Financial Terms Random walk

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# Definition of Random walk

## Random walk

Theory that stock price changes from day to day are at random; the changes are independent
of each other and have the same probability distribution. Many believers of the random walk theory believe
that it is impossible to outperform the market consistently without taking additional risk.

# Related Terms:

## random walk theory

Security prices change randomly, with no predictable trends or patterns.

## Weak form efficiency

A form of pricing efficiency where the price of the security reflects the past price and
trading history of the security. In such a market, security prices follow a random walk. Related: Semistrong
form efficiency, strong form efficiency.

## Continuous random variable

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

## 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, . . .

## Normal random variable

A random variable that has a normal probability distribution.

## Random variable

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

## Randomized strategy

A strategy of introducing into the decision-making process a random element that is
designed to reduce the information content of the decision-maker's observed choices.

## Random-location storage

The technique of storing incoming inventory in any
available location, which is then tracked in a locator file.

## Agency theory

The analysis of principal-agent relationships, wherein one person, an agent, acts on behalf of
anther person, a principal.

## Arbitrage Pricing Theory (APT)

An alternative model to the capital asset pricing model developed by
Stephen Ross and based purely on arbitrage arguments.

## Asymmetric information

Information that is known to some people but not to other people.

## BARRA's performance analysis (PERFAN)

A method developed by BARRA, a consulting firm in
Berkeley, Calif. It is commonly used by institutional investors applying performance attribution analysis to
evaluate their money managers' performances.

## Bubble theory

Security prices sometimes move wildly above their true values.

## Capital market efficiency

Reflects the relative amount of wealth wasted in making transactions. An efficient
capital market allows the transfer of assets with little wealth loss. See: efficient market hypothesis.

## Committee, AIMR Performance Presentation Standards Implementation Committee

The Association for Investment Management and Research (AIMR)'s Performance Presentation Standards Implementation
Committee is charged with the responsibility to interpret, revise and update the AIMR Performance
Presentation Standards (AIMR-PPS(TM)) for portfolio performance presentations.

## Efficiency

Reflects the amount of wasted energy.

## Expected value of perfect information

The expected value if the future uncertain outcomes could be known
minus the expected value with no additional information.

## External efficiency

Related: pricing efficiency.

## Flat benefit formula

Method used to determine a participant's benefits in a defined benefit plan by
multiplying months of service by a flat monthly benefit.

## Formula basis

A method of selling a new issue of common stock in which the SEC declares the registration
statement effective on the basis of a price formula rather than on a specific range.

## Information asymmetry

A situation involving information that is known to some, but not all, participants.

## 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.

## Information costs

Transaction costs that include the assessment of the investment merits of a financial asset.
Related: search costs.

## Information services

Organizations that furnish investment and other types of information, such as
information that helps a firm monitor its cash position.

## Information-content effect

The rise in the stock price following the dividend signal.

## Informational efficiency

The speed and accuracy with which prices reflect new information.

## Informationless trades

Trades that are the result of either a reallocation of wealth or an implementation of an
investment strategy that only utilizes existing information.

## Information-motivated trades

Trades in which an investor believes he or she possesses pertinent
information not currently reflected in the stock's price.

## Insider information

Relevant information about a company that has not yet been made public. It is illegal for
holders of this information to make trades based on it, however received.

## Liquidity theory of the term structure

A biased expectations theory that asserts that the implied forward
rates will not be a pure estimate of the market's expectations of future interest rates because they embody a
liquidity premium.

## Local expectations theory

A form of the pure expectations theory which suggests that the returns on bonds
of different maturities will be the same over a short-term investment horizon.

## Market segmentation theory or preferred habitat theory

A biased expectations theory that asserts that the
shape of the yield curve is determined by the supply of and demand for securities within each maturity sector.

## Marketplace price efficiency

The degree to which the prices of assets reflect the available marketplace
information. Marketplace price efficiency is sometimes estimated as the difficulty faced by active
management of earning a greater return than passive management would, after adjusting for the risk
associated with a strategy and the transactions costs associated with implementing a strategy.

## Modern portfolio theory

Principles underlying the analysis and evaluation of rational portfolio choices
based on risk-return trade-offs and efficient diversification.

## Normal annuity form

The manner in which retirement benefits are paid out.

## Normal backwardation theory

Holds that the futures price will be bid down to a level below the expected
spot price.

## Overperform

When a security is expected to appreciate at a rate faster than the overall market.

## Performance attribution analysis

The decomposition of a money manager's performance results to explain
the reasons why those results were achieved. This analysis seeks to answer the following questions: (1) What
were the major sources of added value? (2) Was short-term factor timing statistically significant? (3) Was
market timing statistically significant? And (4), Was security selection statistically significant?

## Performance evaluation

The evaluation of a manager's performance which involves, first, determining
whether the money manager added value by outperforming the established benchmark (performance
measurement) and, second, determining how the money manager achieved the calculated return (performance
attribution analysis).

## Performance measurement

The calculation of the return realized by a money manager over some time interval.

## Performance shares

Shares of stock given to managers on the basis of performance as measured by earnings
per share and similar criteria. A control device used by shareholders to tie management to the self-interest of
shareholders.

## Preferred habitat theory

A biased expectations theory that believes the term structure reflects the
expectation of the future path of interest rates as well as risk premium. However, the theory rejects the
assertion that the risk premium must rise uniformly with maturity. Instead, to the extent that the demand for
and supply of funds does not match for a given maturity range, some participants will shift to maturities
showing the opposite imbalances. As long as such investors are compensated by an appropriate risk premium
whose magnitude will reflect the extent of aversion to either price or reinvestment risk.

## Pricing efficiency

Also called external efficiency, a market characteristic where prices at all times fully
reflect all available information that is relevant to the valuation of securities.

## Pro forma capital structure analysis

A method of analyzing the impact of alternative capital structure
choices on a firm's credit statistics and reported financial results, especially to determine whether the firm will
be able to use projected tax shield benefits fully.

## Pro forma financial statements

Financial statements as adjusted to reflect a projected or planned transaction.

## Pro forma statement

A financial statement showing the forecast or projected operating results and balance
sheet, as in pro forma income statements, balance sheets, and statements of cash flows.

## Pure expectations theory

A theory that asserts that the forward rates exclusively represent the expected
future rates. In other words, the entire term structure reflects the markets expectations of future short-term
rates. For example, an increasing sloping term structure implies increasing short-term interest rates. Related:
biased expectations theories

## Semi-strong form efficiency

A form of pricing efficiency where the price of the security fully reflects all
public information (including, but not limited to, historical price and trading patterns). Compare weak form
efficiency and strong form efficiency.

## Static theory of capital structure

theory that the firm's capital structure is determined by a trade-off of the
value of tax shields against the costs of bankruptcy.

## Strong-form efficiency

Pricing efficiency, where the price of a, security reflects all information, whether or
not it is publicly available. Related: weak form efficiency, semi strong form efficiency

## Tax Reform Act of 1986

A 1986 law involving a major overhaul of the U.S. tax code.

## Underperform

When a security is expected to appreciate at a slower rate than the overall market.

## Unit benefit formula

Method used to determine a participant's benefits in a defined benefit plan by
multiplying years of service by the percentage of salary.

## efficiency

a measure of the degree to which tasks were performed
to produce the best yield at the lowest cost from
the resources available; the degree to which a satisfactory
relationship of outputs to inputs occurs

## information

bits of knowledge or fact that have been carefully
chosen from a body of data and arranged in a meaningful way

## labor efficiency variance

the number of hours actually worked minus the standard hours allowed for the production
achieved multiplied by the standard rate to establish
a value for efficiency (favorable) or inefficiency (unfavorable)
of the work force

## management information system (MIS)

a structure of interrelated elements that collects, organizes, and communicates
data to managers so they may plan, control, evaluate
performance, and make decisions; the emphasis of the
MIS is on internal demands for information rather than external
demands; some or all of the MIS may be computerized
for ease of access to information, reliability of input
and processing, and ability to simulate outcomes of
alternative situations

## manufacturing cycle efficiency (MCE)

a ratio resulting from dividing the actual production time by total lead time;
reflects the proportion of lead time that is value-added

## material requisition form

a source document that indicates
the types and quantities of material to be placed into production
or used in performing a service; it causes materials
and its cost to be released from the Raw Material Inventory
warehouse and sent to Work in Process Inventory

## organizational form

an entityâ€™s legal nature (for example,
sole proprietorship, partnership, corporation)

## overhead efficiency variance

the difference between total budgeted overhead at actual hours and total budgeted
overhead at standard hours allowed for the production
achieved; it is computed as part of a three-variance analysis;
it is the same as variable overhead efficiency variance

## performance evaluation

the process of determining the degree
of success in accomplishing a task; it equates to both
effectiveness and efficiency

## performance management system

a system reflecting the entire package of decisions regarding performance measurement and evaluation

## theory of constraints (TOC)

a method of analyzing the bottlenecks
(constraints) that keep a system from achieving
higher performance; it states that production cannot take
place at a rate faster than the slowest machine or person
in the process

## variable overhead efficiency variance

the difference between budgeted variable overhead based on actual input activity and variable overhead applied to production

## Labor efficiency variance

The difference between the amount of time that was budgeted
to be used by the direct labor staff and the amount actually used, multiplied
by the standard labor rate per hour.

## Pro forma (Proforma)

A set of financial statements that incorporates some assumptions, usually
regarding future events. For example, pro forma statements can be constructed that
extend a companyâ€™s financial statements through the end of its fiscal year, and
which contain assumptions regarding the final few months of the year, which have
not yet occurred.

## expectations theory of exchange rates

theory that expected spot exchange rate equals the forward rate.

## information content of dividends

Dividend increases send good news about cash flow and earnings. Dividend cuts send bad news.

## pecking order theory

Firms prefer to issue debt rather than equity if internal finance is insufficient.

## pro formas

Projected or forecasted financial statements.

## semi-strong-form efficiency

Market prices reflect all publicly available information.

## strong-form efficiency

Market prices rapidly reflect all information that could in principle be used to determine true value.

## trade-off theory

Debt levels are chosen to balance interest tax shields against the costs of financial distress.

## Efficiency

The ability to produce the things most wanted at the least cost.

## Efficiency Wage

Wage that maximizes profits.

See efficiency.

## Quantity Theory of Money

theory that velocity is constant, and so a change in money supply will change nominal income by the same percentage. formalized by the equation Mv = PQ.

## Real Business Cycle Theory

Belief that business cycles arise from real shocks to the economy, such as technology advances and natural resource discoveries, and have little to do with monetary policy.

## Form 1099

A form used by businesses to report to the government payments
made to certain types of suppliers.

## Form 4070

A form used by employees to report to an employer the amount of
their tip income.

## Form 668-W

The standard form used for notifying a company to garnish an employeeâ€™s
wages for unpaid taxes.

## Form 8027

The form used by employers to report tip income by their employees
to the government.

## Form 940

A form used to report federal unemployment tax remittances and liabilities.

## Form 940-EZ

A shortened version of the form 940.
form 941
A form used to identify to the government the amount of all quarterly
wages on which taxes were withheld, the amount of taxes withheld, and any adjustments
to withheld taxes from previous reporting periods.

## Form I-9

The Employment Eligibility Verification form, which must be filled
out for all new employees to establish their identity and eligibility to work.

## Illegal Immigration Reform and Immigrant Responsibility Act of 1996 (IIRIRA)

A federal Act shielding employers from liability if they have made
a good-faith effort to verify a new employeeâ€™s identity and employment eligibility.

## Immigration Reform and Control Act of 1986

A federal Act requiring all employers having at least four employees to verify the identity and employment
eligibility of all regular, temporary, casual, and student employees.

## Uniform Interstate Family Support Act

A federal Act specifying which jurisdiction
shall issue family support-related garnishment orders.

## Uniformed Services Employment and Reemployment Rights Act of 1994

A federal act that minimizes the impact on people serving in the Armed Forces
when they return to civilian employment by avoiding discrimination and increasing
their employment opportunities.

## W-2 Form

A form used to report gross pay and tax deductions for each employee
to the IRS for a calendar year.
W-4 form
A form on which an employee declares the amount of federal tax deductions
to be deducted from his or her pay.

## W-9 Form

A form issued to a companyâ€™s suppliers, requesting that they identify
their form of legal organization and tax identification number.

## Direct-Method Format

A format for the operating section of the cash-flow statement that reports actual cash receipts and cash disbursements from operating activities.

## Indirect-Method Format

A format for the operating section of the cash-flow statement that
presents the derivation of cash flow provided by operating activities. The format starts with net
income and adjusts for all nonoperating items and all noncash expenses and changes in working capital accounts.

## Pro-Forma Earnings

Reported net income with selected nonrecurring items of revenue or gain
and expense or loss deducted from or added back, respectively, to reported net income. Occasionally
selected nonoperating or noncash items are also treated as adjustment items.

## Nonconforming material

Any inventory item that does not match its original design
specifications within approved tolerance levels.

## Medical Information Bureau

This organization was established in 1902. The Medical Information Bureau (M.I.B.) is a non-profit association of life insurance companies. Its purpose is to detect and deter fraud by providing warnings called, alerts, to member companies. For example, if an insurance applicant advised one insurance company of a heart attack and then applied to another insurance company omitting this history, codes, reported by the first insurance company, indicating a heart attack would alert the second insurance company to the undisclosed history. It is a rarity, however, that the alert is the only notice of a specific medical impairement as most applicants completely disclose their history.

## Formalized Line of Credit

A contractual commitment to make loans to a particular borrower up to a specified maximum during a specified period, usually one year.

## Future-Oriented Financial Information

Information about prospective results of operations, financial position and/or changes in financial position, based on assumptions about future economic conditions and courses of action. Future-oriented financial information is presented as either a forecast or a projection.

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