Financial Terms Alpha equation

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# Definition of Alpha equation

## Alpha equation

The alpha of a fund is determined as follows:
[ (sum of y) -((b)(sum of x)) ] / n
where:
n =number of observations (36 months)
b = beta of the fund
x = rate of return for the S&P 500
y = rate of return for the fund

# Related Terms:

## Accounting equation

The representation of the double-entry system of accounting such that assets are equal to liabilities plus capital.

## Accounting equation

The formula Assets = Liabilities + Equity.

## accounting equation

An equation that reflects the two-sided nature of a
business entity, assets on the one side and the sources of assets on the
other side (assets = liabilities + owners’ equity). The assets of a business
entity are subject to two types of claims that arise from its two basic
sources of capital—liabilities and owners’ equity. The accounting equation
is the foundation for double-entry bookkeeping, which uses a
scheme for recording changes in these basic types of accounts as either
debits or credits such that the total of accounts with debit balances
equals the total of accounts with credit balances. The accounting equation
also serves as the framework for the statement of financial condition,
or balance sheet, which is one of the three fundamental financial
statements reported by a business.

## Alpha

A measure of selection risk (also known as residual risk) of a mutual fund in relation to the market. A
positive alpha is the extra return awarded to the investor for taking a risk, instead of accepting the market
return. For example, an alpha of 0.4 means the fund outperformed the market-based return estimate by 0.4%.
An alpha of -0.6 means a fund's monthly return was 0.6% less than would have been predicted from the
change in the market alone. In a Jensen Index, it is factor to represent the portfolio's performance that
diverges from its beta, representing a measure of the manager's performance.

## Beta equation (Mutual Funds)

The beta of a fund is determined as follows:
[(n) (sum of (xy)) ]-[ (sum of x) (sum of y)]
[(n) (sum of (xx)) ]-[ (sum of x) (sum of x)]
where: n = # of observations (36 months)
x = rate of return for the S&P 500 Index
y = rate of return for the fund

## Beta equation (Stocks)

The beta of a stock is determined as follows:
[(n) (sum of (xy)) ]-[(sum of x) (sum of y)]
[(n) (sum of (xx)) ]-[(sum of x) (sum of x)]
where: n = # of observations (24-60 months)
x = rate of return for the S&P 500 Index
y = rate of return for the stock

## Equation of Exchange

The quantity theory equation Mv = PQ.

## Regression equation

An equation that describes the average relationship between a dependent variable and a
set of explanatory variables.

## "Soft" Capital Rationing

capital rationing that under certain circumstances can be violated or even viewed
as made up of targets rather than absolute constraints.

## 12b-1 funds

Mutual funds that do not charge an upfront or back-end commission, but instead take out up to
1.25% of average daily fund Assets each year to cover the costs of selling and marketing shares, an
arrangement allowed by the SEC's Rule 12b-I (passed in 1980).

## Abnormal returns

Part of the return that is not due to systematic influences (market wide influences). In
other words, abnormal returns are above those predicted by the market movement alone. Related: excess
returns.

## Absolute Right of Return

Goods may be returned to the seller by the purchaser without restrictions.

## Accelerated cost recovery system (ACRS)

Schedule of depreciation rates allowed for tax purposes.

## Accelerated depreciation

Any depreciation method that produces larger deductions for depreciation in the
early years of a project's life. Accelerated cost recovery system (ACRS), which is a depreciation schedule
allowed for tax purposes, is one such example.

## accelerated depreciation

(1) The estimated useful life of the fixed asset being depreciated is
shorter than a realistic forecast of its probable actual service life;
(2) more of the total cost of the fixed asset is allocated to the first
half of its useful life than to the second half (i.e., there is a
front-end loading of depreciation expense).

## Accelerated depreciation

Any of several methods that recognize an increased amount
of depreciation in the earliest years of asset usage. This results in increased tax benefits
in the first few years of asset usage.

## Accounting rate of return (ARR)

A method of investment appraisal that measures
the profit generated as a percentage of the
investment – see return on investment.

## accounting rate of return (ARR)

the rate of earnings obtained on the average capital investment over the life of a capital project; computed as average annual profits divided by average investment; not based on cash flow

## Accounting system

A set of accounts that summarize the transactions of a business that have been recorded on source documents.

## Acquisition of assets

A merger or consolidation in which an acquirer purchases the selling firm's Assets.

## Active portfolio strategy

A strategy that uses available information and forecasting techniques to seek a
better performance than a portfolio that is simply diversified broadly. Related: passive portfolio strategy

## actual cost system

a valuation method that uses actual direct
material, direct labor, and overhead charges in determining
the cost of Work in Process Inventory

## Additional paid-in capital

Amounts in excess of the par value or stated value that have been paid by the public to acquire stock in the company; synonymous with capital in excess of par.

## Additional paid-in capital

Any payment received from investors for stock that exceeds
the par value of the stock.

## additional paid-in capital

Difference between issue price and par value of stock. Also called capital surplus.

## Adjustable rate preferred stock (ARPS)

Publicly traded issues that may be collateralized by mortgages and MBSs.

## After-tax real rate of return

Money after-tax rate of return minus the inflation rate.

## Aggressive Capitalization Policies

capitalizing and reporting as Assets significant portions of
expenditures, the realization of which require unduly optimistic assumptions.

## Aggressive Cost Capitalization

Cost capitalization that stretches the flexibility within generally
accepted accounting principles beyond its intended limits, resulting in reporting as Assets
items that more reasonably should have been expensed. The purpose of this activity is likely to
alter financial results and financial position in order to create a potentially misleading impression
of a firm's business performance or financial position.

## All equity rate

The discount rate that reflects only the business risks of a project and abstracts from the
effects of financing.

## Allocation base A measure of activity or volume such as labour

hours, machine hours or volume of production
used to apportion overheads to products and
services.

## Alpha

A measure of selection risk (also known as residual risk) of a mutual fund in relation to the market. A
positive alpha is the extra return awarded to the investor for taking a risk, instead of accepting the market
return. For example, an alpha of 0.4 means the fund outperformed the market-based return estimate by 0.4%.
An alpha of -0.6 means a fund's monthly return was 0.6% less than would have been predicted from the
change in the market alone. In a Jensen Index, it is factor to represent the portfolio's performance that
diverges from its beta, representing a measure of the manager's performance.

## Amortizing interest rate swap

Swap in which the principal or national amount rises (falls) as interest rates
rise (decline).

## Annual fund operating expenses

For investment companies, the management fee and "other expenses,"
including the expenses for maintaining shareholder records, providing shareholders with financial statements,
and providing custodial and accounting services. For 12b-1 funds, selling and marketing costs are included.

## Annual percentage rate (APR)

The periodic rate times the number of periods in a year. For example, a 5%
quarterly return has an APR of 20%.

## annual percentage rate (APR)

Interest rate that is annualized using simple interest.

## annual return

The fund return, for any 12-month period, including changes in unit value and the reinvestment of distributions, but not taking into account sales, redemption, distribution or other optional charges or income taxes payable by any unitholder that would reduce returns.

## Annualized holding period return

The annual rate of return that when compounded t times, would have
given the same t-period holding return as actually occurred from period 1 to period t.

## Arithmetic average (mean) rate of return

Arithmetic mean return.

## Arithmetic mean return

An average of the subperiod returns, calculated by summing the subperiod returns
and dividing by he number of subperiods.

## Asset/equity ratio

The ratio of total Assets to stockholder Equity.

## Assets

A firm's productive resources.

## ASSETS

Anything of value that a company owns.

## Assets

Things that the business owns.

## Assets

Items owned by the company or expenses that have been paid for but have not been used up.

## Assets requirements

A common element of a financial plan that describes projected capital spending and the
proposed uses of net working capital.

## Auction rate preferred stock (ARPS)

Floating rate preferred stock, the dividend on which is adjusted every
seven weeks through a Dutch auction.

## authorized share capital

Maximum number of shares that the company is permitted to issue, as specified in the firm’s articles of incorporation.

## Automated storage/retrieval system

A racking system using automated systems
to load and unload the racks.

## Average accounting return

The average project earnings after taxes and depreciation divided by the average
book value of the investment during its life.

## Average cost of capital

A firm's required payout to the bondholders and to the stockholders expressed as a
percentage of capital contributed to the firm. Average cost of capital is computed by dividing the total
required cost of capital by the total amount of contributed capital.

## Average Propensity to Consume

Ratio of consumption to disposable income. See also marginal propensity to consume.

## Average rate of return (ARR)

The ratio of the average cash inflow to the amount invested.

## Average tax rate

Taxes as a fraction of income; total taxes divided by total taxable income.

## average tax rate

Total taxes owed divided by total income.

## Balanced fund

An investment company that invests in stocks and bonds. The same as a balanced mutual fund.

## Balanced mutual fund

This is a fund that buys common stock, preferred stock and bonds. The same as a
balanced fund.

## Barbell strategy

A strategy in which the maturities of the securities included in the portfolio are concentrated
at two extremes.

## Base interest rate

Related: Benchmark interest rate.

## Basic business strategies

Key strategies a firm intends to pursue in carrying out its business plan.

## Benchmark interest rate

Also called the base interest rate, it is the minimum interest rate investors will
demand for investing in a non-Treasury security. It is also tied to the yield to maturity offered on a
comparable-maturity Treasury security that was most recently issued ("on-the-run").

## Beta

A measure of the riskiness of a specific security compared to the
riskiness of the market as a whole; measure of the systematic risk
of a security or a portfolio of securities

## Beta

The price volatility of a financial instrument relative to the price
volatility of a market or index as a whole. beta is most commonly used with
respect to equities. A high-beta instrument is riskier than a low-beta
instrument.

## beta

Sensitivity of a stock’s return to the return on the market
portfolio.

## Beta coefficient

A measurement of the extent to which the returns on a given stock move with stock market.

## Beta equation (Mutual Funds)

The beta of a fund is determined as follows:
[(n) (sum of (xy)) ]-[ (sum of x) (sum of y)]
[(n) (sum of (xx)) ]-[ (sum of x) (sum of x)]
where: n = # of observations (36 months)
x = rate of return for the S&P 500 Index
y = rate of return for the fund

## Beta equation (Stocks)

The beta of a stock is determined as follows:
[(n) (sum of (xy)) ]-[(sum of x) (sum of y)]
[(n) (sum of (xx)) ]-[(sum of x) (sum of x)]
where: n = # of observations (24-60 months)
x = rate of return for the S&P 500 Index
y = rate of return for the stock

## Beta (Mutual Funds)

The measure of a fund's or stocks risk in relation to the market. A beta of 0.7 means
the fund's total return is likely to move up or down 70% of the market change; 1.3 means total return is likely
to move up or down 30% more than the market. beta is referred to as an index of the systematic risk due to
general market conditions that cannot be diversified away.

## Beta risk

Risk of a firm measured from the standpoint of an investor who holds a highly diversified portfolio.

## Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees

A committee formed in response to SEC chairman Arthur Levitt's initiative to improve the financial
reporting environment in the United States. In a report dated February 1999, the committee
made recommendations for new rules for regulation of financial reporting in the United States that
either duplicated or carried forward the recommendations of the Treadway Commission.

## Book-entry securities

The Treasury and federal agencies are moving to a book-entry system in which securities are not represented by engraved pieces of paper but are maintained in computerized records at the
Fed in the names of member banks, which in turn keep records of the securities they own as well as those they
are holding for customers. In the case of other securities where a book-entry has developed, engraved
securities do exist somewhere in quite a few cases. These securities do not move from holder to holder but are
usually kept in a central clearinghouse or by another agent.

## book rate of return

Accounting income divided by book value.
Also called accounting rate of return.

## Book Returns

Book yield is the investment income earned in a year on a portfolio of Assets purchased over a number of years and at different interest rates, divided by the book value of those Assets.

## Bottom-up equity management style

A management style that de-emphasizes the significance of economic
and market cycles, focusing instead on the analysis of individual stocks.

## Break-even payment rate

The prepayment rate of a MBS coupon that will produce the same CFY as that of
a predetermined benchmark MBS coupon. Used to identify for coupons higher than the benchmark coupon
the prepayment rate that will produce the same CFY as that of the benchmark coupon; and for coupons lower
than the benchmark coupon the lowest prepayment rate that will do so.

## Break-even tax rate

The tax rate at which a party to a prospective transaction is indifferent between entering
into and not entering into the transaction.

## Broker loan rate

Related: Call money rate.

## Bullet strategy

A strategy in which a portfolio is constructed so that the maturities of its securities are highly
concentrated at one point on the yield curve.

## business intelligence (BI) system

a formal process for gathering and analyzing information and producing intelligence to meet decision making needs; requires information about
internal processes as well as knowledge, technologies, and competitors

## Buy-and-hold strategy

A passive investment strategy with no active buying and selling of stocks from the
time the portfolio is created until the end of the investment horizon.

## Call money rate

Also called the broker loan rate , the interest rate that banks charge brokers to finance
margin loans to investors. The broker charges the investor the call money rate plus a service charge.

## Capital

Money invested in a firm.

## CAPITAL

The money, raised by selling stock or bonds or taking out loans, that you use to start, operate, and grow a business.

## Capital

The shareholders’ investment in the business; the difference between the Assets and Liabilities
of a business.

## capital

A very broad term rooted in economic theory and referring to
money and other Assets that are invested in a business or other venture
for the general purpose of earning a profit, or a return on the investment.
Generally speaking, the sources of capital for a business are
divided between debt and Equity. Debt, as you know, is borrowed money
on which interest is paid. Equity is the broad term for the ownership
capital invested in a business and is most often called owners’ Equity.
Owners’ Equity arises from two quite different sources: (1) money or
other Assets invested in the business by its owners and (2) profit earned
by the business that is retained and not distributed to its owners (called
retained earnings).

## Capital

The investment by a company’s owners in a business, plus the impact of any
accumulated gains or losses.

## Capital

a) Physical capital: buildings, equipment, and any materials used to produce other goods and services in the future rather than being consumed today.
b) Financial capital: funds available for acquiring real capital.
c) Human capital: the value of the education and experience that make people more productive.

## Capital

Expenditures Purchases of productive long-lived Assets, in particular, items of property,
plant, and equipment.

## Capital

Any asset or stock of Assets, financial or physical, capable of producing income.

## Capital account

Net result of public and private international investment and lending activities.

## Capital Account

That part of the balance of payments accounts that records demands for and supplies of a currency arising from purchases or sales of Assets.

## Capital allocation

decision Allocation of invested funds between risk-free Assets versus the risky portfolio.

## capital asset

an asset used to generate revenues or cost savings
by providing production, distribution, or service capabilities
for more than one year

## Capital asset

A fixed asset, something that is expected to have long-term usage within
a company, and which exceeds a minimum dollar amount (known as the capitalization
limit, or cap limit).

## Capital asset pricing model (CAPM)

An economic theory that describes the relationship between risk and
expected return, and serves as a model for the pricing of risky securities. The CAPM asserts that the only risk
that is priced by rational investors is systematic risk, because that risk cannot be eliminated by diversification.
The CAPM says that the expected return of a security or a portfolio is equal to the rate on a risk-free security
plus a risk premium.

## Capital Asset Pricing Model (CAPM)

A model for estimating equilibrium rates of return and values of
Assets in financial markets; uses beta as a measure of asset risk
relative to market risk

## capital asset pricing model (CAPM)

Theory of the relationship between risk and return which states that the expected risk
premium on any security equals its beta times the market risk premium.

## Capital budget

A firm's set of planned capital expenditures.

## capital budget

management’s plan for investments in longterm
property, plant, and equipment

## capital budget

List of planned investment projects.

## Capital budgeting

The process of choosing the firm's long-term capital Assets.

## capital budgeting

Refers generally to analysis procedures for ranking
investments, given a limited amount of total capital that has to be allocated
among the various capital investment opportunities of a business.
The term sometimes is used interchangeably with the analysis techniques
themselves, such as calculating present value, net present value,
and the internal rate of return of investments.

## Capital Budgeting

The process of ranking and selecting investment alternatives and
capital expenditures

## capital budgeting

a process of evaluating an entity’s proposed
long-range projects or courses of future activity for
the purpose of allocating limited resources to desirable
projects

## Capital budgeting

The series of steps one follows when justifying the decision to purchase
an asset, usually including an analysis of costs and related benefits, which
should include a discounted cash flow analysis of the stream of all future cash flows
resulting from the purchase of the asset.

## capital budgeting decision

Decision as to which real Assets the firm should acquire.

## Capital Consumption Allowance

See depreciation.

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