Financial Terms R squared (R^2)

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# Definition of R squared (R^2)

## R squared (R^2)

Square of the correlation coefficient proportion of the variability explained by the linear
regression model. For example, an r squared of 75% means that 75% of the variability observed in the
dependent variable is explained by the independent variable.

## R squared (R^2)

Square of the correlation coefficientthe proportion of the variability in one series that can be
explained by the variability of one or more other series.

# Related Terms:

## economic components model

Abramsâ€™ model for calculating DLOM based on the interaction of discounts from four economic components.
This model consists of four components: the measure of the economic impact of the delay-to-sale, monopsony power to buyers, and incremental transactions costs to both buyers and sellers.

## Gordon model

present value of a perpetuity with growth.
The end-ofyear Gordon model formula is: 1/(r - g)
and the midyear formula is: SQRT(1 + r)/(r - g).

## log size model

Abramsâ€™ model to calculate discount rates as a function of the logarithm of the value of the firm.

## Ordinary least squares (OLS)

regression analysis a statistical technique that minimizes the sum of the Squared deviations between a dependent variable and one or more independent variables and provides the user
with a y-intercept and x-coefficients, as well as feedback such as R2 (explained
variation/total variation) t-statistics, p-values, etc.

## QMDM (quantitative marketability discount model)

model for calculating DLOM for minority interests r the discount rate

## All or none

Requirement that none of an order be executed unless all of it can be executed at the specified price.

## All-or-none underwriting

An arrangement whereby a security issue is canceled if the underwriter is unable
to re-sell the entire issue.

## Arbitrage-free option-pricing models

Yield curve option-pricing models.

## Asset pricing model

A model for determining the required rate of return on an asset.

## Asset pricing model

A model, such as the Capital Asset Pricing model (CAPM), that determines the required
rate of return on a particular asset.

## At-the-money

An option is at-the-money if the strike price of the option is equal to the market price of the
underlying security. For example, if xyz stock is trading at 54, then the xyz 54 option is at-the-money.

## Autocorrelation

The correlation of a variable with itself over successive time intervals.

## Binomial option pricing model

An option pricing model in which the underlying asset can take on only two
possible, discrete values in the next time period for each value that it can take on in the preceding time period.

## Black-Scholes option-pricing model

A model for pricing call options based on arbitrage arguments that uses
the stock price, the exercise price, the risk-free interest rate, the time to expiration, and the standard deviation
of the stock return.

## 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 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.

## Coefficient of determination

A measure of the goodness of fit of the relationship between the dependent and
independent variables in a regression analysis; for instance, the percentage of variation in the return of an
asset explained by the market portfolio return.

## Common stock/other equity

Value of outstanding common shares at par, plus accumulated retained
earnings. Also called shareholders' equity.

## Constant-growth model

Also called the Gordon-Shapiro model, an application of the dividend discount
model which assumes (1) a fixed growth rate for future dividends and (2) a single discount rate.

## Continuous random variable

A random value that can take any fractional value within specified ranges, as
contrasted with a discrete variable.

## Correlation

See: correlation coefficient.

## Correlation coefficient

A standardized statistical measure of the dependence of two random variables,
defined as the covariance divided by the standard deviations of two variables.

## Dependent

Acceptance of a capital budgeting project contingent on the acceptance of another project.

## Deterministic models

Liability-matching models that assume that the liability payments and the asset cash
flows are known with certainty. Related: Compare stochastic models

## Discounted dividend model (DDM)

A formula to estimate the intrinsic value of a firm by figuring the
present value of all expected future dividends.

## Discrete random variable

A random variable that can take only a certain specified set of discrete possible
values - for example, the positive integers 1, 2, 3, . . .

## Dividend discount model (DDM)

A model for valuing the common stock of a company, based on the
present value of the expected cash flows.

## Dividend growth model

A model wherein dividends are assumed to be at a constant rate in perpetuity.

## Dow Jones industrial average

This is the best known U.S.index of stocks. It contains 30 stocks that trade on
the New York Stock Exchange. The Dow, as it is called, is a barometer of how shares of the largest
U.S.companies are performing. There are thousands of investment indexes around the world for stocks,
bonds, currencies and commodities.

## Endogenous variable

A value determined within the context of a model.

## European Monetary System (EMS)

An exchange arrangement formed in 1979 that involves the currencies
of European Union member countries.

## Exogenous variable

A variable whose value is determined outside the model in which it is used. Also called
a parameter.

## Extrapolative statistical models

models that apply a formula to historical data and project results for a
future period. Such models include the simple linear trend model, the simple exponential model, and the
simple autoregressive model.

## Factor model

A way of decomposing the factors that influence a security's rate of return into common and
firm-specific influences.

## First-pass regression

A time series regression to estimate the betas of securities portfolios.

## Garmen-Kohlhagen option pricing model

A widely used model for pricing foreign currency options.

## Hot money

Money that moves across country borders in response to interest rate differences and that moves
away when the interest rate differential disappears.

## Independent project

A project whose acceptance or rejection is independent of the acceptance or rejection of
other projects.

## Index model

A model of stock returns using a market index such as the S&P 500 to represent common or
systematic risk factors.

## Information Coefficient (IC)

The correlation between predicted and actual stock returns, sometimes used to
measure the value of a financial analyst. An IC of 1.0 indicates a perfect linear relationship between predicted
and actual returns, while an IC of 0.0 indicates no linear relationship.

## International Monetary Fund

An organization founded in 1944 to oversee exchange arrangements of
member countries and to lend foreign currency reserves to members with short-term balance of payment
problems.

## International Monetary Market (IMM)

A division of the CME established in 1972 for trading financial
futures. Related: Chicago Mercantile Exchange (CME).

## In-the-money

A put option that has a strike price higher than the underlying futures price, or a call option
with a strike price lower than the underlying futures price. For example, if the March COMEX silver futures
contract is trading at \$6 an ounce, a March call with a strike price of \$5.50 would be considered in-the-money
by \$0.50 an ounce.
Related: put.

## Law of one price

An economic rule stating that a given security must have the same price regardless of the
means by which one goes about creating that security. This implies that if the payoff of a security can be
synthetically created by a package of other securities, the price of the package and the price of the security
whose payoff it replicates must be equal.

## Linear programming

Technique for finding the maximum value of some equation subject to stated linear constraints.

## Linear regression

A statistical technique for fitting a straight line to a set of data points.

## Log-linear least-squares method

A statistical technique for fitting a curve to a set of data points. one of the
variables is transformed by taking its logarithm, and then a straight line is fitted to the transformed set of data
points.

## Market model

This relationship is sometimes called the single-index model. The market model says that the
return on a security depends on the return on the market portfolio and the extent of the security's
responsiveness as measured, by beta. In addition, the return will also depend on conditions that are unique to
the firm. Graphically, the market model can be depicted as a line fitted to a plot of asset returns against
returns on the market portfolio.

## Modeling

The process of creating a depiction of reality, such as a graph, picture, or mathematical
representation.

## Monetary gold

Gold held by governmental authorities as a financial asset.

## Monetary policy

Actions taken by the Board of Governors of the Federal Reserve System to influence the
money supply or interest rates.

## Monetary / non-monetary method

Under this translation method, monetary items (e.g. cash, accounts
payable and receivable, and long-term debt) are translated at the current rate while non-monetary items (e.g.
inventory, fixed assets, and long-term investments) are translated at historical rates.

## Money base

Composed of currency and coins outside the banking system plus liabilities to the deposit money banks.

## Money center banks

Banks that raise most of their funds from the domestic and international money markets, relying less on depositors for funds.

## Money management

Related: Investment management.

## Money manager

Related: Investment manager.

## Money market

Money markets are for borrowing and lending money for three years or less. The securities in
a money market can be U.S.government bonds, treasury bills and commercial paper from banks and
companies.

## Money market demand account

An account that pays interest based on short-term interest rates.

## Money market fund

A mutual fund that invests only in short term securities, such as bankers' acceptances,
commercial paper, repurchase agreements and government bills. The net asset value per share is maintained at
\$1. 00. Such funds are not federally insured, although the portfolio may consist of guaranteed securities
and/or the fund may have private insurance protection.

## Money market hedge

The use of borrowing and lending transactions in foreign currencies to lock in the
home currency value of a foreign currency transaction.

## Money market notes

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

## Money purchase plan

A defined benefit contribution plan in which the participant contributes some part and
the firm contributes at the same or a different rate. Also called and individual account plan.

## Money rate of return

Annual money return as a percentage of asset value.

## Money supply

M1-A: Currency plus demand deposits
M1-B: M1-A plus other checkable deposits.
M2: M1-B plus overnight repos, money market funds, savings, and small (less than \$100M) time deposits.
M3: M-2 plus large time deposits and term repos.
L: M-3 plus other liquid assets.

## Multiple regression

The estimated relationship between a dependent variable and more than one explanatory variable.

## New money

In a Treasury auction, the amount by which the par value of the securities offered exceeds that of
those maturing.

## Normal random variable

A random variable that has a normal probability distribution.

## One man picture

The picture quoted by a broker is said to be a one-man picture if both the bid and offered
prices come from the same source.

## One-factor APT

A special case of the arbitrage pricing theory that is derived from the one-factor model by
using diversification and arbitrage. It shows the expected return on any risky asset is a linear function of a
single factor.

## One-way market

1) A market in which only one side, the bid or asked, is quoted or firm.
2) A market that is moving strongly in one direction.

## Other capital

In the balance of payments, other capital is a residual category that groups all the capital
transactions that have not been included in direct investment, portfolio investment, and reserves categories. It
is divided into long-term capital and short-term capital and, because of its residual status, can differ from
country to country. Generally speaking, other long-term capital includes most non-negotiable instruments of a
year or more like bank loans and mortgages. other short-term capital includes financial assets of less than a
year such as currency, deposits, and bills.

## Other current assets

Value of non-cash assets, including prepaid expenses and accounts receivable, due
within 1 year.

## Other long term liabilities

Value of leases, future employee benefits, deferred taxes and other obligations
not requiring interest payments that must be paid over a period of more than 1 year.

## Other sources

Amount of funds generated during the period from operations by sources other than
depreciation or deferred taxes. Part of Free cash flow calculation.

## Out-of-the-money option

A call option is out-of-the-money if the strike price is greater than the market price
of the underlying security. A put option is out-of-the-money if the strike price is less than the market price of
the underlying security.

## Path dependent option

An option whose value depends on the sequence of prices of the underlying asset
rather than just the final price of the asset.

## Phone switching

In mutual funds, the ability to transfer shares between funds in the same family by
telephone request. There may be a charge associated with these transfers. Phone switching is also possible
among different fund families if the funds are held in street name by a participating broker/dealer.

## Pie model of capital structure

A model of the debt/equity ratio of the firms, graphically depicted in slices of
a pie that represent the value of the firm in the capital markets.

## Postponement option

The option of postponing a project without eliminating the possibility of undertaking it.

## Precautionary demand (for money)

The need to meet unexpected or extraordinary contingencies with a
buffer stock of cash.

## Random variable

A function that assigns a real number to each and every possible outcome of a random experiment.

## Regression analysis

A statistical technique that can be used to estimate relationships between variables.

## Regression equation

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

## Regression toward the mean

The tendency for subsequent observations of a random variable to be closer to its mean.

## Risk prone

Willing to pay money to transfer risk from others.

## Seasoned datings

Extended credit for customers who order goods in periods other than peak seasons.

## Seasoned issue

Issue of a security for which there is an existing market. Related: Unseasoned issue.

## Seasoned new issue

A new issue of stock after the company's securities have previously been issued. A
seasoned new issue of common stock can be made by using a cash offer or a rights offer.

## Second pass regression

A cross-sectional regression of portfolio returns on betas. The estimated slope is the
measurement of the reward for bearing systematic risk during the period analyzed.

## Series bond

Bond that may be issued in several series under the same indenture.

## Series

Options: All option contracts of the same class that also have the same unit of trade, expiration date,
and exercise price. Stocks: shares which have common characteristics, such as rights to ownership and voting,
dividends, par value, etc. In the case of many foreign shares, one series may be owned only by citizens of the
country in which the stock is registered.

## SIMEX (Singapore International Monetary Exchange)

A leading futures and options exchange in Singapore.

## Single factor model

A model of security returns that acknowledges only one common factor.
See: factor model.

## Single index model

A model of stock returns that decomposes influences on returns into a systematic factor,
as measured by the return on the broad market index, and firm specific factors.

## Simple linear regression

A regression analysis between only two variables, one dependent and the other explanatory.

## Simple linear trend model

An extrapolative statistical model that asserts that earnings have a base level and
grow at a constant amount each period.

## Single-index model

Related: market model

## Speculative demand (for money)

The need for cash to take advantage of investment opportunities that may arise.

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