ATM :: Confused by Financial Jargon?

Adam Zoll explains a few terms that investors most commonly come across.
By Morningstar | 12-02-14 | Adam Zoll

Newbie investors are often thrown for a loop by some of the jargon investing professionals use, so much so that it can feel almost like listening to a foreign language.

In some cases investment industry jargon is used as short-hand for complex concepts–such as when a pro mentions MPT, an acronym for Modern Portfolio Theory, a sophisticated investment approach aimed at optimizing a group of holdings to balance performance and risk.

In other cases, jargon is simply used as a synonym for more commonly used verbiage–why the financial-services industry prefers the term “equities” to the more colloquial “stocks” seems more a matter of convention than anything else.

There’s no Rosetta Stone edition that translates financial industry-speak to English (at least, not yet), but the following glossary is a start. Of course, this is just the tip of the iceberg, and new investing terms come into vogue all the time. But at a minimum, the terms defined below should help those who are new to investing or who sometimes are left scratching their heads after reading a fund manager’s quarterly message.

Active/passive investment: Differing approaches to managing a fund’s basket of securities, also known as its portfolio. Picking individual securities based on a strategy is considered active while building a portfolio based on an index is considered passive.

Alpha: A measure of a fund’s performance relative to its benchmark given the degree of risk taken on by the fund. The ability to generate a positive alpha is generally seen as a plus.

Arbitrage: An investment strategy that seeks to capitalize on price variances for an asset. This includes low-risk strategies, such as buying a stock on one exchange and selling it on another exchange where it trades at a higher price, as well as higher-risk strategies, such as buying stock in a company that is being acquired in anticipation that its price will rise as the sale date draws nearer.

Bear market: Typically refers to a decline of at least 20% from a stock market peak during a period of months or years.

Beta: A measure of volatility based on the degree to which a fund moves relative to a benchmark. A fund with a high beta experiences higher highs and lower lows and is considered riskier than a fund with low beta.

Black swan event: An extremely rare and unexpected occurrence having a significant impact on the markets, such as the 2008 financial crisis. This concept was popularized by the book “The Black Swan: The Impact of the Highly Improbable” by Nassim Nicholas Taleb.

Bull/Bear: An investor who believes that markets will head higher (bull) or lower (bear).

Correlation: The degree to which two securities tend to move in the same direction.

Correction: Technically, a 10% drop in stock prices from their high, though it is sometimes used to describe smaller drops occurring in a short time frame.

Derivative: A financial instrument, such as futures and options, in which performance is based on an underlying asset.

Duration: A measure of the interest-rate sensitivity of a bond or portfolio of bonds (average duration).

Equities: Just a more impressive-sounding name for stocks. They represent ownership in a company.

Fixed income: Generally used to refer to bonds but also other securities that pay a fixed rate of interest or a dividend, including Treasuries.

Hedge: An investment used to offset risk as part of a broader strategy–for example, using options as a safeguard against an underperforming investment.

Leverage: The use of borrowed funds, options, and other techniques to gain added exposure to an asset’s performance.

Market cap: Short for market capitalization. The total value of the equity of a company as set by the market, calculated by multiplying a company’s share price by the number of shares outstanding. Often divided into large-, mid-, and small-cap ranges.

Mean reversion: The expectation that a security’s returns–if they are higher or lower than they deserve to be–eventually will fall back in line with their historical trend.

Premium/discount: The extent to which a bond trades at a price above (premium) or below (discount) its face value, or the degree to which an exchange-traded fund trades above (premium) or below (discount) its net asset value.

Risk-on/risk-off: Market environment in which investors favor either low-risk, conservative investments (risk-off) or high-risk, more speculative ones (risk-on).

Valuation: Estimated worth of a company, typically used to determine whether its stock is a bargain, fairly priced, or overpriced.

Volatility: A measure of the degree to which a fund’s performance fluctuates, typically expressed as standard deviation. Higher volatility suggests a broader range of potential returns and therefore higher risk.

Yield curve: Rate at which interest rates change as one moves from bonds with shorter maturities to those with longer maturities.

Adam Zoll is assistant site editor with Morningstar U.S.

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