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FAQ

Additional Resources

Financial Dictionary

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Active Management - Pursuit of investment returns in excess of a specified benchmark, such as the S&P 500.

Acquisition - One company buying controlling interest in another company. Investors are always watching for companies which are likely to be acquired, because those who wish to acquire such companies often will have to pay a substantial premium for the shares they need to complete the acquisition.

AIMR - Association For Investment Management and Research - Effective May 9, 2004, the global non-profit professional association that administers the Chartered Financial Analyst® study and examination program worldwide voted to change the name of the organization to “CFA Institute.” Please refer to CFA Institute, below.

AIMR Performance Presentation Standards (AIMR-PPS®) - A set of standardized industry guidelines used throughout the U.S. and Canada outlining how investment firms should calculate and report their investment results. Currently, this AIMR-PPS name is not affected by the May 9, 2004 name change of AIMR to CFA Institute. The AIMR-PPS name may change in the next two years for different reasons, as the North American standards converge to a newer, global standard, called Global Investment Performance Standards, or GIPS®, which also were established under AIMR’s leadership. (See Global Investment Performance Standards, or GIPS®, below.)

American Depositary Receipt (ADR) - Receipt for the shares of a foreign-based corporation held in the vault of a U.S. bank and entitling the shareholder to all dividends and capital gains. Instead of buying shares of foreign-based companies in overseas markets, Americans can buy shares in the U.S. in the form of an ADR.

Arbitrage - Profiting from differences in price when the same security, currency, or commodity is traded on two or more markets. For example, an arbitrageur simultaneously buys one contract of gold in the New York market and sells one contract of gold in the Chicago market, locking in a profit because at that moment the price on the two markets is different. (The arbitrageur's selling price is higher than the buying price.) Index arbitrage exploits price differences between stock index futures and underlying stocks. By taking advantage of momentary disparities in prices between markets, arbitrageurs perform the economic function of making those markets trade more efficiently. In addition, arbitrageurs frequently play inefficient spreads associated with merger and acquisition activity. For instance, when one company is being acquired by another, it usually trades at a discount to its acquisition price. An arbitrageur buys the stock of the company being acquired, in hopes of profiting from the 5% to 15% discount to the acquisition price, and sells short the shares of the acquiring company.

Average Down - Strategy to lower the average price paid for a company's shares. If the price of a stock continues to decline, then purchasing more at the lower cost will make the average cost lower than it would have been if all of the shares had been bought at once.

Balance Sheet - Financial report, also called statement of condition or statement of financial position, showing the status of a company's assets, liabilities, and owners' equity on a given date, usually the close of a month. It is a convenient way of organizing and summarizing what a firm owns (its assets), what a firm owes (its liabilities), and the difference between the two (the firm's equity) at a given point in time. Unlike a Profit and Loss Statement, which shows the results of operations over a period of time, a balance sheet shows the state of affairs at one point in time. It is a snapshot, not a motion picture, and must be analyzed with reference to comparative prior balance sheets and other operating statements.

Basis Point - Smallest measure used in quoting yields on bonds and notes. One basis point is 0.01% of yield. Thus a bond's yield that changed from 10.67% to 11.57% would be said to have moved 90 basis points.

Beta - The tendency of a security's returns to respond to swings in the broad market, which is usually deemed to be the S&P 500 Index. For example, if the beta of a stock is 1.3, it is theoretically 30% more volatile than the S&P 500 Index.

Bid and Asked - "Bid" is the highest price a prospective buyer is prepared to pay at a particular time for a trading unit of a given security; "asked" is the lowest price acceptable to a prospective seller of the same security. Together, the two prices constitute a quotation; the difference between the two prices is the spread.

Blue Chip - Common stock of a nationally known company that has a long record of profit growth and a reputation for quality management, products, and services. Some examples of blue chip stocks: International Business Machines, General Electric, and DuPont. Blue chip stocks typically are relatively high priced on a valuation basis.

Bond Rating - Method of evaluating the possibility of default by a bond issuer. Standard & Poor's, Moody's Investors Service, and Fitch's Investors Service analyze the financial strength of each bond's issuer, whether a corporation or a government body. Their ratings range from AAA (highly unlikely to default) to D (in default).

Book Value - Accounting value of a firm's equity. Also commonly referred to as net worth. Book value can be a guide in selecting underpriced stocks and is an indication of the ultimate value of securities in liquidation.

Bottom-Up Approach to Investing - Search for undervalued individual stocks before considering the impact of economic trends. The companies may be identified from research reports, stock screens, or proprietary research. Also see Top-Down Approach to Investing.

Breadth of the Market - Percentage of stocks participating in a particular market move. Analysts say there was good breadth if two thirds of the stocks listed on an exchange rose during a trading session. A market trend with good breadth is more significant and probably more long-lasting than one with limited breadth, because more investors are participating.

Buy and Hold Strategy - Strategy which calls for an investor to hold shares in a company over several years. This allows the investor to pay favorable long-term capital gains tax on profits and requires far less attention than a more active trading strategy.

Buyout - Purchase of at least a controlling percentage of a company's stock in order to take over the company's assets and operations. A buyout can be accomplished through negotiation or through a tender offer. A leveraged buyout occurs when a small group borrows the money to finance the purchase of the shares. The loan is ultimately repaid out of cash generated from the acquired company's operations or from the sale of its assets.

Call Option - Right to buy 100 shares of a particular stock or stock index at a predetermined price before a preset deadline, in exchange for a premium. For buyers who think a stock will go up dramatically, call options permit a profit from an investment that is smaller than buying the stock.

Capital Structure - The mixture of debt and equity maintained by a company.

Cash Cow - Business that generates a continuing flow of cash. Such a business usually has well-established brand names whose familiarity stimulates repeated buying of the products. For example, a magazine company that has a high rate of subscription renewals can be considered a cash cow.

Cash Flow - In a larger financial sense, an analysis of all the changes that affect the cash account during an accounting period. The statement of cash flows included in annual reports analyzes all changes affecting cash in the categories of operations, investments, and financing. For example: net operating income is an increase; the purchase of a new building is a decrease; and the issuance of stock or bonds is an increase. When more cash comes in than goes out, we speak of a positive cash flow; the opposite is a negative cash flow. Companies with assets well in excess of liabilities may nevertheless go bankrupt because they cannot generate enough cash to meet current obligations. In the most simple terms, cash flow is equal to net earnings plus depreciation and amortization.

Certified Financial Planner (CFP®) - Individuals who adhere to the internationally recognized standards of competence and ethical practice as set out by Financial Planners Standards Council (FPSC). Individuals who attain the CFP® designation must meet the education, examination, experience, and ethical requirements set by FPSC and are identified by the CFP® registered certification marks. Only FPSC can authorize an individual to use the CFP® marks.

CFA Institute - Formerly AIMR, is an international, nonprofit organization of more than 70,000 investment practitioners and educators in over 100 countries that administers the Chartered Financial Analyst® study and examination program worldwide.

Chartered Financial Analyst (CFA) - A designation awarded by the CFA Institute to experienced financial analysts who pass examinations in economics, financial accounting, portfolio management, quantitative analysis, security analysis, and ethics.

Chartist - Technical analyst who charts the patterns of stocks, bonds, and commodities to make buy and sell recommendations to clients. Chartists believe recurring patterns of trading can help them forecast future price movements.

Circuit Breakers - Measures instituted by the major stock and commodities exchange to halt trading temporarily in stocks and stock index futures when the market has fallen by a specified amount within a specified period. Circuit breakers were instituted after Black Monday in 1987 and were modified following another sharp market drop in October 1989. Their purpose is to prevent a market free-fall by permitting a rebalancing of buy and sell orders.

Closely Held - Corporation most of whose voting stock is held by a few shareholders and is not considered likely to be available for purchase; differs from a closed corporation because enough stock is publicly held to provide a basis for trading.

Compound Interest - Interest earned on both the initial principal plus the interest reinvested from prior periods. If $100 is deposited in a bank account at 10%, the depositor will be credited with $110 at the end of the first year and $121 at the end of the second year. That extra $1, which was earned on the $10 interest from the first year, is the compound interest. This example involves interest compounded annually; interest can also be compounded on a daily, quarterly, half-yearly, or other basis.

Consolidation - See Merger.

Consumer Price Index (CPI) - Measure of change in consumer prices, as determined by a monthly survey by the U.S. Bureau of Labor Statistics. Among the CPI components are housing costs, food, transportation, and electricity. Also see Producer Price Index.

Contrarian - Investor who does the opposite of what most investors are doing at any particular time. According to contrarian opinion, if everyone is certain that something is about to happen, it usually won't. This is because most people who say the market is going up are fully invested and have no additional purchasing power, which means the market is already at its peak. When people predict a decline, they have already sold and the market can only go up.

Convertible Bond - A bond which can be exchanged for a fixed number of shares of stock for a specified amount of time.

Correction - Reverse movement, usually downward, in the price of an individual stock, bond, commodity, or index. If prices have been rising on the market as a whole, then fall dramatically, this is known as a correction within an upward trend. Technical analysts note that markets do not move straight up or down and that corrections are to be expected during any long-term move.

Cyclical Stock - Stock that tends to rise quickly when the economy turns up and to fall quickly when the economy turns down. Examples are housing, automobiles, and paper. Stocks of noncyclical industries - such as foods, insurance, and drugs - are not as directly affected by economic changes.

Date of Record - Date on which holders of record are designated to receive a dividend.

Day Trade - Purchase and sale of a position during the same day, often utilizing a great degree of leverage.

Debt-to-Equity Ratio - Total liabilities divided by total shareholders' equity. This measure indicates the extent to which owners' equity can cushion creditors' claims in the event of liquidation.

Devaluation - Lowering of the value of a country's currency relative to gold and/or the currencies of other nations. Devaluation can also result from a rise in value of other currencies relative to the currency of a particular country.

Dilution - Loss in existing shareholders' value, in terms of either ownership, market value, book value, or earnings per share.

Discount Rate - Interest rate which the Federal Reserve charges member banks for loans, using government securities or eligible paper as collateral.

Discounting the News - Bidding a firm's stock price up or down in anticipation of good or bad news about the company's prospects.

Disinflation - Slowing down of the rate at which prices increase, usually during a recession, when sales drop and retailers are not always able to pass on higher prices to consumers. Not to be confused with deflation, when prices actually drop.

Dow Jones Industrial Average (DJIA) - The oldest and the most popular stock-market indicator series. The DJIA is a price-weighted average - meaning a $80 stock has more effect on the index than a $20 stock - of 30 large, well-known industrial stocks which are generally leaders in their industry (blue chips) and are listed on the New York Stock Exchange. While popularly quoted, the DJIA is not representative of the stock market as a whole due to its concentration in just 30 stocks.

Earnings per Share - Portion of a company's profit allocated to each outstanding share of common stock. For instance, a corporation that earned $10 million last year and has 10 million shares outstanding would report earnings of $1 per share. The figure is calculated after paying taxes and after paying preferred shareholders and bondholders.

EBITDA - Earnings Before Interest, Tax, Depreciation, and Amortization; also commonly referred to as cash flow. Removes noncash charges, such as depreciation and amortization, to get a cleaner view of the cash-flow-generating ability of a company.

Economic Indicators - Key statistics showing the direction of the economy. Among them are the unemployment rate, inflation rate, factory utilization rate, and balance of trade.

Efficient Market Theory - Theory that market prices reflect the knowledge and expectations of all investors. Those who adhere to this frequently disputed theory consider it futile to seek undervalued stocks or to forecast market movements. Any new development is reflected in a firm's stock price, they claim, making it impossible to beat the market. The Efficient Market Theory holds that an investor who throws darts at a newspaper's stock listings has as good a chance to outperform the market as any professional investor.

Ex-Dividend Date - Date which is four business days before the date of record, determining those individuals entitled to a dividend.

FED - See Federal Reserve Board.

Federal Funds Rate - Interest rate charged by banks with excess reserves at a Federal Reserve district bank to banks needing overnight loans to meet reserve requirements. The federal funds rate is the most sensitive indicator of the direction of interest rates, because it is set daily by the market, unlike the prime rate and the discount rate which are periodically changed by banks and by the Federal Reserve Board, respectively.

Federal Open Market Committee (FOMC) - Key committee in the Federal Reserve System, which sets short-term monetary policy for the Federal Reserve (the Fed). The committee is comprised of the seven Federal Reserve governors and the presidents of six Federal Reserve Banks. To tighten the money supply, which decreases the amount of money available in the banking system, the Fed sells government securities. The meetings of the committee, which are secret, are the subject of much speculation on Wall Street, as analysts try to guess whether the Fed will tighten or loosen the money supply, thereby causing interest rates to rise or fall.

Federal Reserve Board - The governing board of the Federal Reserve System. It is comprised of seven members who are appointed by the President of the United States, subject to Senate confirmation, and serve 14 terms. The Board establishes Fed policies on such key matters as reserve requirements and other banking regulations, sets the discount rate, tightens or loosens the availability of credit in the economy, and regulates the purchase of securities on margin.

Fiduciary - Person, company, or association holding assets in trust for a beneficiary. The fiduciary is charged with the responsibility of investing the money wisely for the beneficiary's benefit.

Financial Accounting Standards Board (FASB) - Independent board responsible for establishing and interpreting generally accepted accounting principles (GAAP).

Financial Ratios - Relationships determined from a firm's financial information and used for comparison purposes. Examples include Return-on-Equity (ROE), Return-on-Assets (ROA), Current Ratio, and Debt-to-Equity.

Flight to Quality - Moving capital to safer investments to protect oneself from potential losses during an unsettling period in the market. For example, when a major bank fails, cautious money market investors might buy only government-backed money market securities instead of those issued by major banks.

Float - Number of shares of a corporation which are outstanding and available for trading by the public. A small float means the stock might be more volatile, since a large order to buy or sell shares can influence the stock's price dramatically. A larger float means the stock will probably be less volatile.

Forward P/E - See Price/Earnings Ratio.

Fundamental Analysis - Analysis of the earnings prospects, balance sheet, and income statements of companies in order to forecast their future stock price movements. Fundamental analysts consider past records of assets, earnings, sales, products, management, and markets in predicting future trends in these indicators of a company's success or failure. By appraising a firm's prospects, these analysts assess whether a particular stock or group of stocks is undervalued or overvalued at the current market price. The other major school of stock market analysis is technical analysis, which relies on price and volume movements of stocks and does not concern itself with financial statistics.

Generally Accepted Accounting Principles (GAAP) - The common set of standards and procedures, promulgated by the Financial Accounting Standards Board, by which audited financial statements are prepared.

Global Investment Performance Standards, or GIPS® - In February 2005, the CFA (Chartered Financial Analyst) Centre worked with sponsors of GIPS, representing 25 countries, to develop the most comprehensive global performance reporting standards. The CFA Institute created and administers the GIPS standards. The GIPS standards are a set of standardized, industry-wide ethical principles that provide investment firms with guidance on how to calculate and report their investment results to prospective clients. The GIPS standards provide investment firms with the ability to compete across the globe, and provides investors with the ability to make comparisons. Currently, organizations in nearly 30 countries sponsor and promote the Standards.

Going Public - Securities industry phrase discussing the time when a private company first offers its shares to the public. The firm's ownership shifts from the hands of a few private stockowners to a base that includes public shareholders. At the moment of going public, the stock is called an initial public offering.

Graham and Dodd Method of Investing - Investment approach outlined in Benjamin Graham and David Dodd's landmark book Security Analysis, published in the 1930's. Graham and Dodd founded the modern discipline of security analysis with their work. They believed that investors should buy stocks with undervalued assets because eventually those assets would appreciate to their true value in the marketplace. Graham and Dodd advocated buying stocks in companies whose current assets exceed current liabilities and all long-term debt and whose stock is selling at a low price/earnings ratio or price/book ratio.

Gross National Product (GNP) - Total value of goods and services produced in the U.S. economy over a particular period of time, usually one year. GNP is made up of consumer and government purchases, private domestic and foreign investments in the U.S., and the total value of exports. The GNP growth rate is the primary indicator of the status of the economy.

Growth Stock - Stock of a corporation that has exhibited faster-than-average gains in earnings over the last few years and is expected to continue to show high levels of profit growth. Growth stocks may be riskier investments than average stocks because growth stocks usually sport higher price/earnings ratios and make little or no dividend payments to shareholders.

Hedge Fund - A private investment partnership limited to 99 high net-worth or institutional investors. A hedge fund may take long and short positions in various types of securities and use leverage. The investment managers are compensated by a percentage of the funds profits.

High-Yield Bond - See Junk Bond.

Illiquid - Not readily convertible into cash; examples are stocks, bonds, or commodities which are not traded actively and would be difficult to sell at once without taking a large loss. Other assets for which there is not a ready market, and which therefore might take some time to sell, include real estate and collectibles such as rare stamps, coins, and antique furniture.

In Play - Stock affected by takeover rumors or activities.

Index Fund - Mutual fund whose portfolio matches that of a broad-based index such as the S&P 500 Index and whose performance therefore mirrors the market as a whole.

Indexing - Weighting one's portfolio to match a broad-based index such as S&P 500 Index, so as to match its performance. Can also be accomplished by buying shares in an index fund.

Initial Public Offering (IPO) - Corporation's first offering of stock to the public. IPOs are almost invariably an opportunity for the existing investors and participating venture capitalists to make big profits, since for the first time their shares will be given a market value reflecting expectations for the company's future growth. Also see Going Public.

Insider - Person with access to key information before it is announced to the public. Usually the term refers to directors, officers, and key employees, but the definition has been extended judicially to include relatives and others in a position to capitalize on inside information. Insiders are prohibited from trading on their knowledge.

Interest-Sensitive Stock - Stock of a firm whose earnings change when interest rates change, such as a bank or utility. The price movement of these stocks, therefore, tends to go up or down on news of rate movements.

Intrinsic Value (Of A Firm) - The present value of a firm's expected future net cash flow discounted by the required rate of return.

Inverted Yield Curve - Unusual situation where short-term interest rates are higher than long-term rates. Normally, lenders receive a higher yield when committing their money for a longer period of time; this situation is called a positive yield curve. An inverted yield curve occurs when a surge in demand for short-term credit drives up short-term rates on instruments like Treasury bills and money-market funds, while long-term rates move up more slowly, since borrowers are not willing to commit themselves to paying high interest rates for many years. The existence of an inverted yield curve can be a sign of an unhealthy economy, marked by high inflation and low levels of confidence.

January Effect - Phenomenon wherein stocks, especially small-cap stocks, have historically tended to rise markedly in price during hte period starting on the last day of December and ending on the fourth trading day of January. The January Effect is owed to year-end selling to create tax losses, recognize capital gains, effect portfolio window dressing, or raise holiday cash. Because such selling depresses the stocks but has nothing to do with their fundamental worth, bargain hunters quickly buy in, causing the January rally.

Joint Venture - Agreement by two or more parties to work on a project together. Frequently, a joint venture will be formed when companies with complimentary technology wish to create a product or service that takes advantage of the strengths of the participants. A joint venture, which is usually limited to one project, differs from a partnership, which forms the basis for cooperation on many projects. There are also legal and tax implications which differ between joint ventures and partnerships.

Junk Bond - Bond with a credit rating of BB or lower by rating agencies. Although commonly used, the term has a pejorative connotation, and issuers and holders prefer the securities be called high-yield bonds. Junk bonds are issued by companies without long track records of sales and earnings, or by those with questionable credit strength.

Leverage - In the context of financial leverage, debt in relation to equity in a firm's capital structure. The more long-term debt there is, the greater the financial leverage. Shareholders benefit from financial leverage to the extent that return on the borrowed money exceeds the interest costs, and the market value of their shares rises. Because leverage also means required interest and principal payments and thus ultimately the risk of default, how much leverage is desirable is largely a question of stability of earnings. In the context of investments, leverage is a means of enhancing return or value without increasing investment. Buying securities on margin is an example of leverage with borrowed money.

Leveraged Buyout (LBO) - Takeover transaction in which a large percentage of the money used to buy the acquiring stock is borrowed. Most often, the target company's assets serve as security for the loans taken out by the acquiring firm repays the loans out of the cash flow of the acquired company and/or the sale of assets. Management might use this technique to retain control by converting a company from public to private. A group of investors might also borrow from banks, using their own assets as collateral, to take over another firm. In almost all leveraged buyouts, public shareholders receive a premium over the current market value for their shares.

Liquidity - Ability to buy or sell an asset quickly and at a known price which is not substantially different from the prices for prior transactions (assuming no new information is available). An illiquid asset is one which cannot be quickly converted to cash without a substantial price reduction. Real estate is an example of an illiquid asset.

London Interbank Offer Rate (LIBOR) - Rate most international banks charge one another for overnight Eurodollar loans.

Margin Call - Demand that a customer deposit enough money or securities to bring a margin account up to the initial margin or minimum maintenance requirements. A margin call occurs when the price of a stock pledged as collateral declines. If a customer fails to respond, securities in the account may be liquidated.

Market Capitalization - Value of a corporation as determined by the market price of its issued and outstanding common stock. It is calculated by multiplying the number of outstanding shares by the current market price of a share.

Market Timing - Decisions on when to buy or sell securities made in light of economic factors such as the strength of the economy and the direction of interest rates, or technical indications such as the direction of stock prices and the volume of trading.

Merger - Combination of two or more companies, either through a pooling of interests, where the accounts are combined; a purchase, where the amount paid over and above the acquired company's book value is carried on the books of the purchaser as goodwill; or a consolidation, where a new company is formed to acquire the net assets of the combining companies. Mergers which meet the legal criteria for pooling of interests, where common stock is exchanged for common stock, are nontaxable and are called tax-free mergers. When an acquisition takes place by the purchase of assets or stock using cash or a debt instrument for payment, the merger is a taxable capital gain to the selling company and/or its stockholders. There is a potential benefit to such taxable purchase acquisitions, however, in that the acquiring company can write up the acquired company's assets by the amount by which the market value exceeds the book value; that difference can then be charged off to depreciation with resultant tax savings.

Monetary Policy - Federal Reserve Board decisions on the money supply. To make the economy grow faster, the Fed can supply more credit to the banking system through its open market operations; lower the member bank reserve requirement; or lower the discount rate, which is the rate that banks pay to borrow additional reserves from the Fed. If, on the other hand, the economy is growing too fast and inflation is an increasing problem, the Fed might withdraw money from the banking system, raise the reserve requirement, or raise the discount rate, thereby putting a brake on economic growth. Monetary policy differs from fiscal policy, which is carried out through government spending and taxation. Both seek to control the level of economic activity as measured by such factors as industrial production, employment, and prices.

Naked Put - See Put Option.

NASDAQ - National Association of Securities Dealers Automated Quotations system, which is owned and operated by the National Association of Securities Dealers. NASDAQ is a computerized system that provides brokers and dealers with price quotations for securities traded over the counter as well as for many securities listed on the New York Stock Exchange.

Net Operating Loss (NOL) - Tax term for the excess of business expenses over income in a tax year. Under tax loss carryback/carryforward provisions, NOLs can be carried back three years and forward 15 years, if deserved. A firm with NOLs might be an attractive merger partner for a firm with significant tax liabilities. Absent other effects, the combined firm will have a lower tax bill than the two firms considered separately, making the firms more valuable merged than on a stand-alone basis.

New York Stock Exchange Index - In 1966 the NYSE derived five market value indexes (industrial, utility, transportation, financial, and a composite index). In contrast to other indexes, the various NYSE series are not based on sample stocks, but include all stocks listed on the NYSE. While broader in scope than the Dow Jones Industrial Average or the S&P 500, the index is still value weighted, and thus stocks of large companies still control major movements in the index.

Nikkei Stock Average - Index of 225 leading stocks traded on the Tokyo Stock Exchange. It is similar to the Dow Jones Industrial Average (DJIA) because it is composed of representative blue chip companies. Another similarity is that both indices are price-weighted, meaning that the movement of each stock, included in the Nikkei or hte DJIA, in yen or dollars respectively, is weighed equally regardless of its market capitalization.

No-Load Fund - Mutual fund offered by an open-end investment company that imposes no sales charge (load) on its shareholders. Investors buy shares in no-load funds directly from the fund companies, rather than through a broker, as is done in load funds.

Nominal Interest Rate - Interest rate earned or being paid, not adjusted for inflation.

Noncash Items - Expenses charged against revenues, which do not directly affect cash flow. One example is depreciation.

Operating Cash Flow - Cash generated from a firm's normal business activities.

Opportunity Cost - Most valuable alternative which is given up if a particular investment is undertaken.

Option - Contract that gives its owner the right, but not the obligation, to buy or sell some asset at a fixed price on or before a given date.

Over the Counter (OTC) - Security which is not listed or traded on an organized exchange. Also, a market in which securities transactions are conducted through a telephone and computer network connecting dealers in stocks and bonds, rather than on the floor of an exchange. Over-the-counter stocks are traditionally those of smaller companies that do not meet the listing requirements of the New York Stock Exchange or the American Stock Exchange. In recent years, however, many companies that qualify for listing have chosen to remain with over-the-counter trading, because they feel that the system of multiple trading by many dealers is preferable to the centralized trading approach of the New York Stock Exchange, where all trading in a stock goes through the exchange specialist in that stock. It is the largest secondary market in the U.S. in terms of the number of issues traded; over 6000 issues are traded daily over-the-counter, substantially more than the New York Stock Exchange and American Exchange combined. It is also the most diverse in terms of quality. The rules of over-the-counter stock trading are written and enforced largely by the National Association of Securities Dealers (NASD), a self-regulatory group.

Overvalued - Description of a stock whose current price is not justified by the earnings outlook or the price/earnings ratio; therefore, the stock is expected to drop in price. Overvaluation may result from an emotional buying spurt, which inflates the market price of the stock, or from a deterioration of the company's financial strength or outlook.

Paper Profit or Loss - Unrealized capital gain or capital loss in an investment or portfolio. These profits or losses become realized only when the securities are sold.

Partnership - See Joint Venture.

Passive Investing - Investing in a mutual fund that replicates a market index, such as the S&P 500 Index, assuring investment performance is no worse or better than the market as a whole.

Poison Pill - Financial device designed to make unfriendly takeover attempts unappealing, if not impossible. For instance, a firm might issue a new series of preferred stock that gives shareholders the right to redeem it at a premium price after a takeover, a measure which would likely raise the cost of an acquisition and cause dilution.

Pooling of Interests - Accounting method used in the combining or merging of companies following an acquisition, whereby the balance sheets (assets and liabilities) of the two companies are simply added together, item by item. This tax-free method contrasts with the purchase acquisition method, whereby the buying company treats the acquired company as an investment and any premium paid over the fair market value of the assets is reflected on the buyer's balance sheet as goodwill. Because reported earnings are higher under the pooling of interests method, most companies prefer it to the purchase acquisition method, particularly when the amount of goodwill is sizable. In 1999, the Financial Accounting Standards Board decided to eliminate pooling as a means of accounting for mergers and acquisitions, effective at the end of 2000. The elimination, expected at the end of 2000, should result in an acceleration in M&A activity as companies try to take advantage of the pooling method while time permits. Also see Purchase Acquisition.

Positive Yield Curve - Situation in which interest rates are higher on long-term debt securities than on short-term debt securities of the same quality. For example, a positive yield curve exists when 20-year Treasury bonds yield 14% and 3-month Treasury bills yield 10%. Such a situation is common, since an investor who ties up his money for a longer time is taking more risk and is usually compensated by a higher yield.

Preferred Stock - Class of capital stock that pays dividends at a specified rate and that has preference over common stock in the payment of dividends and the liquidation of assets. Preferred stock does not ordinarily carry voting rights.

Present Value - Value today of a future payment, or stream of payments, discounted at some appropriate compound interest- or discount-rate. For example, the present value of $100 to be received 10 years from now is about $38.55, using a discount rate equal to 10% interest compounded annually. Also called time value of money.

Price/Earnings Ratio (P/E) - Price of a stock divided by its earnings per share. The P/E ratio can use either the reported earnings from the latest year (called a trailing P/E) or employ an analyst's forecast of next year's earnings (called a forward P/E). For instance, a stock selling for $20 per share that earned $1 last year has a trailing P/E of 20. If the same stock has projected earnings of $2 next year, it will have a forward P/E of 10. The price/earnings ratio, also known as the multiple, gives investors an idea of how much they are paying for a company's earning power. The higher the P/E, the more investors are paying, and therefore the more earnings growth they are expecting.

Price-Weighted Index - Index in which the component stocks are weighted by their price. Higher-priced stocks therefore have a greater percentage impact on the index than lower-priced stocks. A prime example is the Dow Jones Industrial Average.

Private-Market Value (PMV) - Price that a private or strategic buyer would pay to acquire a company. Also called takeover value. Analysts look for high PMV in relation to market value to identify bargains and potential target companies. PMV differs from liquidating value, which excludes going-concern value, and book value, which is an accounting concept.

Private Placement - Arrangement whereby the firm, with the assistance of an investment banker, designs an issue and sells it to a small group of institutions; the issue is not available to the public and does not trade on the public markets such as the NASDAQ, NYSE, or the AMEX. The issuing firm enjoys lower issuing costs because it does not need to prepare the extensive registration statement required for a public offering. Higher liquidity risks are associated with private placement because there are no secondary markets for the securities.

Pro Rata - Latin for "according to the rate"; method of proportionate allocation. For example, a pro rata property tax rebate might be divided proportionately (prorated) among taxpayers based on their original assessments, so that each gets the same percentage.

Producer Price Index (PPI) - Measure of change in wholesale prices, as released monthly by the U.S. Bureau of Labor Statistics. The index is broken down into components by commodity, industry sector, and stage of processing. The consumer equivalent of this index is the Consumer Price Index.

Profit and Loss Statement (P&L) - Summary of the revenues, costs, and expenses of a company during an accounting period. Together with the balance sheet as of the end of the accounting period, it constitutes a company's financial statement. Also called income statement, operating statement, statement of profit and loss, or income and expense statement.

Program Trading - Computer-driven buying (buy program) or selling (sell program) of baskets of 15 or more stocks by index arbitrage specialists or institutional traders. "Program" refers to computer programs that constantly monitor stock, futures, and options markets, giving buy and sell signals when opportunities for arbitrage profits occur or when market conditions warrant portfolio accumulation/liquidation transactions. Program trading has been blamed for excessive volatility in the markets, especially on Black Monday in 1987.

Proxy Fight - Technique used by an acquiring company to attempt to gain control of a takeover target. The acquirer tries to persuade the shareholders of the target company that the present management of the firm should by ousted in favor of a slate of directors favorable to the acquiror. If the shareholders agree by virtue of their proxy votes, then the acquiring company can gain control of the company without paying a premium price for the firm.

Proxy Statement - Information that the Securities and Exchange Commission requires be provided to shareholders before they vote by proxy on company matters. The statement includes the names of proposed members of the Board of Directors, inside directors' salaries, and pertinent information regarding directors'/management's bonus and option plans, as well as any resolutions of minority stockholders and management. Typically, proxy statements are issued once a year prior to a company's annual shareholders meeting.

Purchase Acquisition - Accounting method used in a business merger whereby the purchasing company treats the acquired company as an investment and adds the acquired company's assets to its own at their fair market value. Any premium paid over and above the fair market value of the acquired assets is reflected as goodwill on the buyer's balance sheet and must be written off against future earnings. Goodwill amortization is not deductible for tax purposes, so the reduction of reported future earnings can be a disadvantage of this method of merger accounting as compared with the alternative pooling of interests method. The purchase acquisition method is mandatory unless all the criteria for a pooling of interests combination are met. Also see Pooling of Interests.

Pure Play - Stock market jargon for a company that is virtually devoted to one line of business. An investor who wishes to invest in that line of business looks for such a pure play. For instance, General Dynamics can be considered a pure play in the defense business, or Weyerhauser in the forest products business. The opposite of a pure play is a widely diversified company, such as a conglomerate.

Put Option - Right to sell 100 shares of a particular stock or stock index at a predetermined price before a preset deadline. For buyers who think a stock will decline dramatically, put options can be used to either make a profit if the owner does not own the stock (referred to as a naked put), or limit losses if the owner does own the underlying stock. For example, if an individual owns ABC stock, which currently trades at $55, but is concerned that the stock price will fall, that person can buy a put with an exercise price of $50. If the stock price then falls to $45, the person incurs a loss on the stock position of $10 ($55 minus $45), but gains $5 on the put position ($50 exercise price minus $45).

Real Estate Investment Trust (REIT) - Company, usually traded publicly, which manages a portfolio of real estate to earn profits for shareholders. REITs make investments in a diverse array of real estate, from shopping centers and office buildings to apartment complexes and hotels.

Real Interest Rate - Current interest rate minus inflation rate. The real interest rate gives investors in bonds and other fixed-rate instruments a way to see whether their interest will allow them to keep up with, fall behind, or beat the erosion in dollar values caused by inflation. With a bond yielding 10% and inflation of 3%, for instance, the real interest rate of 7% would bring a return high enough to beat inflation. If inflation were at 15%, however, the investor would fall behind as prices rise.

Red Herring - Preliminary prospectus distributed to prospective investors in a new issue of securities, for example in an initial public offering of common stock.

RBOC's (Regional Bell Operating Companies) - Term given to the by-products of the break-up in the 1980s. RBOCs include Bell Atlantic and Southwestern Bell.

Relative Strength - Rate at which a stock falls relative to other stocks in a falling market or rises relative to other stocks in a rising market. Analysts reason that a stock which holds value on the downside will be a strong performer on the upside, and vice versa.

Resistance Level - Price ceiling at which technical analysts note persistent selling of a commodity or security. If XYZ's stock generally trades between a low of $50 and a high of $60 per share, $50 is called the support level and $60 is called the resistance level. Technical analysts think it significant when a stock breaks through its resistance level because the stock usually will go on to new higher prices.

Retained Earnings - Net earnings kept to reinvest in a business after dividends are paid. Also called undistributed profits or earned surplus.

Return on Equity - Amount, expressed as a percentage, earned on a company's common stock investment for a given period. It is calculated by dividing stockholders' equity at the beginning of the accounting period by net income for the period after preferred stock dividends but before common stock dividends. Return on equity tells common shareholders how effectively their money is being employed. Comparing percentages for current and prior periods reveals trends, and comparison with industry composites reveals how well a company is holding its own against its competitors.

Risk-Free Return - Yield on a risk-free investment. The 3-month Treasury bill is considered a riskless investment because it is a direct obligation of the U.S. government and its term is short enough to minimize the risks of inflation and market interest rate changes.

Rule of 72 - Formula for approximating the time it will take for a given amount of money to double at a given compound interest rate. The formula is simply 72 divided by the interest rate. In six years $100 will double at a compound annual rate of 12%, thus: 72 divided by 12 equals 6.

Rule 144 - Provides instructions about how to sell unregistered securities. The SEC will provide exemption from public registration requirements if certain conditions are met, including a) the length of time the securities are held (usually a minimum of two years); b) how they are sold; and c) the quantity that can be sold at any one time.

Rule 144A - Provides instructions about how to sell unregistered securities without meeting the conditions required under Rule 144. The SEC will provide exemption if the investment is sold to a Qualified Institutional Buyer (QUIB). There are a very large number of entities that qualify as a QUIB, but any such entity must manage at least $100 million.

Russell 1000 Index - Index consisting of the largest 1000 capitalization-ranked stocks in the Russell 3000 Index.

Russell 2000 Index - Index consisting of the smallest 2000 stocks in the Russell 3000, which have market values ranging from approximately $3 million to $3.6 billion. This index is a popular measure of the stock price performance of small companies. The 2000 companies which comprise the Russell 2000 Index represent approximately 11% of the Russell 3000's total market capitalization.

Russell 3000 Index - Index consisting of the 3000 largest U.S. stocks in terms of market capitalization and representing approximately 98% of the U.S. equity market in terms of market value. The Russell 3000 Index is comprised of stocks within the Russell 1000 and the Russell 2000 Indices.

S&P 500 Index - Capitalization-weighted index of 500 stocks. The index was designed to measure performance of the broad domestic economy through changes in the aggregate value of 500 stocks representing all major industries. In reality, it is an index which more accurately reflects the movement of large-cap stocks. When large-cap issues lead the overall market, it becomes increasingly difficult to outperform the S&P 500.

S&P Phenomenon - Tendency of stocks newly added to the Standard & Poor's indices to rise temporarily in price as S&P-related index funds adjust their portfolios, creating heavy buying activity.

Safe Harbor - Provision in a law which excuses liability if an attempt to comply in good faith can be demonstrated. For example, safe harbor provisions would protect management from liability under Securities and Exchange Commission rules for financial projections made in good faith.

Screen Stocks - To look for stocks that meet certain predetermined investment and financial criteria. Often stocks are screened using a computer and a data base containing financial statistics on thousands of companies. For instance, an investor might want to screen for all companies that have a price/earnings ratio of less than 10, an earnings growth rate of more than 15%, and a dividend yield of more than 4%.

Secondary Offering - Public sale of previously issued securities held by large investors, usually corporations, institutions, or other affiliated persons, as distinguished from a new issue or primary distribution, where the seller is the issuing corporation. As with a primary offering, secondaries are usually handled by investment bankers, acting alone or as a syndicate, who purchase the shares from the seller at an agreed price and then resell them, sometimes with the help of a selling group, at a higher public offering price, thus making their profit on the difference.

Sell Program - See Program Trading.

Selling Short - Sale of stock that an investor does not own, with the intent of purchasing it back at a later date and at a lower price. Specifically, stock is borrowed from another investor through a broker, sold in the open market, and subsequently replaced, one hopes, at a price lower than the price at which you sold. If the stock declines, the investor profits from the difference between the price at which the stock was sold short and the price at which the stock was purchased to cover the short. If the stock moves higher, the investor incurs losses.

Share Repurchase Plan - Program by which a corporation buys back its own shares in the open market. It is usually done when management believes that its shares are undervalued. It is another method used to pay out a firm's earnings to its owners, which provides more favorable tax treatment than dividends. Since it reduces the number of shares outstanding and thus increases earnings per share, repurchase plans tend to elevate the market value of the remaining shares held by stockholders.

Shareholder's Equity - Total assets minus total liabilities of a corporation. Also called stockholder's equity, equity, and net worth.

Short Interest Theory - Theory that a large short interest in a stock will often result in a rise in the market price. Advocatese of short interest theory reason that even though short selling reflects a belief that prices will decline, the fact that short positions must eventually be covered is a source of upward price pressure.

Soft Dollars - Means of paying brokerage firms for their services through commission revenue, rather than through direct payments known as hard-dollar fees. For example, a mutual fund may offer to pay for the research of a brokerage firm by executing trades generated by the research through that brokerage firm. The broker might agree to this arrangement if the fund manager promises to spend at least $100,000 in commissions with the broker that year; otherwise, the fund would have to pay a hard-dollar fee of $50,000 for the research.

Special Situation - In one context, an undervalued stock which should soon rise in value because of an imminent favorable turn of events. A special situation stock might be close to introducing a revolutionary new product or be undergoing a needed management change. Many securities analysts concentrate on looking for and analyzing special situation stocks. In another context, a special situation is a stock which fluctuates widely in daily trading due to a particular news development, such as the announcement of a takeover bid.

Specialist - Member of a stock exchange who maintains a fair and orderly market in one or more securities.

Spread - See Bid and Asked.

Standard Deviation - Statistical measure of the degree to which an individual value in a probability distribution tends to vary from the mean of the distribution.

Support Level - See Resistance Level.

Synergy - Positive incremental gain associated with the combination of two firms through a merger or acquisition. Synergies are hoped to improve the performance of the combined enterprise over its previously separate parts. For example, a merger between two telecommunications companies, one a traditional phone company and the other one a wireless company, could have synergies and might be expected, on a combined basis, to have higher earnings or cash flow per share than as separate companies.

Tax Selling - Selling of securities, usually at year end, to realize losses in a portfolio, which can be used to offset capital gains and thereby lower an investor's tax liability.

Technical Analysis - Research into the demand and supply for securities and commodities based on trading volume and price studies. Technical analysts use charts or computer programs to identify and project price trends in a market, security, or commodity future. Also see Fundamental Analysis.

Tender Offer - Offer to buy shares of a corporation, usually at a premium above the shares' market price, for cash, securities, or both, often with the objective of taking control of the target company. A tender offer can arise from friendly negotiations between the company and a corporate suitor or can be unsolicited and possibly unfriendly, resulting in counter-measures being taken by the target firm.

Time Value of Money - Fact that a dollar today is worth more than a dollar promised at some point in the future. You can earn interest on a dollar you currently have, so a dollar today can grow to be worth more than a dollar received at a later date. Also see Present Value.

Top-Down Approach to Investing - Method by which an investor looks first at trends in the general economy, then selects industries, and finally chooses companies which should benefit from those trends. For example, an investor who thinks inflation will stay low might be attracted to the retailing industry, since consumers' spending power will be enhanced by low inflation. The investor then might look at Macy's, Federated Department Stores, and other major retailers to see which company has the best earnings prospects in the near term. The opposite investing method is called the bottom-up approach. Also see Bottom-Up Approach to Investing.

Tracking Stock - A stock which does not represent ownership interest, unlike common stock, but instead pays dividends based on the operating performance of specified businesses. For example, a multi-media conglomerate could issue tracking stock for its interest in its communications assets. Tracking stock is frequently issued by conglomerates when they believe their assets are not being accurately valued in the market.

Trailing P/E - See Price/Earnings Ratio.

Triple Witching - Trading on the third Friday of March, June, September, and December, when options and futures on stock indices expire concurrently. Massive trades in index futures, options, and underlying stocks by hedge strategists and arbitrageurs cause abnormal activity and volatility.

Turnaround - Favorable reversal in the fortunes of a company, a market, or the economy at large. Investors who speculate that a poorly performing company is about to show a marked improvement in earnings might profit handsomely from its turnaround.

Underwriter - Investment firm acts as intermediary between a company selling securities and the investing public.

Value Line Composite Index - Index reflecting the equally-weighted geometric average of approximately 1,700 NYSE, AMEX, and NASDAQ stocks tracked by the Value Line Investment Survey. This index is designed to reflect price changes of typical industrial stocks; being neither price nor market value-weighted, it largely succeeds.

Wash Sale - Purchase and sale of a security either simultaneously or within a short period of time. Wash sales taking place within 30 days of the underlying purchase do not qualify as tax losses under Internal Revenue Service rules.

When Issued - Short form of "when, as, and if issued." Refers to a transaction made conditionally because a security, although authorized, has not yet been issued. In a newspaper listing, a "WI" is placed next to the price of such a security.

Yield to Maturity (YTM) - Concept used to determine the rate of return that an investor will receive if a long-term, interest-bearing investment, such as a bond, is held to its maturity date.

For more detail on these and other terms and phrases, refer to The Wall Street Journal; Barron's Dictionary of Finance and Investment Terms; Fundamentals of Corporate Finance by Stephen A. Ross, Randolph W. Westerfield, and Bradford D. Jordan; Investments by Zvi Bodie, Alex Kane, and Alan J. Marcus; and Investment Analysis and Portfolio Management by Frank K. Reilly. This Dictionary of Financial Terms is inspired by and draws from these resources and others.