Definition of 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.
The alpha of a fund is determined as follows:
[ (sum of y) -((b)(sum of x)) ] / n
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
The signal-to-noise ratio of an analyst's forecasts. The ratio of alpha to residual standard
An index that uses the capital asset pricing model to determine whether a money manager
outperformed a market index. The "alpha" of an investment or investment manager.
Capital rationing that under certain circumstances can be violated or even viewed
as made up of targets rather than absolute constraints.
Clause causing repayment of a debt, if specified events occur or are not met.
Belief that an effort to keep unemployment below its natural rate results in an accelerating inflation.
The representation of the double-entry system of accounting such that assets are equal to liabilities plus capital.
The formula Assets = Liabilities + Equity.
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.
A ratio computed by dividing annual
sales revenue by the year-end balance of accounts receivable. Technically
speaking, to calculate this ratio the amount of annual credit sales should
be divided by the average accounts receivable balance, but this information
is not readily available from external financial statements. For
reporting internally to managers, this ratio should be refined and finetuned
to be as accurate as possible.
Also called the quick ratio, the ratio of current assets minus inventories, accruals, and prepaid
items to current liabilities.
A ratio that shows how well a company could pay its current debts using only its most liquid or “quick” assets. It’s a more pessimistic—but also realistic—measure of safety than the current ratio, because it ignores sluggish, hard-toliquidate current assets like inventory and notes receivable. Here’s the formula:
(Cash + Accounts receivable + Marketable securities) / (Current liabilities)
See quick ratio
The sum of cash, accounts receivable, and short-term marketable
investments (if any) is divided by
total current liabilities to compute this ratio. Suppose that the short-term
creditors were to pounce on a business and not agree to roll over the
debts owed to them by the business. In this rather extreme scenario, the
acid test ratio reveals whether its cash and near-cash assets are enough
to pay its short-term current liabilities. This ratio is an extreme test that
is not likely to be imposed on a business unless it is in financial straits.
This ratio is quite relevant when a business is in a liquidation situation
or bankruptcy proceedings.
Cash flow provided by operating
activities adjusted to provide a more recurring, sustainable measure. Adjustments to reported cash
provided by operating activities are made to remove such nonrecurring cash items as: the operating
component of discontinued operations, income taxes on items classified as investing or financing activities, income tax benefits from nonqualified employee stock options, the cash effects of purchases and sales of trading securities for nonfinancial firms, capitalized expenditures, and other nonrecurring cash inflows and outflows.
a quality control cost incurred for monitoring
or inspection; compensates for mistakes not eliminated
through prevention activities
A right of shareholders in a merger to demand the payment of a fair price for their shares, as
Articles of incorporation
Legal document establishing a corporation and its structure and purpose.
Asset activity ratios
ratios that measure how effectively the firm is managing its assets.
The ratio of total assets to stockholder equity.
asset turnover ratio
A broad-gauge ratio computed by dividing annual
sales revenue by total assets. It is a rough measure of the sales-generating
power of assets. The idea is that assets are used to make sales, and the
sales should lead to profit. The ultimate test is not sales revenue on
assets, but the profit earned on assets as measured by the return on
assets (ROA) ratio.
Basic Earnings Power Ratio
Percentage of earnings relative to total assets; indication of how
effectively assets are used to generate earnings. It is calculated by
dividing earnings before interest and taxes by the book value of all
Benefit Ratio Method
The proportion of unemployment benefits paid to a company’s
former employees during the measurement period, divided by the total
payroll during the period. This calculation is used by states to determine the unemployment
contribution rate to charge employers.
Benefit Wage Ratio Method
The proportion of total taxable wages for laid off
employees during the measurement period divided by the total payroll during
the period. This calculation is used by states to determine the unemployment
contribution rate to charge employers.
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
Canadian Deposit Insurance Corporation
Better known as CDIC, this is an organization which insures qualifying deposits and GICs at savings institutions, mainly banks and trust companys, which belong to the CDIC for amounts up to $60,000 and for terms of up to five years. Many types of deposits are not insured, such as mortgage-backed deposits, annuities of duration of more than five years, and mutual funds.
Placing one or more limits on the amount of new investment undertaken by a firm, either
by using a higher cost of capital, or by setting a maximum on parts of, and/or the entirety of, the capital
a condition that exists when there is an
upper-dollar constraint on the amount of capital available
to commit to capital asset acquisition
Limit set on the amount of funds available for investment.
Also called financial leverage ratios, these ratios compare debt to total capitalization
and thus reflect the extent to which a corporation is trading on its equity. Capitalization ratios can be
interpreted only in the context of the stability of industry and company earnings and cash flow.
Cash flow coverage ratio
The number of times that financial obligations (for interest, principal payments,
preferred stock dividends, and rental payments) are covered by earnings before interest, taxes, rental
payments, and depreciation.
Cash flow from operations
A firm's net cash inflow resulting directly from its regular operations
(disregarding extraordinary items such as the sale of fixed assets or transaction costs associated with issuing
securities), calculated as the sum of net income plus non-cash expenses that were deducted in calculating net
Cash Flow–to–Income Ratio (CFI)
Adjusted cash flow provided by continuing operations
divided by adjusted income from continuing operations.
CASH FLOWS FROM OPERATIONS
A section on the cash-flow Stockholders’ equity statement that shows how much cash came into a company and how much went out during the normal course of business.
The proportion of a firm's assets held as cash.
ratio of cash and cash equivalents to liabilities; in the case of a bank, the ratio of cash to total deposit liabilities.
Common stock ratios
ratios that are designed to measure the relative claims of stockholders to earnings
(cash flow per share), and equity (book value per share) of a firm.
A single centralized account into which funds collected at regional locations
(lockboxes) are transferred.
System whereby customers make payments to a regional collection center which transfers funds to
a principal bank.
Movement of cash from different lockbox locations into a single concentration
account from which disbursements and investments are made.
A review of all engineering documentation used as the basis
for a manufactured product to see if the documentation accurately represents
the finished product.
Verifying that a delivered product matches authorizing
engineering documentation. This also refers to engineering changes made subsequent
to the initial product release.
contribution margin ratio
the proportion of each revenue dollar remaining after variable costs have been covered;
computed as contribution margin divided by sales
Controlled foreign corporation (CFC)
A foreign corporation whose voting stock is more than 50% owned
by U.S. stockholders, each of whom owns at least 10% of the voting power.
The number of shares of common stock that the security holder will receive from
exercising the call option of a convertible security.
A legal "person" that is separate and distinct from its owners. A corporation is allowed to own
assets, incur liabilities, and sell securities, among other things.
A legal entity, organized under state laws, whose investors purchase
shares of stock as evidence of ownership in it. A corporation is a legal entity, which
eliminates much of the liability for the corporation’s actions from its investors.
Business owned by stockholders who are not personally
liable for the business’s liabilities.
The net present value of an investment divided by the investment's initial cost. Also called
the profitability index.
ratios used to test the adequacy of cash flows generated through earnings for purposes of
meeting debt and lease obligations, including the interest coverage ratio and the fixed charge coverage ratio.
Restriction of loans by lenders so that not all borrowers willing to pay the current interest rate are able to obtain loans.
Indicator of short-term debt paying ability. Determined by dividing current assets by current
liabilities. The higher the ratio, the more liquid the company.
A ratio that shows how many times a company could pay its current debts if it used its current assets to pay them. The formula:
(Current assets) / (Current liabilities)
Calculated to assess the short-term solvency, or debt-paying
ability of a business, it equals total current assets divided by total current
liabilities. Some businesses remain solvent with a relatively low current
ratio; others could be in trouble with an apparently good current ratio.
The general rule is that the current ratio should be 2:1 or higher, but
please take this with a grain of salt, because current ratios vary widely
from industry to industry.
A measure of the ability of a company to use its current assets to
pay its current liabilities. It is calculated by dividing the total current
assets by the total current liabilities.
Current assets divided by current liabilities. This ratio indicates the extent to which the claims of short-term creditors are covered by assets expected to be converted to cash in the near future.
Customary payout ratios
A range of payout ratios that is typical based on an analysis of comparable firms.
Days' sales in inventory ratio
The average number of days' worth of sales that is held in inventory.
Indicator of financial leverage. Compares assets provided by creditors to assets provided
by shareholders. Determined by dividing long-term debt by common stockholder equity.
A comparison of debt to equity in a company's capital structure.
Total debt divided by total assets.
The percentage of debt that is used in the total capitalization of a
company. It is calculated by dividing the total book value of the
debt by the book value of all assets.
Debt-service coverage ratio
Earnings before interest and income taxes plus one-third rental charges, divided
by interest expense plus one-third rental charges plus the quantity of principal repayments divided by one
minus the tax rate.
A widely used financial statement ratio to assess the
overall debt load of a business and its capital structure, it equals total liabilities
divided by total owners’ equity. Both numbers for this ratio are
taken from a business’s latest balance sheet. There is no standard, or
generally agreed on, maximum ratio, such as 1:1 or 2:1. Every industry
is different in this regard. Some businesses, such as financial institutions,
have very high debt-to-equity ratios. In contrast, many businesses
use very little debt relative to their owners’ equity.
The date on which a firm's directors meet and announce the date and amount of the next
The date on which the board of directors has declared a dividend.
A business segment that has been or is planned to be closed or sold off.
Net income and the gain or loss on disposal of a business segment whose assets and operations are clearly distinguishable from the other assets and operations of an entity.
Dividend payout ratio
Percentage of earnings paid out as dividends.
dividend payout ratio
Computed by dividing cash dividends for the year
by the net income for the year. It’s simply the percent of net income distributed
as cash dividends for the year.
dividend payout ratio
Percentage of earnings paid out as dividends.
dividend yield ratio
Cash dividends paid by a business over the most
recent 12 months (called the trailing 12 months) divided by the current
market price per share of the stock. This ratio is reported in the daily
stock trading tables in the Wall Street Journal and other major newspapers.
The product of modified duration and the initial price.
Domestic International Sales Corporation (DISC)
A U.S. corporation that receives a tax incentive for
A common gauge of the price sensitivity of an asset or portfolio to a change in interest rates.
The weighted average of the time until maturity of each of the
expected cash flows of a debt security
The expected life of a fixed-income security considering its coupon
yield, interest payments, maturity, and call features. As market interest rates
rise, the duration of a financial instrument decreases. See Macaulay duration.
The time it takes for a policy or annuity to reach maturity.
Earnings retention ratio
the creation of multi-country markets
by developing transnational rules that reduce the fiscal and
physical barriers to trade as well as encourage greater economic
cooperation among countries
Specialized banking institutions, authorized and chartered by the Federal Reserve Board
in the U.S., which are allowed to engage in transactions that have a foreign or international character. They
are not subject to any restrictions on interstate banking. Foreign banks operating in the U.S. are permitted to
organize and own and Edge corporation.
The duration calculated using the approximate duration formula for a bond with an
embedded option, reflecting the expected change in the cash flow caused by the option. Measures the
responsiveness of a bond's price taking into account the expected cash flows will change as interest rates
change due to the embedded option.
Equation of Exchange
The quantity theory equation Mv = PQ.
The percentage of the assets that were spent to run a mutual fund (as of the last annual
statement). This includes expenses such as management and advisory fees, overhead costs and 12b-1
(distribution and advertising ) fees. The expense ratio does not include brokerage costs for trading the
portfolio, although these are reported as a percentage of assets to the SEC by the funds in a Statement of
Additional Information (SAI). the SAI is available to shareholders on request. Neither the expense ratio or the
SAI includes the transaction costs of spreads, normally incurred in unlisted securities and foreign stocks.
These two costs can add significantly to the reported expenses of a fund. The expense ratio is often termed an
Operating Expense ratio (OER).
The time when the option contract ceases to exist (expires).
An expiration cycle relates to the dates on which options on a particular security expire. A
given option will be placed in 1 of 3 cycles, the January cycle, the February cycle, or the March cycle. At any
point in time, an option will have contracts with 4 expiration dates outstanding, 2 in near-term months and 2
in far-term months.
The last day (in the case of American-style) or the only day (in the case of European-style)
on which an option may be exercised. For stock options, this date is the Saturday immediately following the
3rd Friday of the expiration month; however, brokerage firms may set an earlier deadline for notification of
an option holder's intention to exercise. If Friday is a holiday, the last trading day will be the preceding
Feasible target payout ratios
Payout ratios that are consistent with the availability of excess funds to make
cash dividend payments.
Federal Deposit Insurance Corporation (FDIC)
A federal institution that insures bank deposits.
Financial leverage ratios
Related: capitalization ratios.
The result of dividing one financial statement item by another. ratios help analysts interpret
financial statements by focussing on specific relationships.
Fisher's separation theorem
The firm's choice of investments is separate from its owner's attitudes towards
investments. Also refered to as portfolio separation theorem.
Fixed asset turnover ratio
The ratio of sales to fixed assets.
Fixed Assets Turnover Ratio
A measure of the utilization of a company's fixed assets to
generate sales. It is calculated by dividing the sales for the period
by the book value of the net fixed assets.
Fixed-charge coverage ratio
A measure of a firm's ability to meet its fixed-charge obligations: the ratio of
(net earnings before taxes plus interest charges paid plus long-term lease payments) to (interest charges paid
plus long-term lease payments).
Fixed Charge Coverage Ratio
A measure of how well a company is able to meet its fixed
charges (interest and lease payments) based on the cash
generated by its operations. It is calculated by dividing the
earnings before interest and taxes by the total interest charges
and lease payments incurred by the firm.
Foreign Sales Corporation (FSC)
A special type of corporation created by the Tax Reform Act of 1984 that
is designed to provide a tax incentive for exporting U.S.-produced goods.
Freddie Mac (Federal Home Loan Mortgage Corporation)
A Congressionally chartered corporation that
purchases residential mortgages in the secondary market from S&Ls, banks, and mortgage bankers and
securitizes these mortgages for sale into the capital markets.
The ratio of a pension plan's assets to its liabilities.
Funds From Operations (FFO)
Used by real estate and other investment trusts to define the cash flow from
trust operations. It is earnings with depreciation and amortization added back. A similar term increasingly
used is Funds Available for Distribution (FAD), which is FFO less capital investments in trust property and
the amortization of mortgages.
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