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Glossary

 

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Active Portfolio Management: A portfolio management strategy in which the manager seeks to exceed the return of a benchmark by making investment decisions based on following or forecasting market trends.

Agency: A transaction or arrangement where an agent acts as intermediary to arrange trades between buyers and sellers.  The agent charges a commission for their services.

Aggregate Demand: The sum of all personal, business, and government expenditures in a given period of time.

Ask Price: The price at which a seller is willing to sell a security.  Also called the offer price.

Asset-Liability Management (ALM): a portfolio management strategy that involves matching the cash flows of the portfolio assets with liabilities.

Authority: A separate governmental entity expressly created to issue bonds and/or manage an enterprise.

Basis Point: One hundredth of a percentage point (0.01%)

Bearer Bond: A negotiable, unregistered bond which is payable to the current holder, regardless of whom originally purchased the bond.  Bearer bonds have coupons attached that represent the interest payments.  The coupons are presented to a paying agent to collect the interest payment.

Benchmark: In investing, a benchmark is a security or index that is used as a comparison in order to measure the performance of another security or portfolio.

Bid Price: The price at which a buyer is willing to pay to purchase a security.

Bond Anticipation Notes (BANs): Short-term municipal notes that are issued in anticipation of a future bond issue.

Bond Ladder: A fixed income portfolio strategy that consists of an investor deploying their investment capital in evenly among bonds that mature at regular intervals,

Bond Swap: The simultaneous sale of a bond for the portfolio and purchase of another bond from the sale proceeds.

Book-Entry Security: A security that is issued as a book-entry in a bank account, rather than as a physical certificate.

Bullet Bond: A bond that is not redeemable prior to maturity.

Business Cycle: The long-term pattern of alternating periods of economic growth and decline that results in changing production, employment, inflation, and interest rates.

Call Protection: A period of time during which a callable bond is not callable, typically the first few years after it is issued.

Call Schedule: A schedule of a bond’s call dates and corresponding call price.

Cash Management Bills (CMBs): Treasury bills that are issued to meet short-term funding needs.

Commercial Paper: A short-term promissory note that is issued for periods of up to 270 days.

Competitive Bid Underwriting: An underwriting in which prospective underwriters submit sealed bids to the issuer.  See also negotiated underwriting.

Consumer Price Index (CPI): An indicator of inflation that measures the change in price of a fixed basket of consumer goods and services.  CPI is also referred to as the cost-of-living index.

Contraction Risk: For mortgage-backed security holders the risk that some underlying mortgages will be prepaid as interest rates decline and homeowners seek to refinance at lower rates, thus shortening the maturity of their security.  This is undesirable as the bondholder will be forced to reinvest the prepayments at lower rates.

Convexity: A measure of the sensitivity of the duration of a bond to changes in interest rates.  The sensitivity of the change of prices to changes in interest rates (the duration) tends to increase as price appreciates.

Cost of Carry: the cost associated with financing a trade position.

Coupon Rate: The interest rate on a fixed income security, expressed as a percentage of principal.

Covenant: A clause in a contractual obligation that requires or forbids specific acts.  Covenants are typically included in bond indentures to protect the bondholders.

Credit Risk: The risk that the issuer of a fixed income security defaults by failing to make payments of interest and principal in a timely manner.  Also called default risk.

Credit Spread: The yield spread or premium that investors demand to assume the credit risk of a fixed income security.

Currency Risk: The risk that changes in exchange rates may adversely affect the value of a security denominated in a foreign currency.  Also called exchange rate risk.

Current Issue: The most recently issued treasury security.  Also called the on-the-run issue.

Current Yield: The annualized rate of return on a security expressed as a percentage of the current price.

Debt Service Coverage Ratio (DSCR): The ratio of cash available to cover the interest and principal of debt.

Default: The failure to make required payments on a debt, or to otherwise comply with the debt agreement.

Deflationary Spiral: A negative rate of inflation that continues to decrease over time.  Lower demand leads to lower production and wages, which tend to further decreases in demand.

Discount:

  1. The amount that a security sells for below its par amount.
  2. The amount that a closed-end fund sells for below the value of its holdings.

Discount Rate:

  1. The rate that the Federal Reserve Bank charges member banks for short-term (usually overnight) loans.
  2. The interest rate used to discount future cash flows in order to calculate present value.

Double-Barreled Bonds: Municipal securities that are backed by the full faith and credit and taxing power of the municipality, as well as revenue from the project or facility that they were issued to finance.

Duration: A measure of how price sensitivity a bond is to changes in interest rates.

DV01: A measure of the dollar change of a bond’s price as the result of a one basis point change in interest rates.

Early Redemption Risk: The risk that a fixed income investment will be called or otherwise redeemed before maturity in a falling rate environment, forcing the investor to reinvest the proceeds at a lower rate of return.

Efficient Market Hypothesis: The theory that it is impossible to obtain above average return in investment markets because securities prices always reflect all relevant information.

Enhanced Indexing: A portfolio management strategy that combines indexing with active portfolio management.

Event Risk: The risk that reorganization or other event will adversely affect the value of a security.

Exchange Rate Risk: The risk that changes in exchange rates may adversely affect the value of a security denominated in a foreign currency.  Also called currency risk.

Extendable Bond: A bond that has a maturity date that is extendable at the option of either the issuer (most common), or the bondholder.

Extension Risk: For mortgage-backed security holders the risk that prepayments of underlying mortgages will decline as interest rates increase, thus extending the maturity of their security.  This is undesirable as the bondholder will not be able to reinvest the prepayments at higher rates.

Face Value: The nominal dollar amount assigned to a security by the issuer.  For fixed income securities, it is the amount of principal per bond that is paid back to the bondholder at maturity.

Federal Funds: the rate at which depository institutions lend to each other on an overnight basis at the Fed.

Federal Open Market Committee (FOMC): A 12-member committee of Federal Reserve Bank Presidents and members of the Board of Governors that determines monetary policy.

Fiscal Policy: Policy decisions made by the federal government regarding government spending and taxation in pursuit of economic goals.  Typically, these goals are related to economic growth, employment levels, and inflation.

Fixed Income Security: A security that pays a specific interest rate.

Floating-Rate Bond: A bond whose coupon rate is pegged to a benchmark, such as libor, and is adjusted periodically.  Also known as a Variable-Rate Bond.

General Obligation Bonds (GOs): Municipal securities backed by the full faith and credit and taxing power of the issuer.

General Obligation Notes: Short-term municipal notes backed by the full faith and credit and taxing power of the issuer.

Government Sponsored Enterprise (GSE): Financial services companies created by Congress.  GSEs include the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), and the Government National Mortgage Association (Ginnie Mae).

Grant Anticipation Notes (GANs): Short-term municipal notes that are issued in anticipation of future grants.

Gross Domestic Product (GDP): The sum of all of a country’s goods and services produced in a year.  GDP is equal to total consumer, investment and government spending and net imports/exports.

Immunization: A strategy designed to protect a portfolio from interest rate risk by holding assets and liabilities of equal durations.

Indenture: A contract between the issuer of bonds and the bondholders that stipulates the terms of the bond issue such as maturity date, coupon rate, etc.

Indexing: A passive portfolio management strategy in which the manager recreates an index by matching the securities of the index in the portfolio.

Inflation Premium: The yield premium that that investors demand to offset inflation.  It is equal to the expected rate of inflation.

Inflation Risk: The risk that inflation will reduce the value of an asset or fixed income payments due to the erosion of purchasing power.

Interest Rate Risk: The risk that a security’s value will decrease if interest rates rise.

Liquidity Risk: The risk that a lack of buyers for a security will prevent an investor from being able to sell the security or that the security will have to be sold at a substantial discount.

Long Bond: The 30-year treasury bond.

Macaulay Duration: The present value weighted average term to maturity of a bond’s cash flow.

Macroeconomics: The study of economic behavior and activity on the aggregate level, typically on the industrial or national level.

Markdown: The difference between the highest current inter-dealer bid price a security and the higher price that it charges its customer.

Markup: The difference between the lowest current inter-dealer offer price a security and the higher price that it charges its customer.

Maturity Date: The date that a debt becomes due for repayment.

Maturity Spread: The yield spread between any two maturity points along the yield curve.

Microeconomics: The study of economic behavior and activity on the level of specific subgroups or individuals.

Modified Duration: A measure of price sensitivity of a bond derived from the Macaulay duration of the bond.

Monetary Policy: Policy decisions made by the Federal Reserve Bank regarding levels of interest rate and money supply in the pursuit of achieving levels of economic growth and inflation.

Money Market: A market of extremely liquid short-term debt.

Mortgage-Backed Securities (MBS): Debt securities that represent a claim of the cash flows of a pool of mortgages.

Multiplier Effect: How an increase in economic activity creates a chain reaction that causes overall activity to increase at a multiple of the original increase due to the ability of banks to lend in excess of their reserve requirement as set by the Fed.  For example, if the reserve requirement is set at 5%, a bank can loan $95 of a $100 deposit. This $95 is deposited at another bank that can now lend 95% of the $95, or $90.25.  This $90.25 is deposited in another bank and this process is repeated through the economy to increase the money supply.

Negotiated Underwriting: An underwriting in which the underwriter negotiates the price in which it pays the issuer for the securities and the price at which it sells the issue to investors.  See also competitive bid underwriting.

Odd Lot: Less than a round lot.

Off-the-Run Issue: Treasury securities that were issued prior to the most recent issue

Open Market Operations: The purchase and sale of government securities by the Federal Reserve Bank in order to control the nation’s money supply.

Original Issue Discount (OID): A security that is issued at a discount to par, but matures at par.

Over-the-Counter: A security that does not trade on an organized exchange.

Par Amount: The nominal amount that the issuer assigns to a security.

Passive Portfolio Management: A portfolio management strategy that seeks to replicate the risk and return characteristics of an index or market sector by matching its composition.

Paying Agent: An agent that makes principal and/or interest payments on behalf of the issuers of securities.

Political Risk: The risk that an international investment may be adversely affected by a change in a country’s government and/or its policies.  Such adverse changes in policies can include increased taxes or tariffs or the seizure of assets and/or profits.

Premium:

  1. The amount that a security sells for above its par amount.
  2. The amount an option buyer pays the seller.
  3. The amount that a closed-end fund sells for above the value of its holdings.

Prepayment Risk: The risk to mortgage-backed securities (MBS) investors that holders of their underlying mortgages will prepay their mortgages in a falling rate environment as they seek to refinance.  The MBS holder will then be forced to reinvest at a lower rate of return.

Present Value: The current value of a future payment, or series of payments, discounted at an appropriate interest rate.

Price Risk: The risk that the price of an asset will decline.

Primary Market: The market where investors purchase securities directly from the issuer.

Principal: A transaction or arrangement where a dealer executes a trade for its own account.

Private Activity Bonds: Bonds that are issued by a municipality to finance a project of a private entity.

Pull to Par: A term that refers to the fact that a bonds price will approach par as it gets closer to maturity.

Recession: A decline in the economy, typically as measured by Gross Domestic Product (GDP) for at least two consecutive quarters.

Reinvestment Risk: The risk that falling interest rates will force an investor to reinvest periodic payments of interest, dividends or principal at lower rates.

Repurchase Agreement: A contract in which a seller of securities, most often treasuries, agrees to buy them back at a specified future time and price.  Also called repo or RP.

Reserve Requirement: The amount of liquid assets, expressed as a percentage of deposits, the Federal Reserve Bank requires member banks to maintain.

Revenue Anticipation Notes (RANs): Short-term municipal notes that are issued in anticipation of future revenue.

Revenue Bonds: Municipal securities that are backed by the revenue generated by the project or facility that they were issued to finance.

Risk-Adjusted Return: The rate of return on an investment or portfolio, adjusted for the amount of risk of the investment or portfolio.

Round Lot: A security’s normal unit of trading.

Secondary Market: A market in which an investor buys a security from another investor rather than the issuer.  Investors also sell securities in the secondary market.

Serial Bonds: A series of bonds issued at the same time, but with different maturity dates.  Also called installment bonds.

Short Sale: Selling a security that the investor does not own by borrowing the security to deliver to the buyer.

Sinking Fund: Funds set aside by a company to retire securities.

Sovereign Risk: The risk of investing in foreign securities.  Sovereign risk can entail the risk of the government seizing the assets of an issuer of securities, or of a government defaulting on its debt obligations.  Also called political risk.

Tax and Revenue Anticipation Notes (TRANs): Short-term municipal notes that are issued in anticipation of future taxes and revenue.

Tax Anticipation Notes (TANs): Short-term municipal notes that are issued in anticipation of future taxes.

Tax-Equivalent Yield: The yield that a taxable bond needs to pay in order to be equivalent to the tax-free yield of a municipal bond.  Tax Equivalent Yield=Tax-Free Yield/1-Tax Rate.

Time Value of Money: The concept that a dollar is worth more today than at a future date because today’s dollar can earn interest or principal appreciation until the future date.

Underwriter: An intermediary that sells securities to investors and behalf of an issuer.

Variable Rate Demand Obligations (VRDOs): Debt securities that pay a variable rate of interest that is adjusted at regular intervals and are redeemable at the holder’s option.

Volatility Premium: The yield premium of a bond that compensates investors for the price sensitivity of longer maturity bonds to changes in interest rates.  It is a function of the length of time to maturity.

Wash Sale: The sale and subsequent repurchase of the same or “substantially identical” security within 30 days before or after the sale date.

Weighted Average: A statistical average in which each number being averaged is multiplied by the numerical proportion of that number in the overall sample.  For example, if a $60,000 portfolio consists of 10,000 in bonds yielding 5%, 20,000 in bonds yielding 6%, and 30,000 in bonds yielding 7%, the weighted average would be: ((10,000 X .05)+(20,000 X .06)+(30,000 X .07))/60,000= 6.333%

When Issued: Conditional transactions in a security that has been authorized, but has not yet been issued.

Yield Curve: A graph of the yields of closely related securities of different maturities.

Yield Spread: The difference in yields between different fixed income securities.

Yield to Best Put: For a bond with a put option, it is the yield that would be realized on a callable bond if it was redeemed on the put date that would result in the highest yield.

Yield to Call: the yield that would be realized on a callable bond if it was redeemed on the next call date.

Yield to Maturity: The yield that would be realized on a fixed income security if it is held to maturity.

Yield to Put: For a bond with a put option, it is the yield that would be realized on a callable bond if it was redeemed on the next put date.

Yield to Worst Call: the yield that would be realized on a callable bond if it was redeemed on the call date that would result in the lowest yield.

Zero Coupon Bond (ZC): A bond that does not make coupon interest payments and is issued at a discount from face value.  The return to the investor is the gain achieved when the bond matures at face value.

 
 
 
 
 
 
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