Unsystematic risk or risk that is uncorrelated to the overall market risk. In other words, the risk that is firm specific and can be diversified through holding a portfolio of stocks.
Delivery and settlement of securities within five business days.
The construction of an asset and a liability that are subject to offsetting changes in value.
A bond portfolio strategy whose goal is to eliminate the portfolio’s risk against a general change in the rate of interest through the use of duration.
The right of the homeowner to prepay, or call, the mortgage at any time.
Implied repo rate
The rate that a seller of a futures contract can earn by buying an issue and then delivering it at the settlement date. Related: cheapest to deliver issue
The expected volatility in a stock’s return derived from its option price, maturity date, exercise price, and riskless rate of return, using an option-pricing model such as Black/Scholes.
A bond on which the payment of interest is contingent on sufficient earnings. These bonds are commonly used during the reorganization of a failed or failing business.
A mutual fund providing for liberal current income from investments.
Income statement (statement of operations)
A statement showing the revenues, expenses, and income (the difference between revenues and expenses) of a corporation over some period of time.
Common stock with a high dividend yield and few profitable investment opportunities.
Incremental cash flows
Difference between the firm’s cash flows with and without a project.
Incremental costs and benefits
Costs and benefits that would occur if a particular course of action were taken compared to those that would occur if that course of action were not taken.
Incremental internal rate of return
IRR on the incremental investment from choosing a large project instead of a smaller project.
Agreement between lender and borrower which details specific terms of the bond issuance. Specifies legal obligations of bond issuer and rights of bondholders.
Index Amortizing Swap
A swap whose Notional Amount amortizes (declines) each period by an amount that depends on the level of one or more interest rates. This gives the IAS a superficial resemblance to a mortgage loan or mortgage-backed security, which has optional prepayment. This superficial similarity has been the basis for a sales pitch to institutions with a large prepayment risk to hedge. Alas, the basis risk is large enough to discourage intelligent, experienced – or even merely intelligent – professionals from hedging this way. The IAS – like the legendary House of the Rising Sun, in New Orleans – has been the ruin of many a poor boy
An investment/trading strategy that exploits divergences between actual and theoretical futures prices.
Investment fund designed to match the returns on a stockmarket index.
A model of stock returns using a market index such as the S&P 500 to represent common or systematic risk factors.
A call or put option based on a stock market index.
A stock index option issued by either a corporate or sovereign entity as part of a security offering, and guaranteed by an option clearing corporation.
Bond whose payments are linked to an index, e.g. the consumer price index.
A passive instrument strategy consisting of the construction of a portfolio of stocks designed to track the total return performance of an index of stocks.
The graphical expression of a utility function, where the horizontal axis measures risk and the vertical axis measures expected return. The curve connects all portfolios with the same utilities according to and .
For foreign exchange, the number of units of a foreign currency needed to buy one U.S.$.
Industrial revenue bond (IRB)
Bond issued by local government agencies on behalf of corporations.
The rate at which the general level of prices for goods and services is rising.
Inflation-Linked Bonds have coupons that depend on the rate of inflation or a related index. They have two main structures.
1. Capital Indexed Bonds. The principal accretes according to the CPI or another price index or deflator. The bond’s coupon is a fixed percent of the accreted principal.
2. Floating Rate Bonds. The principal is fixed, but its coupon floats. The floating rate depends on inflation or something related, such as the rate of change in the CPI or on the Treasury Inflation Protected Security (TIPS) variable coupon rate.
A flurry of issues have hit the market in 1997. Issuers include Federal Home Loan Banks, JP Morgan & Co. Inc., Sallie Mae, Salomon Brothers, Toyota Motor Credit Corporation, the U.S. Treasury.
The two main unresolved issues of Inflation-Linked Bonds are how large and variable (1) the coupon and (2) the market price should be.The real yields on Inflation-Linked Treasury Bondsbegan large enough to surprise many observers, and has fallen little in a few months. Some observers believe that these high real rates are sustainable and have historical precedent. Others believe that they are the result of investor uncertainty about the market and will fall over time. (Jonathan Clements, “Second Thoughts: Inflation-Tied Bonds Offer an Intriguing Option for Investors,” Wall Street Journal, 3/11/97.)
Advocates for the U.S. market envisioned a bond with a variable coupon and a stable price. However, the experience with Australian Capital Indexed Bonds is that the price varies significantly. (Wesley Phoa, “Inflation-Linked Bonds; are they too safe or too exciting?”, Financial Trader 4 (2), p. 30.)
Also called purchasing-power risk, the risk that changes in the real return the investor will realize after adjusting for inflation will be negative.
The fact that future inflation rates are not known. It is a possible contributing factor to the makeup of the term structure of interest rates.
A clause in a contract providing for increases or decreases in inflation based on fluctuations in the cost of living, production costs, and so forth.
A situation involving information that is known to some, but not all, participants.
Information Coefficient (IC)
The correlation between predicted and actual stock returns, sometimes used to measure the value of a financial analyst. An IC of 1.0 indicates a perfect linear relationship between predicted and actual returns, while an IC of 0.0 indicates no linear relationship.
Transaction costs that include the assessment of the investment merits of a financial asset.
The rise in the stock price following the dividend signal.
The speed and accuracy with which prices reflect new information.
Initial margin requirement
When buying securities on margin, the proportion of the total market value of the securities that the investor must pay for in cash. The Security Exchange Act of 1934 gives the board of governors of the Federal Reserve the responsibility to set initial margin requirements, but individual brokerage firms are free to set higher requirements. In futures contracts, initial margin requirements are set by the exchange.
Initial public offering (IPO)
A company’s first sale of stock to the public. Securities offered in an IPO are often, but not always, those of young, small companies seeking outside equity capital and a public market for their stock. Investors purchasing stock in IPOs generally must be prepared to accept very large risks for the possibility of large gains. IPO’s by investment companies (closed-end funds) usually contain underwriting fees which represent a load to buyers.
Relevant information about a company that has not yet been made public. It is illegal for holders of this information to make trades based on it, however received.
Trading by officers, directors, major stockholders, or others who hold private inside information allowing them to benefit from buying or selling stock.
These are directors and senior officers of a corporation — in effect those who have access to inside information about a company. An insider also is someone who owns more than 10% of the voting shares of a company.
The risk that a firm will be unable to satisfy its debts. Also known as bankruptcy risk.
A firm that is unable to pay debts (liabilities are greater than assets).
An option on an option on an option …
The sale of an asset in exchange for a specified series of payments (the installments).
Aussie for what is simultaneously a Compound Option (q.v.) and a Warrant (q.v.), and which apparently confers some of the benefits of ownership. “They involve two payments: an initial payment followed by a second, which includes fees and interest, paid optionally about 14 months afterwards. In the meantime, depending on the issuer, the instalments confer full dividends, franking credits and voting rights.” (Source: Australian Financial Review Dictionary of Investment Terms.)
Organizations that invest, including insurance companies, depository institutions, pension funds, investment companies, mutual funds, and endowment funds.
The gradual domination of financial markets by institutional investors, as opposed to individual investors. This process has occurred throughout the industrialized world.
Financial securities, such as money market instruments or capital market insturments.
A municipal bond backed both by the credit of the municipal issuer and by commercial insurance policies.
A legal claim to some future benefit, typically a claim to future cash. Goodwill, intellectual property, patents, copyrights, and trademarks are examples of intangible assets.
The price paid for borrowing money. It is expressed as a percentage rate over a period of time and reflects the rate of exchange of present consumption for future consumption. Also, a share or title in property.
Interest coverage ratio
The ratio of the earnings before interest and taxes to the annual interest expense. This ratio measures a firm’s ability to pay interest.
Interest coverage test
A debt limitation that prohibits the issuance of additional long-term debt if the issuer’s interest coverage would, as a result of the issue, fall below some specified minimum.
Contractual debt payments based on the coupon rate of interest and the principal amount.
Interest-only strip (IO)
A security based solely on the interest payments form a pool of mortgages, Treasury bonds, or other bonds. Once the principal on the mortgages or bonds has been repaid, interest payments stop and the value of the IO falls to zero.
Interest rate agreement
An agreement whereby one party, for an upfront premium, agrees to compensate the other at specific time periods if a designated interest rate (the reference rate) is different from a predetermined level (the strike rate).
Interest rate cap
Also called an interest rate ceiling, an interest rate agreement in which payments are made when the reference rate exceeds the strike rate.
Interest rate floor
An interest rate agreement in which payments are made when the reference rate falls below the strike rate.
Interest rate parity theorem
Interest rate differential between two countries is equal to the difference between the forward foreign exchange rate and the spot rate.
Interest rate risk
The risk that a security’s value changes due to a change in interest rates. For example, a bond’s price drops as interest rates rise. For a depository institution, also called funding risk, the risk that spread income will suffer because of a change in interest rates.
Interest rate swap
A binding agreement between counterparties to exchange periodic interest payments on some predetermined dollar principal, which is called the notional principal amount. For example, one party will pay fixed and receive variable.
A firm’s deduction of the interest payments on its debt from its earnings before it calculates its tax bill under current tax law.
Intermarket sector spread
The spread between the interest rate offered in two sectors of the bond market for issues of the same maturity.
Intermarket spread swaps
An exchange of one bond for another based on the manager’s projection of a realignment of spreads between sectors of the bond market.
Finance generated within a firm by retained earnings and depreciation.
Internal growth rate
Maximum rate a firm can expand without outside source of funding. Growth generated by cash flows retained by company.
The securities market within the boundaries of a particular country, consisting of the domestic market and the foreign market. Example: Most Daimler Chrysler debt trades in the German internal market.
Internal rate of return
Dollar-weighted rate of return. Discount rate at which net present value (NPV) investment is zero. The rate at which a bond’s future cash flows, discounted back to today, equals its price.
International Bank for Reconstruction and Development – IBRD or World Bank
International Bank for Reconstruction and Development makes loans at nearly conventional terms to countries for projects of high economic priority.
International Banking Facility (IBF)
International Banking Facility. A branch that an American bank establishes in the United States to do Eurocurrency business.
A collective term that refers to global bonds, Eurobonds, and foreign bonds.
International Depository Receipt (IDR)
A receipt issued by a bank as evidence of ownership of one or more shares of the underlying stock of a foreign corporation that the bank holds in trust. The advantage of the IDR structure is that the corporation does not have to comply with all the regulatory issuing requirements of the foreign country where the stock is to be traded. The U.S. version of the IDR is the American Depository Receipt (ADR).
The attempt to reduce risk by investing in the more than one nation. By diversifying across nations whose economic cycles are not perfectly correlated, investors can typically reduce the variability of their returns.
International Fisher effect
States that the interest rate differential between two countries should be an unbiased predictor of the future change in the spot rate.
A mutual fund that can invest only outside the United States.
International Monetary Fund
An organization founded in 1944 to oversee exchange arrangements of member countries and to lend foreign currency reserves to members with short-term balance of payment problems.
International Swaps and Derivatives Association
The principal trade association for Swap and Derivatives dealers, as well as allied organizations.
International Monetary Market (IMM)
A division of the CME established in 1972 for trading financial futures. Related: Chicago Mercantile Exchange (CME).
A put option that has a strike price higher than the underlying futures price, or a call option with a strike price lower than the underlying futures price. For example, if the March COMEX silver futures contract is trading at $6 an ounce, a March call with a strike price of $5.50 would be considered in-the-money by $0.50 an ounce. Related: put.
Intramarket sector spread
The spread between two issues of the same maturity within a market sector. For instance, the difference in interest rates offered for five-year industrial corporate bonds and five-year utility corporate bonds.
Intrinsic value of an option
The amount by which an option is in-the-money. An option which is not in-the-money has no intrinsic value. Related: in-the-money.
Intrinsic value of a firm
The present value of a firm’s expected future net cash flows discounted by the required rate of return.
For companies: Raw materials, items available for sale or in the process of being made ready for sale. They can be individually valued by several different means, including cost or current market value, and collectively by FIFO, LIFO or other techniques. The lower value of alternatives is usually used to preclude overstating earnings and assets. For security firms: securities bought and held by a broker or dealer for resale.
A secured short-term loan to purchase inventory. The three basic forms are a blanket inventory lien, a trust receipt, and field warehousing financing.
The ratio of annual sales to average inventory which measures the speed that inventory is produced and sold. Low turnover is an unhealthy sign, indicating excess stocks and/or poor sales.
A Floating Rate Note with a coupon that decreases as the underlying index rate increases (e.g., a simple Inverse Floater’s coupon rate might be 11.5% minus LIBOR). The Replicating Portfolio (q.v.) for a simple Inverse Floater is long a pair of Fixed Rate Notes and short a Floating Rate Note. Commonly, an Inverse Floater’s coupon has a ceiling and a floor, (e.g., no more than ten percent, never negative). Thus, its replicating portfolio is the same as for a simple Inverse Floater, plus long a Cap and short a Floor.
A futures market in which the nearer months are selling at price premiums to the more distant months. Related: premium.
Financial intermediaries who perform a variety of services, including aiding in the sale of securities, facilitating mergers and other corporate reorganizations, acting as brokers to both individual and institutional clients, and trading for their own accounts.
Investment grade bonds
A bond that is assigned a rating in the top four categories by commercial credit rating companies. For example, S&P classifies investment grade bonds as BBB or higher, and Moodys’ classifies investment grade bonds as Ba or higher. Related: High-yield bond.
Also called portfolio management and money management, the process of managing money.
Also called a portfolio manager and money manager, the individual who manages a portfolio of investments.
Investment product line (IPML)
The line of required returns for investment projects as a function of beta (nondiversifiable risk).
A closed-end fund regulated by the Investment Company Act of 1940. These funds have a fixed number of shares which are traded on the secondary markets similarly to corporate stocks. The market price may exceed the net asset value per share, in which case it is considered at a “premium.” When the market price falls below the NAV/share, it is at a “discount.” Many closed-end funds are of a specialized nature, with the portfolio representing a particular industry, country, etc. These funds are usually listed on US and foreign exchanges.
As a discipline, the study of financial securities, such as stocks and bonds, from the investor’s viewpoint. This area deals with the firm’s financing decision, but from the other side of the transaction.
The owner of a financial asset.
In the mortgage pipeline, risk that occurs when the originator commits loan terms to the borrowers and gets commitments from investors at the time of application, or if both sets of terms are made at closing.
The process by which the corporation communicates with its investors.
The balance of a margin account. Related: buying on margin, initial margin requirement.
Bill written by a seller of goods or services and submitted to the purchaser.
Billing system in which the invoices are sent off at the time of customer orders are all separate bills to be paid.
Usually the date when goods are shipped. Payment dates are set relative to the invoice date.
The price that the buyer of a futures contract must pay the seller when a Treasury Bond is delivered.
In-house processing float
Refers to the time it takes the receiver of a check to process the payment and deposit it in a bank for collection.
In the box
This means that a dealer has a wire receipt for securities indicating that effective delivery on them has been made.
Irrational call option
The implied call imbedded in the MBS. Identified as irrational because the call is sometimes not exercised when it is in the money (interest rates are below the threshold to refinance). Sometimes exercised when not in the money (home sold without regard to the relative level of interest rates).
The Modigliani and Miller theorem that a firm’s capital structure is irrelevant to the firm’s value.
International Security Market Association. ISMA is a Swiss law association located in Zurich that regroups all the participants on the Eurobond primary and secondary markets. Establishes uniform trading procedures in the international bond markets.
Issued share capital
Total amount of shares that are in issue.
An entity that issues a financial asset.