L2 Glossary 2023

G-1 Glossary Abnormal earnings See residual income. Abnormal return The amount by which a security’s actual return differs from its expected return, given the security’s risk and the market’s return. Absolute convergence The idea that developing countries, regardless of their particular characteristics, will eventually catch up with the developed countries and match them in per capita output. Absolute valuation model A model that specifies an asset’s intrinsic value. Absolute version of PPP An extension of the law of one price whereby the prices of goods and services will not differ internationally once exchange rates are considered. Accounting estimates Estimates used in calculating the value of assets or liabilities and in the amount of revenue and expense to allocate to a period. Examples of accounting estimates include, among others, the useful lives of depreciable assets, the salvage value of depreciable assets, product returns, warranty costs, and the amount of uncollectible receivables. Accumulated benefit obligation The actuarial present value of benefits (whether vested or non-vested) attributed, generally by the pension benefit formula, to employee service rendered before a specified date and based on employee service and compensation (if applicable) before that date. The accumulated benefit obligation differs from the projected benefit obligation in that it includes no assumption about future compensation levels. Accuracy The percentage of correctly predicted classes out of total predictions. It is an overall performance metric in classification problems. Acquisition When one company, the acquirer, purchases from the seller most or all of another company’s (the target) shares to gain control of either an entire company, a segment of another company, or a specific group of assets in exchange for cash, stock, or the assumption of liabilities, alone or in combination. Once an acquisition is complete, the acquirer and target merge into a single entity and consolidate management, operations, and resources. Activation function A functional part of a neural network’s node that transforms the total net input received into the final output of the node. The activation function operates like a light dimmer switch that decreases or increases the strength of the input. Active factor risk The contribution to active risk squared resulting from the portfolio’s different-than-benchmark exposures relative to factors specified in the risk model. Active return The return on a portfolio minus the return on the portfolio’s benchmark. Active risk The standard deviation of active returns. Active risk squared The variance of active returns; active risk raised to the second power. Active share A measure of how similar a portfolio is to its benchmark. A manager who precisely replicates the benchmark will have an active share of zero; a manager with no holdings in common with the benchmark will have an active share of one. Active specific risk The contribution to active risk squared resulting from the portfolio’s active weights on individual assets as those weights interact with assets’ residual risk. Adjusted funds from operations (AFFO) Funds from operations adjusted to remove any non-cash rent reported under straight-line rent accounting and to subtract maintenance-type capital expenditures and leasing costs, including leasing agents’ commissions and tenants’ improvement allowances. Adjusted present value As an approach to valuing a company, the sum of the value of the company, assuming no use of debt, and the net present value of any effects of debt on company value. Adjusted R2 Goodness-of-fit measure that adjusts the coefficient of determination, R2, for the number of independent variables in the model. Administrative regulations or administrative law Rules issued by government agencies or other regulators. Advanced set An arrangement in which the reference interest rate is set at the time the money is deposited. Advanced settled An arrangement in which a forward rate agreement (FRA) expires and settles at the same time, at the FRA expiration date. Agency issues Conflicts of interest that arise when the agent in an agency relationship has goals and incentives that differ from the principal to whom the agent owes a fiduciary duty. Also called agency problems or principal–agent problems. Agglomerative clustering A bottom-up hierarchical clustering method that begins with each observation being treated as its own cluster. The algorithm finds the two closest clusters, based on some measure of distance (similarity), and combines them into one new larger cluster. This process is repeated iteratively until all observations are clumped into a single large cluster. Akaike’s information criterion (AIC) A statistic used to compare sets of independent variables for explaining a dependent variable. It is preferred for finding the model that is best suited for prediction. Allowance for loan losses A balance sheet account; it is a contra asset account to loans. Alpha The return on an asset in excess of the asset’s required rate of return; the risk-adjusted return. American Depositary Receipt A negotiable certificate issued by a depositary bank that represents ownership in a non-US company’s deposited equity (i.e., equity held in custody by the depositary bank in the company’s home market). Analysis of variance (ANOVA) The analysis that breaks the total variability of a dataset (such as observations on the dependent variable in a regression) into components representing different sources of variation. Application programming interface (API) A set of well-defined methods of communication between various software components and typically used for accessing external data. Arbitrage 1) The simultaneous purchase of an undervalued asset or portfolio and sale of an overvalued but equivalent asset or portfolio, in order to obtain a riskless profit on the price differential. Taking advantage of a market inefficiency G-2 in a risk-free manner. 2) The condition in a financial market in which equivalent assets or combinations of assets sell for two different prices, creating an opportunity to profit at no risk with no commitment of money. In a well-functioning financial market, few arbitrage opportunities are possible. 3) A risk-free operation that earns an expected positive net profit but requires no net investment of money. Arbitrage-free models Term structure models that project future interest rate paths that emanate from the existing term structure. Resulting prices are based on a no-arbitrage condition. Arbitrage-free valuation An approach to valuation that determines security values consistent with the absence of any opportunity to earn riskless profits without any net investment of money. Arbitrage opportunity An opportunity to conduct an arbitrage; an opportunity to earn an expected positive net profit without risk and with no net investment of money. Arbitrage portfolio The portfolio that exploits an arbitrage opportunity. Ask price The price at which a trader will sell a specified quantity of a security. Also called ask, offer price, or offer. Asset-based approach Approach that values a private company based on the values of the underlying assets of the entity less the value of any related liabilities. Asset-based valuation An approach to valuing natural resource companies that estimates company value on the basis of the market value of the natural resources the company controls. At market contract When a forward contract is established, the forward price is negotiated so that the market value of the forward contract on the initiation date is zero. Authorized participants (APs) A special group of institutional investors who are authorized by the ETF issuer to participate in the creation/redemption process. APs are large broker/dealers, often market makers. Autocorrelations The correlations of a time series with its own past values. Autoregressive model (AR) A time series regressed on its own past values in which the independent variable is a lagged value of the dependent variable. Backtesting The process that approximates the real-life investment process, using historical data, to assess whether an investment strategy would have produced desirable results. Backward propagation The process of adjusting weights in a neural network, to reduce total error of the network, by moving backward through the network’s layers. Backwardation A condition in the futures markets in which the spot price exceeds the futures price, the forward curve is downward sloping, and the convenience yield is high. Bag-of-words (BOW) A collection of a distinct set of tokens from all the texts in a sample dataset. BOW does not capture the position or sequence of words present in the text. Balance sheet restructuring Altering the composition of the balance sheet by either shifting the asset composition, changing the capital structure, or both. Bankruptcy A declaration provided for by a country’s laws that typically involves the establishment of a legal procedure that forces creditors to defer their claims. Barbell portfolio Fixed-income portfolio that combines short and long maturities. Base error Model error due to randomness in the data. Glossary Basic earnings per share (EPS) Net earnings available to common shareholders (i.e., net income minus preferred dividends) divided by the weighted average number of common shares outstanding during the period. Basis The difference between the spot price and the futures price. As the maturity date of the futures contract nears, the basis converges toward zero. Basis trade A trade based on the pricing of credit in the bond market versus the price of the same credit in the CDS market. To execute a basis trade, go long the “underpriced” credit and short the “overpriced” credit. A profit is realized as the implied credit prices converge. Bearish flattening Term structure shift in which short-term bond yields rise more than long-term bond yields, resulting in a flatter yield curve. Benchmark value of the multiple In using the method of comparables, the value of a price multiple for the comparison asset; when we have comparison assets (a group), the mean or median value of the multiple for the group of assets. Best ask The offer to sell with the lowest ask price. Also called best offer or inside ask. Best bid The highest bid in the market. Best offer The lowest offer (ask price) in the market. Bias error Describes the degree to which a model fits the training data. Algorithms with erroneous assumptions produce high bias error with poor approximation, causing underfitting and high in-sample error. Bid price In a price quotation, the price at which the party making the quotation is willing to buy a specified quantity of an asset or security. Bid–ask spread The ask price minus the bid price. Bill-and-hold basis Sales on a bill-and-hold basis involve selling products but not delivering those products until a later date. Blockage factor An illiquidity discount that occurs when an investor sells a large amount of stock relative to its trading volume (assuming it is not large enough to constitute a controlling ownership). Bond indenture A legal contract specifying the terms of a bond issue. Bond risk premium The expected excess return of a default-free long-term bond less that of an equivalent short-term bond. Bond yield plus risk premium (BYPRP) approach An estimate of the cost of common equity that is produced by summing the before-tax cost of debt and a risk premium that captures the additional yield on a company’s stock relative to its bonds. Bonus issue of shares A type of dividend in which a company distributes additional shares of its common stock to shareholders instead of cash. Book value The net amount shown for an asset or liability on the balance sheet; book value may also refer to the company’s excess of total assets over total liabilities. Also called carrying value. Book value of equity Shareholders’ equity (total assets minus total liabilities) minus the value of preferred stock; common shareholders’ equity. Book value per share The amount of book value (also called carrying value) of common equity per share of common stock, calculated by dividing the book value of shareholders’ equity by the number of shares of common stock outstanding. Glossary Bootstrap aggregating (or bagging) A technique whereby the original training dataset is used to generate n new training datasets or bags of data. Each new bag of data is generated by random sampling with replacement from the initial training set. Bootstrapping The use of a forward substitution process to determine zero-coupon rates by using the par yields and solving for the zero-coupon rates one by one, from the shortest to longest maturities. Bottom-up approach With respect to forecasting, an approach that usually begins at the level of the individual company or a unit within the company. Breakup value The value derived using a sum-of-the-parts valuation. Breusch–Godfrey (BG) test A test used to detect autocorrelated residuals up to a predesignated order of the lagged residuals. Breusch–Pagan (BP) test A test for the presence of heteroskedasticity in a regression. Bullet portfolio A fixed-income portfolio concentrated in a single maturity. Bullish flattening Term structure change in which the yield curve flattens in response to a greater decline in long-term rates than short-term rates. Bullish steepening Term structure change in which short-term rates fall by more than long-term yields, resulting in a steeper term structure. Buy-side analysts Analysts who work for investment management firms, trusts, bank trust departments, and similar institutions. Buyback A transaction in which a company buys back its own shares. Unlike stock dividends and stock splits, share repurchases use corporate cash. CDS spread A periodic premium paid by the buyer to the seller that serves as a return over a market reference rate required to protect against credit risk. Callable bond A bond containing an embedded call option that gives the issuer the right to buy the bond back from the investor at specified prices on pre-determined dates. Canceled shares Shares that were issued, subsequently repurchased by the company, and then retired (cannot be reissued). Capital asset pricing model (CAPM) A single factor model such that excess returns on a stock are a function of the returns on a market index. Capital charge The company’s total cost of capital in money terms. Capital deepening An increase in the capital-to-labor ratio. Capitalization of earnings method In the context of private company valuation, a valuation model based on an assumption of a constant growth rate of free cash flow to the firm or a constant growth rate of free cash flow to equity. Capitalization rate The divisor in the expression for the value of perpetuity. In the context of real estate, it is the divisor in the direct capitalization method of estimating value. The cap rate equals net operating income divided by value. Capitalized cash flow method In the context of private company valuation, a valuation model based on an assumption of a constant growth rate of free cash flow to the firm or a constant growth rate of free cash flow to equity. Also called capitalized cash flow model. G-3 Capitalized income method In the context of private company valuation, a valuation model based on an assumption of a constant growth rate of free cash flow to the firm or a constant growth rate of free cash flow to equity. Capped floater Floating-rate bond with a cap provision that prevents the coupon rate from increasing above a specified maximum rate. It protects the issuer against rising interest rates. Carry arbitrage model A no-arbitrage approach in which the underlying instrument is either bought or sold along with an opposite position in a forward contract. Carry benefits Benefits that arise from owning certain underlyings; for example, dividends, foreign interest, and bond coupon payments. Carry costs Costs that arise from owning certain underlyings. They are generally a function of the physical characteristics of the underlying asset and also the interest forgone on the funds tied up in the asset. Cash available for distribution See adjusted funds from operations. Cash-generating unit The smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows of other assets or groups of assets. Cash settlement A procedure used in certain derivative transactions that specifies that the long and short parties settle the derivative’s difference in value between them by making a cash payment. Catalyst An event or piece of information that causes the marketplace to re-evaluate the prospects of a company. Ceiling analysis A systematic process of evaluating different components in the pipeline of model building. It helps to understand what part of the pipeline can potentially improve in performance by further tuning. Centroid The center of a cluster formed using the k-means clustering algorithm. Chain rule of forecasting A forecasting process in which the next period’s value as predicted by the forecasting equation is substituted into the right-hand side of the equation to give a predicted value two periods ahead. Cheapest-to-deliver The debt instrument that can be purchased and delivered at the lowest cost yet has the same seniority as the reference obligation. Classification and regression tree A supervised machine learning technique that can be applied to predict either a categorical target variable, producing a classification tree, or a continuous target variable, producing a regression tree. CART is commonly applied to binary classification or regression. Clean surplus relation The relationship between earnings, dividends, and book value in which ending book value is equal to the beginning book value plus earnings less dividends, apart from ownership transactions. Club convergence The idea that only rich and middle-income countries sharing a set of favorable attributes (i.e., are members of the “club”) will converge to the income level of the richest countries. Cluster A subset of observations from a dataset such that all the observations within the same cluster are deemed “similar.” Clustering The sorting of observations into groups (clusters) such that observations in the same cluster are more similar to each other than they are to observations in other clusters. Cobb–Douglas production function A function of the form Y = Kα L1−α relating output (Y) to labor (L) and capital (K) inputs. G-4 Coefficient of determination The percentage of the variation of the dependent variable that is explained by the independent variables. Also referred to as the R-squared or R2. Cointegrated Describes two time series that have a long-term financial or economic relationship such that they do not diverge from each other without bound in the long run. Collateral return The component of the total return on a commodity futures position attributable to the yield for the bonds or cash used to maintain the futures position. Also called collateral yield. Collection frequency (CF) The number of times a given word appears in the whole corpus (i.e., collection of sentences) divided by the total number of words in the corpus. Commercial real estate properties Income-producing real estate properties; properties purchased with the intent to let, lease, or rent (in other words, produce income). Commodity swap A type of swap involving the exchange of payments over multiple dates as determined by specified reference prices or indexes relating to commodities. Company fundamental factors Factors related to the company’s internal performance, such as factors relating to earnings growth, earnings variability, earnings momentum, and financial leverage. Company share-related factors Valuation measures and other factors related to share price or the trading characteristics of the shares, such as earnings yield, dividend yield, and book-to-market value. Comparables Assets used as benchmarks when applying the method of comparables to value an asset. Also called comps, guideline assets, or guideline companies. Compiled financial statements Financial statements that are not accompanied by an auditor’s opinion letter. Complexity A term referring to the number of features, parameters, or branches in a model and to whether the model is linear or non-linear (non-linear is more complex). Composite variable A variable that combines two or more variables that are statistically strongly related to each other. Comprehensive income All changes in equity other than contributions by, and distributions to, owners; income under clean surplus accounting; includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. Comprehensive income equals net income plus other comprehensive income. Comps Assets used as benchmarks when applying the method of comparables to value an asset. Concentrated ownership Ownership structure consisting of an individual shareholder or a group (controlling shareholders) with the ability to exercise control over the corporation. Conditional convergence The idea that convergence of per capita income is conditional on the countries having the same savings rate, population growth rate, and production function. Conditional heteroskedasticity A condition in which the variance of residuals of a regression are correlated with the value of the independent variables. Conditional VaR (CVaR) The weighted average of all loss outcomes in the statistical (i.e., return) distribution that exceed the VaR loss. Thus, CVaR is a more comprehensive measure of tail loss than VaR is. Sometimes referred to as the expected tail loss or expected shortfall. Glossary Confirmation bias A belief perseverance bias in which people tend to look for and notice what confirms their beliefs, to ignore or undervalue what contradicts their beliefs, and to misinterpret information as support for their beliefs. Confusion matrix A grid used for error analysis in classification problems, it presents values for four evaluation metrics including true positive (TP), false positive (FP), true negative (TN), and false negative (FN). Conglomerate discount When an issuer is trading at a valuation lower than the sum of its parts, which is generally the result of diseconomies of scale or scope or the result of the capital markets having overlooked the business and its prospects. Constant dividend payout ratio policy A policy in which a constant percentage of net income is paid out in dividends. Constant returns to scale The condition that if all inputs into the production process are increased by a given percentage, then output rises by that same percentage. Contango A condition in the futures markets in which the spot price is lower than the futures price, the forward curve is upward sloping, and there is little or no convenience yield. Contingent consideration Potential future payments to the seller that are contingent on the achievement of certain agreed-on occurrences. Continuing earnings Earnings excluding nonrecurring components. Also referred to as core earnings, persistent earnings, or underlying earnings. Continuing residual income Residual income after the forecast horizon. Continuing value The analyst’s estimate of a stock’s value at a particular point in the future. Control premium An increment or premium to value associated with a controlling ownership interest in a company. Convergence The tendency for differences in output per capita across countries to diminish over time. In technical analysis, the term describes the case when an indicator moves in the same manner as the security being analyzed. Conversion period For a convertible bond, the period during which bondholders have the right to convert their bonds into shares. Conversion price For a convertible bond, the price per share at which the bond can be converted into shares. Conversion rate (or ratio) For a convertible bond, the number of shares of common stock that a bondholder receives from converting the bond into shares. Conversion value For a convertible bond, the value of the bond if it is converted at the market price of the shares. Also called parity value. Convertible bond Bond that gives the bondholder the right to exchange the bond for a specified number of common shares in the issuing company. Convexity A measure of how interest rate sensitivity changes with a change in interest rates. Cook’s distance A metric for identifying influential data points. Also known as Cook’s D (Di). Core earnings Earnings excluding nonrecurring components. Also referred to as continuing earnings, persistent earnings, or underlying earnings. Core real estate investment style Investing in high-quality, well-leased, core property types with low leverage (no more than 30% of asset value) in the largest markets with strong, diversified economies. It is a conservative strategy designed to avoid real estate–specific risks, including leasing, development, and speculation in favor of steady returns. Hotel Glossary properties are excluded from the core categories because of the higher cash flow volatility resulting from single-night leases and the greater importance of property operations, brand, and marketing. Corpus A collection of text data in any form, including list, matrix, or data table forms. Cost approach An approach that values a private company based on the values of the underlying assets of the entity less the value of any related liabilities. In the context of real estate, this approach estimates the value of a property based on what it would cost to buy the land and construct a new property on the site that has the same utility or functionality as the property being appraised. Cost of carry model A model that relates the forward price of an asset to the spot price by considering the cost of carry (also referred to as future-spot parity model). Cost of debt The required return on debt financing to a company, such as when it issues a bond, takes out a bank loan, or leases an asset through a finance lease. Cost of equity The return required by equity investors to compensate for both the time value of money and the risk. Also referred to as the required rate of return on common stock or the required return on equity. Cost restructuring Actions to reduce costs by improving operational efficiency and profitability, often to raise margins to a historical level or to those of comparable industry peers. Country risk premium (CRP) The additional return required by investors to compensate for the risk associated with investing in a foreign country relative to the investor’s domestic market. Country risk rating (CRR) The rating of a country based on many risk factors, including economic prosperity, political risk, and ESG risk. Covariance stationary Describes a time series when its expected value and variance are constant and finite in all periods and when its covariance with itself for a fixed number of periods in the past or future is constant and finite in all periods. Covered bonds A senior debt obligation of a financial institution that gives recourse to the originator/issuer and a predetermined underlying collateral pool. Covered interest rate parity The relationship among the spot exchange rate, the forward exchange rate, and the interest rates in two currencies that ensures that the return on a hedged (i.e., covered) foreign risk-free investment is the same as the return on a domestic risk-free investment. Also called interest rate parity. Cox-Ingersoll-Ross model A general equilibrium term structure model that assumes interest rates are mean reverting and interest rate volatility is directly related to the level of interest rates. Creation basket The list of securities (and share amounts) the authorized participant (AP) must deliver to the ETF manager in exchange for ETF shares. The creation basket is published each business day. Creation units Large blocks of ETF shares transacted between the authorized participant (AP) and the ETF manager that are usually but not always equal to 50,000 shares of the ETF. Creation/redemption The process in which ETF shares are created or redeemed by authorized participants transacting with the ETF issuer. Credit correlation The correlation of credit (or default) risks of the underlying single-name CDS contained in an index CDS. G-5 Credit curve The credit spreads for a range of maturities of a company’s debt. Credit default swap A derivative contract between two parties in which the buyer makes a series of cash payments to the seller and receives a promise of compensation for credit losses resulting from the default. Credit derivative A derivative instrument in which the underlying is a measure of the credit quality of a borrower. Credit event An event that defines a payout in a credit derivative. Events are usually defined as bankruptcy, failure to pay an obligation, or an involuntary debt restructuring. Credit protection buyer One party to a credit default swap; the buyer makes a series of cash payments to the seller and receives a promise of compensation for credit losses resulting from the default. Credit protection seller One party to a credit default swap; the seller makes a promise to pay compensation for credit losses resulting from the default. Credit risk The risk of loss caused by a counterparty’s or debtor’s failure to make a promised payment. Also called default risk. Credit spread The compensation for the risk inherent in a company’s debt security. Credit valuation adjustment The value of the credit risk of a bond in present value terms. Cross-validation A technique for estimating out-of-sample error directly by determining the error in validation samples. Cumulative preferred stock Preferred stock that requires that the dividends be paid in full to preferred stock owners for any missed dividends prior to any payment of dividends to common stock owners. Current exchange rate For accounting purposes, the spot exchange rate on the balance sheet date. Current rate method Approach to translating foreign currency financial statements for consolidation in which all assets and liabilities are translated at the current exchange rate. The current rate method is the prevalent method of translation. Curvature One of the three factors (the other two are level and steepness) that empirically explain most of the changes in the shape of the yield curve. A shock to the curvature factor affects mid-maturity interest rates, resulting in the term structure becoming either more or less hump-shaped. Curve trade Buying a CDS of one maturity and selling a CDS on the same reference entity with a different maturity. Customer concentration risk The risk associated with sales dependent on a few customers. Cyclical businesses Businesses with high sensitivity to business- or industry-cycle influences. Data preparation (cleansing) The process of examining, identifying, and mitigating (i.e., cleansing) errors in raw data. Data snooping The practice of determining a model by extensive searching through a dataset for statistically significant patterns. Data wrangling (preprocessing) This task performs transformations and critical processing steps on cleansed data to make the data ready for ML model training (i.e., preprocessing), and includes dealing with outliers, extracting useful variables from existing data points, and scaling the data. Deep learning Machine learning using neural networks with many hidden layers. G-6 Deep neural networks Neural networks with many hidden layers—at least 2 but potentially more than 20—that have proven successful across a wide range of artificial intelligence applications. Default risk See credit risk. Defined benefit pension plans Plans in which the company promises to pay a certain annual amount (defined benefit) to the employee after retirement. The company bears the investment risk of the plan assets. Defined contribution pension plans Individual accounts to which an employee and typically the employer makes contributions during their working years and expect to draw on the accumulated funds at retirement. The employee bears the investment and inflation risk of the plan assets. Delay costs Implicit trading costs that arise from the inability to complete desired trades immediately. Also called slippage. Delta The relationship between the option price and the underlying price, which reflects the sensitivity of the price of the option to changes in the price of the underlying. Delta is a good approximation of how an option price will change for a small change in the stock. Dendrogram A type of tree diagram used for visualizing a hierarchical cluster analysis; it highlights the hierarchical relationships among the clusters. Depository Trust and Clearinghouse Corporation A US-headquartered entity providing post-trade clearing, settlement, and information services. Diluted earnings per share (Diluted EPS)Net income, minus preferred dividends, divided by the weighted average number of common shares outstanding considering all dilutive securities (e.g., convertible debt and options); the EPS that would result if all dilutive securities were converted into common shares. Dilution A reduction in proportional ownership interest as a result of the issuance of new shares. Dimension reduction A set of techniques for reducing the number of features in a dataset while retaining variation across observations to preserve the information contained in that variation. Diminishing marginal productivity When each additional unit of an input, keeping the other inputs unchanged, increases output by a smaller increment. Direct capitalization method In the context of real estate, this method estimates the value of an income-producing property based on the level and quality of its net operating income. Discount To reduce the value of a future payment in allowance for how far away it is in time; to calculate the present value of some future amount. Also, the amount by which an instrument is priced below its face value. Discount factor The price equivalent of a zero rate. Also may be stated as the present value of a currency unit on a future date. Discount for lack of control An amount or percentage deducted from the pro rata share of 100% of the value of an equity interest in a business to reflect the absence of some or all of the powers of control. Discount for lack of marketability An amount of percentage deducted from the value of an ownership interest to reflect the relative absence of marketability. Discount function Discount factors for the range of all possible maturities. The spot curve can be derived from the discount function and vice versa. Glossary Discounted abnormal earnings model A model of stock valuation that views intrinsic value of stock as the sum of book value per share plus the present value of the stock’s expected future residual income per share. Discounted cash flow (DCF) method Income approach that values an asset based on estimates of future cash flows discounted to present value by using a discount rate reflective of the risks associated with the cash flows. In the context of real estate, this method estimates the value of an income-producing property based on discounting future projected cash flows. Discounted cash flow method Income approach that values an asset based on estimates of future cash flows discounted to present value by using a discount rate reflective of the risks associated with the cash flows. In the context of real estate, this method estimates the value of an income-producing property based on discounting future projected cash flows. Discounted cash flow model A model of intrinsic value that views the value of an asset as the present value of the asset’s expected future cash flows. Dispersed ownership Ownership structure consisting of many shareholders, none of which has the ability to individually exercise control over the corporation. Divestiture When a seller sells a company, segment of a company, or group of assets to an acquirer. Once complete, control of the target is transferred to the acquirer. Dividend A distribution paid to shareholders based on the number of shares owned. Dividend coverage ratio The ratio of net income to dividends. Dividend discount model (DDM) A present value model of stock value that views the intrinsic value of a stock as present value of the stock’s expected future dividends. Dividend discount model (DDM) The model of the value of stock that is the present value of all future dividends, discounted at the required return on equity. Dividend displacement of earnings The concept that dividends paid now displace earnings in all future periods. Dividend imputation tax system A taxation system that effectively assures corporate profits distributed as dividends are taxed just once and at the shareholder’s tax rate. Dividend index point A measure of the quantity of dividends attributable to a particular index. Dividend payout ratio The ratio of cash dividends paid to earnings for a period. Dividend policy The strategy a company follows with regard to the amount and timing of dividend payments. Dividend rate The annualized amount of the most recent dividend. Dividend recapitalization Restructuring the mix of debt and equity, typically shifting the capital structure from equity to debt through debt-financed share repurchases. The objective is to reduce the issuer’s weighted average cost of capital by replacing expensive equity with cheaper debt by purchasing equity from shareholders using newly issued debt. Dividend yield Annual dividends per share divided by share price. Divisive clustering A top-down hierarchical clustering method that starts with all observations belonging to a single large cluster. The observations are then divided into two clusters based on some measure of distance (similarity). The algorithm then progressively partitions the intermediate clusters into smaller ones until each cluster contains only one observation. Glossary Document frequency (DF) The number of documents (texts) that contain a particular token divided by the total number of documents. It is the simplest feature selection method and often performs well when many thousands of tokens are present. Document term matrix (DTM) A matrix where each row belongs to a document (or text file), and each column represents a token (or term). The number of rows is equal to the number of documents (or text files) in a sample text dataset. The number of columns is equal to the number of tokens from the BOW built using all the documents in the sample dataset. The cells typically contain the counts of the number of times a token is present in each document. Dominance An arbitrage opportunity when a financial asset with a risk-free payoff in the future must have a positive price today. Double taxation system Corporate earnings are taxed twice when paid out as dividends. First, corporate pretax earnings are taxed regardless of whether they will be distributed as dividends or retained at the corporate level. Second, dividends are taxed again at the individual shareholder level. Downstream A transaction between two related companies, an investor company (or a parent company) and an associate company (or a subsidiary) such that the investor company records a profit on its income statement. An example is a sale of inventory by the investor company to the associate or by a parent to a subsidiary company. Dual-class shares Shares that grant one share class superior or even sole voting rights, whereas the other share class has inferior or no voting rights. Due diligence Investigation and analysis in support of an investment action, decision, or recommendation. Dummy variable An independent variable that takes on a value of either 1 or 0, depending on a specified condition. Also known as an indicator variable. Duration A measure of the approximate sensitivity of a security to a change in interest rates (i.e., a measure of interest rate risk). Durbin–Watson (DW) test A test for the presence of first-order serial correlation. Dutch disease A situation in which currency appreciation driven by strong export demand for resources makes other segments of the economy (particularly manufacturing) globally uncompetitive. ESG integration An ESG investment approach that focuses on systematic consideration of material ESG factors in asset allocation, security selection, and portfolio construction decisions for the purpose of achieving the product’s stated investment objectives. Used interchangeably with ESG investing. Earnings surprise The portion of a company’s earnings that is unanticipated by investors and, according to the efficient market hypothesis, merits a price adjustment. Earnings yield EPS divided by price; the reciprocal of the P/E. Economic profit Equal to accounting profit less the implicit opportunity costs not included in total accounting costs; the difference between total revenue (TR) and total cost (TC). Also called abnormal profit or supernormal profit. Economic sectors Large industry groupings. Economic value added (EVA®) A commercial implementation of the residual income concept; the computation of EVA® is the net operating profit after taxes minus the cost of capital, where these inputs are adjusted for a number of items. G-7 Economies of scale A situation in which average costs per unit of good or service produced fall as volume rises. In reference to mergers, the savings achieved through the consolidation of operations and elimination of duplicate resources. Edwards–Bell–Ohlson model A model of stock valuation that views intrinsic value of stock as the sum of book value per share plus the present value of the stock’s expected future residual income per share. Effective convexity A curve convexity statistic that measures the secondary effect of a change in a benchmark yield curve on a bond’s price. Effective duration Sensitivity of the bond’s price to a 100 bps parallel shift of the benchmark yield curve, assuming no change in the bond’s credit spread. Effective spread Two times the difference between the execution price and the midpoint of the market quote at the time an order is entered. Eigenvalue A measure that gives the proportion of total variance in the initial dataset that is explained by each eigenvector. Eigenvector A vector that defines new mutually uncorrelated composite variables that are linear combinations of the original features. Embedded options Contingency provisions found in a bond’s indenture or offering circular representing rights that enable their holders to take advantage of interest rate movements. They can be exercised by the issuer, by the bondholder, or automatically depending on the course of interest rates. Ensemble learning A technique of combining the predictions from a collection of models to achieve a more accurate prediction. Ensemble method The method of combining multiple learning algorithms, as in ensemble learning. Enterprise value Total company value (the market value of debt, common equity, and preferred equity) minus the value of cash and investments. Enterprise value multiple A valuation multiple that relates the total market value of all sources of a company’s capital (net of cash) to a measure of fundamental value for the entire company (such as a pre-interest earnings measure). Equity charge The estimated cost of equity capital in money terms. Equity investment A company purchasing another company’s equity but less than 50% of its shares. The two companies maintain their independence, but the investor company has investment exposure to the investee and, in some cases depending on the size of the investment, can have representation on the investee’s board of directors to influence operations. Equity REITs REITs that own, operate, and/or selectively develop income-producing real estate. Equity risk premium (ERP) Compensation for bearing market risk. Equity swap A swap transaction in which at least one cash flow is tied to the return on an equity portfolio position, often an equity index. Error autocorrelations The autocorrelations of the error term. Ex ante tracking error A measure of the degree to which the performance of a given investment portfolio might be expected to deviate from its benchmark; also known as relative VaR. G-8 Ex ante version of PPP The hypothesis that expected changes in the spot exchange rate are equal to expected differences in national inflation rates. An extension of relative purchasing power parity to expected future changes in the exchange rate. Ex-dividend Trading ex-dividend refers to shares that no longer carry the right to the next dividend payment. Ex-dividend date The first date that a share trades without (i.e., “ex”) the right to receive the declared dividend for the period. Excess earnings method Income approach that estimates the value of all intangible assets of the business by capitalizing future earnings in excess of the estimated return requirements associated with working capital and fixed assets. Exercise date The date when employees actually exercise stock options and convert them to stock. Exercise value The value of an option if it were exercised. Also sometimes called intrinsic value. Expanded CAPM An adaptation of the CAPM that adds to the CAPM a premium for small size and company-specific risk. Expectations approach A procedure for obtaining the value of an option derived from discounting at the risk-free rate its expected future payoff based on risk neutral probabilities. Expected exposure The projected amount of money an investor could lose if an event of default occurs, before factoring in possible recovery. Expected shortfall The average loss conditional on exceeding the VaR cutoff; sometimes referred to as conditional VaR or expected tail loss. Expected tail loss See expected shortfall. Exploratory data analysis (EDA) The preliminary step in data exploration, where graphs, charts, and other visualizations (heat maps and word clouds) as well as quantitative methods (descriptive statistics and central tendency measures) are used to observe and summarize data. Exposure to foreign exchange risk The risk of a change in value of an asset or liability denominated in a foreign currency due to a change in exchange rates. Extendible bond Bond with an embedded option that gives the bondholder the right to keep the bond for a number of years after maturity, possibly with a different coupon. Extra dividend A dividend paid by a company that does not pay dividends on a regular schedule, or a dividend that supplements regular cash dividends with an extra payment. F1 score The harmonic mean of precision and recall. F1 score is a more appropriate overall performance metric (than accuracy) when there is unequal class distribution in the dataset and it is necessary to measure the equilibrium of precision and recall. FX carry trade An investment strategy that involves taking long positions in high-yield currencies and short positions in low-yield currencies. Factor A common or underlying element with which several variables are correlated. Factor betas An asset’s sensitivity to a particular factor; a measure of the response of return to each unit of increase in a factor, holding all other factors constant. Factor portfolio See pure factor portfolio. Factor price The expected return in excess of the risk-free rate for a portfolio with a sensitivity of 1 to one factor and a sensitivity of 0 to all other factors. Glossary Factor risk premium The expected return in excess of the risk-free rate for a portfolio with a sensitivity of 1 to one factor and a sensitivity of 0 to all other factors. Also called factor price. Factor risk premiums The expected return in excess of the risk-free rate for a portfolio with a sensitivity of 1 to one factor and a sensitivity of 0 to all other factors. Also called factor price. Failure to pay When a borrower does not make a scheduled payment of principal or interest on any outstanding obligations after a grace period. Fair market value The price, expressed in terms of cash equivalents, at which a property (asset) would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at “arm’s length” in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts. Fair market value is most often used in a tax reporting context in the United States. Fair value The amount at which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s-length transaction; the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Fama–French models Factor models that explain the drivers of returns related to three, four, or five factors. Feature engineering A process of creating new features by changing or transforming existing features. Feature selection A process whereby only pertinent features from the dataset are selected for model training. Selecting fewer features decreases model complexity and training time. Features The independent variables (X’s) in a labeled dataset. Finance (or capital) lease A lease that is viewed as a financing arrangement. Financial contagion A situation in which financial shocks spread from their place of origin to other locales. In essence, a faltering economy infects other, healthier economies. Financial leverage The use of fixed sources of capital, such as debt, relative to sources without fixed costs, such as equity. Financial transaction A purchase involving a buyer having essentially no material synergies with the target (e.g., the purchase of a private company by a company in an unrelated industry or by a private equity firm would typically be a financial transaction). First-differencing A transformation that subtracts the value of the time series in period t − 1 from its value in period t. First-order serial correlation The correlation of residuals with residuals adjacent in time. Fitting curve A curve which shows in- and out-of-sample error rates (Ein and Eout) on the y-axis plotted against model complexity on the x-axis. Fixed price tender offer Offer made by a company to repurchase a specific number of shares at a fixed price that is typically at a premium to the current market price. Fixed-rate perpetual preferred stock Nonconvertible, noncallable preferred stock that has a fixed dividend rate and no maturity date. Flight to quality During times of market stress, investors sell higher-risk asset classes such as stocks and commodities in favor of default-risk-free government bonds. Float Amounts collected as premium and not yet paid out as benefits. Glossary Floored floater Floating-rate bond with a floor provision that prevents the coupon rate from decreasing below a specified minimum rate. It protects the investor against declining interest rates. Flotation cost Fees charged to companies by investment bankers and other costs associated with raising new capital. Forced conversion For a convertible bond, when the issuer calls the bond and forces bondholders to convert their bonds into shares, which typically happens when the underlying share price increases above the conversion price. Foreign currency transactions Transactions that are denominated in a currency other than a company’s functional currency. Forward curve A series of forward rates, each having the same time frame. Forward dividend yield A dividend yield based on the anticipated dividend during the next 12 months. Forward-looking estimates Estimates based on current and expectations. Also referred to as ex ante estimates. Forward P/E A P/E calculated on the basis of a forecast of EPS; a stock’s current price divided by next year’s expected earnings. Forward price Represents the price agreed upon in a forward contract to be exchanged at the contract’s maturity date, T. This price is shown in equations as F0(T). Forward pricing model The model that describes the valuation of forward contracts. Forward propagation The process of adjusting weights in a neural network, to reduce total error of the network, by moving forward through the network’s layers. Forward rate An interest rate determined today for a loan that will be initiated in a future period. Forward rate agreement An over-the-counter forward contract in which the underlying is an interest rate on a deposit. A forward rate agreement (FRA) calls for one party to make a fixed interest payment and the other to make an interest payment at a rate to be determined at contract expiration. Forward rate model The forward pricing model expressed in terms of spot and forward interest rates. Forward rate parity The proposition that the forward exchange rate is an unbiased predictor of the future spot exchange rate. Forward value The monetary value of an existing forward contract. Franchising An owner of an asset and associated intellectual property divests the asset and licenses intellectual property to a third-party operator (franchisee) in exchange for royalties. Franchisees operate under the constraints of a franchise agreement. Franking credit A tax credit received by shareholders for the taxes that a corporation paid on its distributed earnings. Free cash flow method Income approach that values an asset based on estimates of future cash flows discounted to present value by using a discount rate reflective of the risks associated with the cash flows. Free cash flow to equity The cash flow available to a company’s common shareholders after all operating expenses, interest, and principal payments have been made and necessary investments in working and fixed capital have been made. Free cash flow to equity model A model of stock valuation that views a stock’s intrinsic value as the present value of expected future free cash flows to equity. G-9 Free cash flow to the firm The cash flow available to the company’s suppliers of capital after all operating expenses (including taxes) have been paid and necessary investments in working and fixed capital have been made. Free cash flow to the firm model A model of stock valuation that views the value of a firm as the present value of expected future free cash flows to the firm. Frequency analysis The process of quantifying how important tokens are in a sentence and in the corpus as a whole. It helps in filtering unnecessary tokens (or features). Functional currency The currency of the primary economic environment in which an entity operates. Fundamental factor models A multifactor model in which the factors are attributes of stocks or companies that are important in explaining cross-sectional differences in stock prices. Fundamentals Economic characteristics of a business, such as profitability, financial strength, and risk. Funds available for distribution (FAD) See adjusted funds from operations. Funds from operations (FFO) Net income (computed in accordance with generally accepted accounting principles) plus (1) gains and losses from sales of properties and (2) depreciation and amortization. Futures price The pre-agreed price at which a futures contract buyer (seller) agrees to pay (receive) for the underlying at the maturity date of the futures contract. Futures value The monetary value of an existing futures contract. Gamma A numerical measure of how sensitive an option’s delta (the sensitivity of the derivative’s price) is to a change in the value of the underlying. General linear F-test A test statistic used to assess the goodness of fit for an entire regression model, so it tests all independent variables in the model. Generalize When a model retains its explanatory power when predicting out-of-sample (i.e., using new data). Global CAPM (GCAPM) A single-factor model with a global index representing the single factor. Going-concern assumption The assumption that the business will maintain its business activities into the foreseeable future. Going-concern value A business’s value under a going-concern assumption. Goodwill An intangible asset that represents the excess of the purchase price of an acquired company over the value of the net identifiable assets acquired. Gordon growth model A DDM that assumes dividends grow at a constant rate into the future. Grant date The day that stock options are granted to employees. Green bond Bonds in which the proceeds are designated by issuers to fund a specific project or portfolio of projects that have environmental or climate benefits. Greenmail The purchase of the accumulated shares of a hostile investor by a company that is targeted for takeover by that investor, usually at a substantial premium over market price. Greenwashing The risk that a green bond’s proceeds are not actually used for a beneficial environmental or climate-related project. G-10 Grid search A method of systematically training a model by using various combinations of hyperparameter values, cross validating each model, and determining which combination of hyperparameter values ensures the best model performance. Gross domestic product The market value of all final goods and services produced within the economy during a given period (output definition) or, equivalently, the aggregate income earned by all households, all companies, and the government within the economy during a given period (income definition). Gross lease A lease under which the tenant pays a gross rent to the landlord, who is responsible for all operating costs, utilities, maintenance expenses, and real estate taxes relating to the property. Ground truth The known outcome (i.e., target variable) of each observation in a labelled dataset. Growth accounting equation The production function written in the form of growth rates. For the basic Cobb–Douglas production function, it states that the growth rate of output equals the rate of technological change plus α multiplied by the growth rate of capital plus (1 − α) multiplied by the growth rate of labor. Growth capital expenditures Capital expenditures needed for expansion. Guideline assets Assets used as benchmarks when applying the method of comparables to value an asset. Guideline companies Assets used as benchmarks when applying the method of comparables to value an asset. Guideline public companies Public-company comparables for the company being valued. Guideline public company method A variation of the market approach; establishes a value estimate based on the observed multiples from trading activity in the shares of public companies viewed as reasonably comparable to the subject private company. Guideline transactions method A variation of the market approach; establishes a value estimate based on pricing multiples derived from the acquisition of control of entire public or private companies that were acquired. Harmonic mean A type of weighted mean computed as the reciprocal of the arithmetic average of the reciprocals. Hazard rate The probability that an event will occur, given that it has not already occurred. Hedonic index Unlike a repeat-sales index, a hedonic index does not require repeat sales of the same property. It requires only one sale. The way it controls for the fact that different properties are selling each quarter is to include variables in the regression that control for differences in the characteristics of the property, such as size, age, quality of construction, and location. Heteroskedastic When the variance of the residuals differs across observations in a regression. Heteroskedasticity The property of having a nonconstant variance; refers to an error term with the property that its variance differs across observations. Hierarchical clustering An iterative unsupervised learning procedure used for building a hierarchy of clusters. High-leverage point An observation of an independent variable that has an extreme value and is potentially influential. Highest and best use The concept that the best use of a vacant site is the use that would result in the highest value for the land. Presumably, the developer that could earn the highest Glossary risk-adjusted profit based on time, effort, construction and development cost, leasing, and exit value would be the one to pay the highest price for the land. Historical exchange rates For accounting purposes, the exchange rates that existed when the assets and liabilities were initially recorded. Historical scenario analysis A technique for exploring the performance and risk of investment strategies in different structural regimes. Historical simulation A simulation method that uses past return data and a random number generator that picks observations from the historical series to simulate an asset’s future returns. Historical simulation method The application of historical price changes to the current portfolio. Historical stress testing The process that tests how investment strategies would perform under some of the most negative (i.e., adverse) combinations of events and scenarios. Ho–Lee model The first arbitrage-free term structure model. The model is calibrated to market data and uses a binomial lattice approach to generate a distribution of possible future interest rates. Holdout samples Data samples that are not used to train a model. Homoskedasticity The property of having a constant variance; refers to an error term that is constant across observations. Horizontal ownership Companies with mutual business interests (e.g., key customers or suppliers) that have cross-holding share arrangements with each other. Human capital An implied asset; the net present value of an investor’s future expected labor income weighted by the probability of surviving to each future age. Also called net employment capital. Hybrid approach With respect to forecasting, an approach that combines elements of both top-down and bottom-up analyses. Hyperparameter A parameter whose value must be set by the researcher before learning begins. iNAVs “Indicated” net asset values are intraday “fair value” estimates of an ETF share based on its creation basket. ISDA Master Agreement A standard or “master” agreement published by the International Swaps and Derivatives Association. The master agreement establishes the terms for each party involved in the transaction. I-spreads Shortened form of “interpolated spreads” and a reference to a linearly interpolated yield. Idiosyncratic risk premium (IRP) The additional return required for bearing company-specific risks. Illiquidity discount A reduction or discount to value that reflects the lack of depth of trading or liquidity in that asset’s market. Impairment Diminishment in value as a result of carrying (book) value exceeding fair value and/or recoverable value. Impairment of capital rule A legal restriction that dividends cannot exceed retained earnings. Implementation shortfall (IS) The difference between the return for a notional or paper portfolio, where all transactions are assumed to take place at the manager’s decision price, and the portfolio’s actual return, which reflects realized transactions, including all fees and costs. Implied volatility The standard deviation that causes an option pricing model to give the current option price. Glossary In-sample forecast errors The residuals from a fitted time-series model within the sample period used to fit the model. Income approach A valuation approach that values an asset as the present discounted value of the income expected from it. In the context of real estate, this approach estimates the value of a property based on an expected rate of return. The estimated value is the present value of the expected future income from the property, including proceeds from resale at the end of a typical investment holding period. Incremental borrowing rate (IBR) The rate of interest that the lessee would have to pay to borrow using a collateralized loan over the same term as a lease. Incremental VaR (IVaR) A measure of the incremental effect of an asset on the VaR of a portfolio by measuring the difference between the portfolio’s VaR while including a specified asset and the portfolio’s VaR with that asset eliminated. Indenture A written contract between a lender and borrower that specifies the terms of the loan, such as interest rate, interest payment schedule, or maturity. Independent board directors Directors with no material relationship with the company with regard to employment, ownership, or remuneration. Independent regulators Regulators recognized and granted authority by a government body or agency. They are not government agencies per se and typically do not rely on government funding. Index CDS A type of credit default swap that involves a combination of borrowers. Industry risk premium (IP) The additional return that is required to bear industry -specific risk. Industry shocks Unexpected changes to an industry from regulations or the legal environment, technology, or changes in the growth rate of the industry. Industry structure An industry’s underlying economic and technical characteristics. Influence plot A visual that shows, for all observations, studentized residuals on the y-axis, leverage on the x-axis, and Cook’s D as circles whose size is proportional to the degree of influence of the given observation. Influential observation An observation in a statistical analysis whose inclusion may significantly alter regression results. Information gain A metric which quantifies the amount of information that the feature holds about the response. Information gain can be regarded as a form of non-linear correlation between Y and X. Information ratio (IR) Mean active return divided by active risk; or alpha divided by the standard deviation of diversifiable risk. Informational frictions Forces that restrict availability, quality, and/or flow of information and its use. Inside ask See best ask. Inside bid See best bid. Inside spread The spread between the best bid price and the best ask price. Also called the market bid-ask spread, inside bid-ask spread, or market spread. Insiders Corporate managers and board directors who are also shareholders of a company. Intangible assets Assets without a physical form, such as patents and trademarks. Inter-temporal rate of substitution The ratio of the marginal utility of consumption s periods in the future (the numerator) to the marginal utility of consumption today (the denominator). G-11 Interaction term A term that combines two or more variables and represents their joint influence on the dependent variable. Intercept dummy An indicator variable that allows a single regression model to estimate two lines of best fit, each with differing intercepts, depending on whether the dummy takes a value of 1 or 0. Interest rate risk The risk that interest rates will rise and therefore the market value of current portfolio holdings will fall so that their current yields to maturity then match comparable instruments in the marketplace. Interlocking directorates Corporate structure in which individuals serve on the board of directors of multiple corporations. International CAPM (ICAPM) A two-factor model with a global index and a wealth-weighted currency index. International Fisher effect The proposition that nominal interest rate differentials across currencies are determined by expected inflation differentials. Intrinsic value The amount gained (per unit) by an option buyer if an option is exercised at any given point in time. May be referred to as the exercise value of the option. Inverse price ratio The reciprocal of a price multiple—for example, in the case of a P/E, the “earnings yield” E/P (where P is share price and E is earnings per share). Investment value The value to a specific buyer, taking account of potential synergies based on the investor’s requirements and expectations. Joint test of hypotheses The test of hypotheses that specify values for two or more independent variables in the hypotheses. Joint venture Two or more companies form and control a new, separate company to achieve a business objective. Each participant contributes assets, employees, know-how, or other resources to the joint venture company. The participants maintain their independence otherwise and continue to do business apart from the joint venture, but they share in the joint venture’s profits or losses. Judicial law Interpretations of courts. Justified price multiple The estimated fair value of the price multiple, usually based on forecasted fundamentals or comparables. Justified (fundamental) P/E The price-to-earnings ratio that is fair, warranted, or justified on the basis of forecasted fundamentals. K-fold cross-validation A technique in which data (excluding test sample and fresh data) are shuffled randomly and then are divided into k equal sub-samples, with k – 1 samples used as training samples and one sample, the kth, used as a validation sample. K-means A clustering algorithm that repeatedly partitions observations into a fixed number, k, of non-overlapping clusters. K-nearest neighbor A supervised learning technique that classifies a new observation by finding similarities (“nearness”) between this new observation and the existing data. Kalotay–Williams–Fabozzi (KWF) model An arbitrage-free term structure model that describes the dynamics of the log of the short rate and assumes constant drift, no mean reversion, and constant volatility. Key rate durations Sensitivity of a bond’s price to changes in specific maturities on the benchmark yield curve. Also called partial durations. G-12 kth-order autocorrelation The correlation between observations in a time series separated by k periods. LASSO Least absolute shrinkage and selection operator is a type of penalized regression which involves minimizing the sum of the absolute values of the regression coefficients. LASSO can also be used for regularization in neural networks. Labeled dataset A dataset that contains matched sets of observed inputs or features (X’s) and the associated output or target (Y). Labor force Everyone of working age (ages 16 to 64) who either is employed or is available for work but not working. Labor force participation rate The percentage of the working age population that is in the labor force. Labor productivity The quantity of goods and services (real GDP) that a worker can produce in one hour of work. Labor productivity growth accounting equation States that potential GDP growth equals the growth rate of the labor input plus the growth rate of labor productivity. Lack of marketability discount An extra return to investors to compensate for lack of a public market or lack of marketability. Latency The elapsed time between the occurrence of an event and a subsequent action that depends on that event. Law of one price A principle that states that if two investments have the same or equivalent future cash flows regardless of what will happen in the future, then these two investments should have the same current price. Leading dividend yield Forecasted dividends per share over the next year divided by current stock price. Leading P/E A P/E calculated on the basis of a forecast of EPS; a stock’s current price divided by next year’s expected earnings. Learning curve A curve that plots the accuracy rate (= 1 – error rate) in the validation or test samples (i.e., out-of-sample) against the amount of data in the training sample, which is thus useful for describing under- and overfitting as a function of bias and variance errors. Learning rate A parameter that affects the magnitude of adjustments in the weights in a neural network. Level One of the three factors (the other two are steepness and curvature) that empirically explain most yield curve shape changes. A shock to the level factor changes the yield for all maturities by an almost identical amount. Leverage A measure for identifying a potentially influential high-leverage point. Leveraged buyout (LBO) An acquirer (typically an investment fund specializing in LBOs) uses a significant amount of debt to finance the acquisition of a target and then pursues restructuring actions, with the goal of exiting the target with a sale or public listing. Libor–OIS spread The difference between Libor and the overnight indexed swap rate. Likelihood ratio (LR) test A method to assess the fit of logistic regression models and is based on the log-likelihood metric that describes the model’s fit to the data. Limit order book The book or list of limit orders to buy and sell that pertains to a security. Linear classifier A binary classifier that makes its classification decision based on a linear combination of the features of each data point. Linear trend A trend in which the dependent variable changes at a constant rate with time. Glossary Liquidating dividend A dividend that is a return of capital rather than a distribution from earnings or retained earnings. Liquidation value The value of a company if the company were dissolved and its assets sold individually. Liquidity preference theory A term structure theory that asserts liquidity premiums exist to compensate investors for the added interest rate risk they face when lending long term. Liquidity premium An extra return that compensates investors for the risk of loss relative to an investment’s fair value if the investment needs to be converted to cash quickly. Local currency The currency of the country where a company is located. Local expectations theory A term structure theory that contends the return for all bonds over short periods is the risk-free rate. Log-linear model With reference to time-series models, a model in which the growth rate of the time series as a function of time is constant. Log odds The natural log of the odds of an event or characteristic happening. Also known as the logit function. Logistic regression (logit) A regression in which the dependent variable uses a logistic transformation of the event probability. Logistic transformation The log of the probability of an occurrence of an event or characteristic divided by the probability of the event or characteristic not occurring. Long/short credit trade A credit protection seller with respect to one entity combined with a credit protection buyer with respect to another entity. Look-ahead bias A bias caused by using information that was unavailable on the test date. Lookback period The time period used to gather a historical data set. Loss given default The amount that will be lost if a default occurs. Macroeconomic factor model A multifactor model in which the factors are surprises in macroeconomic variables that significantly explain equity returns. Macroeconomic factors Factors related to the economy, such as the inflation rate, industrial production, or economic sector membership. Maintenance capital expenditures Capital expenditures needed to maintain operations at the current level. Majority shareholders Shareholders that own more than 50% of a corporation’s shares. Majority-vote classifier A classifier that assigns to a new data point the predicted label with the most votes (i.e., occurrences). Marginal VaR (MVaR) A measure of the effect of a small change in a position size on portfolio VaR. Market approach Valuation approach that values an asset based on pricing multiples from sales of assets viewed as similar to the subject asset. Market conditions Interest rates, inflation rates, and other economic characteristics that comprise the macroeconomic environment. Market conversion premium per share For a convertible bond, the difference between the market conversion price and the underlying share price, which allows investors to identify the premium or discount payable when buying a convertible bond rather than the underlying common stock. Glossary Market conversion premium ratio For a convertible bond, the market conversion premium per share expressed as a percentage of the current market price of the shares. Market efficiency A finance perspective on capital markets that deals with the relationship of price to intrinsic value. The traditional efficient markets formulation asserts that an asset’s price is the best available estimate of its intrinsic value. The rational efficient markets formulation asserts that investors should expect to be rewarded for the costs of information gathering and analysis by higher gross returns. Market fragmentation Trading the same instrument in multiple venues. Market impact The effect of the trade on transaction prices. Also called price impact. Market model A regression model with the return on a stock as the dependent variable and the returns on a market index as the independent variable. Market value of invested capital The market value of debt and equity. Mature growth rate The earnings growth rate in a company’s mature phase; an earnings growth rate that can be sustained long term. Maximum drawdown The worst cumulative loss ever sustained by an asset or portfolio. More specifically, maximum drawdown is the difference between an asset’s or a portfolio’s maximum cumulative return and its subsequent lowest cumulative return. Maximum likelihood estimation (MLE) A method that estimates values for the intercept and slope coefficients in a logistic regression that make the data in the regression sample most likely. Mean reversion The tendency of a time series to fall when its level is above its mean and rise when its level is below its mean; a mean-reverting time series tends to return to its long-term mean. Metadata Data that describes and gives information about other data. Method based on forecasted fundamentals An approach to using price multiples that relates a price multiple to forecasts of fundamentals through a discounted cash flow model. Method of comparables An approach to valuation that involves using a price multiple to evaluate whether an asset is relatively fairly valued, relatively undervalued, or relatively overvalued when compared to a benchmark value of the multiple. Midquote price The average, or midpoint, of the prevailing bid and ask prices. Minority interest The proportion of the ownership of a subsidiary not held by the parent (controlling) company. Minority shareholders Particular shareholders or a block of shareholders holding a small proportion of a company’s outstanding shares, resulting in a limited ability to exercise control in voting activities. Mispricing Any departure of the market price of an asset from the asset’s estimated intrinsic value. Model specification The set of independent variables included in a model and the model’s functional form. Molodovsky effect The observation that P/Es tend to be high on depressed EPS at the bottom of a business cycle and tend to be low on unusually high EPS at the top of a business cycle. G-13 Momentum indicators Valuation indicators that relate either price or a fundamental (such as earnings) to the time series of their own past values (or in some cases to their expected value). Monetary assets and liabilities Assets and liabilities with value equal to the amount of currency contracted for, a fixed amount of currency. Examples are cash, accounts receivable, accounts payable, bonds payable, and mortgages payable. Inventory is not a monetary asset. Most liabilities are monetary. Monetary/non-monetary method Approach to translating foreign currency financial statements for consolidation in which monetary assets and liabilities are translated at the current exchange rate. Non-monetary assets and liabilities are translated at historical exchange rates (the exchange rates that existed when the assets and liabilities were acquired). Monetizing Unwinding a position to either capture a gain or realize a loss. Monte Carlo simulation A technique that uses the inverse transformation method for converting a randomly generated uniformly distributed number into a simulated value of a random variable of a desired distribution. Each key decision variable in a Monte Carlo simulation requires an assumed statistical distribution; this assumption facilitates incorporating non-normality, fat tails, and tail dependence as well as solving high-dimensionality problems. Mortgage A loan with real estate serving as collateral for the loan. Multicollinearity When two or more independent variables are highly correlated with one another or are approximately linearly related. Multiple linear regression Modeling and estimation method that uses two or more independent variables to describe the variation of the dependent variable. Also referred to as multiple regression. Mutual information Measures how much information is contributed by a token to a class of texts. MI will be 0 if the token’s distribution in all text classes is the same. MI approaches 1 as the token in any one class tends to occur more often in only that particular class of text. N-grams A representation of word sequences. The length of a sequence varies from 1 to n. When one word is used, it is a unigram; a two-word sequence is a bigram; and a 3-word sequence is a trigram; and so on. n-Period moving average The average of the current and immediately prior n − 1 values of a time series. NTM P/E Next 12-month P/E: current market price divided by an estimated next 12-month EPS. Naked credit default swap A position where the owner of the CDS does not have a position in the underlying credit. Name entity recognition An algorithm that analyzes individual tokens and their surrounding semantics while referring to its dictionary to tag an object class to the token. Negative serial correlation A situation in which residuals are negatively related to other residuals. Nested models Models in which one regression model has a subset of the independent variables of another regression model. Net asset balance sheet exposure When assets translated at the current exchange rate are greater in amount than liabilities translated at the current exchange rate. Assets exposed to translation gains or losses exceed the exposed liabilities. G-14 Net asset value per share (NAVPS) Net asset value divided by the number of shares outstanding. Net lease A lease under which the tenant pays a net rent to the landlord and an additional amount based on the tenant’s pro rata share of the operating costs, utilities, maintenance expenses, and real estate taxes relating to the property. Net liability balance sheet exposure When liabilities translated at the current exchange rate are greater assets translated at the current exchange rate. Liabilities exposed to translation gains or losses exceed the exposed assets. Net operating income (NOI) Gross rental revenue minus operating costs but before deducting depreciation, corporate overhead, and interest expense. In the context of real estate, a measure of the income from the property after deducting operating expenses for such items as property taxes, insurance, maintenance, utilities, repairs, and insurance but before deducting any costs associated with financing and before deducting federal income taxes. It is similar to EBITDA in a financial reporting context. Net regulatory burden The private costs of regulation less the private benefits of regulation. Network externalities The impact that users of a good, a service, or a technology have on other users of that product; it can be positive (e.g., a critical mass of users makes a product more useful) or negative (e.g., congestion makes the product less useful). Neural networks Computer programs based on how our own brains learn and process information. No-arbitrage approach A procedure for obtaining the value of an option based on the creation of a portfolio that replicates the payoffs of the option and deriving the option value from the value of the replicating portfolio. No-growth company A company without positive expected net present value projects. No-growth value per share The value per share of a no-growth company, equal to the expected level amount of earnings divided by the stock’s required rate of return. Non-cash rent An amount equal to the difference between the average contractual rent over a lease term (the straight-line rent) and the cash rent actually paid during a period. This figure is one of the deductions made from FFO to calculate AFFO. Non-convergence trap A situation in which a country remains relatively poor, or even falls further behind, because it fails to implement necessary institutional reforms and/or adopt leading technologies. Non-monetary assets and liabilities Assets and liabilities that are not monetary assets and liabilities. Non-monetary assets include inventory, fixed assets, and intangibles, and non-monetary liabilities include deferred revenue. Non-renewable resources Finite resources that are depleted once they are consumed; oil and coal are examples. Non-residential properties Commercial real estate properties other than multi-family properties, farmland, and timberland. Nonearning assets Cash and investments (specifically cash, cash equivalents, and short-term investments). Normal EPS The EPS that a business could achieve currently under mid-cyclical conditions. Also called normalized EPS. Normal Q-Q plot A visual used to compare the distribution of the residuals from a regression to a theoretical normal distribution. Glossary Normalized EPS The EPS that a business could achieve currently under mid-cyclical conditions. Also called normal EPS. Normalized earnings The expected level of mid-cycle earnings for a company in the absence of any unusual or temporary factors that affect profitability (either positively or negatively). Normalized P/E P/E based on normalized EPS data. Notional amount The amount of protection being purchased in a CDS. Off-the-run A series of securities or indexes that were issued/ created prior to the most recently issued/created series. Offshoring Refers to relocating operations from one country to another, mainly to reduce costs through lower labor costs or to achieve economies of scale through centralization, but still maintaining operations within the corporation. Omitted variable bias Bias resulting from the omission of an important independent variable from a regression model. On-the-run The most recently issued and most actively traded sovereign securities. One hot encoding The process by which categorical variables are converted into binary form (0 or 1) for machine reading. It is one of the most common methods for handling categorical features in text data. One-sided durations Effective durations when interest rates go up or down, which are better at capturing the interest rate sensitivity of bonds with embedded options that do not react symmetrically to positive and negative changes in interest rates of the same magnitude. One-tier board Board structure consisting of a single board of directors, composed of executive (internal) and non-executive (external) directors. Opportunity cost Reflects the foregone opportunity of investing in a different asset. It is typically denoted by the risk-free rate of interest, r. Option-adjusted spread (OAS) Constant spread that, when added to all the one-period forward rates on the interest rate tree, makes the arbitrage-free value of the bond equal to its market price. Orderly liquidation value The estimated gross amount of money that could be realized from the liquidation sale of an asset or assets, given a reasonable amount of time to find a purchaser or purchasers. Other comprehensive income Items of comprehensive income that are not reported on the income statement; comprehensive income minus net income. Other post-employment benefits Promises by the company to pay benefits in the future, such as life insurance premiums and all or part of health care insurance for its retirees. Out-of-sample forecast errors The differences between actual and predicted values of time series outside the sample period used to fit the model. Outlier An observation that has an extreme value of the dependent variable and is potentially influential. Outsourcing Shifting internal business services to a subcontractor that can offer services at lower costs by scaling to serve many clients. Overfitting Situation in which the model has too many independent variables relative to the number of observations in the sample, such that the coefficients on the independent variables represent noise rather than relationships with the dependent variable. Glossary Overnight indexed swap (OIS) rate An interest rate swap in which the periodic floating rate of the swap equals the geometric average of a daily unsecured overnight rate (or overnight index rate). PEG ratio The P/E-to-growth ratio, calculated as the stock’s P/E divided by the expected earnings growth rate. Pairs trading An approach to trading that uses pairs of closely related stocks, buying the relatively undervalued stock and selling short the relatively overvalued stock. Par curve A sequence of yields-to-maturity such that each bond is priced at par value. The bonds are assumed to have the same currency, credit risk, liquidity, tax status, and annual yields stated for the same periodicity. Par swap A swap in which the fixed rate is set so that no money is exchanged at contract initiation. Parametric method A method of estimating VaR that uses the historical mean, standard deviation, and correlation of security price movements to estimate the portfolio VaR. Generally assumes a normal distribution but can be adapted to non-normal distributions with the addition of skewness and kurtosis. Sometimes called the variance– covariance method or the analytical method. Partial regression coefficient Coefficient that describes the effect of a one-unit change in the independent variable on the dependent variable, holding all other independent variables constant. Also known as partial slope coefficient. Parts of speech An algorithm that uses language structure and dictionaries to tag every token in the text with a corresponding part of speech (i.e., noun, verb, adjective, proper noun, etc.). Payout amount The loss given default times the notional. Payout policy The principles by which a company distributes cash to common shareholders by means of cash dividends and/or share repurchases. Payouts Cash dividends and the value of shares repurchased in any given year. Penalized regression A regression that includes a constraint such that the regression coefficients are chosen to minimize the sum of squared residuals plus a penalty term that increases in size with the number of included features. Pension obligation The present value of future benefits earned by employees for service provided to date. Perfect capital markets Markets in which, by assumption, there are no taxes, transaction costs, or bankruptcy costs and in which all investors have equal (“symmetric”) information. Perpetuity A perpetual annuity, or a set of never-ending level sequential cash flows, with the first cash flow occurring one period from now. Persistent earnings Earnings excluding nonrecurring components. Also referred to as core earnings, continuing earnings, or underlying earnings. Physical settlement Involves actual delivery of the debt instrument in exchange for a payment by the credit protection seller of the notional amount of the contract. Point-in-time data Data consisting of the exact information available to market participants as of a given point in time. Point-in-time data is used to address look-ahead bias. Portfolio balance approach A theory of exchange rate determination that emphasizes the portfolio investment decisions of global investors and the requirement that global investors willingly hold all outstanding securities denominated in each currency at prevailing prices and exchange rates. G-15 Positive serial correlation A situation in which residuals are positively related to other residuals. Potential GDP The maximum amount of output an economy can sustainably produce without inducing an increase in the inflation rate. The output level that corresponds to full employment with consistent wage and price expectations. Precision In error analysis for classification problems it is ratio of correctly predicted positive classes to all predicted positive classes. Precision is useful in situations where the cost of false positives (FP), or Type I error, is high. Preferred habitat theory A term structure theory that contends that investors have maturity preferences and require yield incentives before they will buy bonds outside of their preferred maturities. Premise of value The status of a company in the sense of whether it is assumed to be a going concern or not. Premium leg The series of payments the credit protection buyer promises to make to the credit protection seller. Premiums Amounts paid by the purchaser of insurance products. Present value model A model of intrinsic value that views the value of an asset as the present value of the asset’s expected future cash flows. Present value of growth opportunities The difference between the actual value per share and the no-growth value per share. Also called value of growth. Presentation currency The currency in which financial statement amounts are presented. Price improvement When trade execution prices are better than quoted prices. Price momentum A valuation indicator based on past price movement. Price multiples The ratio of a stock’s market price to some measure of value per share. Price-to-earnings ratio (P/E) The ratio of share price to earnings per share. Priced risk Risk for which investors demand compensation for bearing (e.g., equity risk, company-specific factors, macroeconomic factors). Principal components analysis (PCA) An unsupervised ML technique used to transform highly correlated features of data into a few main, uncorrelated composite variables. Principle of no arbitrage In well-functioning markets, prices will adjust until there are no arbitrage opportunities. Prior transaction method A variation of the market approach; considers actual transactions in the stock of the subject private company. Private market value The value derived using a sum-of-the-parts valuation. Pro forma financial statements Financial statements that include the effect of a corporate restructuring. Probability of default The likelihood that a borrower defaults or fails to meet its obligation to make full and timely payments of principal and interest. Probability of survival The probability that a bond issuer will meet its contractual obligations on schedule. Procedural law The body of law that focuses on the protection and enforcement of the substantive laws. Projection error The vertical (perpendicular) distance between a data point and a given principal component. Prospective P/E A P/E calculated on the basis of a forecast of EPS; a stock’s current price divided by next year’s expected earnings. G-16 Protection leg The contingent payment that the credit protection seller may have to make to the credit protection buyer. Protection period Period during which a bond’s issuer cannot call the bond. Provision for loan losses An income statement expense account that increases the amount of the allowance for loan losses. Prudential supervision Regulation and monitoring of the safety and soundness of financial institutions to promote financial stability, reduce system-wide risks, and protect customers of financial institutions. Pruning A regularization technique used in CART to reduce the size of the classification or regression tree—by pruning, or removing, sections of the tree that provide little classifying power. Purchasing power gain A gain in value caused by changes in price levels. Monetary liabilities experience purchasing power gains during periods of inflation. Purchasing power loss A loss in value caused by changes in price levels. Monetary assets experience purchasing power loss during periods of inflation. Purchasing power parity (PPP) The idea that exchange rates move to equalize the purchasing power of different currencies. Pure expectations theory A term structure theory that contends the forward rate is an unbiased predictor of the future spot rate. Also called the unbiased expectations theory. Pure factor portfolio A portfolio with sensitivity of 1 to the factor in question and a sensitivity of 0 to all other factors. Putable bond Bond that includes an embedded put option, which gives the bondholder the right to put back the bonds to the issuer prior to maturity, typically when interest rates have risen and higher-yielding bonds are available. Qualitative dependent variable A dependent variable that is discrete (binary). Also known as a categorical dependent variable. Quality of earnings analysis The investigation of issues relating to the accuracy of reported accounting results as reflections of economic performance. Quality of earnings analysis is broadly understood to include not only earnings management but also balance sheet management. Random forest classifier A collection of a large number of decision trees trained via a bagging method. Random walk A time series in which the value of the series in one period is the value of the series in the previous period plus an unpredictable random error. Rate implicit in the lease (RIIL) The discount rate that equates the present value of the lease payment with the fair value of the leased asset, considering also the lessor’s direct costs and the present value of the leased asset’s residual value. Rational efficient markets formulation See market efficiency. Readme files Text files provided with raw data that contain information related to a data file. They are useful for understanding the data and how they can be interpreted correctly. Real estate investment trusts (REITs) Tax-advantaged entities (companies or trusts) that own, operate, and—to a limited extent—develop income-producing real estate property. Real estate operating companies (REOCs) Regular taxable real estate ownership companies that operate in the real estate industry in countries that do not have a tax-advantaged REIT regime in place or that are engage in real estate activities of a kind and to an extent that do not fit in their country’s REIT framework. Glossary Real interest rate parity The proposition that real interest rates will converge to the same level across different markets. Real options Options that relate to investment decisions such as the option to time the start of a project, the option to adjust its scale, or the option to abandon a project that has begun. Rebalance return A return from rebalancing the component weights of an index. Recall Also known as sensitivity, in error analysis for classification problems it is the ratio of correctly predicted positive classes to all actual positive classes. Recall is useful in situations where the cost of false negatives (FN), or Type II error, is high. Recency bias The behavioral tendency to place more relevance on recent events. Reconstitution When dealers recombine appropriate individual zero-coupon securities and reproduce an underlying coupon Treasury. Recovery rate The percentage of the loss recovered. Redemption basket The list of securities (and share amounts) the authorized participant (AP) receives when it redeems ETF shares back to the ETF manager. The redemption basket is published each business day. Reference entity The borrower (debt issuer) covered by a single-name CDS. Reference obligation A particular debt instrument issued by the borrower that is the designated instrument being covered. Regime With reference to a time series, the underlying model generating the times series. Regular expression (regex) A series of texts that contains characters in a particular order. Regex is used to search for patterns of interest in a given text. Regularization A term that describes methods for reducing statistical variability in high-dimensional data estimation problems. Regulatory arbitrage Entities identify and use some aspect of regulations that allows them to exploit differences in economic substance and regulatory interpretation or in foreign and domestic regulatory regimes to their (the entities’) advantage. Regulatory burden The costs of regulation for the regulated entity. Regulatory capture Theory that regulation often arises to enhance the interests of the regulated. Regulatory competition Regulators may compete to provide a regulatory environment designed to attract certain entities. Reinforcement learning Machine learning in which a computer learns from interacting with itself or data generated by the same algorithm. Relative-strength indicators Valuation indicators that compare a stock’s performance during a period either to its own past performance or to the performance of some group of stocks. Relative VaR See ex ante tracking error. Relative valuation models A model that specifies an asset’s value relative to the value of another asset. Relative version of PPP The hypothesis that changes in (nominal) exchange rates over time are equal to national inflation rate differentials. Renewable resources Resources that can be replenished, such as a forest. Rental price of capital The cost per unit of time to rent a unit of capital. Glossary Reorganization A court-supervised restructuring process available in some jurisdictions for companies facing insolvency from burdensome debt levels. A bankruptcy court assumes control of the company and oversees an orderly negotiation process between the company and its creditors for asset sales, conversion of debt to equity, refinancing, and so on. Repeat sales index As the name implies, this type of index relies on repeat sales of the same property. In general, the idea supporting this type of index is that because it is the same property that sold twice, the change in value between the two sale dates indicates how market conditions have changed over time. Replacement cost In the context of real estate, the value of a building assuming it was built today using current construction costs and standards. Reporting unit For financial reporting under US GAAP, an operating segment or one level below an operating segment (referred to as a component). Required rate of return on equity The minimum rate of return required by an investor to invest in an asset, given the asset’s riskiness. Also known as the required return on equity. Residential properties Properties that provide housing for individuals or families. Single-family properties may be owner-occupied or rental properties, whereas multi-family properties are rental properties even if the owner or manager occupies one of the units. Residual autocorrelations The sample autocorrelations of the residuals. Residual income Earnings for a given period, minus a deduction for common shareholders’ opportunity cost in generating the earnings. Also called economic profit or abnormal earnings. Residual income method Income approach that estimates the value of all intangible assets of the business by capitalizing future earnings in excess of the estimated return requirements associated with working capital and fixed assets. Residual income model (RIM) A model of stock valuation that views intrinsic value of stock as the sum of book value per share plus the present value of the stock’s expected future residual income per share. Also called discounted abnormal earnings model or Edwards–Bell–Ohlson model. Restricted model A regression model with a subset of the complete set of independent variables. Restructuring Reorganizing the capital structure of a firm. Return on invested capital A measure of the profitability of a company relative to the amount of capital invested by the equity- and debtholders. Reverse carry arbitrage A strategy involving the short sale of the underlying and an offsetting opposite position in the derivative. Reverse stock split A reduction in the number of shares outstanding with a corresponding increase in share price, but no change to the company’s underlying fundamentals. Reverse stress testing A risk management approach in which the user identifies key risk exposures in the portfolio and subjects those exposures to extreme market movements. Reviewed financial statements A type of non-audited financial statements; typically provide an opinion letter with representations and assurances by the reviewing accountant that are less than those in audited financial statements. G-17 Rho The change in a given derivative instrument for a given small change in the risk-free interest rate, holding everything else constant. Rho measures the sensitivity of the option to the risk-free interest rate. Risk-based models Models of the return on equity that identify risk factors or drivers and sensitivities of the return to these factors. Risk budgeting The establishment of objectives for individuals, groups, or divisions of an organization that takes into account the allocation of an acceptable level of risk. Risk decomposition The process of converting a set of holdings in a portfolio into a set of exposures to risk factors. Risk factors Variables or characteristics with which individual asset returns are correlated. Sometimes referred to simply as factors. Risk-free rate The minimum rate of return expected on a security that has no default risk. Risk parity A portfolio allocation scheme that weights stocks or factors based on an equal risk contribution. Robust standard errors Method for correcting residuals for conditional heteroskedasticity. Also known as heteroskedasticity-consistent standard errors or White-corrected standard errors. Roll When an investor moves its investment position from an older series to the most current series. Roll return The component of the return on a commodity futures contract attributable to rolling long futures positions forward through time. Also called roll yield. Rolling down the yield curve A maturity trading strategy that involves buying bonds with a maturity longer than the intended investment horizon. Also called riding the yield curve. Rolling windows A backtesting method that uses a rolling-window (or walk-forward) framework, rebalances the portfolio after each period, and then tracks performance over time. As new information arrives each period, the investment manager optimizes (revises and tunes) the model and readjusts stock positions. Root mean squared error (RMSE) The square root of the average squared forecast error; used to compare the out-of-sample forecasting performance of forecasting models. Sale-leaseback A situation in which a company sells the building it owns and occupies to a real estate investor and the company then signs a long-term lease with the buyer to continue to occupy the building. At the end of the lease, use of the property reverts to the landlord. Sales comparison approach In the context of real estate, this approach estimates value based on what similar or comparable properties (comparables) transacted for in the current market. Sales risk The uncertainty regarding the price and number of units sold of a company’s products. Scaled earnings surprise Unexpected earnings divided by the standard deviation of analysts’ earnings forecasts. Scaling The process of adjusting the range of a feature by shifting and changing the scale of the data. Two of the most common ways of scaling are normalization and standardization. Scatterplot matrix A visualization technique that shows the scatterplots between different sets of variables, often with the histogram for each variable on the diagonal. Also referred to as a pairs plot. G-18 Scenario analysis A technique for exploring the performance and risk of investment strategies in different structural regimes. Schwarz’s Bayesian information criterion (BIC or SBC) A statistic used to compare sets of independent variables for explaining a dependent variable. It is preferred for finding the model with the best goodness of fit. Scree plots A plot that shows the proportion of total variance in the data explained by each principal component. Screening The application of a set of criteria to reduce a set of potential investments to a smaller set having certain desired characteristics. Seasonality A characteristic of a time series in which the data experience regular and predictable periodic changes; for example, fan sales are highest during the summer months. Secured overnight financing rate (SOFR) A daily volume-weighted index of rates on qualified cash borrowings collateralized by US Treasuries that is expected to replace Libor as a floating reference rate for swaps. Security selection risk See active specific risk. Segmented markets theory A term structure theory that contends yields are solely a function of the supply and demand for funds of a particular maturity. Self-regulating organizations (SROs) Self-regulating bodies that are given recognition and authority, including enforcement power, by a government body or agency. Self-regulatory bodies Private, non-governmental organizations that both represent and regulate their members. Some self-regulating organizations are also independent regulators. Sell-side analysts Analysts who work at brokerages. Sensitivity analysis Analysis that shows the range of possible outcomes as specific assumptions are changed. Sentence length The number of characters, including spaces, in a sentence. Serial correlation A condition found most often in time series in which residuals are correlated across observations. Also known as autocorrelation. Serial-correlation consistent standard errors Method for correcting serial correlation. Also known as serial correlation and heteroskedasticity adjusted standard errors, Newey–West standard errors, and robust standard errors. Service period For employee stock options, usually the period between the grant date and the vesting date. Settled in arrears An arrangement in which the interest payment is made (i.e., settlement occurs) at the maturity of the underlying instrument. Settlement The closing date at which the counterparties of a derivative contract exchange payment for the underlying as required by the contract. Shadow banking Lending by financial institutions that are not regulated as banks. Shaping risk The sensitivity of a bond’s price to the changing shape of the yield curve. Share repurchase A transaction in which a company buys back its own shares. Unlike stock dividends and stock splits, share repurchases use corporate cash. Shareholder activism Strategies used by shareholders to attempt to compel a company to act in a desired manner. Shareholders’ equity Total assets minus total liabilities. Simulation A technique for exploring how a target variable (e.g. portfolio returns) would perform in a hypothetical environment specified by the user, rather than a historical setting. Glossary Single-name CDS Credit default swap on one specific borrower. Sinking fund bond A bond that requires the issuer to set aside funds over time to retire the bond issue, thus reducing credit risk. Size premium (SP) Additional return compensation for bearing the additional risk associated with smaller companies. Slope dummy An indicator variable that allows a single regression model to estimate two lines of best fit, each with differing slopes, depending on whether the dummy takes a value of 1 or 0. Soft margin classification An adaptation in the support vector machine algorithm which adds a penalty to the objective function for observations in the training set that are misclassified. Sovereign yield spread The spread between the yield on a foreign country’s sovereign bond and a similar-maturity domestic sovereign bond. Special dividend A dividend paid by a company that does not pay dividends on a regular schedule, or a dividend that supplements regular cash dividends with an extra payment. Specific-company risk premium (SCRP) Additional return required by investors for bearing non-diversifiable company-specific risk. Spin off When a company separates a distinct part of its business into a new, independent company. The term is used to describe both the transaction and the separated component, while the company that conducts the transaction and formerly owned the spin off is known as the parent. Split-rate tax system In reference to corporate taxes, a split-rate system taxes earnings to be distributed as dividends at a different rate than earnings to be retained. Corporate profits distributed as dividends are taxed at a lower rate than those retained in the business. Spot curve A sequence of yields-to-maturity on zero-coupon bonds. Sometimes called zero or strip curve (because coupon payments are “stripped” off the bonds). Spot price The current price of an asset or security. For commodities, the current price to deliver a physical commodity to a specific location or purchase and transport it away from a designated location. Spot rate The interest rate that is determined today for a risk-free, single-unit payment at a specified future date. Spot yield curve The term structure of spot rates for loans made today. Stabilized NOI In the context of real estate, the expected NOI when a renovation is complete. Stable dividend policy A policy in which regular dividends are paid that reflect long-run expected earnings. In contrast to a constant dividend payout ratio policy, a stable dividend policy does not reflect short-term volatility in earnings. Standardized beta With reference to fundamental factor models, the value of the attribute for an asset minus the average value of the attribute across all stocks, divided by the standard deviation of the attribute across all stocks. Standardized unexpected earnings Unexpected earnings per share divided by the standard deviation of unexpected earnings per share over a specified prior time period. Statistical factor model A multifactor model in which statistical methods are applied to a set of historical returns to determine portfolios that best explain either historical return covariances or variances. Statutes Laws enacted by legislative bodies. Glossary Steady-state rate of growth The constant growth rate of output (or output per capita) that can or will be sustained indefinitely once it is reached. Key ratios, such as the capital–output ratio, are constant on the steady-state growth path. Steepness The difference between long-term and short-term yields that constitutes one of the three factors (the other two are level and curvature) that empirically explain most of the changes in the shape of the yield curve. Stock dividend A type of dividend in which a company distributes additional shares of its common stock to shareholders instead of cash. Stop-loss limit Constraint used in risk management that requires a reduction in the size of a portfolio, or its complete liquidation, when a loss of a particular size occurs in a specified period. Straight bond An underlying option-free bond with a specified issuer, issue date, maturity date, principal amount and repayment structure, coupon rate and payment structure, and currency denomination. Straight debt Debt with no embedded options. Straight-line rent The average annual rent under a multi-year lease agreement that contains contractual increases in rent during the life of the lease. Straight-line rent adjustment See non-cash rent. Straight voting A shareholder voting process in which shareholders receive one vote for each share owned. Stranded assets Assets that are obsolete or not economically viable. Strategic transaction A purchase involving a buyer that would benefit from certain synergies associated with owning the target firm. Stress tests A risk management technique that assesses the portfolio’s response to extreme market movements. Stripping A dealer’s ability to separate a bond’s individual cash flows and trade them as zero-coupon securities. Studentized residual A t-distributed statistic that is used to detect outliers. Substantive law The body of law that focuses on the rights and responsibilities of entities and relationships among entities. Succession event A change of corporate structure of the reference entity, such as through a merger, a divestiture, a spinoff, or any similar action, in which ultimate responsibility for the debt in question is unclear. Sum-of-the-parts valuation A valuation that sums the estimated values of each of a company’s businesses as if each business were an independent going concern. Summation operator A functional part of a neural network’s node that multiplies each input value received by a weight and sums the weighted values to form the total net input, which is then passed to the activation function. Supernormal growth Above-average or abnormally high growth rate in earnings per share. Supervised learning A machine learning approach that makes use of labeled training data. Support vector machine A linear classifier that determines the hyperplane that optimally separates the observations into two sets of data points. Survivorship bias The exclusion of poorly performing or defunct companies from an index or database, biasing the index or database toward financially healthy companies. G-19 Sustainable growth rate The rate of dividend (and earnings) growth that can be sustained over time for a given level of return on equity, keeping the capital structure constant and without issuing additional common stock. Swap curve The term structure of swap rates. Swap rate The fixed rate to be paid by the fixed-rate payer specified in a swap contract. Swap rate curve The term structure of swap rates. Swap spread The difference between the fixed rate on an interest rate swap and the rate on a Treasury note with equivalent maturity; it reflects the general level of credit risk in the market. Synergies The combination of two companies being more valuable than the sum of the parts. Generally, synergies take the form of lower costs (“cost synergies”) or increased revenues (“revenue synergies”) through combinations that generate lower costs or higher revenues, respectively. Systematic risk Risk that affects the entire market or economy; it cannot be avoided and is inherent in the overall market. Systematic risk is also known as non-diversifiable or market risk. Systemic risk Refers to risks supervisory authorities believe are likely to have broad impact across the financial market infrastructure and affect a wide swath of market participants. TED spread A measure of perceived credit risk determined as the difference between Libor and the T-bill yield of matching maturity. Tail risk The risk that losses in extreme events could be greater than would be expected for a portfolio of assets with a normal distribution. Takeover premium The amount by which the per-share takeover price exceeds the unaffected price expressed as a percentage of the unaffected price. It reflects the amount shareholders require to relinquish their control of the company to the acquirer. Tangible assets Identifiable, physical assets such as property, plant, and equipment. Tangible book value per share Common shareholders’ equity minus intangible assets reported on the balance sheet, divided by the number of shares outstanding. Target In machine learning, the dependent variable (Y) in a labeled dataset; the company in a merger or acquisition that is being acquired. Target capital structure A company’s chosen proportions of debt and equity. Target payout ratio A strategic corporate goal representing the long-term proportion of earnings that the company intends to distribute to shareholders as dividends. Taxable REIT subsidiaries Subsidiaries that pay income taxes on earnings from non-REIT-qualifying activities like merchant development or third-party property management. Technical indicators Momentum indicators based on price. Temporal method A variation of the monetary/non-monetary translation method that requires not only monetary assets and liabilities, but also non-monetary assets and liabilities that are measured at their current value on the balance sheet date to be translated at the current exchange rate. Assets and liabilities are translated at rates consistent with the timing of their measurement value. This method is typically used when the functional currency is other than the local currency. G-20 Term frequency (TF) Ratio of the number of times a given token occurs in all the texts in the dataset to the total number of tokens in the dataset. Term premium The additional return required by lenders to invest in a bond to maturity net of the expected return from continually reinvesting at the short-term rate over that same time horizon. Terminal price multiples The price multiple for a stock assumed to hold at a stated future time. Terminal share price The share price at a particular point in the future. Terminal value of the stock The analyst’s estimate of a stock’s value at a particular point in the future. Also called continuing value of the stock. Test sample A data sample that is used to test a model’s ability to predict well on new data. Theta The change in a derivative instrument for a given small change in calendar time, holding everything else constant. Specifically, the theta calculation assumes nothing changes except calendar time. Theta also reflects the rate at which an option’s time value decays. Time series A set of observations on a variable’s outcomes in different time periods. Tobin’s q The ratio of the market value of debt and equity to the replacement cost of total assets. Token The equivalent of a word (or sometimes a character). Tokenization The process of representing ownership rights to physical assets on a blockchain or distributed ledger. Top-down approach With respect to forecasting, an approach that usually begins at the level of the overall economy. Forecasts are then made at more narrowly defined levels, such as sector, industry, and market for a specific product. Total factor productivity (TFP) A multiplicative scale factor that reflects the general level of productivity or technology in the economy. Changes in total factor productivity generate proportional changes in output for any input combination. Total invested capital The sum of market value of common equity, book value of preferred equity, and face value of debt. Tracking error The standard deviation of the differences between a portfolio’s returns and its benchmark’s returns; a synonym of active risk. Also called tracking risk. Tracking risk The standard deviation of the differences between a portfolio’s returns and its benchmarks returns. Also called tracking error. Trailing dividend yield The reciprocal of current market price divided by the most recent annualized dividend. Trailing P/E A stock’s current market price divided by the most recent four quarters of EPS (or the most recent two semi-annual periods for companies that report interim data semi-annually). Also called current P/E. Training sample A data sample that is used to train a model. Tranche CDS A type of credit default swap that covers a combination of borrowers but only up to pre-specified levels of losses. Transaction exposure The risk of a change in value between the transaction date and the settlement date of an asset of liability denominated in a foreign currency. Treasury shares/stock Shares that were issued and subsequently repurchased by the company. Trend A long-term pattern of movement in a particular direction. Glossary Triangular arbitrage An arbitrage transaction involving three currencies that attempts to exploit inconsistencies among pairwise exchange rates. Trimming Also called truncation, it is the process of removing extreme values and outliers from a dataset. Triple-net leases Leases that require each tenant to pay its share of the following three operating expenses: common area maintenance and repair expenses; property taxes; and building insurance costs. Also known as NNN leases. Two-tier board Board structure consisting of a supervisory board that oversees a management board. Unbiased expectations theory A term structure theory that contends the forward rate is an unbiased predictor of the future spot rate. Also called the pure expectations theory. Unconditional heteroskedasticity When heteroskedasticity of the error variance is not correlated with the regression’s independent variables. Uncovered interest rate parity The proposition that the expected return on an uncovered (i.e., unhedged) foreign currency (risk-free) investment should equal the return on a comparable domestic currency investment. Underlying earnings Earnings excluding nonrecurring components. Also referred to as continuing earnings, core earnings, or persistent earnings. Unexpected earnings The difference between reported EPS and expected EPS. Also referred to as an earnings surprise. Unit root A time series that is not covariance stationary is said to have a unit root. Unrestricted model A regression model with the complete set of independent variables. Unsupervised learning A machine learning approach that does not make use of labeled training data. Upfront payment The difference between the credit spread and the standard rate paid by the protection buyer if the standard rate is insufficient to compensate the protection seller. Also called upfront premium. Upfront premium See upfront payment. Upstream A transaction between two related companies, an investor company (or a parent company) and an associate company (or a subsidiary company) such that the associate company records a profit on its income statement. An example is a sale of inventory by the associate to the investor company or by a subsidiary to a parent company. Validation sample A data sample that is used to validate and tune a model. Valuation The process of determining the value of an asset or service either on the basis of variables perceived to be related to future investment returns or on the basis of comparisons with closely similar assets. Value additivity An arbitrage opportunity when the value of the whole equals the sum of the values of the parts. Value at risk (VaR) The minimum loss that would be expected a certain percentage of the time over a certain period of time given the assumed market conditions. Value of growth The difference between the actual value per share and the no-growth value per share. Variance error Describes how much a model’s results change in response to new data from validation and test samples. Unstable models pick up noise and produce high variance error, causing overfitting and high out-of-sample error. Variance inflation factor (VIF) A statistic that quantifies the degree of multicollinearity in a model. Glossary Vasicek model A partial equilibrium term structure model that assumes interest rates are mean reverting and interest rate volatility is constant. Vega The change in a given derivative instrument for a given small change in volatility, holding everything else constant. A sensitivity measure for options that reflects the effect of volatility. Venture capital investors Private equity investors in development-stage companies. Vertical ownership Ownership structure in which a company or group that has a controlling interest in two or more holding companies, which in turn have controlling interests in various operating companies. Vested benefit obligation The actuarial present value of vested benefits. Vesting date The date that employees can first exercise stock options. Visibility The extent to which a company’s operations are predictable with substantial confidence. Voting caps Legal restrictions on the voting rights of large share positions. G-21 Web spidering (scraping or crawling) programs Programs that extract raw content from a source, typically web pages. Weighted average cost of capital (WACC) A weighted average of the after-tax required rates of return on a company’s common stock, preferred stock, and long-term debt, where the weights are the fraction of each source of financing in the company’s target capital structure. Weighted harmonic mean See harmonic mean. Winsorization The process of replacing extreme values and outliers in a dataset with the maximum (for large value outliers) and minimum (for small value outliers) values of data points that are not outliers. Write-down A reduction in the value of an asset as stated in the balance sheet. Yield curve factor model A model or a description of yield curve movements that can be considered realistic when compared with historical data. Zero A bond that does not pay a coupon but is priced at a discount and pays its full face value at maturity. Zero-coupon bond A bond that does not pay interest during its life. It is issued at a discount to par value and redeemed at par. Also called pure discount bond.