Glossary of Key Terms

Absolute Return measured as the standard deviation of active The percentage change in value of an asset returns and is often referred to as tracking or portfolio over a given period of time. error. Investment managers must take on The portfolio’s or asset’s can active in order to seek active return. be compared with that of a benchmark to (See Active Return.) derive “relative return.” (See Benchmark, Relative Return and Total Return.) Alpha is a -adjusted measure of return. Absolute-Return Strategy Positive alpha indicates that an investment An investment strategy that seeks to gen- portfolio has earned, on average, a pre- erate the highest possible absolute return mium above what is expected for the level within specified, often multiple, asset of variability (beta). A negative classes without the construction limitations alpha indicates that the investment port- imposed when managing against a specific folio has received, on average, a premium benchmark. By separating itself from a lower than that expected for the level of benchmark, an absolute-return strategy market variability. (See Beta.) seeks to generate a positive return regard- less of the positive or negative performance Arbitrage of relevant markets. A that exploits differences between two or more markets involving Active Return similar financial instruments—the profit The performance difference between being the price spread between the a portfolio and a benchmark that is in the different markets. Arbitrage is com- attributable to an investment manager’s mon in the , and mar- decisions to construct a portfolio of kets. For instance, an investor may identify securities that differs from the benchmark’s an exchange-rate disparity for a given cur- construction. For example, if a portfolio rency in two countries. The investor may of securities selected by an investment sell a given currency in the US where the manager returned 5% while the benchmark is higher and then repurchase returned 3%, the portfolio’s “active return” the same currency in the UK where the is 2%. Active return is only possible when exchange rate is lower, pocketing the dif- a manager takes on active risk. (See Active ference. Risk.) Ask Price (Offer Price) Active Risk Typically the lowest price that a seller is The risk that the performance of a portfo- willing to accept for a —the coun- lio will differ from a benchmark and the terpart of the bid price, which is the high- risk that is attributable to an investment est price that the buyer is willing to pay. manager’s decisions to construct a portfolio The difference between the ask price and of securities that differs from the bench- bid price is known as the bid-ask spread. mark’s construction. Active risk is typically (See Bid-Ask Spread and Bid Price.)

Glossary of Key Investment Terms 1 Bid-Ask (Bid-Offer) Spread A judicial, regulatory or administrative The difference between the selling and proceeding or filing that is triggered when purchasing price of an asset. (See Ask Price, a company is unable to meet its debt obli- Bid Price and Spread.) gations. typically end either with reorganization and debt relief or with Bid Price liquidation of the company. The purchase price that a buyer is willing to pay for an asset. (See Ask Price and Bid- Basis Point Ask Spread.) One hundredth of one percentage point (0.01%). Bond A security that pays interest. The issuer Benchmark agrees to pay the bondholder a regular set A standard barometer against which sum based on the amount borrowed and can be measured in terms of the bond’s , and to repay the prin- performance, characteristics, construction cipal amount of the loan at a future date. and similar criteria. Sometimes widely Many variations exist on this basic format, recognized instruments (e.g., US including bonds with no coupon and with Treasuries) or interest rates (e.g., the US fed variable coupons; bonds may also contain funds rate or ) serve as benchmarks. call or put provisions. The price of a bond More commonly, a benchmark is composed of an unmanaged group of securities with is quoted assuming a of 100; the same general characteristics as the thus, if a bond price is quoted as £90 and portfolio being measured against it. Stock the principal value of the actual holding is indices such as the S&P 500, the FTSE £1,000, that holding is valued at £900. A 100 and the Nikkei 225 are commonly bond selling above 100 is said to be trad- used for equities, while indices such as the ing at a premium; at 100, at par; and below Lehman Aggregate or the Nomura Bond 100, at a discount. The price varies over the Performance Index are commonly used life of the bond as interest rates, perceived in . (See Market Weight, credit quality and other factors fluctuate, Overweight and Underweight.) and as the bond approaches its date. A bond’s price is inversely related to Beta its yield: It rises when the bond’s yield falls A measure of the expected change of a and declines when the yield rises. security’s or portfolio’s return relative to that of the market. By definition, the beta Bonds belong to the fixed-income asset of a benchmark index is 1.00. A security class. (See Call Provision, Coupon, Matu- with a beta of more than 1.00 tends to rise rity, Par or Face Value and Put Provision; or fall more than the market; a security also, see The Major Fixed-Income Sectors, with a beta of less than 1.00 tends to rise or page 15.) fall less.

2 Glossary of Key Investment Terms Book Value specified weight; fixed-weight indices are An accounting term that defines the net often equal weighted. (See Equal-Weighted value of an asset as it appears on a compa- Index.) ny’s balance sheet; a company’s book value is equal to its total assets minus its total Cash Earnings liabilities. Net earnings, excluding intangibles such as goodwill. The higher the proportion Call of cash earnings to reported earnings, the A contract that gives an investor the right higher a company’s earnings quality is to buy a specified asset at a predetermined deemed to be. (See Earnings per .) price and date prior to the security’s stated maturity, if any ( doesn’t Compressed Valuations have a maturity), or the date that the issuer When the difference between the high- makes the final payment to the security est- and lowest-priced segment of a stock holder. (See .) market is much smaller than usual. This limits an investor’s opportunity to buy Call Provision value trading at deep discounts but A bond feature that allows the issuer to increases the ability to buy faster-growing retire the debt, in full or in part, prior to stocks at a lower-than-usual premium to the bond’s stated maturity date. Such a the market. (See Growth Stock and Value feature is favorable to the borrower, who Stock.) can retire the bond and replace it with a lower-coupon issue if market rates fall. Conversely, such a feature is detrimental to A bond that, at the option of the issuer or the investor, who losing the higher- the investor, can be exchanged for com- coupon bond when rates fall. Because of mon stock of the issuing company, at a this disadvantage to the investor, callable predetermined conversion ratio and at pre- bonds typically yield more than otherwise determined dates. Some convertible bonds comparable bonds without a call provision. are convertible throughout their lives. (See Put Provision.) Although a convertible bond is chiefly a fixed-income instrument, its price tends to Cap-Weighted Index be highly influenced by the stock price. An index weighted by the market capi- talization of each security in the index. Convexity Larger-cap companies thus account for a A measure of a bond’s price volatility that, greater portion of the index. For example, in conjunction with duration, describes if a company’s market capitalization is its sensitivity to changes in interest rates, $1 billion and the market capitalization of particularly when the change in rates is all securities in the index is $100 billion, sizable. Duration describes a linear rela- the company would be 1% of the index. tionship between yield and price that holds An index may also be fixed weighted, with true only for small shifts in rates. As rate each security, sector or country having a shifts increase in magnitude, a bond’s dura-

Glossary of Key Investment Terms 3 Positive and Negative Convexity

Positive Convexity Negative Convexity Price Price

Yield Estimated price based on duration Actual price

tion changes, causing it to become more Coupon or less sensitive to the change in rates than The rate at which a bond pays interest, would be expected based on a static dura- expressed in percentage terms. A bond tion measure. Convexity aims to describe with a 4% coupon and a principal value that changing relationship. Bond convexity of £1,000 would pay £40 annually to the falls into two camps: positive convexity and bondholder. Coupon payments are typi- negative convexity. The durations of bonds cally made either annually or semiannually, with positive convexity—most option- according to the terms of the bond’s cove- free bonds—lengthen when rates fall and nant. The coupon may be fixed or variable. shorten when rates rise. This is a ben- Credit Rating eficial effect, as it means that their prices A measure of credit quality. Bond-rating rise faster and fall more slowly than in a agencies such as Moody’s Investors Service, one-to-one, linear relationship with incre- Standard & Poor’s and Fitch Ratings mental changes in yield. The durations of publish issuer ratings that, in their view, bonds with negative convexity experience reflect the likelihood that the issuer will the opposite effect: They lengthen when default on interest and principal payments. rates rise and shorten when rates fall, caus- Rating systems vary from agency to ing their prices to fall faster and rise less agency; generally, however, bonds rated rapidly than in a linear relationship with triple A (AAA or Aaa) are of the highest yield. Mortgages, which have implicit call quality, while those rated below triple B options (the homeowner may prepay at (BBB or Baa) are of the lowest quality any time), and corporate bonds that have and are considered speculative or non- embedded call provisions exhibit negative investment grade. convexity. (See Duration.)

4 Glossary of Key Investment Terms Default The risk that a bond issuer may default on An event triggered when a debt obligor its debt obligations or that a counterparty fails to pay the interest or principal of its will default on a payment in the sale or obligations and a specified grace period has purchase of a negotiable instrument. (See expired. Default.) Defensive Stock Currency Forward Refers to a company that tends to produce A contract that obligates participants to buy goods or services that are in demand irre- or sell a specified quantity of a currency spective of economic cycles, such as health- at a specified price on a specified future care companies or utilities. date. Investors often use these contracts to lock in the current value of a foreign cur- rency that the investor expects to lose value A tradable that derives against his or her home market. its value from underlying assets—such as stocks, bonds, market indices, commodi- Current Coupon ties and livestock. It is typically a contract The prevailing coupon rate in the new- based on the buyer’s/seller’s assumptions issue market for securities that are priced at regarding the future price of the underly- or close to par. (See Discount Coupon and ing assets. Given the uncertainty of future Premium Coupon.) prices, participants often their bets Cyclical Stock by entering into a contract for a future sale Equity in a company that makes products or purchase at a specified price. This con- or provides services that tend to be in tract, or financial instrument, is the deriva- demand during periods of strong economic tive. (See Future, Hedging and Option.) growth and out of favor when the economy is weak. Examples include Discount Coupon and durable goods, both of which are in A rate below current coupon. Bonds with greater demand during economic booms. discount coupons are typically priced (See Defensive Stock.) below par. (See Current Coupon.)

Cyclical Trend Discount to Fair Value Recurring movements in prices or interest A measure of the valuation difference rates, usually linked to different stages in a between the lowest-valued segment of a business cycle. (See Secular Trend.) , such as the cheapest 20%, relative to the overall market. It indicates Debt-to-Equity Ratio whether the value opportunity is strong or A company’s debt (borrowings) divided by muted at any given time relative to long- the market value of its shareholder equity. term history. (See Fair Value.)

Glossary of Key Investment Terms 5 Duration EBITDA A measure of a bond’s price sensitivity to (Earnings Before Interest, Taxes, Depreciation changes in interest rates, expressed in years. and Amortization) Duration approximates how much a bond’s A measure of a company’s cash flow, price will change if interest rates change by excluding the impact of its financial struc- a given amount. For each year of duration, ture or tax , both of which could a bond’s price will fall (or rise) roughly one be altered. percentage point for each one-percent- age-point increase (or decrease) in yield. Equal-Weighted Index Thus, a bond with a longer duration will An index in which all the securities are perform worse when rates rise than a bond given equal weight. As soon as the price with a shorter duration; conversely, it will of one security changes, it is no longer perform better when rates fall. Technically, duration is the weighted average term to equal weighted. Therefore, such indices are maturity of the bond’s cash flows. Thus, it rebalanced on a quarterly, semiannual or is shorter than maturity for coupon-bearing annual basis. bonds, which make annual or semiannual payments throughout the life of the bond. Equity Duration is an excellent approximation of Ownership of a company in the form price sensitivity when interest-rate changes of shares that represent a claim on the are small, but it becomes less accurate when corporation’s earnings and assets. Common rate changes are large. (See Convexity.) stockholders have the right to vote on directors and other key matters. While Dynamic Gap preferred stockholders lack voting rights, The difference between our analysts’ they have priority in dividend payments. estimates of a company’s growth poten- A corporation can authorize additional tial and the market’s, as measured by classes of stock, each with its own set of consensus forecasts of earnings, revenues contractual rights. or other barometers. Alliance Growth Equities research shows that “upside sur- Equity Risk Premium prise”—growth above what the market was A forward-looking estimate of how much expecting—is more closely associated with equities are likely to outperform bonds. outperformance than the absolute level of Equity investors typically demand a higher growth. The Alliance investment process return due to their greater risk of not favors companies with dynamic gaps that receiving cash flows for their investment. are positive and widening over those whose gaps are narrowing or negative. Excess Return Difference between returns, which may Earnings per Share (EPS) be applied to managers or sectors. When A company’s net profit divided by the referring to a manager or portfolio, the number of common shares outstanding. excess return is typically the same as the active return—the difference between

6 Glossary of Key Investment Terms the manager’s/portfolio’s return and the futures fall below fair value. (See Discount benchmark’s. A fixed-income sector’s to Fair Value.) excess return is the difference between its return and that of a comparable-duration Fundamental Success : If -term corporate When a company is well positioned to debt returns 6% and a short-term govern- outperform over the long term due to the ment security returns 4%, the excess return growth or stability of earnings or cash flow is 2%. (See Risk-Free Rate.) and balance-sheet strength. Longer-term investors tend to focus more on such fun- Exchange-Traded Fund (ETF) damental strengths than on bouts of under- An instrument that provides exposure to performance due, for instance, to market an index and is traded on a . volatility, technical factors or short-term The price of these units depends on the difficulties. (See Debt-to-Equity Ratio.) prevailing market prices of the underlying index components. ETFs offer investors a Future low-cost, liquid means to invest in indices; A that is traded on an they are essentially an alternative to an exchange, requiring the future delivery of a index portfolio. , bond, stock index or currency at a specified price and date. Factor Risk A common trait that causes many securi- Government-Sponsored Enterprise ties to trade together. Equity factor risks (GSE) include industry or sector, home country, A private corporation created by the US currency, valuation, earnings variability, Congress to reduce the growth rate and market capitalization; for certain sectors of the economy. GSEs fixed-income factor risks include sector, include the Federal Home Loan Mortgage industry, rating and currency. (See Idiosyn- Corporation (Freddie Mac), the Federal cratic Risk and Systemic Risk.) National Mortgage Association (Fannie Mae) and the Student Loan Marketing Fair Value Association (Sallie Mae). GSE securities A price deemed to accurately reflect the the implicit backing of the US value of a company, asset or financial government but are not the government’s instrument and thought to be equitable direct obligations. for both buyer and seller. Fair value is generally calculated based on measurable Growth Factor Risk financial performance and potential. In the A benchmark-relative measure of a futures market, fair value refers to the rela- portfolio’s exposure to characteristics tionship between the on typically associated with the growth a market index and the actual value of the investment style. A positive reading index. When futures are above fair value, indicates that the portfolio is more traders are betting that the market index leveraged to the growth style and, thus, will go higher. The converse is true when should outperform when growth stocks are

Glossary of Key Investment Terms 7 in favor; the higher the reading, the higher transaction when the proceeds are brought this . For example, a growth factor back home. There are many forms of hedg- risk of 0.2 typically means that a portfolio ing, which, in effect, seeks to neutralize a is 20% more leveraged to the growth style specific risk. (See Future.) than the index. Conversely, a negative reading would indicate that the portfolio is Hybrid Security less exposed than its benchmark to growth A security that combines characteristics of and will likely underperform when growth two or more financial instruments, gener- is in favor, and outperform when growth is ally debt and equity. The most common out of favor. type of hybrid is a so-called convertible bond, which is a fixed-income security Growth Stock that can be exchanged for common stock. A company that is expected to gener- Another popular type of hybrid is a Basket ate above-average revenue and earnings D. Basket Ds, which are issued by growth relative to its industry or the and insurance companies, are considered overall market. Such companies usually 75% equity and 25% debt. Hybrid securities pay little or no dividend, preferring to use are typically lower in the excess cash to finance expansion. However, than senior corporate bonds, so recovery because of the company’s rapid earnings rates in times of corporate financial stress growth, investors typically expect the tend to be lower; however, debt-equity stock’s price appreciation over time to more hybrids usually rank ahead of common than compensate for the lack of short-term stock. (See Convertible Bond.) dividends. (See Defensive Stock.) Idiosyncratic Risk Hedging Risk that is isolated to a limited number A trading practice aimed at limiting finan- of assets, such as an individual company cial loss in an asset due to unexpected price or a small group of securities, and that can changes. For example, cross-border securi- be reduced through diversification. Errors ties investors need to exchange their home in management strategy are one kind of for the local currencies of the idiosyncratic risk. (See Factor Risk and markets in which they’re investing in order Systemic Risk.) to make the purchases. Through hedging instruments such as forwards or futures Information Ratio contracts, they can arrange to re-exchange The ratio of a portfolio’s excess return, the currencies at fixed prices at specified or premium, to its tracking error, or the points in the future. This arrangement standard deviation of the premium over the allows an investor to gain exposure to price period being measured. It is designed to changes in the underlying security without measure how much excess return a man- having to risk depreciation of the home ager delivers for each unit of risk. A higher currency relative to the local currency, number indicates a more favorable balance which would lower the total value of the of reward to risk than a lower number. A

8 Glossary of Key Investment Terms positive number indicates that the portfo- company’s balance sheet. Short-term liabil- lio outperformed, and a negative number ities are those payable within the next year, indicates underperformance. (See Excess and long-term liabilities are those payable Return and Tracking Error.) over a longer time frame. iShares LIBOR Index funds traded like shares on stock (London InterBank Offered Rate) markets. Each share represents a proportion The that banks charge one of ownership in the collection of stocks that another in the short-term international make up an index. This investment vehicle interbank market. It applies to loans bor- enables smaller investors to diversify their rowed anywhere from one day to five holdings by giving them exposure to a years. LIBOR is officially fixed each day by potentially large number of companies a handful of large London banks, although without the necessity of buying each stock. the actual rate changes throughout the day. It is also used as a benchmark to set other Leverage short-term interest rates, which are some- In a financial context, the degree to times set as specific increments relative to which a business or asset is financed by LIBOR (e.g., LIBOR plus 2%). borrowing. High financial leverage is generally regarded as a negative for a Liquidity company, since it increases the risk of The ease with which an asset can be bought bankruptcy in the event of a financial or sold quickly. High liquidity means that squeeze and can make future borrowing an asset can very easily be exchanged for more difficult and/or expensive. However, currency, and low liquidity means that sup- leverage to finance highly profitable ply and demand are somewhat constrained. new ventures, for example, can result in Highly liquid assets tend to have more nar- higher returns to shareholders. “Leveraged row bid-ask spreads; illiquid assets tend to investing” is when investors borrow money have wide bid-ask spreads. to purchase more securities or other assets than they could with cash. This allows an Long-Duration Assets investor to capture more of the upside if a Securities or other assets whose cash flows security appreciates, but increases the loss if to investors tend to be further out in the the security depreciates. future. In equity markets, these are typi- cally companies that pay little or no divi- Liability dends, often because they are reinvesting A legal obligation to pay a specific amount most of their earnings. The term is most within a defined time frame. For busi- typically used in conjunction with growth nesses, this typically includes debt pay- stocks but may also apply to emerging- ments, accounts payable, taxes, wages and market stocks and other assets. similar pending expenses recorded on a

Glossary of Key Investment Terms 9 Market Capitalization final coupon and principal payments owed Also referred to as market cap, it reflects to a bondholder. Bonds with a remaining the total equity of a company. A company’s term to maturity of one to five years are market capitalization is determined by generally considered short-term; those multiplying the number of shares out- maturing between six and 12 years out standing by the current stock price. Stock are considered intermediate-term; and markets are frequently subdivided in terms those with maturities beyond 12 years are of capitalization, with typical groups often considered long-term. Bonds maturing in including large-cap (those with the larg- less than one year are categorized as cash est capitalizations), mid-cap (medium-size equivalents. companies) and small-cap (the smallest publicly traded companies). Each group has Net Asset Value (NAV) distinct attributes and performance pat- The dollar value of a mutual-fund share, terns, and spreading investments across the calculated by dividing the fund’s total various groups tends to diversify risk. net assets (assets minus liabilities) by the total number of shares outstanding. NAV, Market Value which is typically calculated at the end of The current price of a security in the each day, can change constantly to reflect market, as reflected by the last reported changes in the value of a fund’s holdings. price on an exchange, or the current bid- ask price if the security is traded over the Option counter. (See Bid-Ask Spread, Market A contract that provides the right to buy or Capitalization and Over the Counter.) sell a specific asset such as a stock, a com- modity or a currency at a particular price Market Weight during a defined period of time. The right When a portfolio allocates the same per- to buy is referred to as a “,” centage of assets to a specific security or while the right to sell is known as a “put group of securities as its benchmark. Also option.” Although option holders have the known as a “neutral weight.” right to buy or sell, they are not obligated to do so. Mark to Market To record the value of open positions in a Option-Adjusted Spread (OAS) security, a portfolio or an account based A measure of a bond’s relative on current prices, not the purchase price to another instrument (typically a govern- or “cost basis.” This technique allows any ment bond or ) that adjusts for the interim gain or loss to be recognized for yield effect of a bond’s explicit or implicit tax or accounting purposes even though call or put options. Using OAS rather than the positions have not yet been closed out. nominal spread allows for direct compari- son between option-free bonds and those Maturity with put or call features. (See Spread.) The date when, or the remaining time until, an issuer is obligated to deliver the

10 Glossary of Key Investment Terms Over the Counter (OTC) the current closing price of the stock by the Securities not listed on an established latest quarter’s book value per share. exchange such as the London Stock Exchange, Tokyo Stock Exchange or New Price-to-Earnings Ratio (P/E) York Stock Exchange, but rather traded The most common measure of a stock’s by broker-dealers who negotiate directly value, calculated by dividing the market with one another over computer networks value per share by after-tax earnings per and by telephone. Stocks traded over the share. The higher the P/E ratio, the more counter may be more speculative, since the market is willing to pay for each unit of these companies often have not yet met earnings. the size or stability requirements for listing Price-to-Growth Ratio (PEG) on an established exchange and have less A ratio used to determine a stock’s current accurate pricing data and other information value per unit of earnings growth. It is cal- readily available. Still, these tend culated by dividing the price/earnings ratio to fall under the oversight of relevant by the annual earnings-per-share growth regulatory bodies. Many bonds trade over and indicates a stock’s potential value. the counter rather than on an exchange. A lower PEG means that the company’s Also known as “unlisted securities.” growth is priced more attractively than its Overweight peers. When a portfolio allocates a larger percent- Put Option age of assets to a specific security or group A financial contract that gives the holder of securities than its benchmark does. (See the right, but not the obligation, to sell an Benchmark.) asset at a predetermined price on or before Par or Face Value a particular date. (See Call Option.) The amount of principal that the issuer Put Provision must pay the bondholder at maturity. A bond feature that allows the investor to Although an individual bond typically has redeem the bond at par value before the a par value of $1,000, the term “par” is bond’s stated maturity date. A put provision often used interchangeably with 100 in the is typically valid only for predetermined context of a bond’s price. (See Bond.) dates and would only be attractive to the Premium Coupon investor if the bond’s market value declined A rate above current coupon. Bonds with below par. Such a feature is favorable to premium coupons are typically priced the investor and detrimental to the issuer. above par. (See Current Coupon and Dis- Because of their potential advantage to the count Coupon.) investor, putable bonds typically yield less than otherwise comparable bonds without Price-to-Book Ratio (P/B) a put provision. (See Call Provision.) A comparison of a stock’s market value with its book value, calculated by dividing

Glossary of Key Investment Terms 11 Relative Return Risk Premium An asset’s or a portfolio’s return over a The expected return above the risk-free period of time relative to that of a chosen rate that investors demand to compensate benchmark. It is calculated as the difference for the volatility of returns or the possibil- between the asset’s absolute return and the ity of default of risky assets. (See Risk-Free benchmark’s performance. (See Absolute Rate.) Return and Benchmark.) Secular Trend Return on Equity (ROE) A long-term change attributable to A measure of how much profit a company an important fundamental shift in the is able to generate with the capital provided economy or business environment that is by shareholders. Calculated by dividing not related to seasonal or cyclical factors. after-tax income for a specified time period Industrialization and globalization are (e.g., trailing 12 months, trailing five years, examples of secular trends. (See Cyclical forward 12 months) by the book value. Trend.) ROE is expressed as a percentage. Risk The process of creating a tradable finan- In common parlance, the chance of loss or cial instrument from a pool of underlying of something bad occurring. In financial assets, such as loans or mortgages, which parlance, it usually means the uncertainty generate an income stream for the issuers. of outcomes due to one or many causes; it Securitization allows issuers to remove can be positive as well as negative. Return assets from their balance sheets, thereby is usually measured by the standard devia- freeing up capital for other uses. It also tion of returns—in other words, the extent allows investors to better diversify risk. to which returns may vary from the norm. Volatile assets tend to have a wider range Share Buyback of possible returns and thus are said to be A company’s repurchase of its own shares. higher-risk. It typically increases the market price of the remaining shares because each of the Risk-Free Rate remaining shares represents a larger claim An investment with a predictable rate of on earnings and assets. return. An example is a short-term gov- ernment bond. A short-term government Spread bond has the explicit backing of a govern- The difference between two variables, ment, and the time period before the bond such as a security’s bid and ask prices matures is short enough to minimize the (bid-ask spread). In the , the risks of inflation and market interest-rate “yield spread” is the difference in yield changes. Its yield is therefore considered between bonds, most often between the risk-free. (See Credit Risk.) yield of a bond and a benchmark such as a government bond, swap or LIBOR.

12 Glossary of Key Investment Terms Valuation spreads measure the difference between expensive and cheap segments of When a bond’s cash flows are repackaged as the market. a collateralized debt obligation (CDO) or a portfolio of mortgage securities is repack- Standard Deviation aged as a collateralized mortgage obligation A statistical measure of risk that shows how (CMO), the various securities constituting aligned or at variance the returns of an the CDO or CMO are called . asset, industry or fund are relative to their Each tranche within a deal has a different historical performance. risk/return profile, and the tranches trade separately from one another. Style Drift The tendency of a portfolio manager to Transaction Costs stray from its investment philosophy and The costs incurred when buying or selling process to boost short-term returns. an asset security, such as commission, fees and any indirect taxes. Swap A contract between two parties to Underweight exchange future cash flows based on a set When a portfolio allocates a smaller per- principal amount. An interest-rate swap centage of assets to a specific security or normally involves swapping fixed-rate and group of securities than its benchmark floating-rate payments in the same cur- does. (See Benchmark.) rency. Other common types include cur- rency swaps and credit default swaps. Valuation The worth of an asset or a company Systemic Risk using various techniques or the value of A risk or event that affects an entire finan- an investment portfolio’s holdings at a cial market or system, such as a stock specific date. market crash or a banking-system failure. Systemic risks cannot be avoided through Value Risk Premium diversification. (See Factor Risk and Idio- The anticipated return premium of value syncratic Risk.) stocks versus the broader market. (See Value Stock.) Total Return The return on an investment, including Value Stock price appreciation and depreciation, as well A stock that is underpriced by the market as income from dividends or interest. relative to its long-term fundamentals, such as dividends, earnings and sales. Such Tracking Error stocks tend to have a high dividend yield, The variance of a portfolio’s investment low price-to-book ratio and/or low price- returns relative to those of its benchmark or to-earnings ratio. index. (See Active Risk, Information Ratio and Standard Deviation.)

Glossary of Key Investment Terms 13 Volatility the rate that will make the present value of The extent to which the price of a financial the bond’s expected cash flows equal to the asset or market fluctuates, measured by the bond’s market price. standard deviation of its returns. Volatility is a commonly cited risk measure. (See Standard Deviation.) A line connecting the yields of bonds from one end of the maturity spectrum to the other. Because yields typically rise A certificate entitling the holder to buy sharply at the short end of the maturity or sell a certain quantity of an underlying spectrum and rise more gradually at longer instrument at a predetermined price. The maturities, the plotted line usually forms right to buy the underlying instrument is a curve. However, depending on a host referred to as a call warrant; the right to sell of factors, yield curves may be steeply it is known as a put warrant. In this respect, upward-sloping, flat, inverted, straight, a warrant is similar to an option. Warrants bowed or even kinked. typically have much longer time available to than options. (See Option.) Yield Curve Yield A component of the return on an invest- ment. In the equity market, a share’s divi- dend yield is its annual dividend payment as a percentage of the share’s market price.

In the fixed-income market, a bond’s yield Yield is its annual interest payment as a percent- age of the bond’s market price. Various measures of yield exist: most notably, cur- rent yield, which considers only coupon interest; and , which is Maturity

14 Glossary of Key Investment Terms The Major Fixed-Income Sectors

Adjustable-Rate Mortgage (ARM) bond obligation) or mortgage-backed secu- A mortgage loan whose interest rate rities (collateralized mortgage obligation). is raised or lowered periodically in A CDO repackages the cash flows of the accordance with a stated reference pool of assets into tranches with differ- rate. ARM refers both to the original ent maturities, cash flows and risks. (See homeowner loan and to a securitized pool Collateralized Mortgage Obligation and of such loans. (See Securitization.) Tranche.)

Agency Collateralized Mortgage Obligation (CMO) A bond issued by a government agency or A fixed-income security created by pool- quasi-government agency to finance that ing together mortgage-backed securities. entity. Securities repackaged by an agency, A CMO parses expected and unexpected as with mortgage-backed securities, are not cash flows from the underlying assets into considered . Unlike debt issued multiple tranches according to a set of rules directly by the federal government or its specified in the CMO’s prospectus. Thus, agencies, quasi-government agency debt the various tranches are subject to different is not backed by the full faith and credit of amounts of risk and are suitable for differ- the federal government but is nevertheless ent types of investors or investment pur- very highly rated. (See Government-Spon- poses. (See Collateralized Debt Obligation sored Enterprise.) and Tranche.)

Asset-Backed Security (ABS) Commercial Mortgage-Backed Security A fixed-income security created by pooling (CMBS) together loans of a similar type, such as A mortgage-backed security collateralized home-equity loans, car loans or credit-card by commercial rather than residential receivables. In the US, which has a very mortgage loans. Unlike residential large mortgage-backed securities market, mortgage-backed securities, CMBSs are mortgages are not considered a type of not usually subject to prepayment risk, ABS; however, mortgages are considered as most underlying loans do not permit a subset of the ABS market in many prepayment without substantial penalties. other countries, including the UK. (See (See Mortgage-Backed Security.) Securitization.) Collateralized Debt Obligation (CDO) Debt issued by a corporation. As creditors, A fixed-income security created by pooling corporate bondholders have a prior legal together bonds or loans of a similar type, claim over common and - such as corporate bonds (collateralized holders.

Glossary of Key Investment Terms 15 (CDS) High-Yield Bond An instrument that transfers the credit risk A fixed-income security with a rating of of a specific entity (usually a corporation, BB or lower and thus considered non- financial institution or sovereign) from a investment, or speculative, grade. These protection buyer to a protection seller in instruments tend to offer substantially exchange for a regular payment until the higher yields than investment-grade credits contract expires or a credit event occurs. due to their greater likelihood of default. (See Swap.) Inflation-Linked Security Emerging-Market Debt A bond indexed to and intended to protect Debt issued by governments of and corpo- the investor against inflation. A number of rations within developing economies. A governments and some corporations issue country may issue such securities in its own such debt. currency or, commonly, in US dollars or the currency of another major economy. Mortgage-Backed Security (MBS) Many emerging-market issuers are rated A fixed-income security, especially a mort- below investment grade. gage “pass-through,” created by pooling together home mortgage loans with simi- Government Bond lar interest rates and other characteristics. Debt issued directly by a country’s govern- The pool of mortgages forms the collateral ment in its own currency. Government behind the mortgage-backed security. bonds of the major developed countries are Bondholders receive cash flows based on often, though not always, considered free the pooled mortgages’ collective interest of credit risk. and principal payments, including prepay- ments of principal, less a fee reserved for Country Common Name for Government Debt the originator of the MBS. Originators are Australia Treasuries predominantly government or quasi-gov- Canada Canadas ernment agencies. (See Securitization.) France OATs (Obligations Assimilables du Trésor) Sovereign Bond Germany Bunds Debt issued directly by a country’s govern- Italy BTPs (Buoni del Tesoro Poliennali) ment in a currency other than its own. Japan JGBs (Japanese Government Bonds) UK Gilts US Treasuries

16 Glossary of Key Investment Terms About AllianceBernstein AllianceBernstein L.P. is a leading investment manager. Our worldwide presence, breadth of services and depth of research allow us to offer a full array of investment solutions to meet our clients’ diverse needs.

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