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FINANCIAL GLOSSARY
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A
Annuity
An
annuity is a contract between an insurance company and a buyer. The
buyer pays a premium, in one or several payments, and the insurance
company agrees to pay the buyer a regular return for a specified period
of time, usually the remainder of the buyer's lifetime. The insurance
company invests the money to earn interest, receive dividend income, or
collect capital gains distributions. The insurance company then pays
the buyer an income based on the terms of the contract. Annuities can
be variable or fixed, deferred or immediate. A fixed annuity ensures
that the insurance company will pay a set principal plus a set interest
rate. Returns on a variable annuity, however, fluctuate based on the
performance of the investments. With a deferred annuity, the premium
gathers interest for a certain set period of time, tax-free, before
payments to the buyer begin. Immediate annuities, on the other hand,
establish a return for the buyer based on the buyer's age, part of
which is considered principal and part of which is considered taxable
interest. Thus, age, wealth, and risk tolerance will heavily influence
the type of annuity an individual buyer selects.
Asset
Assets
include any of an individual's possessions that have economic value.
The sum of one's assets is considered to be the individual's net worth.
Assets include stocks, bonds, cash, real estate, jewelry, investments,
and other properties.
Asset Allocation
Asset
allocation refers to the specific distribution of funds among a number
of different asset classes within an investment portfolio; it is
diversification put into practice. Funds may be distributed among a
number of different asset classes, such as stocks, bonds, and cash
funds, each of which has unique types of expected risk and return.
Within each asset class are several variations of the asset, meaning
that there are levels of risk within each asset class. Asset allocation
involves determining what percentage of funds will be invested in each
asset. Determining how to allocate funds depends on the individual
investor. The investor's goals, time frame, and risk tolerance will all
affect how an investor wishes to allocate funds based on the investor's
desired return and acceptable risk.
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B
Back-end
load
A
back-end load is a sales charge or fee charged when funds are withdrawn
from an investment, particularly mutual funds and annuities. In many
cases, the fee is reduced over the years of investment, or holding
period, and eventually is reduced to zero.
Bear
Someone
who believes or speculates that a particular security or the securities
in a market will decline in value is referred to as a bear.
Bear Market
A
bear market is a market in which a group of securities falls in price
or loses value over a period of time. A prolonged bear market may
result in a decrease in market prices by 20% or more. A bear market in
stocks may be due to investor's expectations of economic trends; in
bonds a bear market results from rising interest rates.
Blue Chip
Blue
Chip refers to companies that have become well established and reliable
over time, demonstrating sound management and quality products and
services. Such companies have shown an ability to function throughout
both good and bad economic times, usually paying dividends to investors
even during lean years.
Bond
A bond is
essentially a loan made by an investor to a division of the government,
a government agency, or a corporation. The bond is a promissory note to
repay the loan in full at the end of a fixed time period. The date on
which the principal must be repaid is the called the maturity date, or
maturity. In addition, the issuer of the bond, that is, the agency or
corporation receiving the loan and issuing the promissory note, agrees
to make regular payments of interest at a rate initially stated on the
bond. Interest from bonds is taxable based on the type of bond.
Corporate bonds are fully taxable, municipal bonds issued by state or
local government agencies are free from federal income tax and usually
free from taxes of the issuing jurisdiction, and Treasury bonds are
subject to federal taxes but not state and local taxes. Bonds are rated
according to many factors, including cost, degree of risk, and rate of
income.
Bull
Someone who believes that a particular security or the securities in a
market will increase in value is known as a bull.
Bull Market
A
bull market is a long period of rising prices of securities, usually by
20% or more. Bull markets generally involve heavy trading and are
marked by a general upward trend in the market, independent of daily
fluctuations.
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C
Capital
Gains
A
capital gain is the appreciation in value of an asset, that is, when
the selling price is greater than the original price at which the
security was bought. The tax rate on capital gain depends on how long
the security was held.
Certificate of Deposit
A
Certificate of Deposit (CD) is a note issued by a bank for a savings
deposit that the individual agrees to leave invested in the bank for a
certain term. At the end of this term, on the maturity date, the
principal may either be repaid to the individual or rolled over into
another CD. The bank pays interest to the individual, and interest
rates between banks are competitive. Monies deposited into a
Certificate of Deposit are insured by the bank, thus they are a
low-risk investment and a good way of maintaining a principal.
Maturities may be as short as a few weeks or as long as several years.
Most banks set heavy penalties for premature withdrawal of monies from
a Certificate of Deposit.
Commission
Commission
is a fee charged by an agent making transactions of buying or selling
securities for another individual. This fee is generally a percentage
based on either the number of stocks bought or sold or the value of the
stocks bought or sold.
Credit Risk
Credit
risk refers primarily to the risk involved with debt investments, such
as bonds. Credit risk is essentially the risk that the principal will
not be repaid by the issuer. If the issuer fails to repay the
principal, the issuer is said to default.
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D
Default
To
default is to fail to repay the principal or make timely payments on a
bond or other debt investment security issued. Also, a default is a
breach of or failure to fulfill the terms of a note or contract.
Diversification
Diversification
is the process of optimizing an investment portfolio by allocating
funds to a number of different assets. Diversification minimizes risks
while maximizing returns by spreading out risk across a number of
investments. Different types of assets, such as stocks, bonds, and cash
funds, carry different types of risk. It is important to diversify
among assets with dissimilar risk levels for an optimal portfolio.
Investing in a number of assets allows for unexpected negative
performances to balance out with or be superceded by positive
performances.
Dividend
A dividend is a payment
made by a company to its shareholders that is a portion of the profits
of the company. The amount to be paid is determined by the board of
directors, and dividends may be paid even during a time when the
company is not performing profitably. Mutual funds also pay dividends.
These monies are paid from the income earned on the investments of the
mutual fund. Dividends are paid on a schedule, such as quarterly,
semi-annually, or annually. Dividends may be paid directly to the
investor or reinvested into more shares of the company's stock. Even if
dividends are reinvested, the individual is responsible for paying
taxes on the dividends. Unfortunately, dividends are not guaranteed and
may vary each time they are paid.
Dow Jones Industrial Average
The
Dow Jones Industrial Average is an index to which the performance of
individual stocks can be compared; it is a means of measuring the
change in stock prices. This index is a composite of 30 Blue Chip
companies ranging from AT&T and Hewlett Packard to Kodak and
Johnson & Johnson. These 30 companies represent not just the
United
States; rather, they are companies involved with commerce on a global
scale. The DJIA is computed by adding the prices of these 30 stocks and
dividing by an adjusted number which takes into account stock splits
and other divisions that would interfere with the average. Stocks
represented on the Dow Jones Industrial Average make up between 15% and
20% of the market.
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E
Equity
Equity
is the total ownership or partial ownership an individual possesses
minus any debts that are owed. Equity is the amount of interest
shareholders hold in a company as a part of their rights of partial
ownership. Equity is considered synonymous with ownership, a share of
ownership, or the rights of ownership.
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F
401k
plan
A
401k plan is a retirement plan sponsored by employers. Employees may
choose to have a portion of their salary deferred to any of the 401k
investment choices selected by the employer. The employer may also
contribute to the employee's 401k by matching a portion of the
investment (for example, $.50 for every $1.00 the employee invests).
The investments to which money is deferred may include stocks, bonds,
money market funds, and company stocks. Monies deferred into the 401k
are allowed to grow tax-free, and these monies are subtracted from the
employee's taxable income. The maximum amount allowed to be contributed
to a 401k changes annually. If money is withdrawn from the 401k before
the employee turns 59 , the individual may have to pay penalties. If
the individual changes jobs, the monies in the 401k may be rolled over
to a 401k of the new employer or to an Individual Retirement Account
(IRA).
Front-end load
A front-end load is a
commission or fee that is charged when an investment is initially
purchased. Investments that require a front-end load include mutual
funds, annuities, and life insurance policies. Typically, the fee
amount is a percentage of the net asset value of the investment.
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G
Going
Public
A
company that has previously been privately owned is said to be 'going
public' the first time the company's stock is offered up for public
sale.
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H
Hedge
Hedging
is a strategy of reducing risk by offsetting investments with
investments of opposite risk. Risks must be negatively correlated in
order to hedge each other; for example, an investment with high
inflation risk and low immediate returns with investments with low
inflation risk and high immediate returns. Long hedges protect against
a short-term position and short hedges protect against a long-term
position. Hedging is not the same as diversification, as it aims to
protect against risk by counterbalancing a specific area of risk.
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I
Individual
Retirement Account (IRA)
An
Individual Retirement Account allows individuals who are earning income
to contribute to a tax-deferred investment fund. An individual can
contribute up to $2,000 per year or $4,000 if married to an unemployed
spouse. Contributions to an IRA are tax-deductible based on the
individual's marriage status and income level. Monies contributed to an
IRA may be invested in stocks, bonds, mutual funds, annuities, bank
savings accounts, Certificates of Deposit, government bonds, and
investment trusts but not more personal and immediate investments such
as a home or collectibles. The individual may contribute to the
Individual Retirement Account until age 70 , but if money is withdrawn
before age 50 , penalties will be incurred.
Inflation Risk
Inflation
risk is the risk that rising prices of goods and services over time,
or, generally the cost of living, will decrease the value of the return
on investments. Inflation risk is also known as 'purchasing-power risk'
since it refers to increased prices of goods and services and a
decreased value of cash.
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J
Junk
Bond
Junk
bonds are bonds that are considered high yield but also have a high
credit risk. They are generally low rated bonds and are usually bought
on speculation, with the investor hoping for the yield, rather than the
default. An investor with high risk tolerance may choose to invest in
junk bonds.
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K
Keogh
Plan
The
Keogh Plan is a type of tax-deductible retirement plan, similar to
Individual Retirement Accounts, for self-employed individuals. It is
also known as a self-employed pension plan. The individual may
contribute up to $30,000 or 15% of total earned income per year,
whichever is less.
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L
Liquidity
Liquidity
refers to the ease with which investments can be converted to cash at
their present market value. Additionally, liquidity is a condition of
an investment that shows how greatly the investment price is affected
by trading. An investment that is highly liquid is composed of enough
units (such as shares) that many transactions can take place without
greatly affecting the market price. High liquidity is associated with a
high number of buyers and sellers trading investments at a high volume.
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M
Market
Risk
Market
risk is the risk that investments will lose money based on the daily
fluctuations of the market. Bond market risk results from fluctuations
in interest. Stock prices, on the other hand, are influenced by factors
ranging from company performance to economic factors to political news
and events of national importance. Time is a stabilizing element in the
stock market, as returns tend to outweigh risks over long periods of
time. Market risk cannot be systematically diversified away.
Market Value
Market
value is the value of an investment if it were to be resold, or the
current price of a security being sold on the market.
Modern Portfolio Theory
Aims
to minimize the risks of investing while maximizing returns through the
diversification of a portfolio. Diversification is the process of
allocating funds among a number of different asset classes. Modern
portfolio theory looks at three main factors in determining appropriate
investments for an investor's portfolio: the investor's goals and
objectives for investing, the time frame of investment, and the
investor's risk tolerance, or how comfortable the investor is with
taking certain risks. Optimizing a portfolio according to modern
portfolio theory involves matching the statistics of expected risk and
return for a number of different assets with the individual's terms of
investment.
Mutual Fund
Mutual funds are
investment companies whose job it is to handle their investors' money
by reinvesting it into stocks, bonds, or a combination of both. Mutual
funds are divided into shares and can be bought much like stocks,
allowing mutual funds to have a high liquidity. Mutual funds are
convenient, particularly for small investors, because they diversify an
individual's monies among a number of investments. Investors share in
the profits of a mutual fund, and mutual fund shares can be sold back
to the company on any business day at the net asset value price. Mutual
funds may or may not have a load, or fee; however, funds with a load
will provide advice from a specialist, which may help the investor in
choosing a mutual fund.
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N
NASDAQ
(National Association of Securities Dealers Automated Quotation)
The
National Association of Securities Dealers Automated Quotation is a
global automated computer system that provides up-to-the-minute
information on approximately 5,500 over-the-counter stocks. Whereas on
the New York Stock Exchange (NYSE) securities are bought and sold on
the trading floor, securities on the NASDAQ are traded via computer.
NASD (National Association of Securities
Dealers)
The
National Association of Securities Dealers is an organization of
broker/dealers who trade over-the-counter securities. The NASD is
self-regulated. The largest self-regulated securities organization.
This organization operates and regulates both the NASDAQ and
over-the-counter markets, ensuring that securities are traded fairly
and ethically.
NAV (Net Asset Value)
Net Asset
Value is the price of a share in a mutual fund or investment company.
This price is calculated once or twice daily. Net asset value is the
amount by which the assets' value exceeds the company's liabilities. It
is calculated by adding up the market value of all securities owned by
the company, subtracting the company's liabilities, and dividing this
value by the number of shares of the company outstanding. Thus, the NAV
indicates the current buying or selling price of a share in an
investment company.
NYSE (New York Stock Exchange)
Established
in 1792, the New York Stock Exchange in the largest securities exchange
in the United States. Securities are traded by brokers and dealers for
customers on the trading floor at 11 Wall Street in New York City. The
exchange is headed by a board of directors that includes a chairman and
20 representatives who represent both the public and the members of the
exchange. This board approves applicants as new NYSE dealers, sets
policies for exchange, oversees the exchange, regulates member
activities, and lists securities.
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O
Option
An
option is a security that can be bought as a contract to fix the price
on another, underlying security. The buyer can pay the issuer of the
option a premium that fixes the price on an investment, including
stocks, bonds, real estate, and others, for a specified period of time.
The holder of the option can then choose to buy or sell the underlying
security at the fixed price during this time period; however, the
holder is under no obligation to buy. For example, if the holder
purchases an option to buy a stock at $30, the individual may not wish
to buy the stock during the time period of the option if the shares are
being sold for $27. However, if the shares are being sold for $33, the
holder will save $3 per share with the option. Thus, options may or may
not prove advantageous to the holder.
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P
Price-Earnings
Ratio
The
price-earnings ratio is a measure of how much buyers are willing to pay
for shares in a company, based on that company's earnings. Price
earnings ratio is calculated by dividing the current price of a share
in a company by the most recent year's earnings per share of the
company. This ratio is a useful way of comparing the value of stocks
and helps to indicate expectations for the company's growth in
earnings. It is important, however, to compare the P/E ratios of
companies in similar industries. Price-earnings ratio is sometimes also
called the 'multiple'.
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Q
Quotation
A
quotation, or quote, refers to the current price of a security, be it
either the highest bid price for that security or the lowest ask price.
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R
Real
Rate of Return
The Real Rate of Return refers to the annual return on an investment
after being adjusted for inflation and taxes.
Reinvest
Reinvestment
is the use of capital gains, including interest, dividends, or profit,
to buy more of the same investment. For example, the dividends received
from stock holdings may be reinvested by buying more shares of the same
stock.
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S
SEC
(Securities and Exchange Commission)
The
Securities and Exchange Commission is a federal government agency
comprised of 5 commissioners appointed by the president and approved by
the Senate. The SEC was established to protect the individual investor
from fraud and malpractice in the marketplace. The commission oversees
and regulates the activities of registered investment advisors, stock
and bond markets, broker/dealers, and mutual funds.
Security
A
security is any investment purchased with the expectation of making a
profit. Securities include total or partial ownership of an asset,
rights to ownership of an asset, and certificates of debt from an
institution. Examples of securities include stocks, bonds, certificates
of deposit, and options.
S&P (Standard and Poor's) 500
Index
The
Standard and Poor's 500 Index is a market index of 500 of the
top-performing United States corporations. This index is a broader
measure of the domestic market than the Dow Jones Industrial Average,
indicating broad market changes. The S&P 500 index includes 400
industrial firms, 20 transportation firms, 40 utilities, and 40
financial firms.
Split
A split is when a
company's board of directors and the shareholders agree to increase the
number of shares outstanding. The shareholders' equity does not change;
instead, the number of shares increases while the value of each share
decreases proportionally. For example, in a 2-for-1 split, a
shareholder with 100 shares prior to the split would now own 200
shares. The price of the shares, however, would be cut in half; shares
that cost $40 before the split would be worth $20 after the split.
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T
Ticker
The
ticker displays information on a moveable tape or, in modern times, as
a scrolling electronic display on a screen. The symbols and numbers
shown on the ticker indicate the security being traded, the latest sale
price of the security, and the volume of the last transaction.
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U
Underwriter
An
underwriter is an individual distributing securities as an intermediary
between the issuer of the security and the buyer. For example, an
underwriter may be the agent selling insurance policies or the person
distributing shares of a mutual fund to broker/dealers or investors.
Generally, the underwriter agrees to purchase the remaining units of
the security from the issuer, such as remaining shares of stocks or
bonds, if the public does not buy all specified units. An underwriter
may also be a company that backs the issue of a contract, agreeing to
accept responsibility for fulfilling the contract in return for a
premium.
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V
Volatility
Volatility
is an indicator of expected risk. It demonstrates the degree to which
the market price of an asset, rate, or index fluctuates from average.
Volatility is calculated by finding the standard deviation from the
mean, or average, return.
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W
Warrant
A
warrant is similar to an option, giving the holder the right to
purchase securities at a set price for a specific period of time.
Warrant certificates last longer than options, typically holding value
for a few years or indefinitely. Warrants are often traded as
securities at a price that reflects the underlying security.
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X-Y-Z
Yield
Yield
is the return, or profit, on an investment. Yield refers to the
interest gained on a bond or the rate of return on an investment, such
as dividends paid on a mutual fund. Yield does not include capital
gains.
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Burt Associates, Inc.
6010 Executive Blvd.
Suite 900
Rockville, MD 20852
Phone: (301) 770-9880
Fax: (301) 770-9885
Contact: Mr. Fred Cornelius, President
Email: fcornelius@burtassociates.com
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