattresses. Warmer, too.
Sole Proprietorship
Definition
This is a business structure where there is one person in charge and one person owning the company.
There is unlimited liability: If something goes wrong and the business is sued, lawyers can come after all the business assets and all the owner's assets—even their house and car and other stuff that's not linked to the business at all. Why? Because the business is simply an asset the owner has; there is no divide or safety barrier between the business and the owner.
Special Situation
Definition
Everyone loves Apple. Or Google. Or TheWhatever.
But then...
Newscasters from across the globe release information that the son of the high-profile CEO of said company has been caught playing the original Donkey Kong arcade version—and everyone's having a crazy freak-out about it. (Don't ask.)
A lot of people then bail out of the stock because of the uproar which is likely to die away in a couple weeks... or days, given that the 24 hour news cycle is nuts.
This incident would be your "special situation." It's a blip in the radar that doesn't have anything to do with the actual valuation of an investment or its tangible future expectations.
Specialist
Definition
A member of a stock exchange who is responsible for maintaining an orderly market in a particular stock or stocks that are traded on the exchange. The specialist is required to provide liquidity through purchasing shares when there are no other buyers and selling when there are no other sellers.
The specialist maintains a book that shows all limit and stop orders for the stock, which, yes, is considered inside information—but specialists are specifically exempted from the normal insider trading rules as long as the trades made on inside information are to maintain an orderly market.
Order in the market!
Spread To Treasuries
Definition
Ever wonder how bonds get priced? It sure ain't random.
It happens through a spread to treasury, which is the yield difference between a a U.S. Treasury security and a similar bond. U.S. Treasury securities are considered to have pretty much zero risk, so if a U.S. Treasury is yielding 4%, a bond from a private company could yield maybe 14% because (duh) it's a much higher risk.
Stack
Definition
Scrooge McDuck piles his cash in his money bin for easy swimming, but, in the real world, we stack our bills neatly.
"Capital Stack" refers to the totality of all the investment instruments used to fund a particular project or company. The investments at the top of the stack are considered riskier, and people typically require those to pay out better dividends and interest. The lower in the stack you go, the less risk the investments are thought to have.
Think of it like a food pyramid for yummy investments: lenders and stockholders are the ones most concerned with counting their "risk calories."
It also means that Scrooge McDuck is incredibly disorganized and doesn't have a sound grasp of investment risk. He does have a mean backstroke, though.
Stand-by Line Of Credit
Definition
Stand by your money.
That's how the saying goes, right?
This term simply means a specified, predetermined amount of money that a company or investor can get from the bank quickly. It's like having a credit card, only more official. And hopefully with a lower interest rate.
It's different from a normal loan in that the borrower doesn't have to take all the money at once.
Standard & Poor's
Definition
S&P is a ratings agency (owned by a publishing company) that has opinions on the creditworthiness of debt and sometimes other instruments. Opinions that it shares, of course. S&P also manages an index fund series called the S&P 500, which tracks the top 500 U.S. companies by market value across nine industries.
Standard & Poor's is typically mentioned nervously at uncomfortable dinner parties in an effort to appear intelligent and world-wise. Too bad the spaghetti stain on your shirt has already spoken for you.
State Administrator
Definition
The finance cops.
Sorta.
It's the state administrator's job to protect investors from evil overlord swindlers who would abscond with dough and take it on the lamb. The state administrator basically makes sure that the Uniform Securities Code laws are followed/obeyed and manages the arbitration/legal proceedings if they're violated.
Statutory Voting
Definition
For every share you have, you get one vote.
That's statutory voting.
You can't weight your vote, meaning, if you have 100 votes, you can't cast them all for the same director. (That would be cumulative voting.)
Stochastic Analysis
Definition
A term from the far-off land of statistics in which a disparate set of points are analyzed to find patterns that would lead the analyzer to a logical conclusion.
It comes in two flavors: slow and fast, with the fast being much more sensitive to the tiny squiggles and jumps in a stock's price.
It's like using math to read a crystal ball.
Stock Certificate
Definition
The piece of paper that proves you own X shares in a company.
Hopefully it's actually higher than X.
Basically, it's just proof that you own the stock. Today, most of 'em are in electronic form.
Stock Split
Definition
See stock dividend. They are identical in result.
Basically, it's what happens when a company takes its shares outstanding and doubles them. So if you hold 100 shares, after the split, you'll hold 200 shares. That might seem exciting, but it does nothing—for you. If you owned $100 of shares before the split, you will own $100 of shares after; just the number of individual shares will be bigger.
The company might get some benefit from a split because the price per share will be smaller, which can encourage more investors to buy.
Example
You own 100 shares of BananaSplit and each share is worth $10 (for a grand total of $1,000). Then they split their stock. You now have 200 shares of BananaSplit all worth $1,000 or $5 per share. Not much has changed. But if you were a new investor and wanted to invest in the stock, you'd only have to pay $500 to buy 100 shares. That might be more realistic for you if you're on a budget.
Stop Order
Definition
A stop order is a longer-term order you give your broker. It basically says "when the stocks reach this price, buy" or "when they reach this price, sell." The idea is that these orders prevent you from losing money or losing control of stock prices.
Straddle
Definition
You feel like something is about to go down with a stock. You can smell it: big change is coming.
The only problem: You don't know whether the stock will soar or tank hard. So... you need an option trade that will make you money in either case.
Allow us to introduce you to the straddle. In this option trade, you buy a put and a call with the same expiration and strike price. Whether the stock goes up or down, you can make money.
Strategic Asset Allocation
Definition
This is just a fancy word for "putting money in investments that make sense based on your circumstances."
SAA refers to the practice of setting basic percentages of assets in a portfolio that match risk and volatility to the investor's needs. That is, some dude at 30 years old just entering the workplace as a vaunted young cardiologist can take a lot more risk/volatility in his life than an 80 year old retiree. The asset allocation for the 30 year old might be 90% equities, 10% debt; for the 80 year old, it might be the other way around.
The asset allocation for a crazy hill-person would be in a mayonnaise jar in the ground under the moonshine still.
Strike Price
Definition
The price at which you may strike—whaBAM!—lightning fast. It's the price on an option where you can either buy or sell the security. WhaBAM! (We just like saying that.)
Example
You have a stock trading at $14 a share. You were a lucky employee to have joined before the IPO and you received stock options with a strike price of a dollar a share. You can say that you are $13 in the money based on the stock trading here at $14. In practice, to buy your Beemer, you would execute what's called a same-day sale with your broker who would remit to you the difference from the strike price to the actual clearing price or 13 bucks. Then go 325i.
Subordinated Debenture
Definition
A corporate bond that is lower in priority—i.e., subordinated—to other debt that the company has.
Big companies have lots of layers of debt, and they need to prioritize to figure out what gets paid first. Subordinated bonds are lower rated and they get paid after the higher-priority, higher-rated bonds.
P.S. Debentures are usually not secured by specific collateral, so they're the equivalent of a standing room ticket at an English soccer match.
Good luck.
Super-Voting Stock
Definition
Super-voting stock owners have super(voting)powers that other stockholders don't.
This type of stock is sometimes used when owners have founded a company and want to have more voting rights than their shares would allow. It can also be used when a group of people think their vote will better protect the company.
Example
Super-voting stock might be structured so that the founder who owns 20% of a company might have 5 to 1 super voting stock, in which case that founder's 20% economic share gets treated as if it's 100 votes against the 1 vote for 1 normal share owned by everyone else.
Translation: The founder can't be fired by the board.
Supply-Side Economics
Definition
Supply-side economics is a group of theories that suggest we should slash capital gains taxes—and lower corporate and business taxes while we're at it.
The folks behind these theories say that policies that help out suppliers and producers (the people who bring goods and services to the economy) have the best effect on making the economy stronger and that we don't need to worry about consumers or the people buying.
Surety Bond
Definition
Remember when you were a kid at summer camp and had to pony up a buck to prove your heavy roller status at Friday night's poker game?
Surety bonds are kind of like that.
We repeat: kind of.
A surety bond is an agreement between three parties. One party guarantees that second party will fulfill a promise to the third party.
For example, one signer might guarantee that a small business will honor a government contract. If the small business doesn't meet the contract, the person who signed on may have to pay up.
Syndicate
Definition
When a company wants to make an offering, they need underwriters to handle all the details. A syndicate is group of underwriters assembled to handle jobs (issues) too big for one underwriter alone. Like the Avengers of finance—only less cool and more nerdy. Actually, a lot of the Avengers are pretty nerdy, so strike that last one.
Syndicates usually consist of a lead underwriter (like Captain America), investment banks, and smaller broker/dealers.
Syndicate Agreement / Syndicate Letter
Definition
Who gets what? That's the gist, anyway, of a syndicate letter / agreement. In a selling group of, say, an IPO, there needs to be a detailed contract as to who "owns" the various key functions in marketing a given product. That's what the letter does. If you did something really bad in a former life, today you are the lawyer who has to write these for a living.
Systematic Risk
Definition
A big system risk you take when you invest in anything.
If you own stocks, and the whole stock market goes into a swan dive, them's the breaks. You can reduce the risk or hedge the risk by buying puts or sell calls...or investing in something besides the stock market.
T-Bills
Definition
T-Bills are federal debt you can invest in. T-Bills have short maturity dates of 91, 182 or 365 days, so they're a good bet if you want short-term investments. They have low risk because you're basically borrowing money from yourself.
T-Bonds
Definition
Want to invest in federal debt? You hear about it often enough, so why not?
T-bonds are a low-risk way to invest in federal debt; they have a maturity of ten years or more, so be prepared to wait.
T-Notes
Definition
You're always lending money to your BFF, so why not lend to Uncle Sam and actually make money from it?
T-notes are Treasury securities that let you invest in federal debt. These have a maturity date of 2, 3, 5, or 7 years.
What happened to 4 years and 6 years? No one knows. They just don't exist.
Takedown
Definition
A syndicate is a group of underwriters who help a company issue stock. They get paid for it, usually by making a profit when they sell those stocks. When they make this sort of profit, it's called a takedown.
Tax Basis
Definition
Lucky you. You bought WildInternetCompany.com at its IPO of $12 a share. It zoomed after a year to $50 a share. Now you go to sell it, knowing that you'll pay taxes on your gain of $38 a share.
Your tax basis on this investment is $12 a share; you pay taxes on the gains above that 12 bucks or in this case, $38 is taxable at the Federal plus State levels. But you're okay with that because you just made a killing and didn't have to mow a single yard to get it.
Technical Analysis
Definition
Take the two driest words in the English language, put them together, and what do you get?
Something pretty useful, actually.
Technical analysis takes a look at past prices of stocks, trading volume, and other stuff that has gone down in the market. Using charts and formulas, the idea is that you can use this information to figure out what might happen with securities in the near future.
Tenants-in-Common
Definition
A type of account that has more than one owner.
Each owner puts in a certain amount of money, and the amount of money they share in the account is based on this investment. If we put in twice as much as you, our share is twice what yours is. If one of the owners dies, their share of the money goes to their estate, not to the other account owners.
(Yeah, put the baseball bat down.)
Term Life Insurance
Definition
Term life refers to the type of life insurance in which you pay a relatively low monthly fee (called a premium) each month. If you die that month, your beneficiaries win big. If you don't, then you've wasted your money. But you're alive.
So... win win?
With term life insurance, there's is no "savings account" like in whole or universal life insurance. It all goes away.
Term policies typically only last for a certain amount of time (or term); then, if you want to keep the insurance in place, you have either buy a new policy (at a more expensive rate, because you're now older) or pay more premium that increases every year. Either way, you pay more.
You can see how it's a double-edged sword: It's cheaper than whole life insurance at first, but it'll eventually go away or up-in-price, and it lacks the savings-account-ish feature that whole life boasts.
Can you imagine trying to sell this complicated, ultra-dry stuff to people for a living? We should be nicer to insurance salesmen.
Term Sheet
Definition
A piece of paper that sets out terms of a deal. Sometimes on a napkin.
Even if on a napkin, it can be legally binding, so stay away from napkins and other pieces of paper unless you're really sure you want the deal and agree to the terms.
Example
I invest $1,000,000.00 in you.com today.
In return, I get:
- 51% of your company
- your lungs
- your liver
- your soul
Thank you.
Sincerely,
Mr. Faust
Term To Maturity
Definition
The time from when a bond is issued to the time it matures.
That is, you could have bought a 10 year bond 3 years into its life—its term to maturity is 7 years. Term kind of = time. The term to maturity for writers here in the bullpen at Shmoop is... well, still TBD.
Testamentary Trust
Definition
It's basically a legal entity holding the proceeds from a will that becomes active when the writer of that will kicks the bucket.
It it's the kicker's "testament" as to what they want done with their house, car, liver, and lungs.
The Howey Case
Definition
This particular Supreme Court case established just what a security was.
It started when a guy began selling real estate that his established orange grove just happened to be planted in. It was kinda implied that people got profit from these oranges. However, the dude's company managed all of the trees itself, and, if buyers didn't use the company's management services, the buyers couldn't realistically make any money off of their investment.
As a result, the court ruled that the acreage investment was a kind of security contract, and as such, came under different (higher) scrutiny than if the buyer had just bought non-productive-land.
Talk about makin' lemonade out of… oranges.
The Securities Exchange Act Of 1934
Definition
This is the big grand-daddy of modern securities trading, as it created the structure, requirements, and regulations for the secondary (after IPO) market.
The SEC sprung fully formed from the Act's head and began its long reign of dreaded compliance meetings.
Time Value
Definition
See intrinsic value. All options have two parts that decide their value.
- Intrinsic value is how much you'd make if you exercised the option right now: it's the difference between the strike price and the current price of the underlying stock.
- Time value is the difference between the current price of the option and its intrinsic value.
Time value also refers to the way that options can help you use time to make money and to limit how much you can lose.
Let's say you buy a stock option today. You know the value of the stock today—you can just Google it. But will it go up or down? Will the option make you money? Since a stock option doesn't require you to buy or sell a stock today, you can use time to your advantage. Maybe a company is launching a new product in three days. If you have a stock option, the value of the stock (and your option) might increase or decrease sharply after that. A call option lets you make money if the stock price goes up, but limits the amount you stand to lose if the stock value goes down (you only ever lose as much as you paid for the option). The closer the stock option gets to its expiry date, the lower the time value involved, since it's unlikely the stock price will change much in the eleventh hour.
The idea of time value is an important concept in investing in general. That is, "a dollar today is worth more than a dollar tomorrow" (in a normal world). Why? Because today you can invest that dollar. Even if you only buy a 1% very safe T-Bill, that dollar today will be worth something like 1.00001 dollars tomorrow. Thanks to inflation, though, the money you get tomorrow will actually be worth less.
Time-Weighted Rate Of Return
Definition
It's really hard to compare huge pools of investments in an apples-to-apples way. Some of the stocks in a given mutual fund or portfolio could throw off periodic dividends—which is great, but when that happens, it skews the regular rate-of-return number, making it look better than it really should.
So, to figure out what the given portfolio has actually done in the market, the time-weighted return simply looks at the original investment and takes out all the varying cash-flows that occurred. Otherwise, any stock that gives out a healthy dividend would look waaaaay better than one that doesn't. Sometimes we need to just look at how each stock performed, not the stock-and-dividend.
And you thought you had weird hobbies.
Trade Deficit
Definition
A bad thing that happens when the imports from a country are higher than our exports to that country. There's an imbalance, and that country profits more because they make more money on the trade.
Example
For decades, America gathered most of the natural resources it needed to build cars... from America. We made our own steel, tires, leather, rear-view mirror fuzzy dice, etc. We then sold that car to Europeans and Asians and made a friendly killing. We had balanced trade in those days where we were King of the Castle.
Then bad things happened. We lost our dominance in the auto industry; our cost of labor skyrocketed relative to that in emerging countries, so we lost a lot of our industries; and we never even made it to the finals of the World Cup.
Today, more wealth leaves the U.S.—buying things from China and other countries—than wealth comes in. Translation: We have a trade deficit with China.
Trading Authorization (Power Of Attorney)
Definition
Little Old Maybell Bluehair just can't think straight any more, at least when it comes to managing her considerable money. Husband #4 was loaded and had a weak heart...and one too many cheeseburgers.
Maybell trusts her grand nephew Beauregard to make trades on her behalf and has given him "trading authorization" to manage her account—that is, he can make trades without pre-clearing each one with her.
His status is analogous to having "power of attorney" in doing various legal things in life.
Trading Volume
Definition
HOW LOUD IT IS ON THE TRADING FLOOR!
JK.
Trading volume is the number of shares traded in a specific security today or over a period of time. If trade volume is high, it means lots of trades are being made involving a specific market or security.
Example
Can you find it? Keep lookin'... that's the number of shares that have traded thus far today.
Transfer Agent
Definition
When you sell a security, a lot happens. Paperwork gets filed, money gets exchanged, eyes glaze over, the security changes hands.
The person who makes sure that the security gets to the right person and things go smoothly is known as the transfer agent.
Treasury Bond
Definition
See: Treasury Bill. And sing a little bit. F sharp, please. Treasury Bill sings waaaaay better than Treasury Bob, who is really just a karaoke man.
Treasury Stock (Treasury Shares)
Definition
It’s stock. You keep. In your treasury. Like down in that bubbler thing at the bottom of your fish tank with all the shiny jewels. Glug glug.
So how is it that a company would then own shares of its own stock? Well, it would buy them back. From the public or previous investors, most likely.
And companies buy back stock all the time, in part, because it’s a different and more tax-efficient way to return to shareholders quote “excess cash” unquote, as if there ever really is excess cash. When dividends are paid, they are taxed a second time on the backs of the individuals receiving those cash dividends.
But when cash is used to shrink the shares outstanding, in theory, anyway, it charges the stock price per share to go up. So in buying back shares, the company stores them as an asset, and those shares are carefully tracked, because...who knows? The company might some day sell shares and then the treasury stock could come out of the bubbler thing here and get sold back to investors, presumably at a much higher price than at which it was bought.
Treasury stock is really just a kind of placeholder. It doesn’t vote. It doesn’t get dividends. It just sits there, a result of an overfed market.
Trend
Definition
A trend is just a general direction in which something is happening.
Think mom jeans and the term YOLO.
It means more-or-less the same thing in finance, only referring to the general direction that a stock, bond, or general industry is going.
And since we know you're going to ask: no, our ripped courds aren't trendy. They're classic.
Trough
Definition
This one is pretty simple. When you look at a stock chart and you see that big ol' dip where it went down then back up? That's a trough—as opposed to a peak, which is the top o' the squiggly mountain.
Trust Account (or Trust)
Definition
A trust is kinda what it says it is: one person trusts another party to follow certain written instructions.
A bank or trusted party is tasked with being sure that the money that is supposed to get paid actually does gets paid—and to the right people/things. The person creating the trust, the trustor, gives another guy, the trustee, the right to hold official possession of stuff for the benefit of someone else, the beneficiary.
There are lots of adjectives that can be attached to trusts, and tax laws change every time you do so, so check out some of our other definitions and make sure you pick the right one for the right circumstances.
Trust Indenture Act Of 1939
Definition
This Federal Act requires any bond issue over $5,000,000 have an indenture before being offered to the public.
An indenture is the laundry list of details about the bond, such as coupon, maturity date, collateral, mother's maiden name, and so on. "The Trust" in the act refers to the requirement that the issuer hire an independent trustee who acts on behalf of the bondholders.
The same writer who misread the moral obligation bond messed this one up as well. Sorry, 1-800-Fixodent. Okay, so arguably the most boring act of all time - even more boring than the third act of Henry IV, Part 2 - a total snoozefest, the Trust Indenture Act basically extended the set of laws trying to make financial dealings more fair and square for the little guy, the average Joe, the Joneses.
Specifically, this act focused on trusts, i.e. legal entities set up to manage and allocate money in the event that life…changes. You die; you have kids; you get married; you get divorced; you turn into a zombie...yeah. All of those.
So the TIA does a couple of things:
First, there’s the “indenture” part. An indenture is a written agreement - a legal contract, more or less. The Act made it illegal for bonds of $5M+ to be offered without one of these protective docs, and it had to disclose everything up front, so an unwitting bondholder wouldn’t suddenly be shocked to discover that their bond ceased to hold value after the third waning moon following the winter solstice...or whatever other clever catches the issuer decided to throw in there.
And then there’s the “Trust” part. The Act also made it a requirement for there to be a trustee appointed any time a bond is issued, someone whose job it was to make semi-annual disclosures of any relevant info related to the bond. So yeah, by putting these safeguards in place, the little guy, uh, wouldn’t get stepped on.
Trust Instrument
Definition
Trust instrument is just a fancy way of saying trust.
Because that's apparently a thing.
Trustee
Definition
Someone worth-ee of trust-ee.
The trustee oversees the trust and makes sure that its intents are being followed to the letter of the law. They're the ones who hire the lawyer who calls the family together to inform them that they have to spend a night in a haunted mansion to receive the lavish fortune.
U.S. Pay Bonds
Definition
We're safe. We're sound. We're sane.
At least that's how the U.S. looks financially when compared with most of the rest of the world. So, a bunch of countries issue their own bonds—but denominated in U.S. dollars. Ours is a "hard currency" in that we don't or at least haven't historically created massive 10% a month inflation to deflate our own currency and make it super easy for our government to pay off its debts.
Because there exists that trust, the rest of the world often values our own currency higher than its own. When they issue, say, Argentine bonds payable in U.S. dollars, that's a Yankee bond: We are the yanker; they are the yank-ee.
UGMA (Uniform Gift To Minors Act)
Definition
UGMA is what you say when your mother tells you to go wash your face.
It's also the Uniform Gift to Minors Act, a law from the 70s that outlines the gifts minors can receive and the taxes they have to pay. Thanks to this law, you can give your kid securities and assets without having to set up a trust. If you stay below certain limits, Junior, Jr. might not even have to pay taxes on the gift—but you do have to make sure you follow a bunch of rules.
Underwater
Definition
Stock options are only profitable in certain circumstances, mostly depending on the price of the stock.
If a particular option would be worthless if it expired or were executed today, then it would be referred to as "being underwater."
Example
You joined WildInternetCompany.com about 3 months after the very hot IPO. Its stock zoomed to $34 a share after pricing at $12. Your options were granted the day you joined, taking the average close price of the previous month or $34 a share.
Sadly, the new products they launched, well, sucked. The share price has sagged to $24 a share now. You are $10 "underwater" in your options.
Uniform Net Capital Rule
Definition
Say you're a broker-dealer (or at least the guy in the big leather chair who owns it). This rule says that, even though your company's actual worth is constantly, wildly fluctuating (due to making trades for your clients and "holding" stocks and assets for them), you've got to have enough liquid, cold, hard cash to meet all your obligations at the end of the business day.
In 1975, this rule was enacted to give the SEC the power it needed to make sure that these firms didn't become accidental Ponzi schemes. Each security held by the B/D (broker-dealer from now on. Get used to these acronyms; they'll win you credibility in the industry) is valuated by the SEC, factoring in what they call a "haircut," which is different for each security. The haircut for each is determined by the current market price (i.e., "Hey, who wants this smelly fish? It's still made of 100% fish. Anyone?) and how liquid the investment actually is.
So, as you can guess, every security is completely different when figuring how much of it is actually usable by a B/D if everything goes belly-up tomorrow.
Clear as mud? Or at least clear as fish?
It doesn't smell that bad. Come on, people.
Uniform Prudent Investor Act
Definition
Being prudent just means being respectful, careful, measured...you get it.
And, in this case, we're talking about people who act as trustees for estates. In other words, if you happen to find yourself the trustee for a huuuuge portfolio, and it's your job to invest/manage that money on behalf of a beneficiary (that's a big sticking point, by the way; that's the only reason trusts are made in the first place) then this rule says that you cannot invest the money into your own imaginary company you just filed on Legalzoom.com, nor can you invest it in dodo-bird-futures. Because they have been dead for years and there is no such thing as dodo-bird-futures.
So yes, this act says "if you are a trustee, and you act in a willfully stupid manner, you can get in big trouble."
The end.
Universal Life Insurance
Definition
This is a combination of the concepts of "term life" and "a savings account with interest."
The insurance company lets you take out a policy that typically renews every year, meaning that the premium goes up, every year. But—they also let you put money into this tax-deferred savings account called a "sub-account" that makes it to where you can stop paying those term premiums after a certain year or just build up a crazy amount of money inside the policy as if it were a bank.
Sounds great, right? Well, the entire idea took a big hit when interest rates fell hard-core. Mostly because the people who made these policies couldn't imagine a world where prime interest rate could fall below 8%. Guess what? It did.
Unlimited Liability
Definition
It means you can have your pants sued off—literally.
In this structure (like a sole proprietorship or a freelance business), if your company is sued, the lawyers can go after your company and your own money and assets—even the stuff that has nothing to do with your business. That's why lots of people prefer limited liability companies.
If your company destroys a city, the business can be sued. But you can still take your personal money (which remains yours) and move to a city you haven't destroyed yet.
Example
It's a tale of two pizza parlors: the Joneses and the Smiths. The Joneses owned their pizza parlor personally as a sole proprietorship style of business ownership. The Smiths set up a limited liability corporation for $299 on LegalZoom.com.
Both operated basically the same. Until The Cheese Day happened. It was bad cheese. They had the same supplier. It turned all of their clients' stomachs to mush. And both operators got sued. And lost. A million dollar judgment.
The Smiths lost the restaurant, but they had taken money out of it for years, so they were just fine financially. They'd open a new one down the street. And change cheese suppliers.
The Joneses were not so lucky: the parlor brought $300,000 at auction and the family still owed $700,000. The lawyers stepped in and sold their house, net of mortgage and realtor commissions for $500,000. The cars went for $25,000. Then went the fish tank, the shoes, the jewelry brought over from Europe during the war. All of that was another $20,000.
It still wasn't enough. We shan't continue with what happened to the Joneses, but you don't want to keep up with them. It's called a "limited liability corporation" for really good reason and costs a couple hundred bucks to set up.
Unsecured Bond
Definition
An unsecured bond (think: promise) is a bond where you get little more than a promise that the bond will be paid back. There are no assets backing it up, no strongly written legal language saying you'll make money or even get your initial investment back.
So why are unsecured bonds of any interest to investors? Well, if management ever didn't pay back a promised bond, their careers would be pretty much totally over. Management has a lot to lose, and as long as you trust them to act in their own best interest, unsecured bonds may be a good bet—they typically pay higher interest rates than secured bonds and usually issuers do pay them.
Example
Comcast has issued unsecured bonds for decades. They are well known by Wall Street and have never missed a bond payment. As a result, they can issue pretty much anything they want—they've earned the freedom over time. There's nothing guaranteeing the bond but at this point it seems pretty low risk.
Unsystematic Risk
Definition
Risks that are caused by lousy decisions—having a lousy investor or investing in bonds when you should have bought stocks—as opposed to major disasters.
See systematic risk for the opposite.
Example
You think you're smart. You bet the ranch on new IPO whatever.com...and end up giving the ranch to your broker.
That's unsystematic risk because you're the problem. Moral: don't bet the ranch. And if you aren't a pro investor with all the training, just buy an index fund and go play golf. At least you'll get a nice tan out of it.
UTMA (Uniform Trust To Minors Act)
Definition
The UTMA (Uniform Trust to Minors Act) lets parents set up trusts and entities to keep money and assets on ice for their kids. When Junior was 21 and could make his own bad decisions, UTMA made it easy for the assets and cash to pass over to him.
Valuation Ratios
Definition
The valuation ratio is similar tot he price-to-earnings ratio. It's a measure of a company's valuation, usually relative to that of the overall stock market.
Example
If a company—let's call it Theoretical Company Blah—will earn $1 a share this year, and the stock of TCB trades at $20, then it has a 20x or 20:1 price-to-earnings ratio.
The gotcha in here is that companies often carry cash and/or debt, so if TRB has $10 a share in debt and $4 a share in cash, then its price-to-earnings ratio is still 20—but it likely has more volatility in its movements as the debt is gasoline on a fire when things go well or poorly.
Value
Definition
It's a very ethereal, vague concept, but remember this: Value is always what the buyer thinks it is.
What are you willing to pay for Bea Arthur's Sunday dress wig? Anybody? Nothing?
Good. We'll bid $100.
Vanilla Bonds
Definition
Basic bonds. Nothin' fancy. No special features.
Personally, we prefer mint chocolate chip, but what can you do?
Variable Annuity
Definition
A retirement account you create with an insurance company.
For years, you put money in the account, and the company invests in money market funds or different types of mutual funds.
Then you get old and wrinkly.
Time to tap into all that cash so you can get serious about your bingo game. At that point, the insurance company promises a minimum payment ("we'll pay you at least $500 a month"), but the payments each month can vary (always above that minimum) depending on how the investments did and how much money you socked away.
Variable Insurance
Definition
The "variable" part means that "this already established life insurance or annuity product does not have a standard set interest rate."
Translation: The interest rate can vary.
Why? Because they're basing their interest rates off of one of the big stock market funds, like the S&P, the Dow, or sometimes (and this is why it gets complicated, fast) portfolio managers picking other portfolio managers.
This comprises both "variable life insurance" and "variable annuities" because both of those are governed by the same concepts.
Volatility Index (VIX)
Definition
Volatility Index (VIX).
It generally refers to about how choppy the market has been the last 200 days.
The VIX is like a gauge of the anxiety levels of the market: Is the market chewing its nails and rocking back and forth or more sunning itself in the corner and taking a nap? The VIX also helps price derivatives.
Voting
Definition
If you own stock in a company, and that stock has voting rights, you get to have a say in some of the stuff that goes down at the company.
Voting Rights
Definition
In Wall Street jargon, this phrase refers to the right to vote on corporate policy, who is in the board of directors, and decisions on issuing securities like stocks and bonds.
Companies usually have different classes of stock; e.g., A-shares are "one share, one vote," B-shares are "one share, ten votes," and so on.
Warrants
Definition
When the detectives come to your house looking for the missing wi-fi bandwidth, they bring a…oh, wait. That's a different flavor.
A warrant kind of like a call option, in that you get to buy a stock at X price whenever you want (within a few years typically) no matter what the price of the stock is at the time you use it. Could be pretty awesome if you used a warrant that let you buy a stock at $2 when it's suddenly shot up to $10.
Free profit, right?
That's why they're typically given out by publicly traded companies that need a new bond issue (otherwise known as a sudden pile of cash for the company) to go as well as possible. The industry calls them "sweeteners," in that they sweeten the deal. Of course, that means that the stock better go up or the warrants are just pretty pieces of paper.
Wash Sale
Definition
See: Wash Sale Rule.
Whole Life Insurance
Definition
Isn't it a reaffirming name? "I want my life to be whole, thank you very much."
This is your grand-daddy's insurance policy, without bells, whistles, apps, or rss feeds. It's where the insurance company says, "You there. Yes you. I like the cut of your jib. If you give me $50 a month, I'll pay whomever you want (as long as you're not planning to immediately or eventually kill them) $1,000,000! Deal or no deal?"
And, yeah, while that nice huckster-man in the last example is giving a super simplified version, that's basically what whole life insurance is...as long as the monthly, biannually, or annual premium is paid. Otherwise, the policy "lapses." All these policies typically have a given lowest-rate-of-return, and unlike variable insurance policies, the rate is stable. Either way, the amount the customer pays is always the same.
It's more solid than "universal life" and is way more solid than "universal variable life." If health insurance is a safety net for your health, then guess what life insurance is:
Yep, a safety net for your life, i.e. in case you die. Which, unless you’ve found the Fountain of Youth or a genie in a lamp, is gonna happen. With life insurance, there’s the “owner” of the policy, who is usually also the “insured”--you know, the person whose death makes it rain money. The person who would get that money is the “beneficiary.”
And, of course, there’s the “insurer” -- the life insurance company that takes your money every month. They’re also the ones that cough up a wad of cash when you bite the dust.
Whole life insurance--whole with a “w”--is a type of permanent life insurance. It’s “permanent” because it follows you for life...like an insurance grim reaper, always lurking in the shadows. Whole life insurance was born from its mother, term life insurance. Back in the day, when life insurance was just getting its start, in life, term life insurance was the only option.
Like, you’d pay $57 bucks for a month’s worth of a million dollar life insurance. If you didn’t die that month (congratulations!), then the insurance company kept all the money you just gave them. And...then it would start all over again the following month.
For the insured, life insurance can kind of feel like a lose-lose situation, if you live, you’re making payments that go into an abyss, and if you die, well, you’re dead, but at least your kid or mom or whoever the beneficiary is has some money. Uplifting stuff.
Life insurance buyers got tired of this term life insurance gamble every month, losing all the money they gave to the insurance companies. So they began to...think, and using the power of frighteningly large groups, they began to invest the money in markets with a 30-year time horizon. No more giving over that $57 bucks every month to the insurance company, watching all the money go down the drain.
As you might imagine, the life insurance companies weren’t very fond of people getting smart on them, investing their money for insurance instead of dropping it into their black hole, so they decided to cut a deal. They said, “we’ll cover you for three months instead of one, and if you fall off a bridge or get hit by a bus, your wife and kids will be seeing a cool million dollars.
And, we’ll invest half of your monthly premium in a index fund—yes, we’ll even let you choose which one—and the other half we get to keep. And if you want to back out and terminate the plan, not because you’re in a wooden box. But because you ran out of money or are moving or something, you can keep 80% of what’s in that pot.”
This structure further evolved into what we have today: whole life insurance, which covers you not for one month or three, but for life. Remember, it’s permanent. You could still cancel, but it would cost you a pretty penny.
Whole life insurance includes building up savings from part of your premium payments--not watching all your premiums go into the black hole. Since whole life insurance is permanent, it acts as a no-touchy investment account. And, because it has high fixed payouts when you die, it’s super expensive.
In essence, a whole life insurance plan is tricycle-style, a hand-holdy investment vehicle that tries to pull a Miley Cyrus, getting the best of both worlds. For those with the cash and discipline and the ability to stay alive--watch out for that bus--you can make your own whole life insurance policy by buying shares of an index fund for yourself.
With no insurance company middleman taking a cut, you own 100% of the investment. All that’s left to do then is, um...not die, for a decade or three.
Wrap Account
Definition
Jay-Z's brokerage account. Or something.
In a wrap account, you pay an annual fee (based on a percentage of what's in the account), and the broker manages the account for you. The fee you pay covers commissions and extra expenses (but not the costs exchanges or the SEC charge). You don't pay extra commissions each time a trade is made in the account, which prevents brokers from making trades just to earn more commissions.
Examples
If Jay-Z gives his broker $100 million under a wrap account that charges 1%, he'll be charged a million bucks a year in return for handling all of Jay-Z's trading, wiring, account, and a whole bunch of other services.
For many large brokerages, wrap accounts allow for their clients to be able to buy various flavors of funds (mutual, hedge, index) at "wholesale" prices; that is, if the fund is a captive fund maintained by the brokerage, the wrap account allows the client to buy with no commission or upfront charges.
Writer
Definition
Shakespeare was one. But in this case, "writer" is the person who sells an option. They're called a writer because years ago sellers of options probably had to write up some of the sales contract. By hand. By the light of a candle.
Example
We have shares of Google (GOOG) that are trading at $500. We write you a call option that gives you the right to buy a share of GOOG from us for $550 a share. If you decide to exercise that option when Google is trading at $600, we'll sell the stock to you for $550, and you'll make a nice profit. If Google drops to $400, you might not want to buy, and we get to keep the money you paid us for the option.
Yankee Bonds
Definition
We're safe. We're sound. We're sane.
At least that's how we look financially when compared with most of the rest of the world. That's why a bunch of countries issue their own bonds denominated in U.S. dollars. Ours is a "hard currency" in that we don't or at least haven't historically created massive 10% a month inflation to deflate our own currency and make it super easy for our government to pay off its debts.
Because there exists that trust, the rest of the world often values our own currency higher than its own. When they issue, say, Argentine bonds payable in U.S. dollars, that's a Yankee bond.
We are the yanker; they are the yank-ee.
Yield
Definition
Yield is just the dough you get back after investing an initial sum. It can come in the flavor of bond yield—like a coupon—paying whatever percent face value, based on par value. That is, for a bond trading at par, with face yield of 5%, that bond pays the investor 25 bucks twice a year for that 5% face on a grand invested.
Got it? It is just the percentage rate of return on a bond.
But what if the price of the bond got cut in half? Maybe something bad happened to the company—patent law suit or CEO caught in bed with an alien from Mars—so investors suddenly feared for the creditworthiness of the company. And they sold heavily their bond positions. Now the bonds are selling at 50 cents on the dollar or $500 a unit instead of the standard $1,000. The bonds still have to pay the 50 bucks a year interest but now they yield 10%... 50 bucks of the grand at which they were created.
But yield is also derived in the land of equities. Coca Cola stock trades at 50 bucks a share and pays a $1 dividend. It yields 1/50 = 2%. You get 25 cents 4 times a year for each share you own. And another big note: Equities pay dividends 4 times a year while bonds pay twice.
Yield Curve
Definition
The Yield Curve (YC) is just the graphic representation of what investors think will happen to interest rates in the future. The most common YC that gets put in books and in the news is the yield curve of U.S. Treasury securities. This YC can impact the YC of other markets (like mortgage YCs).
Here's what a yield curve looks like:
Notice a few things about it. The vertical axis is the interest rate paid and the horizontal axis is time. Notice that over the short term, money is cheap... around 1% for 1-year paper. But also notice that as we move out 10 years, the yield curve is flirting with 4%. What this curve is saying is that investors believe that 10 years from now, odds are best that bonds will be trading around 4%. The curve is now said to be positively sloped because rates today are lower than they are expected to be in the future.
Yield To Call
Definition
If a bond is callable, the issuer can call in the bond early—meaning you might not get the full amount of money you would have gotten if the bond went to its maturity date.
How much can you make with a callable bond? The answer will depend on when the bond is called. You can figure out a minimum yield by calculating the yield from the day you get the bond to the first possible date that it could be called.
Whether the bond will be called will depend on what interest rates do. If they drop, it's likely that the bond will be called early because the issuer won't want to pay the higher interest on the debt. If the rates stay the same or go up, just calculate yield to maturity. It's cheap borrowed money for the company at that point so they probably won't call the bond early.
Yield To Maturity
Definition
This is the money that a bondholder will enjoy by holding the bond until it matures. The amount you make assumes that the interest payments the bond gave you are all reinvested, so yield to maturity will change over time as the reinvestment rate changes.
Since there are so many variables (such as how much you'll earn when you reinvest your payments) the formula for figuring out YTM is complicated. It's a handy number to figure out, though, as it can tell you whether you're better off selling a bond early or keep it for a long while.
Zero Coupon Bonds
Definition
You know what’s a great graduation present? Getting a bond, especially one that doesn’t pay its face value for 20 years. Thanks, Grandma.
If you ever received one of those Series EE paper savings bonds at graduation, you know that the $50 on the face of that bond won’t reach its value until the date of maturity. Which could be 20 years away. And since they were zero-coupon bonds, you never receive any interest payment for the duration of the investment.
So, you put it in a box, and forget about it, until your parents move out of their old house and tell you to come pick it up. And you have to remember why you have this thing, and how it works. So, you go to Shmoop.
The way it works is simple: Grandma bought the thing at a steep discount, i.e. below its face value. The interest pays over the duration of the bond’s life. And when it reaches its maturity date, you can go to the Post Office and finally turn this bond that’s covered in ketchup and Budweiser in for a picture of Ullyses S. Grant.
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