CFA Program Flashcards PDF November 2024

Level I CFA Program — November 2024 Set Type # of Cards Provider Default 1354 cards cfainstitute Side 1 Side 2 1 Interest rate (or yield) A rate of return that reflects the relationship...

Level I CFA Program — November 2024 Set Type # of Cards Provider Default 1354 cards cfainstitute Side 1 Side 2 1 Interest rate (or yield) A rate of return that reflects the relationship between differently dated cash flows; a discount rate. 2 Opportunity cost The value that investors forgo by choosing a particular course of action; the value of something in its best alternative use. 3 Real risk-free interest rate The single-period interest rate for a completely risk-free security if no inflation were expected. 4 Inflation premium An extra return that compensates investors for expected inflation. 5 Default risk premium An extra return that compensates investors for the possibility that the borrower will fail to make a promised payment at the contracted time and in the contracted amount. 6 Liquidity premium An extra return that compensates investors for the risk of loss relative to an investment’s fair value if the investment needs to be converted to cash quickly. 7 Maturity premium An extra return that compensates investors for the increased sensitivity of the market value of debt to a change in market interest rates as maturity is extended. 8 Holding period return The return that an investor earns during a specified holding period; a synonym for total return. 9 Harmonic mean A type of weighted mean computed as the reciprocal of the arithmetic average of the reciprocals. 10 Cost averaging The periodic investment of a fixed amount of money. 11 Trimmed mean A mean computed after excluding a stated small percentage of the lowest and highest observations. 12 Winsorized mean A mean computed after assigning a stated percentage of the lowest values equal to one specified low value and a stated percentage of the highest values equal to one specified high value. 13 Money-weighted return The internal rate of return on a portfolio, taking account of all cash flows. 14 Time-weighted rate of return The compound rate of growth of one unit of currency invested in a portfolio during a stated measurement period; a measure of investment performance that is not sensitive to the timing and amount of withdrawals or additions to the portfolio. 15 Continuously compounded return The natural logarithm of 1 plus the holding period return, or equivalently, the natural logarithm of the ending price over the beginning price. 16 Leverage A measure for identifying a potentially influential high-_____ point. 17 Zero-coupon bond A bond that does not pay a coupon but is priced at a discount and pays its full face value at maturity. 18 Premium In the case of bonds, _____ refers to the amount by which a bond is priced above its face (par) value. In the case of an option, the amount paid for the option contract. 19 Perpetual bonds Bonds with no stated maturity date. 20 Perpetuity A perpetual annuity, or a set of never-ending level sequential cash flows, with the first cash flow occurring one period from now. 21 Terminal value The expected value of a share at the end of the investment horizon—in effect, the expected selling price. 22 Price-to-earnings ratio (P/E) The ratio of share price to earnings per share. 23 Dividend payout ratio The ratio of cash dividends paid to earnings for a period. 24 Forward price-to-earnings ratio A P/E calculated on the basis of a forecast of EPS; a stock’s current price divided by next year’s expected earnings. 25 Cash flow additivity principle The principle that dollar amounts indexed at the same point in time are additive. 26 Hedge ratio The proportion of an underlying that will offset the risk associated with a derivative position. 27 Measure of central tendency A quantitative measure that specifies where data are centered. 28 Measures of location Quantitative measures that describe the location or distribution of data. They include not only measures of central tendency but also other measures, such as percentiles. 29 Median The value of the middle item of a set of items that has been sorted into ascending or descending order (i.e., the 50th percentile). 30 Mode The most frequently occurring value in a distribution. 31 Arithmetic mean The sum of the observations divided by the number of observations. 32 Sample mean The sum of the sample observations divided by the sample size. 33 Unimodal A distribution with a single value that is most frequently occurring. 34 Bimodal A distribution that has two most frequently occurring values. 35 Trimmed mean A mean computed after excluding a stated small percentage of the lowest and highest observations. 36 Quantile A value at or below which a stated fraction of the data lies. Also referred to as a fractile. 37 Quartiles Quantiles that divide a distribution into four equal parts. 38 Quintiles Quantiles that divide a distribution into five equal parts. 39 Deciles Quantiles that divide a distribution into 10 equal parts. 40 Percentiles Quantiles that divide a distribution into 100 equal parts that sum to 100. 41 Interquartile range The difference between the third and first quartiles of a dataset. 42 Box and whisker plot A graphic for visualizing the dispersion of data across quartiles. It consists of a box with “whiskers” connected to the box. 43 Dispersion The variability of a population or sample of observations around the central tendency. 44 Absolute dispersion The amount of variability present without comparison to any reference point or benchmark. 45 Range The difference between the maximum and minimum values in a dataset. 46 Mean absolute deviation With reference to a sample, the mean of the absolute values of deviations from the sample mean. 47 Variance The expected value (the probability-weighted average) of squared deviations from a random variable's expected value. 48 Standard deviation The positive square root of the variance; a measure of dispersion in the same units as the original data. 49 Sample variance The sum of squared deviations around the mean divided by the degrees of freedom. 50 Sample standard deviation The positive square root of the sample variance. 51 Downside risk Risk of incurring returns below a specified value. 52 Tar arget get semideviation A measure of downside risk, calculated as the square root of the average of the squared deviations of observations below the target (also called target downside deviation). 53 Relative dispersion The amount of dispersion relative to a reference value or benchmark. 54 Coefficient of variation The ratio of a set of observations’ standard deviation to the observations’ mean value. 55 Skewed Not symmetrical. 56 Skewness A quantitative measure of skew (lack of symmetry); a synonym of skew. It is computed as the average cubed deviation from the mean standardized by dividing by the standard deviation cubed. 57 Sample skewness A sample measure of the degree of asymmetry of a distribution. 58 Kurtosis The statistical measure that indicates the combined weight of the tails of a distribution relative to the rest of the distribution. 59 Leptokurtic Describes a distribution that has fatter tails than a normal distribution (also called fat-tailed). 60 Fat-T Fat-Tailed ailed Describes a distribution that has fatter tails than a normal distribution (also called leptokurtic). 61 Platykurtic Describes a distribution that has relatively less weight in the tails than the normal distribution (also called thin- tailed). 62 Thin-tailed Describes a distribution that has relatively less weight in the tails than the normal distribution (also called platykurtic). 63 Mesokurtic Describes a distribution with kurtosis equal to that of the normal distribution, namely, kurtosis equal to three. 64 Excess kurtosis Degree of kurtosis (fatness of tails) relative to the kurtosis of the normal distribution. 65 Sample excess kurtosis A sample measure of the degree of a distribution’s kurtosis in excess of the normal distribution’s kurtosis. 66 Scatter plot A two-dimensional graphical plot of paired observations of values for the independent and dependent variables in a simple linear regression. 67 Correlation A measure of the linear relationship between two random variables. 68 Sample covariance A measure of how two variables in a sample move together. 69 Sample correlation coefficient A standardized measure of how two variables in a sample move together. It is the ratio of the sample covariance to the product of the two variables’ standard deviations. 70 Spurious correlation Refers to: 1) correlation between two variables that reflects chance relationships in a particular dataset; 2) correlation induced by a calculation that mixes each of two variables with a third variable; and 3) correlation between two variables arising not from a direct relation between them but from their relation to a third variable. 71 Expected value of a random variable The probability-weighted average of the possible outcomes of a random variable. 72 Variance of a random variable The expected value (the probability-weighted average) of squared deviations from a random variable's expected value. 73 Conditional expected value The expected value of a stated event given that another event has occurred. 74 Total probability rule for expected value A rule explaining the expected value of a random variable in terms of expected values of the random variable conditional on mutually exclusive and exhaustive scenarios. 75 Probability tree diagram A diagram with branches emanating from nodes representing either mutually exclusive chance events or mutually exclusive decisions. 76 Node Each value on a binomial tree from which successive moves or outcomes branch. 77 Conditional variances The variance of one variable, given the outcome of another. 78 Bayes’ formula The rule for updating the probability of an event of interest—given a set of prior probabilities for the event, information, and information given the event—if you receive new information. 79 Prior probabilities Probabilities reflecting beliefs prior to the arrival of new information. 80 Likelihood The probability of an observation, given a particular set of conditions. 81 Posterior probability An updated probability that reflects or comes after new information. 82 Dif Diffuse fuse prior The assumption of equal prior probabilities. 83 Expected return on the portfolio Denoted as (E (Rp)). The weighted average of the expected returns (R1 to Rn) on the component securities using their respective weights (w1 to wn). 84 Covariance A measure of the co-movement (linear association) between two random variables. 85 Joint probability function A function giving the probability of joint occurrences of values of stated random variables. 86 Independent With reference to events, the property that the occurrence of one event does not affect the probability of another event occurring. With reference to two random variables X and Y, they are independent if and only if P(X,Y) = P(X)P(Y). 87 Mean–variance analysis An approach to portfolio analysis using expected means, variances, and covariances of asset returns. 88 Safety-first rules Rules for portfolio selection that focus on the risk that portfolio value or portfolio return will fall below some minimum acceptable level over some time horizon. 89 Shortfall risk The risk that portfolio value or portfolio return will fall below some minimum acceptable level over some time horizon. 90 Stress testing A specific type of scenario analysis that estimates losses in rare and extremely unfavorable combinations of events or scenarios. 91 Scenario analysis A technique for exploring the performance and risk of investment strategies in different structural regimes. 92 Value at risk A money measure of the minimum value of losses expected during a specified time period at a given level of probability. 93 Independently and identically distributed With respect to random variables, the property of random variables that are independent of each other but follow the identical probability distribution. 94 Volatility The standard deviation of the continuously compounded returns on the underlying asset. 95 Monte Carlo simulation A technique that uses the inverse transformation method for converting a randomly generated uniformly distributed number into a simulated value of a random variable of a desired distribution. Each key decision variable in a _____ requires an assumed statistical distribution; this assumption facilitates incorporating non- normality, fat tails, and tail dependence as well as solving high-dimensionality problems. 96 Contingent claim A type of derivative in which one of the counterparties determines whether and when the trade will settle. An option is a common type of _____. 97 Simulation trial A complete pass through the steps of a simulation. 98 Resampling A statistical method that repeatedly draws samples from the original observed data sample for the statistical inference of population parameters. 99 Bootstrap A resampling method that repeatedly draws samples with replacement of the selected elements from the original observed sample. _____ is usually conducted by using computer simulation and is often used to find standard error or construct confidence intervals of population parameters. 100 Parameter A descriptive measure computed from or used to describe a population of data, conventionally represented by Greek letters. 101 Probability sampling A sampling plan that allows every member of the population to have an equal chance of being selected. 102 Non-probability sampling A sampling plan dependent on factors other than probability considerations, such as a sampler’s judgment or the convenience to access data. 103 Simple random sampling The procedure of drawing a sample to satisfy the definition of a simple random sample. 104 Stratified random sampling A procedure that first divides a population into subpopulations (strata) based on classification criteria and then randomly draws samples from each stratum in sizes proportional to that of each stratum in the population. 105 Sampling plan The set of rules used to select a sample. 106 Simple random sample A subset of a larger population created in such a way that each element of the population has an equal probability of being selected to the subset. 107 Simple random sampling The procedure of drawing a sample to satisfy the definition of a simple random sample. 108 Systematic sampling A procedure of selecting every kth member until reaching a sample of the desired size. The sample that results from this procedure should be approximately random. 109 Sampling error The difference between the observed value of a statistic and the estimate resulting from using subsets of the population. 110 Sampling distribution The distribution of all distinct possible values that a statistic can assume when computed from samples of the same size randomly drawn from the same population. 111 Stratified random sampling A procedure that first divides a population into subpopulations (strata) based on classification criteria and then randomly draws samples from each stratum in sizes proportional to that of each stratum in the population. 112 Indexing An investment strategy in which an investor constructs a portfolio to mirror the performance of a specified index. 113 Cluster sampling A procedure that divides a population into subpopulation groups (clusters) representative of the population and then randomly draws certain clusters to form a sample. 114 Convenience sampling A procedure of selecting an element from a population on the basis of whether or not it is accessible to a researcher or how easy it is for a researcher to access the element. 115 Judgmental sampling A procedure of selectively handpicking elements from the population based on a researcher’s knowledge and professional judgment. 116 Central limit theorem The theorem that states the sum (and the mean) of a set of independent, identically distributed random variables with finite variances is normally distributed, whatever distribution the random variables follow. 117 Resampling A statistical method that repeatedly draws samples from the original observed data sample for the statistical inference of population parameters. 118 Jackknife A resampling method that repeatedly draws samples by taking the original observed data sample and leaving out one observation at a time (without replacement) from the set. 119 Hypothesis testing The process of testing of hypotheses about one or more populations using statistical inference. 120 Hypothesis A proposed explanation or theory that can be tested. 121 Null hypothesis The hypothesis that is tested. 122 Alternative hypothesis The hypothesis that is accepted if the null hypothesis is rejected. 123 Type I error The error of rejecting a true null hypothesis; a false positive. 124 Type II error The error of not rejecting a false null hypothesis; false negative. 125 Level of significance The probability of a Type I error in testing a hypothesis. 126 Confidence level The complement of the level of significance. 127 Power of a test The probability of correctly rejecting the null—that is, rejecting the null hypothesis when it is false. 128 Critical values Values of the test statistic at which the decision changes from fail to reject the null hypothesis to reject the null hypothesis. 129 Statistically significant A result indicating that the null hypothesis can be rejected; with reference to an estimated regression coefficient, frequently understood to mean a result indicating that the corresponding population regression coefficient is different from zero. 130 p-V p-Value alue The smallest level of significance at which the null is rejected. 131 Test of the mean of the dif differences ferences A statistical test for differences based on paired observations drawn from samples that are dependent on each other. 132 Parametric test Any test (or procedure) concerned with parameters or whose validity depends on assumptions concerning the population generating the sample. 133 Nonparametric test A test that is not concerned with a parameter or that makes minimal assumptions about the population from which a sample comes. 134 Pearson correlation A parametric measure of the relationship between two variables. 135 Bivariate correlation Also known as Pearson correlation. A parametric measure of the relationship between two variables. 136 Spearman rank correlation coefficient A measure of correlation applied to ranked data. 137 Frequency table A representation of the frequency of occurrence of two discrete variables. 138 Contingency table A table of the frequency distribution of observations classified on the basis of two discrete variables. 139 Two-way table A table of the frequency distribution of observations classified on the basis of two discrete variables. Also known as Contingency table. 140 Regression analysis Allows us to test hypotheses about the relationship between two variables, by quantifying the strength of the relationship between the two variables, and to use one variable to make predictions about the other variable. 141 Sum of squares total (SST) A measure of the total variation in the dependent variable in a simple linear regression. It is calculated by subtracting the mean of the observed values Y¯ from each of the observed values Yi, squaring each of these differences, and then summing all of these squared differences. 142 Dependent variable The variable that is explained by a regression model. 143 Independent variable An explanatory variable in a regression model. 144 Simple linear regression (SLR) An approach for estimating the linear relationship between a dependent variable and a single independent variable by minimizing the sum of the squared deviations between the fitted line and the observed values. 145 Intercept The estimated value of the dependent variable when the independent variable is zero. 146 Slope coefficient The change in the estimated value of the dependent variable for a one-unit change in the value of the independent variable. 147 Error term Represents the difference between the observed value of the independent variable and that expected from the true underlying population relation between the dependent and independent variable. 148 Regression coefficients The collective term for the intercept and slope coefficients in the regression model. 149 Residual The amount of deviation of an observed value of the dependent variable from its estimated value based on the fitted regression line. 150 Sum of squares error (SSE) A measure of the total deviation between observed and estimated values of the dependent variable. It is calculated by subtracting each estimated value Y^i from its corresponding observed value Yi, squaring each of these differences, and then summing all of these squared differences. 151 Homoskedasticity Constant variance across all observations. 152 Heteroskedasticity Non-constant variance across all observations. 153 Estimated parameters In a simple linear regression, the _____ are the intercept and slope of the fitted line. 154 Sum of squares regression (SSR) A measure of the explained variation in the dependent variable, calculated as the sum of the squared differences between the predicted value of the dependent variable, Y ̂_i, based on the estimated regression line, and the mean of the dependent variable, Ȳ. 155 Coefficient of determination (R2) The percentage of the variation of the dependent variable that is explained by the independent variable. It is a measure of goodness of fit of a regression model. 156 Mean square regression (MSR) Calculated as the sum of squares regression (SSR) divided by the number of independent variables in the regression model. In simple linear regression, there is only one independent variable, so MSR equals SSR. 157 Mean square error (MSE) Calculated as the sum of squares error (SSE) divided by the degrees of freedom, which are the number of observations minus the number of independent variables minus one. Since simple linear regression has just one independent variable, the degrees of freedom calculation is the number of observations minus 2. 158 Standard error of the slope coefficient Calculated for simple linear regression by dividing the standard error of the estimate by the square root of the variation of the independent variable. 159 Indicator variable A variable that takes on only one of two values, 0 or 1, based on a condition. In simple linear regression, the slope is the difference in the dependent variable for the two conditions. Also referred to as a dummy variable. 160 Analysis of variance (ANOV (ANOVA) A) A table that presents the sums of squares, degrees of freedom, mean squares, and F-statistic for a regression model. 161 Standard error of the estimate A measure of the distance between the observed values of the dependent variable and those predicted from the estimated regression. The smaller this value, the better the fit of the model. Also known as the standard error of the regression and the root mean square error. 162 Standard error of the forecast Used to provide an interval estimate around the estimated regression line. It is necessary because the regression line does not describe the relationship between the dependent and independent variables perfectly. 163 Log-lin model A functional form for transforming regression model data in which the dependent variable is logarithmic but the independent variable is linear. 164 Lin-log model A functional form for transforming regression model data in which the dependent variable is linear but the independent variable is logarithmic. 165 Log-log model A functional form for transforming regression model data in which both the dependent and independent variables are in logarithmic form. 166 Fintech Technological innovation in the financial services industry, specifically with the design and delivery of financial services and products. It may also refer more broadly to companies involved in developing the new technologies and their applications, as well as the business sector that includes such companies. 167 Alternative data Data that are generated from non-traditional sources, such as social media and sensor networks. 168 Artificial intelligence (AI) Computer systems that are capable of performing tasks that previously required human intelligence. AI methods are sometimes better suited to identify complex, non-linear relationships than are traditional quantitative and statistical methods. 169 Big data The vast amount of information being generated by both traditional sources—for example, stock exchanges, companies, governments—and non-traditional sources—for example, electronic devices, social media, sensor networks, and company exhaust. 170 Internet of things The vast array of physical devices, home appliances, smart buildings, vehicles, and other items that are embedded with electronics, sensors, software, and network connections that enable the objects in the system to interact and share information. 171 Scraping An automated, large-scale, algorithm-driven approach that retrieves otherwise unstructured data available on websites and creates data in a more structured format. 172 Expert system A type of computer programming, often based on “if–then” rules, that attempts to simulate the knowledge base and analytical abilities of human experts in specific problem-solving contexts. 173 Neural networks A type of computer program design based on how the human brain learns and processes information. 174 Machine learning (ML) Involves computer-based techniques that seek to extract knowledge from large amounts of data without making any assumptions about the data’s underlying probability distribution. The goal of ML algorithms is to automate decision-making processes by generalizing, or “learning,” from known examples to determine an underlying structure in the data. 175 Overfitting When a machine learning model learns the input and target dataset too precisely, making the system more likely to discover false relationships or unsubstantiated patterns that will lead to prediction errors. 176 Underfitted When a machine learning model treats true parameters as if they are noise and is unable to recognize relationships in the training data, making the model more likely to fail to fully discover patterns that underlie the data. 177 Supervised learning A type of machine learning in which the system attempts to learn to model relationships based on labeled training data. 178 Unsupervised learning A type of machine learning in which the system tries to learn the structure of unlabeled data. 179 Deep learning An area of artificial intelligence in which a system uses neural networks to perform multistage, non-linear data processing to identify patterns. Also called _____ nets. 180 Deep learning nets An area of artificial intelligence in which a system uses neural networks to perform multistage, non-linear data processing to identify patterns. Also called deep learning. 181 Data science An interdisciplinary field that harnesses advances in computer science, statistics, and other disciplines for the purpose of extracting information from big data (or data in general). 182 Text analytics Involves the use of computer programs to analyze and derive meaning typically from large, unstructured text- or voice-based datasets, such as company filings, written reports, quarterly earnings calls, social media, email, internet postings, and surveys. 183 Natural language processing (NLP) A field of research within the field of text analytics and at the intersection of computer science, AI, and linguistics that focuses on developing computer programs to analyze and interpret human language. 184 Average revenue (AR) Total revenue divided by quantity sold. 185 Shutdown point The point at which average revenue is equal to the firm’s average variable cost. 186 Breakeven point Represents the price of the underlying in a derivative contract in which the profit to both counterparties would be zero. 187 Short-run average total cost The curve describing average total cost when some costs are considered fixed. 188 Long-run average total cost The curve describing average total cost when no costs are considered fixed. 189 Economies of scale A decline in costs per unit as output grows, generally resulting from having fixed costs in the cost structure that are spread over more units of output. 190 Diseconomies of scale Increase in cost per unit resulting from increased production. 191 Increasing returns to scale When a production process leads to increases in output that are proportionately larger than the increase in inputs. 192 Decreasing returns to scale When a production process leads to increases in output that are proportionately smaller than the increase in inputs. 193 Minimum efficient scale The smallest output that a firm can produce such that its long-run average total cost is minimized. 194 Perfect competition A market structure in which the individual firm has virtually no impact on market price, because it is assumed to be a very small seller among a very large number of firms selling essentially identical products. 195 Monopolistic competition Highly competitive form of imperfect competition; the competitive characteristic is a notably large number of firms, while the monopoly aspect is the result of product differentiation. 196 Oligopoly Market structure with a relatively small number of firms supplying the market. 197 Monopoly In pure _____ markets, there are no substitutes for the given product or service. There is a single seller, which exercises considerable power over pricing and output decisions. 198 Price takers Producers that must accept whatever price the market dictates. 199 Cournot assumption Assumption in which each firm determines its profit-maximizing production level assuming that the other firms’ output will not change. 200 Game theory The set of tools decision makers use to incorporate responses by rival decision makers into their strategies. 201 Nash equilibrium When two or more participants in a non-coop-erative game have no incentive to deviate from their respective equilibrium strategies given their opponent’s strategies. 202 Cartel Participants in collusive agreements that are made openly and formally. 203 Stackelber Stackelbergg model A prominent model of strategic decision making in which firms are assumed to make their decisions sequentially. 204 Business cycles Are recurrent expansions and contractions in economic activity affecting broad segments of the economy. 205 Classical cycle Refers to fluctuations in the level of economic activity when measured by GDP in volume terms. 206 Growth cycle Refers to fluctuations in economic activity around the long-term potential trend growth level, focusing on how much actual economic activity is below or above trend growth in economic activity. 207 Growth rate cycle Refers to fluctuations in the growth rate of economic activity. 208 Expansion The period of a business cycle after its lowest point and before its highest point. 209 Contraction The period of a business cycle after the peak and before the trough; often called a recession or, if exceptionally severe, called a depression. 210 Boom An expansionary phase characterized by economic growth “testing the limits” of the economy. 211 Economic indicators Economic statistics provided by government and established private organizations that contain information on an economy’s recent past activity or its current or future position in the business cycle. 212 Leading economic indicators Turning points that usually precede those of the overall economy; they are believed to have value for predicting the economy’s future state, usually near-term. 213 Coincident economic indicators Turning points that are usually close to those of the overall economy; they are believed to have value for identifying the economy’s present state. 214 Lagging economic indicators Turning points that take place later than those of the overall economy; they are believed to have value in identifying the economy’s past condition. 215 Dif Diffusion fusion index Reflects the proportion of the index’s components that are moving in a pattern consistent with the overall index. 216 Fiscal policy The use of taxes and government spending to affect the level of aggregate expenditures. 217 Monetary policy Actions taken by a nation’s central bank to affect aggregate output and prices through changes in bank reserves, reserve requirements, or its target interest rate. 218 Structural budget deficit Also known as the cyclically adjusted budget deficit. The deficit that would exist if the economy was at full employment (or full potential output). 219 Budget surplus/deficit The difference between government revenue and expenditure for a stated fixed period of time. 220 Expansionary Tending to cause the real economy to grow. 221 Keynesians Economists who believe that fiscal policy can have powerful effects on aggregate demand, output, and employment when there is substantial spare capacity in an economy. 222 Monetarists Economists who believe that the rate of growth of the money supply is the primary determinant of the rate of inflation. 223 Economic stabilization Reduction of the magnitude of economic fluctuations. 224 Expansionary fiscal policy Fiscal policy aimed at achieving real economic growth. 225 Contractionary fiscal policy A fiscal policy that has the objective to make the real economy contract. 226 Automatic stabilizer A countercyclical factor that automatically comes into play as an economy slows and unemployment rises. 227 Balanced With respect to a government budget, one in which spending and revenues (taxes) are equal. 228 Transfer payments Welfare payments made through the social security system that exist to provide a basic minimum level of income for low-income households. 229 Current government spending With respect to government expenditures, spending on goods and services that are provided on a regular, recurring basis including health, education, and defense. 230 Capital expenditure Expenditure on physical capital (fixed assets). 231 Direct taxes Taxes levied directly on income, wealth, and corporate profits. 232 Indirect taxes Taxes such as taxes on spending, as opposed to direct taxes. 233 Net tax rate The tax rate net of transfer payments. 234 Fiscal multiplier The ratio of a change in national income to a change in government spending. 235 Mar Marginal ginal propensity to consume The proportion of an additional unit of disposable income that is consumed or spent; the change in consumption for a small change in income. 236 Mar Marginal ginal propensity to save The proportion of an additional unit of disposable income that is saved (not spent). 237 Household A person or a group of people living in the same residence, taken as a basic unit in economic analysis. 238 Ricardian equivalence An economic theory that implies that it makes no difference whether a government finances a deficit by increasing taxes or issuing debt. 239 Recognition lag The lag in government response to an economic problem resulting from the delay in confirming a change in the state of the economy. 240 Action lag Delay from policy decisions to implementation. 241 Impact lag The lag associated with the result of actions affecting the economy with delay. 242 Policy rate An interest rate that a central bank sets and announces publicly; normally the rate at which it is willing to lend money to the commercial banks. 243 Gold standard With respect to a currency, if a currency is on the _____ a given amount can be converted into a prespecified amount of gold. 244 Legal tender Something that must be accepted when offered in exchange for goods and services. 245 Fiat money Money that is not convertible into any other commodity. 246 Lender of last resort An entity willing to lend money when no other entity is ready to do so. 247 Payments system The system for the transfer of money. 248 Foreign currency reserves Holding by the central bank of non-domestic currency deposits and non-domestic bonds. 249 Price stability In economics, refers to an inflation rate that is low on average and not subject to wide fluctuation. 250 Open market operations The purchase or sale of bonds by the national central bank to implement monetary policy. The bonds traded are usually sovereign bonds issued by the national government. 251 Official interest rate An interest rate that a central bank sets and announces publicly; normally the rate at which it is willing to lend money to the commercial banks. Also called official policy rate or policy rate. 252 Repurchase agreement (Repo) A form of collateralized loan involving the sale of a security with a simultaneous agreement by the seller to buy back the same security from the purchaser at an agreed-on price and future date. The party who sells the security at the inception of the repurchase agreement and buys it back at maturity is borrowing money from the other party, and the security sold and subsequently repurchased represents the collateral. 253 Base rates The reference rate on which a bank bases lending rates to all other customers. 254 Two-week repo rate The interest rate on a two-week repurchase agreement; may be used as a policy rate by a central bank. 255 Refinancing rate A type of central bank policy rate. 256 Federal funds rate The US interbank lending rate on overnight borrowings of reserves. Also known as Fed Funds rate. 257 Fed funds rate The US interbank lending rate on overnight borrowings of reserves. 258 Reserve requirement The requirement for banks to hold reserves in proportion to the size of deposits. 259 Monetary transmission mechanism The process whereby a central bank’s interest rate gets transmitted through the economy and ultimately affects the rate of increase of prices. 260 Operational independence A bank’s ability to execute monetary policy and set interest rates in the way it thought would best meet the inflation target. 261 Tar arget get independent A bank’s ability to determine the definition of inflation that they target, the rate of inflation that they target, and the horizon over which the target is to be achieved. 262 Inflation reports A type of economic publication put out by many central banks. 263 Deflation Negative inflation. 264 Contractionary Tending to cause the real economy to contract. 265 Expansionary Tending to cause the real economy to grow. 266 Neutral rate of interest The rate of interest that neither spurs on nor slows down the underlying economy. 267 Demand shock A typically unexpected disturbance to demand, such as an unexpected interruption in trade or transportation. 268 Supply shock A typically unexpected disturbance to supply. 269 Bond market vigilantes Bond market participants who might reduce their demand for long-term bonds, thus pushing up their yields. 270 Liquidity trap A condition in which the demand for money becomes infinitely elastic (horizontal demand curve) so that injections of money into the economy will not lower interest rates or affect real activity. 271 Quantitative easing An expansionary monetary policy based on aggressive open market purchase operations. 272 Gilts Bonds issued by the UK government. 273 Geopolitics The study of how geography affects politics and international relations. These relations matter for investments because they contribute to important drivers of investment performance, including economic growth, business performance, market volatility, and transaction costs. 274 State actors Typically national governments, political organizations, or country leaders that exert authority over a country’s national security and resources. The South African President, Sultan of Brunei, Malaysia’s Parliament, and the British Prime Minister are all examples of _____. 275 Non-state actors Those that participate in global political, economic, or financial affairs but do not directly control national security or country resources. Examples of _____ are non-governmental organizations (NGOs), multinational companies, charities, and even influential individuals, such as business leaders or cultural icons. 276 Cooperation The process by which countries work together toward some shared goal or purpose. These goals may, and often do, vary widely—from strategic or military concerns, to economic influence, to cultural preferences. 277 Cooperative country A country that engages and reciprocates in rules standardization; harmonization of tariffs; international agreements on trade, immigration, or regulation; and allowing the free flow of information, including technology transfer. 278 Non-cooperative country A country with inconsistent and even arbitrary rules; restricted movement of goods, services, people, and capital across borders; retaliation; and limited technology exchange. 279 Geophysical resource endowment Includes such factors as livable geography and climate as well as access to food and water, which are necessary for sustainable growth. _____ is highly unequal among countries. 280 Standardization The process of creating protocols for the production, sale, transport, or use of a product or service. _____ occurs when relevant parties agree to follow these protocols together. It helps support expanded economic and financial activities, such as trade and capital flows that support higher economic growth and standards of living, across borders. 281 Soft power A means of influencing another country’s decisions without force or coercion. _____ can be built over time through actions, such as cultural programs, advertisement, travel grants, and university exchange. 282 Institution An established organization or practice in a society or culture. An _____ can be a formal structure, such as a university, organization, or process backed by law; or it can be informal, such as a custom or behavioral pattern important to society. Institutions can, but need not be, formed by national governments. Examples of institutions include non-governmental organizations, charities, religious customs, family units, the media, political parties, and educational practice. 283 Globalization The process of interaction and integration among people, companies, and governments worldwide. It is marked by the spread of products, information, jobs, and culture across borders. 284 Nationalism The promotion of a country’s own economic interests to the exclusion or detriment of the interests of other nations. _____ is marked by limited economic and financial cooperation. These actors may focus on national production and sales, limited cross-border investment and capital flows, and restricted currency exchange. 285 Portfolio investment flows Short-term investments in foreign assets, such as stocks or bonds. 286 Foreign direct investments (FDI) Long-term investments in the productive capacity of a foreign country. 287 Autarky Countries seeking political self-sufficiency with little or no external trade or finance. State-owned enterprises control strategic domestic industries. 288 Hegemony Countries that are regional or even global leaders and use their political or economic influence of others to control resources. 289 Multilateralism The conduct of countries who participate in mutually beneficial trade relationships and extensive rules harmonization. Private firms are fully integrated into global supply chains with multiple trade partners. Examples of multilateral countries include Germany and Singapore. 290 Bilateralism The conduct of political, economic, financial, or cultural cooperation between two countries. Countries engaging in _____ may have relations with many different countries but in one-at-a-time agreements without multiple partners. Typically, countries exist on a spectrum between _____ and multilateralism. 291 Regionalism In between the two extremes of bilateralism and multilateralism. In _____, a group of countries cooperate with one another. Both bilateralism and _____ can be conducted at the exclusion of other groups. For example, regional blocs may agree to provide trade benefits to one another and increase barriers for those outside of that group. 292 Cabotage The right to transport passengers or goods within a country by a foreign firm. Many countries—including those with multilateral trade agreements—impose restrictions on _____ across transportation subsectors, meaning that shippers, airlines, and truck drivers are not allowed to transport goods and services within another country’s borders. 293 Event risk Risk that evolves around set dates, such as elections, new legislation, or other date-driven milestones, such as holidays or political anniversaries, known in advance. Example: Brexit referendum. 294 Exogenous risk A sudden or unanticipated risk that impacts either a country’s cooperative stance, the ability of non-state actors to globalize, or both. Examples include sudden uprisings, invasions, or the aftermath of natural disasters. 295 Thematic risks Known risks that evolve and expand over a period of time. Climate change, pattern migration, the rise of populist forces, and the ongoing threat of terrorism fall into this category. 296 Velocity The pace at which geopolitical risk impacts an investor portfolio. 297 Black swan risk An event that is rare and difficult to predict but has an important impact. 298 Scenario analysis A technique for exploring the performance and risk of investment strategies in different structural regimes. 299 Groupthink The practice of thinking or making decisions as a group in a way that discourages creativity or individual responsibility. For scenario analysis to be useful in portfolio management, teams must work hard to build creative processes, identify scenarios, track these scenarios, and assess the need for action on a regular cadence. 300 Signpost An indicator, market level, data piece, or event that signals a risk is becoming more or less likely. An analyst can think of signposts like a traffic light. 301 Tarif ariffs fs Taxes that a government levies on imported goods. 302 Quotas Government policies that restrict the quantity of a good that can be imported into a country, generally for a specified period of time. 303 Export subsidy Paid by the government to the firm when it exports a unit of a good that is being subsidized. 304 Domestic content provisions Stipulate that some percentage of the value added or components used in production should be of domestic origin. 305 Capital restrictions Controls placed on foreigners’ ability to own domestic assets and/or domestic residents’ ability to own foreign assets. 306 Small country A country that is a price taker in the world market for a product and cannot influence the world market price. 307 Import license Specifies the quantity of a good that can be imported into a country. 308 Quota rents Profits that foreign producers can earn by raising the price of their goods higher than they would without a quota. 309 Free trade areas One of the most prevalent forms of regional integration, in which all barriers to the flow of goods and services among members have been eliminated. 310 Customs union Extends the free trade area (FTA) by not only allowing free movement of goods and services among members, but also creating a common trade policy against nonmembers. 311 Common market Level of economic integration that incorporates all aspects of the customs union and extends it by allowing free movement of factors of production among members. 312 Economic union Incorporates all aspects of a common market and in addition requires common economic institutions and coordination of economic policies among members. 313 Monetary union An economic union in which the members adopt a common currency. 314 Trade creation When regional integration results in the replacement of higher cost domestic production by lower cost imports from other members. 315 Trade diversion When regional integration results in lower-cost imports from non-member countries being replaced with higher-cost imports from members. 316 FX swap The combination of a spot and a forward FX transaction. 317 Efficient market A market in which asset prices reflect new information quickly and rationally. See also, informationally _____. 318 Risk premium An extra return expected by investors for bearing some specified risk. 319 Normal distribution A continuous, symmetric probability distribution that is completely described by its mean and its variance. 320 Liquidity The extent to which a company is able to meet its short-term obligations using cash flows and those assets that can be readily transformed into cash. 321 Risk aversion The degree of an investor’s unwillingness to take risk; the inverse of risk tolerance. 322 Risk averse The assumption that an investor will choose the least risky alternative. 323 Risk tolerance The amount of risk an investor is willing and able to bear to achieve an investment goal. 324 Indif Indifference ference curve A curve representing all the combinations of two goods or attributes such that the consumer is entirely indifferent among them. 325 Capital allocation line (CAL) A graph line that describes the combinations of expected return and standard deviation of return available to an investor from combining the optimal portfolio of risky assets with the risk-free asset. 326 Covariance A measure of the co-movement (linear association) between two random variables. 327 Correlation coefficient A number between −1 and +1 that measures the consistency or tendency for two investments to act in a similar way. It is used to determine the effect on portfolio risk when two assets are combined. 328 Minimum-variance portfolio The portfolio with the minimum variance for each given level of expected return. 329 Global minimum-variance portfolio The portfolio on the minimum-variance frontier with the smallest variance of return. 330 Markowitz efficient frontier The graph of the set of portfolios offering the maximum expected return for their level of risk (standard deviation of return). 331 Two-fund separation theorem The theory that all investors regardless of taste, risk preferences, and initial wealth will hold a combination of two portfolios or funds: a risk-free asset and an optimal portfolio of risky assets. 332 Correlation A measure of the linear relationship between two random variables. 333 Homogeneity of expectations The assumption that all investors have the same economic expectations and thus have the same expectations of prices, cash flows, and other investment characteristics. 334 Informationally efficient market A market in which asset prices reflect new information quickly and rationally. 335 Short selling A transaction in which borrowed securities are sold with the intention to repurchase them at a lower price at a later date and return them to the lender. 336 Capital market line (CML) The line with an intercept point equal to the risk-free rate that is tangent to the efficient frontier of risky assets; represents the efficient frontier when a risk-free asset is available for investment. 337 Systematic risk Risk that affects the entire market or economy; it cannot be avoided and is inherent in the overall market. _____ is also known as non-diversifiable or market risk. 338 Nonsystematic risk Unique risk that is local or limited to a particular asset or industry that need not affect assets outside of that asset class. 339 Return-generating model A model that can provide an estimate of the expected return of a security given certain parameters and estimates of the values of the independent variables in the model. 340 Multi-factor model A model that explains a variable in terms of the values of a set of factors. 341 Market model A regression model with the return on a stock as the dependent variable and the returns on a market index as the independent variable. 342 Beta A measure of the sensitivity of a given investment or portfolio to movements in the overall market. 343 Capital asset pricing model (CAPM) An equation describing the expected return on any asset (or portfolio) as a linear function of its beta relative to the market portfolio. 344 Security market line (SML) The graph of the capital asset pricing model. 345 Performance evaluation The measurement and assessment of the outcomes of investment management decisions. 346 Sharpe ratio The average return in excess of the risk-free rate divided by the standard deviation of return; a measure of the average excess return earned per unit of standard deviation of return. 347 Treynor ratio A measure of risk-adjusted performance that relates a portfolio’s excess returns to the portfolio’s beta. 348 M2 A measure of what a portfolio would have returned if it had taken on the same total risk as the market index. 349 M2 alpha Difference between the risk-adjusted performance of the portfolio and the performance of the benchmark. 350 Security characteristic line A plot of the excess return of a security on the excess return of the market. 351 Businesses Organization entities formed and managed for the purpose of providing a return or economic benefits to its investors and owners. Also known as companies. 352 Companies Organization entities formed and managed for the purpose of providing a return or economic benefits to its investors and owners. Also known as businesses. 353 Or Organizational ganizational form A legal and tax classification of a business, specific to a jurisdiction, that determines the organization’s legal identity, owner–manager relationship, owner liability, taxation, and access to financing. 354 General partnership A business organizational form owned entirely by general partners. 355 General partners (GPs) Owners of a general partnership or limited partnership with unlimited liability and other attributes as specified in the partnership agreement. 356 Limited partnership A business organizational form owned by a general partner and limited partners. 357 Limited partners (LPs) Owners of a limited partnership with limited liability and other attributes as specified in the partnership agreement. 358 Pass-through businesses Businesses that, by virtue of their organizational form and/or other legal and regulatory attributes, do not pay entity-level taxes on income or loss; income or loss is passed through to owners, who pay personal taxes. 359 Limited liability partnership (LLP) A business organizational form available in some jurisdictions owned entirely by limited partners with limited liability. 360 Limited company A business organizational form owned by shareholders or members with limited liability who elect a board of directors to appoint management. Generally, limited companies have indefinite life and easier transfer of ownership interests than limited partnerships. 361 Private limited company A type of limited company in many jurisdictions with pass-through taxation but restrictions on the number of shareholders or members and on the transfer of ownership interest. 362 Shares Units of ownership interest in a limited company. 363 Shareholders Individuals or entities that own a share. 364 Board of directors A body or individual selected by a limited company’s member(s) or shareholder(s), in a manner determined by the company’s charter, that manages the company. Typically, for larger companies, boards of directors appoint and oversee executive management. 365 Public limited companies A type of limited company in many jurisdictions with entity-level taxation but no restrictions on the number of shareholders or transferability of ownership interest; the most suitable organizational form for a company that seeks to go public. 366 Corporations Another term for limited companies, though often used to refer to public limited companies. See limited company, private limited company, and public limited company. 367 Corporate issuers Limited companies or corporations that seek financing in financial markets by, for example, issuing debt or equity securities. 368 Voting rights The power of shareholders to cast votes in corporate elections for directors and other matters submitted to a shareholder vote. 369 Equity Ownership interest in an entity. A residual claim on the assets of an entity after more senior claims, such as debt, have been satisfied. Also known as net assets. 370 Debt A claim against an entity to receive cash, stock, or other assets at a future date. From the perspective of the debtor or borrower, an obligation to pay cash, stock, or other assets at a future date. Generally, _____ claims are unconditional and are senior to equity claims. 371 Dividends Distributions of profits and/or net assets from a corporation to its shareholders. While often in cash, _____ can be also be paid in stock or assets, such as property. 372 Security Evidence of equity or debt interest or in an entity or a related right, such as a derivative. Often standardized to conform to _____ exchange requirements. 373 Double taxation The taxation of business income at both the entity and personal or owner levels. In most jurisdictions, this taxation scheme applies to public limited companies. 374 Exchange A rules-based, open access market venue where financial instruments are traded, with price and volume transparency accessible by issuers, investors, and their intermediaries. 375 Stock exchange An exchange in which equity securities are traded. See exchanges. 376 Public (listed) company A company with its equity securities traded on an exchange. 377 Free float The portion of a listed company’s equity securities that are not held by insiders, strategic investors, sponsors, founders, and so on, that are more freely available for trading. 378 Private company A company, typically a limited company, that does not list its equity securities on an exchange. 379 Accredited investors Investors that meet certain minimum regulatory net worth or other requirements in order to invest in certain types of alternative assets. 380 Sophisticated investors Individuals or entities that are permitted in a jurisdiction to trade unregistered or, generally, less regulated securities, including shares of privately held companies; also called accredited investors. 381 Initial public of offering fering (IPO) The process of selling shares to the public on an exchange for the first time. Typically, the company issues and sells shares to an underwriter (or group of underwriters), such as an investment bank, that, in turn, sells the shares to investors. Once the process is complete, the company is a public company with shares listed on an exchange. 382 Direct listing Where the equity of a security is floated on the public markets directly, without underwriters, reducing the complexity and cost of the transaction. 383 Special purpose acquisition company (SP (SPAC) AC) A company that has gone public, raising money to acquire a private company using stock and, often, private investments from institutional investors. In connection with the acquisition (known as a de-SPAC), the private company becomes a public company. 384 Financial leverage The use of debt in the capital structure. Measured using ratios such as operating income to operating income less interest expense, total assets to total equity, or debt to equity. 385 Dilution An increase in the number of shares outstanding from share issuance that decreases the percentage of shares owned by existing shareholders. 386 Stakeholders Any party with an interest, financial or non-financial, in an entity or its actions. 387 Shareholder theory of corporate governance Espoused by Milton Friedman in his famous 1970 essay, the shareholder theory holds that the objective of a business is to increase profits and shareholder value. 388 Stakeholder theory of corporate governance An expansion of the shareholder theory of corporate governance under which the objective of a business is to maximize value for, and balance the interests of, a broad group of stakeholders, including shareholders, employees, society, and the non-human environment. 389 Private debtholders Investors in an entity’s non-securitized debt claims, such as a loan or lease. The most common type of private debtholder is a bank. 390 Bondholders Investors in an entity’s securitized debt claims, such as commercial paper, notes, and bonds. Common types of _____ include investment funds and institutional investors. 391 Inside directors Members of a corporation’s board of directors who are not independent. Typically, _____ are employees or founders (and their family) of the company. 392 Independent directors Members of a corporation’s board of directors who do not have an employment or familial relationship with the company, nor do they have a relationship that would impair their independence such as an economic interest in a vendor or competitor of the company. 393 Supervisory board In some jurisdictions, a corporation’s board of directors is formally composed of a _____ and a management board. The _____ appoints and oversees the management board and often includes representatives of employees and other non-shareholder stakeholders. 394 Staggered board A structure of board elections in which only part of the board is elected simultaneously—for example, only one-third of the board may be up for election each year, so the board can be replaced over three years, not in one year if all seats were elected annually. This structure fosters greater continuity of board members but is an obstacle for shareholders seeking to effect change. 395 Human capital The accumulated knowledge and skill that workers acquire from education, training, or life experience and the corresponding present value of future earnings to be generated by said skilled individual. 396 Negative externalities A cost to a third party because of the production or consumption of a good or service. 397 Material (materiality) Refers to information that is decision-useful for a reasonable investor. 398 Physical risks Economic and financial losses from the increase in the severity and frequency of extreme weather due to climate change—for example, the loss of coastal real estate from a storm. 399 Transition risks Economic and financial losses from the transition to a lower-carbon economy in response to climate change—for example, the abandonment of an oil well that is no longer economical. 400 Stranded assets A resource that is no longer economically valuable owing to changes in demand, regulations, or availability of substitutes—for example, a newly discovered oil well that will not be brought into production. 401 Principal-agent relationship An arrangement in which one party (the agent) has authority to act for or on behalf of another party (the principal). Such an arrangement imposes a duty on the agent to act in the principal’s best interest. 402 Agency costs Direct and indirect costs borne by the principal in a principal-agent relationship owing primarily to information asymmetries. _____ include the costs of monitoring and assessing the agent as well as missed opportunities. 403 Controlling shareholder An individual or entity that owns a majority of the voting rights in a corporation. 404 Minority shareholder An individual or entity that owns less than a majority of the voting rights in a corporation. 405 Share class Types of equity securities that have different voting rights—for example, an issuer may issue Class A shares that carry one vote per share and Class B shares that carry ten votes per share. 406 Dual-class structure A capital structure that includes at least two classes of equity shares with unequal voting rights. 407 Annual general meeting (AGM) A yearly meeting of the corporate board of directors and shareholders, typically held in person and digitally, during which votes on directors, compensation plans, shareholder resolutions, and any other matters properly brought forward at the meeting are held. Issuer management may also make presentations and hold events. 408 Extraordinary general meetings (EGMs) Meetings besides an AGM of the corporate board and shareholders, typically held to deliberate and vote on urgent matters. Corporate charters and bylaws specify who can call an EGM and under what conditions. 409 Proxy voting A form of casting a ballot in an election in which a voter authorizes a representative to vote on their behalf according to instructions. In corporate elections, proxy ballots are cast by shareholders that direct a representative, typically the corporate secretary, to enter their votes as instructed. 410 Shareholder activism A range of actions by a corporation’s shareholders that are intended to result in some change in the corporation, typically a change in the board of directors, management, or business strategy. 411 Shareholder derivative lawsuit A legal action by a shareholder on behalf of a company, not the shareholder personally, against a third party. Often, the third party is a director or manager who the shareholder believes has harmed the company. 412 Private placement A sale of debt or equity securities to a small group of investors on an unregulated basis. The terms of the offering are negotiated by the issuer and investors. 413 Proxy contest When a shareholder or group of shareholders campaigns for certain matters they have submitted to a shareholder vote, often a slate of directors who oppose the incumbent board and management. The incumbent board and management simultaneously campaign for their side. 414 Tender of offer fer A solicitation by a current or prospective shareholder to other shareholders to acquire a substantial percentage, including 100%, of shares at a specified price. This action is usually undertaken by a potential acquirer whose bid was rejected by the issuer’s board of directors, prompting the potential acquirer to appeal directly to shareholders. 415 Hostile takeover When a potential acquirer seeks to acquire a company (the target) against the wishes of the target’s board of directors. Typically, a tender offer is used to carry out the _____, against which a board might use a poison pill in its defense. 416 Poison pill Officially known as a shareholder rights plan, a _____ is a hostile-takeover defense adopted by boards of directors according to rules specified in the corporate charter. There are several types of poison pills. Generally, they allow shareholders, excluding the shareholder making the hostile bid and their affiliates, to buy newly issued shares at a discounted price. The share issuance would dilute the bidder’s ownership percentage, rendering it impossible for the bidder to attain control. 417 Bond indenture A legal document between a bond issuer and investors that governs each party’s rights and responsibilities. 418 Ad hoc committee A small group of lenders or bondholders who negotiate with an issuer on debt restructuring and refinancing before the issuer submits a final proposal to the wider group of all lenders and bondholders. 419 Employee stock ownership plan (ESOP) A type of employee benefit plan in which a company sets up a trust fund to receive contributions of newly issued shares or cash to buy existing shares. Contributions are tax deductible up to certain limits. Shares in the trust fund are allocated to individual employees based on relative pay or a formula. 420 Operating cycle The length of time between a company’s acquisition of goods or raw materials and the collection of cash from sales to customers. 421 Days payable outstanding (DPO) The average number of days it takes a company to pay its suppliers. It is calculated as either the ending or average balance of accounts payable divided by (cost of goods sold/days in the period). 422 Days of inventory on hand (DOH) The average number of days it would take to sell the amount of inventory on hand. It is calculated as either the ending or average balance of inventories divided by (cost of goods sold/days in the period). 423 Days sales outstanding (DSO) The average number of days it takes for a company to receive payment from customers who purchase goods or services on credit. It is calculated as either the ending or average balance of accounts receivable divided by (revenues/days in the period). 424 Cash conversion cycle The amount of time between an issuer paying its suppliers in cash and receiving cash from its customers. 425 Total working capital The difference between current assets and current liabilities. 426 Net working capital Working capital excluding short-term items unrelated to business operations, such as cash, marketable securities, and short-term debt. 427 Statement of cash flows A financial statement that details the movement of cash over a period. The statement is classified into operating, investing, and financing activities. 428 Cash flow from operations A cash profit measure over a period for an issuer’s primary business activities. It includes cash from customers as well as interest and dividends received from financial investments, less cash paid to employees and suppliers as well as taxes paid to governments and interest paid to lenders. 429 Free cash flow The actual cash that would be available to the company’s investors after making all investments necessary to maintain the company as an ongoing enterprise (also referred to as _____ to the firm); the internally generated funds that can be distributed to the company’s investors (e.g., shareholders and bondholders) without impairing the value of the company. 430 Drag on liquidity An action or event that reduces available funds or delays cash inflows. 431 Pull on liquidity An action or event that accelerates cash outflows. 432 Current ratio A measure of liquidity that is the ratio of current assets to current liabilities. 433 Quick ratio A measure of liquidity that is the ratio of cash, marketable securities, and receivables to current liabilities. 434 Cash ratio A measure of liquidity that is the ratio of cash and marketable securities to current liabilities. 435 Capital investments An expenditure for an asset or resource with a useful life of more than one year. 436 Depreciation The process of systematically allocating the cost of long-lived (tangible) assets to the periods during which the assets are expected to provide economic benefits. 437 Amortization The process of allocating the cost of intangible long-term assets having a finite useful life to accounting periods; the allocation of the amount of a bond premium or discount to the periods remaining until bond maturity. 438 Maintenance capital expenditures Investments in assets to keep them in operation or increase their efficiency without extending their useful lives. 439 Match funding Financing an asset with a source, such as a loan or bond, that is aligned with certain attributes of the asset, such as duration and the respective streams of income and financing costs. 440 Capital allocation The process that companies use for decision making on capital investments—those projects with a life of one year or longer. 441 Net present value (NPV) The present value of an investment’s cash inflows (benefits) minus the present value of its cash outflows (costs). 442 Internal rate of return (IRR) The discount rate that makes net present value equal 0; the discount rate that makes the present value of an investment’s costs (outflows) equal to the present value of the investment’s benefits (inflows). 443 Return on invested capital (ROIC) A measure of the profitability of a company relative to the amount of capital invested by the equityholders and debtholders. 444 Hurdle rate Also called “preferred return.” The minimum rate of return on investment that a fund must reach before a GP receives carried interest. 445 Sunk costs A cost that has already been incurred. 446 Pet projects A capital investment that is pursued by management but is not economically justifiable by a disinterested party. Motivations for _____ include self-dealing and vanity. 447 Real option A right, but not an obligation, for management to make a decision with respect to a capital investment that alters future cash flows from the original forecasted scenario. 448 Exercise The decision to transact the underlying by an option holder. 449 Abandonment option The option to terminate an investment at some future time if the financial results are disappointing. 450 Growth option The option to make additional investments in a project at some future time if the financial results are strong. Also called an expansion option. 451 Price-setting option The option to adjust prices when demand or supply varies from what is forecast. 452 Production flexibility option The option to alter production when demand varies from what is forecast. 453 Cost of capital The cost of financing for a company; the rate of return that suppliers of capital require as compensation for their contribution of capital (also called opportunity cost of funds). 454 Cost of debt The required return on debt financing for a company, such as when it issues a bond, takes out a bank loan, or leases an asset through a finance lease. 455 Cost of equity The return required by equity investors to compensate for both the time value of money and the risk. Also referred to as the required rate of return on common stock or the required return on equity. 456 Weighted-average cost of capital (W (WACC) ACC) A weighted average of the after-tax required rates of return on a company’s equity, debt, preferred stock, and other long-term financing sources, where the weights are the fraction of each source of financing in the company’s current market value or management’s target capital structure. 457 Capital structure The mix of debt and equity that a company uses to finance its business; a company’s specific mix of long-term financing. 458 Capital-intensive businesses Companies or business activities that are characterized by a relatively low fixed asset turnover, a high percentage of capital expenditures to sales, or a high net-working-capital-to-sales ratio. 459 Capital-light businesses Also known as asset light businesses, companies or business activities characterized by relatively high fixed asset turnover, a low percentage of capital expenditures to sales, or a low net-working-capital-to-sales ratio. 460 Convertible debt A debt instrument that gives the holder the right to exchange the instrument for a specified number of common shares in the issuing company. 461 Operating leverage The sensitivity of a firm’s operating profit to a change in revenues, determined by the composition of fixed and variable operating costs. 462 Debt tax shield The tax benefit from interest paid on debt being tax deductible from income, equal to the marginal tax rate multiplied by the value of the debt. 463 Static trade-of trade-offf theory of capital structure A theory pertaining to a company’s optimal capital structure; the optimal level of debt is found at the point where additional debt would cause the costs of financial distress to increase by a greater amount than the benefit of the additional tax shield. 464 Optimal capital structure The capital structure at which the value of the company is maximized. 465 Tar arget get capital structure Management’s desired proportions of debt and equity financing, usually stated on a book value basis or indirectly using a financial leverage metric, such as net or gross debt to EBITDA or credit rating. 466 Asymmetric information Also known as information asymmetry; the differential of information between corporate insiders and outsiders regarding the company’s performance and prospects. Managers typically have more information about the company’s performance and prospects than owners and creditors. 467 Pecking order theory The theory that managers consider how their actions might be interpreted by outsiders