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Trading Glossary

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401(k) plan
An employer-sponsored retirement plan that allows tax-deferred contributions. A 401(k) plan is also called a salary-reduction plan since owner contributions to the account come from gross salary. Salary contributions mean the owner’s taxable income is lower. In 2004, one could contribute as much as contribute $13,000 to a 401(k) plan. Employers can contribute up to a combined amount (including the employee’s contributions) of $41,000.

A
Actively-managed mutual fund
A mutual fund that invests in a portfolio of securities with the objective of earning a higher rate of return than a benchmark index. It uses a team of analysts and portfolio managers to pick securities. An actively managed fund is the opposite of a passive fund. A passive fund builds a portfolio that mirrors the security holdings and weights of a benchmark index.
After-tax return
The rate of return earned on an investment after paying income and capital gains taxes. For example, say a $1,000 in a mutual fund earns $120 in dividends and capital gains. After paying taxes on the $120, the investor has an $80 gain remaining. The after-tax return is 8 percent ($80 divided by $1,000).
Agency bond
Issued by an agency that is backed, explicitly or implicitly, by the full authority of the U.S. government. After Treasury bonds, agency bonds are generally the safest bond categories since there is little chance that the U.S. government would permit a bond default. Major issuers of agency bonds include Ginnie Mae Fannie Mae, Freddie Mac and Sallie Mae. The first three entities sell bonds to improve the liquidity of the home mortgage market in the U.S. Sallie Mae sells bonds to raise money for financing college student loans.
Aggressive investor
An aggressive investor is willing to accept a higher degree of investment risk in exchange for a chance to earn a higher rate of return. Investment risk is the volatility of investment returns
All or none (AON)
A round lot or limit order that is to be executed in its entirety or not at all.
Allocation
Asset allocation is an investment process that requires an investor to invest a percentage of the value of the investment portfolio in a designated class of investment assets. The three major asset classes used for asset allocation are stocks, bonds and cash. Allocations usually become more conservative as the investor ages and has less time to recover from declines in the market. Younger investors tend to be more aggressive, allocating higher percentages of their portfolios to stocks. Over time, investors shift assets towards more conservative investments in bonds and cash to preserve their investment capital.
American Savings Education Council (ASEC)
Good source of investor education.
Annualized rate of return
An annualized rate of return converts the rate of return that an investor earns on an investment held for more or less than one year to an annual percentage rate. Since interest rates are yearly percentages, annualizing the rate of return allows one to compare investment performance for the same period of time.
Ask price
The lowest price at which you can buy a security. You will want to know the ask price (the “offer”) if you are buying.
Asset allocation
An investment process that requires one to allocate a percentage of the value of the investment portfolio to a designated class of investment assets. The three major asset classes used for asset allocation are stocks, bonds, and cash. Allocations generally become more conservative as the investor ages and has less time to recover from declines in the market. Younger investors tend to be more aggressive, allocating higher percentages of their portfolios to stocks. Over time, investors shift assets towards more conservative investments in bonds and cash to preserve their investment capital.
Asset classes
Stocks, bonds, and cash. Several investment categories exist within each of these major classes. Other major asset classes include real estate, derivatives, private equity, precious metals, and foreign currencies.

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B
Balanced fund
A mutual fund that invests in a combination of stocks and bonds. Balanced funds are also called hybrid funds. An investment company manages a mutual fund. It sells shares of the fund to individual investors. Open-end mutual funds buy and sell shares at any time and price. Closed-end mutual funds trade like securities, on an exchange, and are often quoted at a discount or premium to net asset value.
Basis points
A basis point is 1/100 of a percentage point. Interest rates and bond yields are often stated in basis points. For example, if you hear that commercial banks raised their prime rate on loans by 25 basis points, they raised their prime lending rate by one-quarter of a percentage point.
Benchmark index
A widely used index of stocks, bonds, or other securities. Managed funds also use a benchmark index to compare investment performance. The S&P 500 index is the most widely used stock index for U.S. domestic equity mutual funds.
Beta coefficient
Measures how closely a stock price mirrors the price change of a stock market index. The stock market index has a beta of 1.0; it is a fully diversified portfolio. The price of a stock whose beta is 1.0 moves in the same direction and same magnitude as the market index. A stock with a beta of 1.2 moves in the same direction but at a higher magnitude than the market index.
Bid price
The highest price at which you can sell a security. You will want to know the bid price if you are selling.
Bond
A financial asset that represents a claim on the assets of the company or other entity that issued the bond. A bond is a form of an IOU. A bond issuer sells bonds to investors who agree to lend to the issuer for a specific bond term and at an agreed-upon interest rate. When the term ends, the bonds mature and are bought back by the issuer. Investors are repaid and collect any accrued interest. If a bond issuer files for bankruptcy or defaults on its debt, bond investors are first in line to be repaid. (Shareholders are last.) Bonds are often called fixed-income securities because they usually pay interest at a fixed interest rate. This fixed interest rate makes bonds a predictable source of income for investors. Bonds are one of the three major asset classes, along with stocks and cash.
Bond mutual fund
A bond mutual fund is a mutual fund that invests primarily in bonds. An investment company manages a mutual fund. It sells shares of the fund to individual investors. Open-end mutual funds buy and sell shares at any time and price. Closed-end mutual funds trade like securities, on an exchange, and are often quoted at a discount or premium to net asset value.
Brokerage account
An account that one opens with a licensed and regulated securities brokerage to buy and sell stocks, mutual funds, and other securities. A discount brokerage account offers the minimum tools for placing trades, seeking to compete by having low brokerage commissions. Full-service brokerages offer more complete and personalized investment advice, as well as a richer variety of market data and information. Full-service brokerages charge higher fees.
Brokerage commission or fee
Brokerage commissions are the fees that investors pay a broker to buy or sell stocks, bonds, or other securities. They are also called transaction fees, trading fees, brokerage fees or, simply, commissions. Brokerage fees are added to the cost of buying a stock or other security. They are included in the basis, which is the cost of buying a security. Brokerage fees lower investment returns.
Budgeting
A process that begins with creating a plan to record all cash inflows and outflows. The process continues with adhering to a budget. Adherence requires discipline to make sure budgeted cash outflows equal budgeted inflows. The final step of the budgeting process is reviewing recent performance and deciding adjustments for the next plan. Personal budgeting is a similar process used to manage personal finances.

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C
Capital gains
An increase in the value of an investor’s capital asset. The IRS defines a capital asset as almost everything used for personal purposes or investment, including stocks and bonds, a home, personal property and collectibles. Capital gain is calculated as the sale price of the asset minus its basis. Basis is the price an investor paid for the asset and includes transaction costs. Capital gains are taxed at different rates, depending on how long the asset is held. A long-term capital gain occurs if the owner holds the stock or bond for more than one year. A short-term capital gain occurs if the owner holds the security for one year or less. Long-term capital gains are taxed at a lower tax rate. Short-term gains are taxed as ordinary income.
Capital gains taxes
The taxes owed on capital gains. The capital gains tax rate is lower than the tax rate on ordinary income. To qualify for the capital gains tax rate, one must hold a capital asset (such as an investment or home) for more than one year. Gains on capital assets held for more than one year are called long-term capital gains. Gains on capital assets held for one year or less are called short-term capital gains. Short-term capital gains are taxed at the ordinary income rate. The long-term capital gains tax rate for most taxpayers is 15%. However, if you are in the 10% or 15% income tax bracket, the long-term capital gains tax rate is 5%. If you are in either of the lower tax brackets and own a capital asset for at least five years, the tax rate continues at 5%.
Cash
One of the three asset class, with Bonds and stocks. Asset classes define the universe of investments used in making asset allocation decisions. In addition to currency, cash assets include saving and deposit accounts, money market accounts (MMAs), money market mutual funds, short-term certificates of deposit (CDs), and Treasury bills. Cash is the base currency used for buying and selling goods and services in an economy. As a result, it is the most liquid and least-risky asset. However, its low risk, compared with the risk of other asset classes, results in a lower rate of return.
Cash inflows
Dollars (or relevant currency) received on an investment. The interest rate realized from continuing cash outflows and inflows for a project, even one extending many years, is called the internal rate of return.
Cash outflows
Dollars (or relevant currency) spent or invested to earn a rate of return. Cash outflows are uses of cash. The interest rate realized from continuing cash outflows and inflows for a project, even one extending many years, is called the internal rate of return.
Certificate of deposit (CD)
A time deposit made at a bank. One also can buy a CD from a broker who is selling them for deposit-taking institutions. Deposit periods of CDs are usually between three months and five years. Deposit amounts range from $500 to $100,000. Since the FDIC guarantees deposits up to $100,000 per depositor per institution, avoid investing in multiple CDs at one institution for amounts over $100,000. CDs pay a lower interest rate than other investment instruments do, in exchange for deposit insurance.
CFP Board (Certified Financial Planner Board)
Professional regulatory organization responsible for licensing Certified Financial Planners.
ChFC (Chartered Financial Consultant) and the American College
Responsible for licensing Chartered Financial Consultants.
Closed-end fund
A closed-end fund sells a limited number of shares. Subsequent fund share trading occurs between investors in the over-the-counter market. A closed-end fund does not redeem its shares. A closed-end fund does not calculate its net asset value daily based on daily valuations of securities in its portfolio. As a result of these characteristics, shares of closed-end funds usually trade at a discount or premium to net asset value.
College savings plan
Together with prepaid tuition plans, college savings plans are a qualified state tuition plan (QSTP) that is regulated by Section 529 of the tax code. These plans are called Section 529 plans. As a result of the 2001 tax cut, withdrawals from these plans used for qualified educational expenses are exempt from federal taxes beginning in 2002. Depending on the plan, contributions or withdrawals might be deductible from state income taxes. College savings plans invest in a professionally managed mutual fund or group of funds. One can save well over $100,000 in most college savings plans. Since states have some discretion in setting up tax rules, contribution limits, and management fees, read the terms and conditions of the state plan you are considering.
Compounding
Adds the interest earned on an investment and invests it, plus the original investment, for another period. The result is more interest earned and a higher rate of return. For example, if you invest $10,000 at 10% for one year with no compounding, you would receive $1,000 in interest at the end of the year. But if the bank compounded interest every three months, you would earn $250 after the first three months, which is added to the original deposit of $10,000 and invested for another three months. After three more months, your $10,250 investment would earn $256.25 in interest. The process is repeated so that at the end of the year you earn $1,038 in interest. This is $38 more than if there were no compounding. Compounding’s dollar benefit also is determined by how often the interest is compounded. For example, a bank may offer 10% on a one-year $10,000 CD. If there is no compounding, you will receive $1,000 in interest at the end of the term. If interest is compounded every three months, the rate is 10.38%. If compounded monthly, the rate is 10.47%. If compounded daily, the rate is 10.52%. For a $10,000 deposit, an extra 52 basis points in the interest rate is equal to an extra $52 in interest.
Compounded yield
The rate of return an investor earns on a money market mutual fund, stated as a yearly percentage. It assumes the fund reinvests any interest it earns. Compounded yields are higher than simple yields. (Simple yield is the yield with no reinvesting.) Money market funds maintain a constant net asset value of $1 and invest only in short-term securities. Compounded yield is considered a better measure of a money market fund’s investment performance than total return.
Conservative investor
An investor who is unwilling to accept a higher degree of investment risk in exchange for a chance to earn a higher rate of return. Investment risk is the volatility of investment returns.
Contribution
The amount one invests in a taxable or tax-advantaged account. A lump-sum contribution is a single deposit. Periodic contributions are deposits made on a regular basis.
Convertible bond fund
A mutual fund that invests in convertible bonds. These are bonds sold with an option for the bond investor to convert them to shares of stock in the same company.
Correlation
The degree to which the prices or returns of securities move together. Correlation is measured by the correlation coefficient. Correlation coefficient is a standardized statistical measure of how the returns of two securities move together. A coefficient of +1.0 means the prices of two securities move in the same direction and magnitude. A correlation coefficient of -1.0 means the prices of two securities move in exactly the opposite direction and magnitude.
Corporate bonds
Corporations issue corporate bonds to raise money for operations. Interest income on corporate bonds is taxable unless the bonds are deposited in a tax-advantaged account. In that case, the investor pays income taxes on the interest upon withdrawal of funds from the account. Corporate bonds are riskier than Treasury securities. As a result, corporate bonds pay a risk premium. Some of the risks associated with corporate bonds are default risk, business risk, and industry risk.
Country stock fund
A mutual fund that concentrates its investments in the securities of a particular country. Investing in a single country fund generally does not provide adequate portfolio diversification.
Creditor
A lender, or someone to whom a person is financially indebted. A creditor can be an institution or an individual. Institutional creditors include banks, credit card companies, and bond investors.
Credit risk
Often called default risk, this is the chance that the borrowing person or institution is unable to repay a debt.
Currency risk
Also called exchange rate risk. It is the risk that the value of an investment denominated in the currency of another country will rise or fall with the changes in the exchange rate between the countries. This risk can positively or adversely affect the value of your return. You can hedge currency risk to eliminate the uncertainty of the direction of future exchange rates and the value of an investment when it is converted to dollars.
Current allocation
How an investor presently has spread investments among stocks, bonds, and cash. These are the major asset classes. For example, you may have 60% of your portfolio in stocks, 30% in bonds, and 10% in cash. An allocation is likely to be even further spread out. For example, you may allocate in equal amounts the 60% in stocks to large-cap, small-cap, and international stocks. Current allocation changes as the relative investment performance of each category changes. This is because current allocation is also based on current values of each category. Money that you contribute or withdraw from your portfolio also affects your allocation.
Current value
The value of assets on a given date. Also called market value.
Cutting your losses
A term that describes selling a security whose price has decreased. Rather than waiting for the price to return to a more tolerable level, even if it remains lower than what they paid for it, many professional traders "cut their losses" and sell the security to prevent any further decrease in the value of the holding.

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D
Day order
An order to buy or sell a security that expires at the end of the day if it is not executed.
Default
Failing to repay a loan under the terms of the loan agreement. Defaulting allows the lender to take extra steps to recover the loan.
Default risk
The likelihood that a borrower or bond issuer will default on their debt. To reduce this risk, lenders rely on underwriting guidelines to screen applicants that have a history of not paying their debts. Bond investors who fear default risk tend to invest only in those bonds with an investment-grade credit rating from rating agencies like Moody's Investors Service, Standard and Poor's Inc., and Fitch.
Discount
A price less than the regular sale price. In bond investing, a discount is a bond price that is less than the par value of the bond. Such a bond is said to be trading at a discount to par value. For example, a bond with a par value of $1,000 that sells at $985 is selling at a discount of $15 to its par value. A bond with a coupon rate that is below the market interest rate for similar bonds trades at a discount.
Discount to net asset value (NAV)
Discount to net asset value (NAV) occurs when the share price of a closed-end mutual fund trades at a lower price than its net asset value. Net asset value is a per-share price calculated by dividing net assets of the fund by the number of shares. If investors think the fund portfolio is actually worth less on a per-share basis, they bid down the share price to below its net asset value.
Dividends
A distribution of profits that companies and mutual funds make to shareholders. Dividends incur ordinary income tax and often pay out quarterly. In the insurance industry, dividends are a return of a part of a premium that an insurer may make if its actual claims expenses are lower than forecast.
Dividend yield
The dividend amount per share divided by the share price. For example, a dividend yield of 3% means that a share of stock that costs $100 would pay a dividend of $3.
Diversification
The process of spreading investments across different assets to lower investment risk. Diversifying is not putting all of your eggs in one basket. Holding a diversified portfolio is a basic principle of investing.
Dollar-cost averaging
An investing technique that requires setting aside a fixed amount at regular intervals to buy shares of an investment. It does not matter what the current price is. Since share prices normally rise and fall, the cost to acquire an investment over time is, on average, cheaper than attempting to time purchases. Market and investment experts recommend dollar-cost averaging.
Double-exempt municipal bond
A bond whose interest is exempt from both federal and state income taxes. To qualify for the state income tax exemption, a bond investor must be a resident of the state issuing the muni bond.
Down payment
A down payment is the initial cash paid towards the purchase of a home, business property, or vehicle. For home loans, a down payment of 20% of the home purchase price is usually required to avoid having to buy private mortgage insurance. The value of a trade-in vehicle often is used as a “down payment” for purchasing a vehicle.
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E
Early redemption fee
Mutual funds: A fee charged when the owner redeems fund shares quickly, often within 90 or 180 days. CDs or other time deposits: A fee charged when the saver redeems the deposit before its contracted maturity date.
 
Economic cycle
Economies tend to perform in cycles. Rising output and employment characterize the growth phase of the cycle. Interest rates tend to creep up, reflecting strong demand for credit. Eventually, a bottleneck in production, a fall in demand, or other factors result in a slowdown. Declining output and higher unemployment characterize the slowdown phase of the cycle. Interest rates begin to fall, aiming to stimulate demand for credit. In time, the economy passes through one cycle. Economic cycles tend to overlap each other a bit. This allows investors to benefit from diversification that comes with buying the stocks and bonds of companies that operate profitably in various economies.
 
Effective interest rate
The real, or actual, cost of borrowing. It includes any closing costs or fees directly related to the loan. It also includes any compounding of interest. Fees and compounded interest cause the effective rate to rise above the simple rate. Tax deductions for interest expense lower the effective rate. This rate is often called your after-tax rate.
 
Emergency fund
Also called a rainy-day fund. Savings parked in a safe and liquid savings instrument so that the owner can access the funds in an emergency. Financial planners recommend having an emergency fund equal to three to six months of income. Major reasons for tapping an emergency fund include losing a job and incurring large, unexpected medical expenses.
 
Emerging market fund
A mutual fund that concentrates its investments in the securities of a particular country or countries that the International Monetary Fund or World Bank considers emerging markets. Investing in an emerging market fund alone generally does not provide adequate portfolio diversification.
 
Exchange-traded fund (ETF)
An index mutual fund that trades like a stock rather than a mutual fund. ETFs invest in a portfolio of securities, the way an index fund does. However, they provide greater liquidity since they can be bought and sold throughout the day. Mutual funds, in comparison, are bought and sold at the fund's NAV, which is calculated only once a day.
 
Ex-dividend
Stocks that have declared a dividend begin trading with the dividend payment stated as having a particular “ex” date. You are entitled to receive the declared dividend if you sell the stock on or after the “ex” date, even if you no longer actually own the stock on the date the dividend is paid. You will not receive the upcoming dividend if you sell your stock before the “ex” date.
 
Expected rate of return
Expected rate of return is the return that one expects to earn on an investment, stated as a yearly percentage. For example, a $10 stock that is expected to be worth $10.80 in one year has an 8% expected rate of return.
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F
FDIC (Federal Deposit Insurance Corporation)
The federal agency that guarantees bank deposits.
 
Financial goal
A goal that involves saving and investing to reach a specific amount by a specific date. For example, a financial goal may be to save $25,000 for a college education fund for a child in 15 years, or it may be to save $500,000 for a retirement fund in 25 years. You achieve financial goals through a combination of saving more, saving longer, and earning a higher rate of return.
 
Foreign stock
Stock issued by a company not registered in the U.S. Generally, foreign stocks do not trade in the U.S. unless they trade as American Depository Receipts. ADRs are shares of a foreign company held in a U.S. trust account and created as a class of shares that U.S. investors can purchase. Typically, only the biggest foreign companies seek to list in the U.S.
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G
Global stock fund
A mutual fund that invests in stocks of foreign companies and might invest in the stocks of U.S. companies. A foreign stock fund limits investments to stocks of foreign companies.
 
Good ‘til cancelled order (GTC)
An order to buy or sell a security. The order remains in effect until the order is executed or until 60 calendar days have passed.
 
Government bond
Issued by a central government. Government bonds are among the safest of bond investments, provided the government has a strong credit rating. U.S. government bonds are called Treasurys, U.K. government bonds are called Gilts, German government bonds are called Bunds, and Japanese government bonds are called JGBs.
 
Government bond fund
A mutual fund that invests primarily in U.S. Treasury bonds and bonds sold by foreign governments.
 
Growth fund
A mutual fund that invests in growth stocks. Growth funds tend to have higher volatility than income or value funds.
 
Growth stock
The stock of a company that focuses on increasing revenues and earnings. (Some growth stocks focus more on growing revenues.) Growth stocks tend to not pay dividends. Instead, they retain any earnings and invest them in additional growth opportunities. Growth stocks tend to have higher volatility than income or value stocks, making them riskier investments.
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H
Hedging
A risk management technique that eliminates future price uncertainty. To hedge, one pays a price today that reflects expectations of buyers and sellers for the future price of a commodity, index, foreign currency, or other financial asset. Hedging helps to limit your losses but also limits chances of earning a higher rate of return. A foreign exchange hedge is the technique of locking in a future exchange rate today.
 
High-yield bond
A corporate bond that offers a yield higher than that offered on investment-grade bonds. High-yield bonds have a non-investment grade bond rating, lower than triple-B or the equivalent. Because of their implicit higher risk of issuer default, high-yield bonds offer a higher potential rate of return.
 
Holding period
The length of time one owns an investment. The rate of return earn over this period is called the holding period return (HPR). For an investment to qualify for the long-term capital gains tax rate, the holding period must be more than one year.
 
Hybrid mutual fund
A mutual fund that invests in a combination of stocks, bonds, cash, or other asset classes to achieve a specific investment objective. Hybrid funds include balanced funds and asset allocation funds
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I
Imputed interest
The amount of interest earned on a zero-coupon bond. For example, consider a 5-year zero-coupon bond, sold for $713, that has an interest rate of 7%. The bond appreciates to about $763 after one year. The amount of this appreciation, $50, is imputed interest.
 
Income stock
The stock of a company that focuses on paying steady or increasing dividends to shareholders. Income stocks tend to have lower volatility than growth stocks, making them less risky investments.
 
Initial allocation
The first asset allocation you set up as a result of analysis of your risk tolerance, investment horizon, and financial goals. You focus on allocating a percentage of the investment portfolio to the major asset classes of stocks, bonds and cash.
 
Investment Company Institute (ICI)
Good source of investor education.
 
Income tax bracket
Income tax bracket is the highest range of taxable incomes on which one pays income taxes. The Economic Growth and Tax Relief Reconciliation Act of 2001 cut tax rates for all individual income tax brackets except the 15% bracket. A sixth tax bracket of 10% was added for the first $6,000 ($7,150 in 2004) of income for single taxpayers, $10,000 ($10,200 in 2004) for single parents, and $12,000 ($14,300 in 2004) for married taxpayers.
 
Index fund
A mutual fund that invests in a combination of securities that mirror a benchmark index. For example, S&P 500 index funds invest in stocks in the same ratio as that stock index. Index funds are called passive funds, since they trade very little. As a result, index funds have lower operating expenses and generally distribute less in capital gains than actively managed funds.
 
Inflation risk
The likelihood that bond prices will fall as a result of either higher actual or anticipated inflation. Inflation erodes the value of bonds. Coupon payments and the bond principal, when repaid at maturity, decrease in value.
 
Initial public offering (IPO)
The stage of selling to the public the shares of a privately held company. The usual process is for an investment bank to underwrite the shares for sale by selling them to investors. In exchange, the investment bank earns an underwriting fee. Prior to trading on an exchange, the investment bank sets a recommended share price or price range. On the first day of trading, the shares begin trading on the exchange. Shares sometimes rise dramatically in the first few days of trading in what is often called a "pop" in share price. However, studies show that IPO share prices quickly give back their pop and fall to a price that more accurately reflects the financial performance of the company.
 
Interest rate risk
The likelihood that interest rates will rise, causing the value of bonds and other fixed-income securities to drop. From a consumer point of view, it is the risk that borrowing cost on a variable-rate loan will rise.
 
Intermediate-term bonds
Bonds that mature in two to 10 years. Long-term bonds are those with a term to maturity of more than 10 years. Short-term bonds have the lowest yields since their short terms to maturity reduce the risk from a change in interest rates between now and maturity. Long-term bonds have the highest yield since their long terms to maturity result in greater interest rate risk.
 
International stock fund
Also called a foreign stock fund. For U.S. investors, an international stock fund invests in the stocks of non-U.S. companies
 
Investment-grade bond
An investment-grade bond is a corporate, government, agency, or municipal bond with a credit rating of triple-B or higher from the major credit rating agencies. An investment-grade corporate bond is considered the safest of bonds after Treasury and agency bonds. The most conservative bond investors limit their investments to investment-grade bonds.
 
Investment horizon
Investment horizon is the period of time, in years, that the investment account owner wishes to remain invested. Investment horizon is the point in time when distributions begin; sometimes people define it as the point in time when distributions are completed.
 
Investment objective
A mutual fund defines its investment objective in its prospectus. The objective shows how much risk the fund is willing to accept in exchange for a higher rate of return. It also defines the types of investments it can make, how much debt it can assume, and any other controls. Major investment objectives of stock mutual funds include growth, value, and income. Fund data research companies often compare funds by investment objective to evaluate their relative investment performance.
 
Investment profile
A sketch of one’s financial goals, risk tolerance, and investment horizon.
 
IRA (Individual Retirement Account)
IRAs are retirement savings plans. Regular IRAs are also called traditional IRAs because they were the first IRAs introduced, in 1981. Roth IRAs were introduced in 1998. Regular IRAs allowed one to make a tax-deferred yearly contribution of $3,000 in 2004. A special catch-up provision of the 2001 tax law allows people over 50 to contribute an additional $500, or a total of $3,500, for 2004. This account grows tax-deferred until the owner begins to take distributions, which are allowed after age 59-1/2. Roth IRAs also grow tax-deferred, and if the owner keeps the account for at least five years and is at least 59-1/2, the entire account can be distributed tax- and penalty-free. Both types of IRAs require income taxes in the year of contributions.
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L
Laddering
An investing strategy that allows an individual to earn interest on savings without sacrificing access to them. One has deposits or bonds with staggered maturities. For example, this may be 6-month, 1-year, 3-year, and 5-year CDs. As each deposit matures, the individual rolls over the principal and accrued interest for a term that coincides with a date when the person might need liquid funds. This strategy allows the individual to have funds available quickly, earn interest, and avoid paying a penalty for ending a term deposit before maturity.
 
Large-cap stock
The stock of a company with a large market capitalization compared with other companies’. Market capitalization is share price times number of shares issued and outstanding. Investment returns of large-cap stocks often move in a different cycle than returns of small- and mid-cap stocks.
 
Leveraging
The process of borrowing at a lower interest rate and investing the funds at a higher rate of return. Leveraging often is a risky process. A low borrowing cost, for example, can increase unexpectedly. Also, the investment rate of return can decrease suddenly.
 
Limit order
An order to buy or sell a security at a specified price or better. A limit order to buy sets the maximum price to pay. A limit order to sell sets the minimum price to accept in selling. When placing a limit order, you must also decide whether you want to place it as a day order or a GTC order.
 
Liquidity
A favorable characteristic of a stock, bond, or other security. It represents the relative ease with which a security can sell. The more buyers and sellers there are for a security, the greater its liquidity. Liquidity is often reflected in the spread of the price of the security: A narrow spread between bid and ask prices is a sign of positive liquidity.
 
Liquidity risk
The chance that one is unable to sell an investment because of a lack of buyers.
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M
Margin account
Allows you to borrow at economical rates against the value of your eligible securities.* You may repay on your own schedule as long as you maintain the minimum equity required in your account.
 
Market capitalization
The aggregate market value of the issued and outstanding shares of a company. To calculate market cap, multiply number of issued and outstanding shares times current share price. For example, a firm with 100 million shares and a share price of $50 has a market capitalization of $5 billion.
 
Market order
An order to buy or sell a security at the best price available at the time the order is received on the trading floor.
 
Market value
The value of an asset as of a certain date. It is the price that the asset would bring in a free and arms-length transaction. Market value is also called current value. For example, the market value of an retirement account today may be $100,000. This is the total market value of the stocks, bonds, cash, and mutual funds in the account. In the case of most securities, market values can be determined every day, even at a given point in time. For less-liquid assets, such as real estate or collectibles, market value may require a professional appraisal.
 
Maturity
Loans: Maturity is the end of a loan term when the full amount of the loan is repaid to the lender. Bonds: Maturity is the date that the face value of the bond is repaid to investors. If the face value is less than the price the investor paid, the bond investor earns a capital loss. (The investor bought the bond at a premium to face value.) The bond investor may have earned enough in coupon interest to make it a profitable investment, however. If the face value exceeds the price the investor paid, the bond investor earns a capital gain. (The investor bought the bond at a discount to face value.)
 
Moderate investor
An investor who is willing to accept some investment risk in exchange for a chance to earn a higher rate of return. Investment risk is the volatility of investment returns. On the risk-tolerance scale, a moderate investor is between aggressive and conservative investors.
 
Money market mutual fund
Invests in Treasury bills and other very short-term securities that have minimal default risk. A money market fund must have an average maturity of less than 91 days. Money market mutual funds are also called money market funds. Money market funds are considered the safest and most liquid category of mutual funds. Money market funds are available as taxable and tax-exempt funds. They aim to keep the net asset value (NAV) of their shares at $1. The Federal Deposit Insurance Corporation (FDIC) does not insure money market funds.
 
Mortgage-backed securities
Bonds secured by hundreds or thousands of individual residential mortgage loans. Fannie Mae and Freddie Mac, two major government-sponsored enterprises that make mortgage loans, bundle up these mortgages and issue billions of dollars worth of MBS every year. Investors buying MBS face prepayment risk. This is the risk that the bonds will be paid back early. Prepayment risk increases when interest rates decline. This is because investors (whose mortgages back the securities) elect to refinance, paying off their mortgages. These prepayments are repaid to MBS investors, who then have to reinvest at lower interest rates.
 
Money market mutual fund
Mutual funds that invest in the safest of short-term securities. These include Treasury bills, commercial paper (CP), and other short-term debt securities. The FDIC does not insure money market mutual funds.
 
Municipal bond
States and municipalities issue municipal, or muni bonds. Investors often buy muni bonds issued by the state or municipality they reside in to derive the greatest income tax benefit. For example, if you are a resident of Massachusetts and buy a bond issued by the state, the interest you earn on the bond is exempt from federal and state income taxes, as a general rule (double tax-exempt muni bond). If you live in New York City and buy bonds issued by the city, the interest you earn on the bond is exempt from federal, state and city income taxes (triple tax-exempt muni bond).
 
Mutual fund
Invests in a portfolio of stocks, bonds, or other investments and sells individual shares of the portfolio to investors. Mutual funds have been around since the 1920s and regulation of their activities was beefed up in the 1940s. Mutual funds earn income on their investments and must pass most of it through to their shareholders each year. Income is earned as interest, dividends, or capital gains. Capital gains are the profits earned on the actual sale of securities in the portfolio. There are two main types of mutual funds: open- and closed-end funds. Most funds fall into the first category. An open-end fund buys and sells its shares at the net asset value of the fund. A closed-end mutual fund sells a limited number of shares, which usually trade on a stock exchange. Shares of closed-end funds routinely trade at a discount or premium to net asset value (NAV).
 
MFEA (Mutual fund Education Alliance)
Good source of investor education.
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Net asset value (NAV)
Net asset value (NAV) is the price of a share of a mutual fund. To calculate net asset value, subtract the expenses and liabilities of the fund from the current value of its portfolio of securities. For example, if a fund has $520 million in assets and $20 million in expenses, this equals $500 million. Next, divide $500 million by the number of shares the fund has issued. For example, if this fund has 10 million issued shares, its net asset value is equal to $50. Net asset value fluctuates daily with changes in the value of securities held in the fund portfolio.
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Online broker
Discount or full-service brokerage offering services on the Web. At a minimum, an online broker provides price quotes, a way to buy and sell securities, and a way to monitor your portfolio. Most online brokers provide additional services, including research, news and data, and advisory services.
 
Open-end fund
An open-end mutual fund buys and sells an unlimited number of shares. An open-end fund redeems its shares and calculates its net asset value daily based on daily valuations of securities in its portfolios. Investors buy and sell open-end fund shares at its net asset value.
 
Opportunity cost
The sacrifice of benefits from the next-best alternative when making a financial or economic decision. For example, consider having $1,000 to invest. You could invest it in a stock mutual fund that might return 10% or more. If you make this investment decision, you sacrifice the opportunity to earn a lower rate of return on an investment that has no risk. This might be a CD or other fixed-term deposit that has a 6% rate of return. This 6% guaranteed return is the opportunity cost of investing in the mutual fund instead.
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Passive mutual fund
A portfolio of investments set up to mirror a popular index. Since the investment choices and weights are already determined by the index, the fund manager does not need to do security research. The fund manager needs only to adjust the fund holdings when there is a change in the index. Active management is the opposite of passive management. It requires deliberate and purposeful research and selection of securities for a mutual fund. Passive mutual funds usually have lower transaction costs and smaller tax bills than actively managed funds.
 
Performance
A report card of the rate of return of a mutual fund or other investment. Rates of return are often reported for several periods of time. If available, investment performance may be shown for a period of up to 10 years. For example, investment performance of Mutual Fund XYZ may show that the fund earned an annualized rate of return of 3% for a three-month period, 5% for a six-month period, and 10% for a 12-month period.
 
Personal budget
A planning tool that lays out in simple and concise terms how much a person or household earns and spends each month. For example, you may decide to spend $1,000 and save $200 from your monthly after-tax income of $1,200. You can do a personal budget for the household. As part of the budgeting process, you want to save for three to six months of emergency funds. Part of setting up a personal budget is comparing actual with planned spending. If you actually spend $1,100 a month and save only $100, you need to either curtail spending, or adjust the budget to more realistic expectations.
 
Personal net cash flow
A person’s or household’s difference in cash inflows and outflows over a period of time. Calculating personal cash flow is an essential part of personal budgeting. Cash inflows include salary and other sources of cash-based income. Non-cash compensation is excluded, as are contributions to a retirement account. Cash outflows include bill payments, including mortgage or rent, living expenses, utilities, and repayment of debt. Personal cash flow usually is measured over a monthly period.
 
Portfolio
One’s collection of securities or other investments. If you invest in a diversified portfolio of securities, you usually reduce your investment risk. A diversified portfolio lets the investor earn a higher rate of return for a given amount of risk or to reduce risk for a given rate of return.
 
Premium to net asset value (NAV)
Occurs when the share price of a closed-end mutual fund trades at a higher price than its net asset value. Net asset value is a per-share price calculated by dividing net assets of the fund by the number of shares. If investors think the fund portfolio is actually worth more on a per-share basis, they bid up the share price to a price higher than its net asset value.
 
Prepayment
An amount paid on a mortgage or other loan that is an additional, unscheduled payment. Prepayments pay off a loan sooner and reduce total interest expense.
 
Prepayment risk
The risk a bond investor faces that a bond will be repaid sooner than expected, forcing the investor to reinvest the money, usually at a lower interest rate. Prepayment risk is a major risk when investing in mortgage- or asset-backed securities.
 
Present value
The value of a future payment, or series of payments, stated in today's dollars. Given the choice of $100 today or a year from now, one would choose to take it now. If invested at 10%, the money would be worth $110 in a year. In other words, the present value of $110 a year from today is $100 if the discount rate is 10%.
 
Pre-tax return
The calculated investment rate of return earned before considering paying income or capital gains taxes.
 
Price-to-book ratio
A measure of relative valuation of the share price of a company. It is calculated by dividing current stock price by its book value per share. Book value is equal to assets minus liabilities on the most recent balance sheet of the company. Divide by number of issued and outstanding common shares to calculate book value per share (BPS).
 
Price-to-earnings ratio
A measure of relative valuation of the share price of a company. It is calculated by dividing current stock price by earnings per share for a 12-month period. If you use EPS for the most recent 12 months, the calculation is sometimes called a trailing P/E ratio. If you use forecast EPS for the current 12-month period, the calculation is sometimes called a forward P/E ratio.
 
Prospectus
A document that a mutual fund, annuity, or company selling shares to the public is required to file with the Securities and Exchange Commission. The prospectus spells out details of a mutual fund or stock offering to the investing public. Mutual fund companies must send all potential investors a copy of the fund prospectus.
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Rate of return
The percentage gain or loss on an investment expressed as a yearly rate. Rates of return for periods shorter than or longer than a year are annualized, or converted to a yearly rate. Rates of return for multiple-year periods are stated as average or compounded returns. Total return includes income earned on retirement plan distributions while the investor owns the investment, as well as income earned on that income.
 
Rebalance
The process of shifting assets from one category to another to maintain a targeted allocation. Rebalancing is also called reallocation. Financial advisers suggest that you rebalance periodically to fine-tune the percentage weightings of your portfolio. In some cases, rebalancing requires selling securities and buying new ones belonging to a different asset class.
 
Redemption; redeem
Shareholder redemptions occur when mutual fund shareholders sell their shares back to the fund company. When an investor redeems funds, the fund sometimes has to sell securities in the portfolio, triggering capital gains. These capital gains are distributed to remaining fund shareholders. If redemptions are substantial, the fund has to sell even more securities, resulting in even larger capital gains. Net shareholder redemptions indicate more money leaving the fund than being invested.
 
Redemption fee
If an investor sells back, or redeems, mutual fund shares to the fund too soon, the fund might charge a redemption fee. The redemption period, or period in which redemption fees may apply, is often between 90 and 180 days.
 
Refinance
A way to replace high-interest debt with a loan that has a lower interest rate. People also refinance to switch from a fixed to a variable rate, or vice versa, or to eliminate a balloon payment. A cash-out refinancing involves paying off a loan and borrowing an additional amount. The entire loan amount is secured by a mortgage lien on the borrower’s home.
 
Regional stock fund
A mutual fund that concentrates its investments in the securities of a particular region of the world. Investing in a single regional fund usually does not provide adequate portfolio diversification.
 
Reinvesting
The act of investing dividends and capital gains received from a company or mutual fund into additional shares of the stock or fund. One also can choose to reinvest the dividends or capital gains in a different investment and interest rate. Investment performance of a stock or mutual fund often assumes that dividends and capital gains are reinvested in additional shares.
 
Repayment plan
A systematic plan to repay debt.
 
Risk
The probability that an investment will lose value. Risk is measured by the volatility of investment returns. If the rate of return of a stock or other security moves up and down over a wide range, the stock is said to have more investment risk than one whose returns fluctuate less. For example, a stock whose price fluctuates between $16 and $2 over a year has more risk than one whose price fluctuates between $12 and $8. One can reduce risk to a large degree by holding a diversified portfolio of investments.
 
Risk-return trade-off
A basic investing principle that says the higher the potential rate of return, the higher the investment risk. Academic and industry studies support this relationship. For example, stocks historically offer a higher rate of return than bonds. They also are riskier. Investment risk is measured by the volatility of investment returns.
 
Risk tolerance
Risk tolerance is the degree to which one is willing to risk losing part of an original investment in exchange for a chance to earn a higher rate of return. The risk-return trade-off requires the investor to accept more risk in exchange for a potentially higher return. If you have a low risk tolerance, you are a conservative investor. If you have a high risk tolerance, you are an aggressive investor. In truth, most investors have a moderate risk tolerance, which means their willingness to accept risk lies between that of conservative and aggressive investors. Younger investors usually have a higher risk tolerance since they have more time to recover from occasional losses. As investors age, their risk tolerance diminishes. By the time they are in late retirement, most people have low tolerance for risk.
 
Roll over
The process of converting a distribution from a qualified employer-sponsored retirement plan to a retirement plan at a new employer or individual retirement account (IRA). Under the rollover terms, one usually must generally convert the distribution within 60 days or be liable for income taxes and, possibly, an early-withdrawal penalty. If you own shares of qualified small business stock, you may be able to roll over some or all of a capital gain on its sale if the replacement stock you buy is also qualified small business stock. Other conditions apply. For more information on Section 1045 rollovers, see IRS Pub. 550.
 
Rotation
A market event that coincides with changes in investors’ asset allocation decisions. For example, consider the three major asset classes of stocks, bonds, and cash. When interest rates are rising, investors generally rotate funds into cash and out of stocks and bonds. When rates are subsiding, the opposite tends to occur. Generally, the independent performance of stock and bond markets leads investors to make rotation decisions into stocks from bonds, and vice versa. Sector rotation is a more narrow allocation of money into and out of sectors of the stock and bond markets.
 
Rule of 72
An investing rule of thumb to calculate how many years it takes to double savings. Divide the number 72 by the interest rate earned on deposits. The result is the number of years it takes, approximately, to double savings. If savings realize a 10% rate of return, it takes 7.2 years to double the savings.
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S&P 500
An index of 500 large-capitalization U.S. stocks. The S&P 500 index is widely used as a benchmark index for mutual funds to compare their investment returns. It is weighted according to the relative value of the 500 stocks that comprise the index.
 
Savings interest rate
The savings interest rate is the yearly interest rate earned on savings. It also is used to calculate the opportunity cost of paying with cash.
 
Savings plan
A systematic plan used to save for a specific financial goal. If you have more than one financial goal, you may wish to set up a savings plan for each goal. First, review your personal budget and personal cash flow to see how much you can save on a periodic basis. Next, pick a period in which you want to save the desired amount. Finally, estimate a realistic rate of return. It's important that you save regularly and avoid paying income taxes on your earnings, if possible. One way to do this is to contribute first to tax-advantaged retirement accounts and college savings plans.
 
Screening tool
An easy-to-use database that allows one to study a universe of stocks or mutual funds and obtain a shorter list by setting sorting criteria. These criteria are called screens, or filters. For example, a mutual fund screening tool may have 10,000 funds. But if you screen for funds with more than $10 billion in assets under management, list may shorten to 200 funds. You obtain an even shorter list by adding a second screen. For example, you may decide to evaluate only those funds with more than $10 billion in assets and an average annual rate of return of more than 15% over the past 10 years. This second screen may reduce the list of 200 funds to a more-manageable list of 20 funds. Adding a third and fourth screen may reduce the list to just one or two funds.
 
Sector fund
A mutual fund that invests in the securities of companies in a particular industry, such as electronics, telecommunications, financial services, or health care.
 
Securities
Stocks, bonds, mutual funds, and other investments that represent a claim or ownership interest in a company, agency, government, or other entity. The U.S. Securities and Exchange Commission regulates securities trading.
 
Shares
The basic units of stock ownership in a company or mutual fund. Owning shares of stock means owning a share of equity in the company. Owning shares of a mutual fund means owning an interest in the net assets of the fund proportional to the number of total shares of the fund.
 
Simple yield
The rate of return that one earns on a money market mutual fund, stated as a yearly percentage. Money market funds maintain a constant net asset value of $1 and invest only in short-term securities. Simple yield is considered a better measure of investment performance for a money market fund than total return. Compounded yield is the rate of return as a yearly percentage if the fund reinvests all interest income. Compounded yields are higher than simple yields because the reinvested returns yield additional returns.
 
Social Security
The federal retirement income security program in the U.S. The program is financed through Social Security taxes that workers pay during their working years. If eligible to receive Social Security, recipients may start receiving benefits when at age 62. The amount of benefit payments is graduated, depending on when a recipient elects to begin receiving benefits.
 
Standard deviation
A statistical measure of the volatility of returns for a stock, bond, or other security.
 
Stock
A financial asset that represents a unit of ownership in the company that issues the stock. Individual units of stock are shares. Stocks are also called equities because they represent an equity interest in the company. If you own stock in a company, you are a shareholder. Shareholders are entitled to share in the distribution of profits that the company makes. If a company goes bankrupt, or its stock price falls to zero, you have no claim or recourse to recover your investment. Together with bonds and cash, stocks are a major asset class for making asset allocation decisions.
 
Stock index
Represents a basket of stocks comprised of a representative portion of the stock market. For example, the S&P 500 is a composite index made up of the stock prices of 500 large companies. The Russell 2000 is an index of 2,000 smaller companies. Stock indexes move together, in some cases, and zigzag with each other, in other cases. Analysts often use stock indexes to assess the health of the economy or to measure the investment performance of a portfolio.
 
Stock mutual fund
A mutual fund that invests primarily in stocks. An investment company manages a mutual fund. It sells shares of the fund to individual investors. Open-end mutual funds buy and sell shares at any time and price. Closed-end mutual funds trade like securities, on an exchange, and are often quoted at a discount or premium to net asset value.
 
Stop order
Helps to protect a profit or limit a loss by becoming a market order when the stock sells at or below the specified stop price. You may place a stop order only if you are selling a listed stock held in your brokerage account.
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Tactical asset allocation (TAA)
Requires skilled timing in rebalancing assets for a short time. Tactical asset allocation decisions aim to exploit a short-term change in interest rates or asset prices that will make TAA profitable. However, excellent timing is necessary to execute profitable tactical asset allocation decisions. Financial advisers recommend focusing on long-term, or strategic, asset allocation decisions.
 
Tax-advantaged account
An investment account with tax-deferred or tax-exempt features. The Internal Revenue Service authorizes the use of tax-advantaged accounts. Investors use these accounts to save for retirement or college and other educational expenses. Tax-advantaged accounts are tax-exempt until the owner withdraws money from the account. In some cases, distributions are tax-exempt if the account holder meets certain conditions or if the money is spent a certain way. In other cases, distributions are taxed.
 
Taxable-equivalent yield
The minimum interest rate that an investor must earn on a taxable investment to match the rate of return on a tax-exempt security. Calculate this yield by subtracting the income tax rate of the investor from 1.0. This factor is called the reciprocal-of-tax bracket. Next, divide the tax-exempt bond yield by the reciprocal-of-tax bracket to calculate taxable-equivalent yield. For example, if an investor is in the 25% income tax bracket, the reciprocal-of-tax bracket is 0.75. If the investor can earn 5% on a tax-exempt bond, the investor must earn 6.67% (the taxable-equivalent yield) on a taxable investment to match the rate of return on the tax-exempt bond.
 
Taxable mutual fund
A fund whose portfolio holdings do not include securities that offer tax advantages.
 
Tax deduction
A tax-deductible expense or contribution that reduces taxable income. To calculate the value of a tax deduction, multiply the deduction by the income tax rate. For example, if you deduct $10,000 in mortgage interest expense and are in the 25% income-tax bracket, the tax deduction is worth $2,500. If you deduct $1,000 in contributions to a charity, the tax deduction is worth $250.
 
Tax-deferred account
A tax-advantaged account allowing one to postpone, or defer, paying taxes on earnings from the account. The purpose of these accounts is to save for retirement. A traditional IRA, a 401(k) plan, or a variable annuity are examples of tax-deferred accounts. Earnings grow compounded, tax-free, until the owner withdraws money from the account. For example, if you invested $2,000 a year in a tax-deferred account at 8%, it would grow to $31,291 at the end of 10 years. A taxable account with the same contributions will grow to only $27,568 over the same time. When you begin to take money out of the account, you pay taxes only on the amount withdrawn. Another benefit of a tax-deferred account is that you may also be in a tax bracket lower than your current bracket when you begin to take money out. This is because retirees, usually have less income than they do in their working years.
 
Tax efficiency
A measure of mutual fund return performance. Since dividends and capital gains are taxed, a fund that earns more dividends and capital gains is less tax-efficient, and fund shareholders face a larger tax liability.
 
Tax-exempt mutual fund
A fund whose portfolio holdings earn interest income that is exempt from state or federal income taxes, or both. Also called a tax-free mutual fund, municipal funds, or munis.
 
Thinly-traded
A stock, bond, or other security that has few buyers and sellers. As a result, a thinly-traded security is said to be illiquid. Illiquid market conditions often force a seller to accept a price less than the price would be if the security had many buyers and sellers.
 
Total return
The rate of return that measures the investment performance of stocks, bonds, and mutual funds that invest in stocks or bonds. Total return assumes the investor reinvests any coupon or dividend income in additional shares or bonds. Realized or unrealized capital gains (change in the price of the security) also are included in the calculation. The rate of return usually is stated as an annualized rate.
 
Treasury bills
Short-term debt obligations of the U.S. Treasury. T-bills are usually issued to mature in three or six months. Prices for T-bills are stated at a discount to the par value. For example, a T-bill with a price of 99.65 is selling for 99.65% of its par value. T-bills are auctioned weekly and used to pay for the operations of the federal government. T-bills are among the safest and most liquid investments.
 
Treasury bonds
Debt obligations of the U.S. government that have a maturity of more than 10 years. Treasury bonds are also called T-bonds or Treasurys. Treasury bonds are issued in denominations of $1,000, and are auctioned every three months by the U.S. Treasury. (Debt obligations with a maturity of between 1 and 10 years are called Treasury notes. Shorter-term securities are called Treasury bills.) Treasury bond prices are stated in thirty-seconds, using a colon to show the fractional value. Each 1 point equals $10. For example, a Treasury bond with a price of 98:25 is selling for 98-25/32 of its par value. Since one point is worth $10 and each 1/32nd is worth 31.25 cents, a bond price of 98-25/32 is equal to $987.8125. You owe federal income taxes on interest and capital gains from Treasury bonds, but income earned on Treasurys is exempt from state income taxes.
 
Triple–exempt municipal bond
A bond whose interest is exempt from federal, state, and local income taxes. To qualify for the state and local income tax deductions, a bond investor must be a resident of the state issuing the muni bond.
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Utilities
Utilities develop, transmit and store gas, electricity, and other forms of energy. Because of their vital economic importance, utilities operate in a regulated environment as quasi-public companies. Regulators limit the rate of return utilities may earn. Utilities generate steady dividends, which appeal to income stock investors. They also tend to have investment-grade bond ratings, which makes them attractive to conservative investors.
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Value stock
A stock or sector that investors see as relatively undervalued. Value investors use such measures as price-to-earnings (P/E) and price-to-book (P/B) ratios to determine relative valuations and make investment decisions.
 
Variances
The difference between actual and budgeted income and expenses. If budgeted expenses exceed actual expenses, there is a positive variance. If actual expenses exceed budgeted expenses, there is a negative variance. As long as positive variances occur, there is money to save. Savings should be about equal to the amount of the variance. Identifying budget variances is an important step in effective personal budgeting.
 
Venture capital
Money pooled and invested in new companies in the early stages of their growth. These companies often have a good idea or technology but lack money. VC firms invest large sums, sometimes hundreds of millions of dollars. They expect to earn a rate of return by selling shares of the companies to the public at a much higher price. Because of the inherent risk of investing in companies with little or no track record, VC firms expect to earn a rate of return that is greater than investing in the stock market.
 
Volatility
The swings in the prices of a market index, security, or other asset. Beta is used as a measure of volatility in the stock market. A stock beta of 1.0 indicates that the stock has the same volatility as the overall market. A stock beta of 1.2 indicates that the stock has a 20% higher volatility than the overall market. Volatility of a security is often measured by the standard deviation of its investment returns.
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Weighted-average rate of return
The investment return on a portfolio of investments. The return is weighted by the relative investment value to the total portfolio value. For example, assume a portfolio is equally weighted in stocks, bonds, and cash (this corresponds to weightings of 33%). Assume that the stock investments earned a rate of return of 10%, while bonds earned a 7% return and cash earned a 5% return. The weighted-average rate of return is ((.33 x 10%) + (.33 x 7%) + (.33 x 5%)), or 7%. If the weightings were 50%, 25% and 25%, respectively, weighted-average return is ((.50 x 10%) + (.25 x 7%) + (.25 x 5%)), or 8%.
 
Weighting
Used in asset allocation to describe the relative percentage of a portfolio that is invested in each asset class. Weightings should total 100%. For example, a portfolio’s weightings might be 60% in stocks, 30% in bonds, and 10% in cash. A portfolio that is 80% in stocks and 10% each in cash and bonds is heavily weighted in stocks.
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Yield
A measure of the investment performance of a security. For mutual funds, yield is dividends as a percentage of the price of a fund share. Calculate bond yield in three major ways: current yield, yield-to-maturity and yield-to-call. Current yield is the bond coupon rate divided by current price. It is an expedient but incomplete method for calculating yield. Yield-to-maturity (YTM) is the expected yield an investor earns for holding a bond to maturity. YTM includes coupon income and any premium or discount the investor pays. Yield-to-call is the expected yield an investor earns if the bond is held until its first call date, (the date people expect the issuing company to call in the bonds). The difference between bond yields is called the yield spread or credit spread. Yield spread measures the extra yield a bond must pay to compensate for additional risk over a risk-free bond. For example, if a 10-year corporate bond earns a yield of 6.25% and a 10-year U.S. Treasury bond yields 5.75%, the yield spread is 50 basis points.
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Zero-coupon bond
Sold at a large discount to par value. It pays no coupon interest. As the bond approaches its maturity date, the price of the bond rises towards par value. This appreciation of a zero-coupon bond is called imputed interest. The IRS requires owners to report imputed interest as taxable income unless they have earned it on a tax-exempt bond.
 
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