Definition of Tracking error

Tracking error

In an indexing strategy, the difference between the performance of the benchmark and the
replicating portfolio.

Variance minimization approach to tracking

An approach to bond indexing that uses historical data to
estimate the variance of the tracking error.

Benchmark error

Use of an inappropriate proxy for the true market portfolio.

Measurement error

errors in measuring an explanatory variable in a regression that leads to biases in
estimated parameters.

Net errors and omissions

In balance of payments accounting, net errors and omissions record the statistical
discrepancies that arise in gathering balance of payments data.

Standard error

In statistics, a measure of the possible error in an estimate.

standard error of the estimate

a measure of dispersion that reflects the average difference between actual observations and expected results provided by a regression line

Accounting Errors

Unintentional mistakes in financial statements. Accounted for by restating
the prior-year financial statements that are in error.

Errors and Omissions Insurance

Insurance coverage purchased by the agent/broker which provides protection against loss incurred by a client because of some negligent act, error, oversight, or omission by the agent/broker.

Benchmark

The performance of a predetermined set of securities, for comparison purposes. Such sets may be
based on published indexes or may be customized to suit an investment strategy.

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").

Benchmark issues

Also called on-the-run or current coupon issues or bellwether issues. In the secondary
market, it's the most recently auctioned Treasury issues for each maturity.

Covariance

A statistical measure of the degree to which random variables move together.

Cross-sectional approach

A statistical methodology applied to a set of firms at a particular point in time.

Customized benchmarks

A benchmark that is designed to meet a client's requirements and long-term
objectives.

Debt service parity approach

An analysis wherein the alternatives under consideration will provide the firm
with the exact same schedule of after-tax debt payments (including both interest and principal).

Mean-variance analysis

Evaluation of risky prospects based on the expected value and variance of possible outcomes.

Mean-variance criterion

The selection of portfolios based on the means and variances of their returns. The
choice of the higher expected return portfolio for a given level of variance or the lower variance portfolio for
a given expected return.

Mean-variance efficient portfolio

Related: Markowitz efficient portfolio

Minimum-variance frontier

Graph of the lowest possible portfolio variance that is attainable for a given
portfolio expected return.

Minimum-variance portfolio

The portfolio of risky assets with lowest variance.
Minority interest An outside ownership interest in a subsidiary that is consolidated with the parent for
financial reporting purposes.

Optimization approach to indexing

An approach to indexing which seeks to Optimize some objective, such
as to maximize the portfolio yield, to maximize convexity, or to maximize expected total returns.

Portfolio variance

Weighted sum of the covariance and variances of the assets in a portfolio.

Posttrade benchmarks

Prices after the decision to trade.

Pre-trade benchmarks

Prices occurring before or at the decision to trade.

Residual dividend approach

An approach that suggests that a firm pay dividends if and only if acceptable
investment opportunities for those funds are currently unavailable.

Risk premium approach

The most common approach for tactical asset allocation to determine the relative
valuation of asset classes based on expected returns.

Serial covariance

The covariance between a variable and the lagged value of the variable; the same as
autocovariance.

Sharpe benchmark

A statistically created benchmark that adjusts for a managers' index-like tendencies.

Signaling approach

approach to the determination of the optimal capital structure asserting that insiders in a
firm have information that the market does not have; therefore, the choice of capital structure by insiders can
signal information to outsiders and change the value of the firm. This theory is also called the asymmetric
information approach.

Stratified sampling approach to indexing

An approach in which the index is divided into cells, each
representing a different characteristic of the index, such as duration or maturity.

Variance

A measure of dispersion of a set of data points around their mean value. The mathematical
expectation of the squared deviations from the mean. The square root of the variance is the standard deviation.

Variance rule

Specifies the permitted minimum or maximum quantity of securities that can be delivered to
satisfy a TBA trade. For Ginnie Mae, Fannie Mae, and Feddie Mac pass-through securities, the accepted
variance is plus or minus 2.499999 percent per million of the par value of the TBA quantity.

Variance analysis

A method of budgetary control that compares actual performance against plan, investigates the causes of the variance and takes corrective action to ensure that targets are achieved.

Benchmark

A standard by which something may be compared and measured

Variance

The weighted average of the squared deviations from the
expected value

benchmarking

the process of investigating how others do something better so that the investigating company can imitate,
and possibly improve upon, their techniques

budget variance

the difference between total actual overhead
and budgeted overhead based on standard hours allowed
for the production achieved during the period; computed
as part of two-variance overhead analysis; also
referred to as the controllable variance

controllable variance

the budget variance of the two variance approach to analyzing overhead variances

fixed overhead spending variance

the difference between the total actual fixed overhead and budgeted fixed overhead;
it is computed as part of the four-variance overhead analysis

fixed overhead volume variance

see volume variance

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

labor mix variance

(actual mix X actual hours X standard rate) - (standard mix X actual hours X standard rate);
it presents the financial effect associated with changing the
proportionate amount of higher or lower paid workers in production

labor rate variance

the actual rate (or actual weighted average rate) paid to labor for the period minus the standard rate multiplied by all hours actually worked during the period;
it is actual labor cost minus (actual hours X standard rate)

labor yield variance

(standard mix X actual hours X standard rate) - (standard mix X standard hours X standard rate);
it shows the monetary impact of using more or fewer total hours than the standard allowed

material price variance

total actual cost of material purchased
minus (actual quantity of material  standard
price); it is the amount of money spent below (favorable)
or in excess (unfavorable) of the standard price for the
quantity of materials purchased; it can be calculated based
on the actual quantity of material purchased or the actual
quantity used

material quantity variance

(actual quantity X standard price) - (standard quantity allowed  standard price);
the standard cost saved (favorable) or expended (unfavorable)
due to the difference between the actual quantity
of material used and the standard quantity of material
allowed for the goods produced during the period

material mix variance

(actual mix X actual quantity X standard price) - (standard mix X actual quantity X standardprice);
it computes the monetary effect of substituting a nonstandard mix of material

material yield variance

(standard mix X actual quantity X standard price) - (standard mix X standard quantity X standard price);
it computes the difference between the
actual total quantity of input and the standard total quantity
allowed based on output and uses standard mix and
standard prices to determine variance

net realizable value approach

a method of accounting for by-products or scrap that requires that the net realizable value of these products be treated as a reduction in the cost of the primary products; primary product cost may be reduced by decreasing either
(1) cost of goods sold when the joint products are sold or
(2) the joint process cost allocated to the joint products

noncontrollable variance

the fixed overhead volume variance;
it is computed as part of the two-variance approach to overhead analysis

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

overhead spending variance

the difference between total actual overhead and total budgeted overhead at actual
hours; it is computed as part of three-variance analysis; it
is equal to the sum of the variable and fixed overhead
spending variances

process benchmarking

benchmarking that focuses on practices and how the best-in-class companies achieved their results

realized value approach

a method of accounting for byproducts or scrap that does not recognize any value for these products until they are sold; the value recognized
upon sale can be treated as other revenue or other income

results benchmarking

benchmarking in which an end product or service is examined; the focus is on product/service specifications and performance results

total overhead variance

the difference between total actual overhead and total applied overhead; it is the amount of underapplied or overapplied overhead

total variance

the difference between total actual cost incurred
and total standard cost for the output produced during
the period

variable overhead efficiency variance

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

variable overhead spending variance

the difference between total actual variable overhead and the budgeted amount of variable overhead based on actual input activity

variance

a difference between an actual and a standard or
budgeted cost; it is favorable if actual is less than standard
and is unfavorable if actual is greater than standard

variance analysis

the process of categorizing the nature (favorable or unfavorable) of the differences between standard and actual costs and determining the reasons for those differences

volume variance

a fixed overhead variance that represents
the difference between budgeted fixed overhead and fixed
overhead applied to production of the period; is also referred
to as the noncontrollable variance

Covariance

A measure of the degree to which returns on two assets move in
tandem. A positive covariance means that asset returns move together; a
negative covariance means they vary inversely.

Variance

The dispersion of a variable. The square of the standard deviation.

Direct materials mix variance

The variance between the budgeted and actual mixes of
direct materials costs, both using the actual total quantity used. This variance isolates
the unit cost of each item, excluding all other variables.

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.

Labor rate variance

The difference between the actual and standard direct labor rates
actually paid to the direct labor staff, multiplied by the number of actual hours
worked.

Materials price variance

The difference between the actual and budgeted cost to
acquire materials, multiplied by the total number of units purchased.

Materials quantity variance

The difference between the actual and budgeted quantities
of material used in the production process, multiplied by the standard cost per
unit.

Production yield variance

The difference between the actual and budgeted proportions
of product resulting from a production process, multiplied by the standard unit cost.

Selling price variance

The difference between the actual and budgeted selling price for
a product, multiplied by the actual number of units sold.

variance

Average value of squared deviations from mean. A measure of volatility.

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