One of the problems that professionals in any field of endeavor have is in communicating in terms the general public can understand. A lot of communications are oft referred to as "inside baseball," meaning that it is information that we work with every day and are obviously familiar with but the average person, unless somewhat obsessive about the subject, does not possess.
Accordingly, given that I myself am somewhat guilty of indulging I am herewith providing a glossary of terms we often use or that you may come across from the media and various publications you may read. Hopefully, you will find this informative and useful.
Investment Financial Terms In Plain English
Accrual Basis Accounting: is an accounting method where revenue or expenses are recorded when a transaction occurs rather than when payment is received or made. The method follows the matching principle, which says that revenues and expenses should be recognized in the same period.
Active/Passive Investing: Differing approaches to managing a fund’s basked of securities, also known as its portfolio. Picking individual stocks or securities or timing markets (i.e. when to get into or out of a market or asset class) based on a strategy is considered “active,” while building a portfolio based on indexes or asset classes without picking individual stocks or timing markets is considered “passive.”
Alpha: A measure of a fund’s or portfolio’s performance relative to its benchmark index given the degree of risk taken by its manager. The ability to generate positive alpha (performance above an index return) is seen as a plus.
Arbitrage: An investment strategy seeking to capitalize on price variances for an asset. An example might be buying a stock on one exchange and then selling it on another where it is trading at a higher price.
Bear Market: Typically this refers to a decline of greater than 20% from a stock market peak over a period of months or years.
Beta: A measure of volatility (fluctuations) based on a degree to which a fund or stock moves relative to a benchmark. A fund or stock with high beta experiences higher highs and lower lows and is considered riskier than one with a low beta.
Black Swan Event: An extremely rare and unexpected occurrence having a significant impact on markets such as the 2008 financial crisis. This concept was popularized by the book, “The Black Swan: The Impact of the Highly Improbable” by Nassim Nicholas Taleb.
Bull/Bear: An investor who believes that markets will move higher (bull) or lower (bear).
Correlation: The degree to which two securities (stocks or asset classes) move in the same direction at the same time.
Correction: Generally a 10% drop in stock prices from their high, though it is sometimes used to describe smaller drops occurring in a short time period.
Derivative: A financial instrument such as futures and options in which performance is based on an underlying asset. As an example, an option to buy or sell a stock for a specific price at some future time.
Duration: A measure time until a bond or portfolio of bonds reaches maturity. Given a mixed portfolio of bonds this could relate to an “average duration” representing the average length of time to maturity.
Equities: Just a more “impressive” sounding name for stocks. They represent ownership in a company.
Fixed Income: Generally used to refer to bonds but also other securities that pay a fixed rate of interest or a dividend, including treasuries.
Hedge: An investment used to offset risk as part of a broader strategy. For example, using options as a safeguard against an underperforming investment.
Leverage: The use of borrowed funds, options and other techniques to gain added exposure to an asset’s performance. Leverage is a two edged sword. While it magnifies gains when an investment moves higher, conversely it magnifies the loss when it moves lower.
Market Cap: Short for market capitalization. The total value of the equity of a company as set by the market, calculated by multiplying a company’s share price by the number of shares outstanding. Often divided into large, mid and small cap ranges.
Mean Reversion: The expectation that a security’s returns, if they are higher or lower than they deserve to be, eventually will fall back in line with their historical trend.
Premium / Discount: The extent to which a bond (and even some specific types of stocks) trades at a price above (premium) or below (discount) it’s face value, or the degree to which an exchange traded fund trades above (premium) or below (discount) its net asset value.
Risk on / Risk Off: Market environment in which investors favor either low risk, conservative investments (risk off) or high risk, more speculative ones (risk on).
Valuation: Estimated worth of a company, typically used to determine whether its stock is a bargain, fairly priced, or overpriced.
Volatility: A measure of the degree to which an investment or portfolio fluctuates, typically expressed as its standard deviation (a statistical measurement). Higher volatility suggests a broader range of potential returns and therefore higher risk.
Yield Curve: Rate at which interest rates change as one moves from bonds with shorter maturities to those with longer maturities.