Investment Analysis Notes Asset Classes A group of securities that exhibit similar characteristics, behave similarly in the marketplace,

and are subject to the same laws and regulations. They are classified as Traditional and Non Traditional. It should be noted that in addition to the three main asset classes, some investment professionals would add real estate and commodities, arts, wine, antiques, and possibly other types of investments, to the asset class mix. The three main asset classes are equities (stocks), fixed-income (bonds) and cash equivalents (money market instruments) (Alternative/Non Traditional). Asset Allocation William Sharp http://en.wikipedia.org/wiki/Asset_allocation CPPI and Constant Mix CPPI-Constant Proportion Portfolio Insurance A method of portfolio insurance in which the investor sets a floor on the dollar value of his or her portfolio, then structures asset allocation around that decision. The two asset classes used in CPPI are a risky asset (usually equities or mutual funds), and a riskless asset of cash, equivalents or Treasury bonds. The percentage allocated to each depends on the "cushion" value, defined as (current portfolio value floor value), and a multiplier coefficient, where a higher number denotes a more aggressive strategy. Consider a hypothetical portfolio of $100,000, of which the investor decides $90,000 is the absolute floor. If the portfolio falls to $90,000 in value, the investor would move all assets to cash to preserve capital. The value of the multiplier is based on the investor's risk profile, and is typically derived by first asking what the maximum one-day loss could be on the risky investment. The multiplier will be the inverse of that percentage. So, if one decides that 20% is the maximum "crash" possibility, the multiplier value will be (1/.20), or 5. Multiplier values between 3 and 6 are very common. Based on the information provided, the investor would allocate 5 x ($100,000 - $90,000) or $50,000 to the risky asset, with the remainder going into cash or a riskless asset. Constant Mix The constant-mix strategy maintains equity allocations that are set at a constant fixed percentage of the total portfolio value. Therefore, periodic rebalancing of the portfolio to return it to the initial desired asset allocation is required. The trading strategy is to purchase equities as they decline, and sell equities as they rise in value. Balanced for 60% equity and 40% bonds. Used in a Volatile Market. Asset Liability Management Investment is driven by asset liability management. Liability driven Investment (LDI). This investment is driven by the demand and asset liability. What is market?

Any place/process that brings together buyers/sellers Physical markets Electronic markets Trading online Telephonic markets Bonds Types of markets Primary MarketThe primary markets are where investors can get first crack at a new security issuance. The issuing company or group receives cash proceeds from the sale, which is then used to fund operations or expand the business. Exchanges have varying levels of requirements which must be met before a security can be sold. Once the initial sale is complete, further trading is said to conduct on the secondary market, which is where the bulk of exchange trading occurs each day. Primary markets can see increased volatility over secondary markets because it is difficult to accurately gauge investor demand for a new security until several days of trading have occurred. Follow On Public Offer - FPO FPOs are popular methods for companies to raise additional equity capital in the capital markets through a stock issue. Public companies can also take advantage of an FPO issuing an offer for sale to investors, which are made through an offer document. FPOs should not be confused with IPOs, as IPOs are the initial public offering of equity to the public while FPOs are supplementary issues made after a company has been established on an exchange. Underwriting The process by which investment bankers raise investment capital from investors on behalf of corporations and governments that are issuing securities (both equity and debt). Private Placement The sale of securities to a relatively small number of select investors as a way of raising capital. Investors involved in private placements are usually large banks, mutual funds, insurance companies and pension funds. Private placement is the opposite of a public issue, in which securities are made available for sale on the open market. Secondary Markets A newly issued IPO will be considered a primary market trade when the shares are first purchased by investors directly from the underwriting investment bank; after that any shares traded will be on the secondary market, between investors themselves. In the primary market prices are often set beforehand, whereas in the secondary market only basic forces like supply and demand determine the price of the security. BSE, NSE Stock Exchanges- NSE revolutionized trading in India.

Money Market Instruments An investment fund that holds the objective to earn interest for shareholders while maintaining a net asset value of $1 per share. Mutual funds, brokerage firms and banks offer these funds. Portfolios are comprised of short-term (less than one year) securities representing high-quality, liquid debt and monetary instruments. Examples T Bills, Commercial Paper, CDs, Call money Order Driven System The difference between these two market systems lies in what is displayed in the market in terms of orders and bid and ask prices. The order driven market displays all of the bids and asks, while the quote driven market focuses only on the bids and asks of market makers and other designated parties. An order driven market is one in which all of the orders of both buyers and sellers are displayed, detailing the price at which they are willing to buy or sell a security and the amount of the security that they are willing to buy or sell at that price. So, if you place an order for 100 shares of Microsoft at $30 per share, your order will be displayed in the market and can be seen by people with access to this level of information. The biggest advantage to this system is its transparency: it clearly shows all of the market orders and what price people are willing to buy at or sell for. The drawback is that in an order driven market, there is no guarantee of order execution - but, in the quote driven market, there is that guarantee. Quote Driven A quote driven market only displays the bid and asks offers of designated market makers, dealers or specialists. These market makers will post the bid and ask price that they are willing to accept at that time. In this market, your order for 100 shares of Microsoft at $30 per share will not be seen in the market. However, if there were one market maker for the stock, it would post its bid - say, $29.50 and its ask - say, $30.50. (This would be all that would be displayed in the market, unless there was more than one market maker, in which case you could see more than one bid or ask offer.) This would mean that you could buy shares of Microsoft for $30.50 and sell shares for $29.50. But, bear in mind that the bid and ask will change constantly depending on the supply and demand in the market. Even though individual orders are not seen in a quote driven market, the market maker will either fill your order from its own inventory or match you with another order. The major advantage of this type of market is the liquidity it presents as the market makers are required to meet their quoted prices either buying or selling. The major drawback of the quote driven market is that, unlike the order driven market, it does not show transparency in the market. There are markets that combine attributes from the two systems to form hybrid systems. For example, a market may show the current bid and ask prices of the market makers but also allow people to view all of the limit orders in the market. Market Efficiency

When money is put into the stock market, it is done with the aim of generating a return on the capital invested. Many investors try not only to make a profitable return, but also to outperform, or beat, the market. What Does Efficient Market Hypothesis - EMH Mean? An investment theory that states it is impossible to "beat the market" because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. According to the EMH, stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. As such, it should be impossible to outperform the overall market through expert stock selection or market timing, and that the only way an investor can possibly obtain higher returns is by purchasing riskier investments. Degrees of Market Hypothesis 1. Strong efficiency - This is the strongest version, which states that all information in a market, whether public or private, is accounted for in a stock price. Not even insider information could give an investor an advantage. 2. Semi-strong efficiency - This form of EMH implies that all public information is calculated into a stock's current share price. Neither fundamental nor technical analysis can be used to achieve superior gains. 3. Weak efficiency - This type of EMH claims that all past prices of a stock are reflected in today's stock price. Therefore, technical analysis cannot be used to predict and beat a market. Key Takeaways Technical analysis has limited value Fundamental analysis difficult to implement Investing in index funds is optimal Access to superior analysis can generate alpha

Fundamental Analysis A method of evaluating a security that entails attempting to measure its intrinsic value by examining related economic, financial and other qualitative and quantitative factors. Fundamental analysts attempt to study everything that can affect the security's value, including macroeconomic factors (like the overall economy and industry conditions) and company-specific factors (like financial condition and management). The end goal of performing fundamental analysis is to produce a value that an investor can compare with the security's current price, with the aim of figuring out what sort of position to take with that security (underpriced = buy, overpriced = sell or short). Technical Analysis A method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volume. Technical analysts do not attempt to measure a security's intrinsic value, but instead use charts and other tools to identify patterns that can suggest future activity.

Circuit Breakers Abnormal Excessive movement causing market to react very sharply in response to a situation causing trade for a particular stock to cease for a while. Noise Traders The term used to describe an investor who makes decisions regarding buy and sell trades without the use of fundamental data. These investors generally have poor timing, follow trends, and overreact to good and bad news. n reality, most people are considered to be noise traders, as very few actually make investment decisions solely using fundamental analysis. Furthermore, technical analysis is considered to be a part of noise trading because the data is unrelated to the fundamentals of a company. Stock Dividend Companies may decide to distribute stock to shareholders of record if the company's availability of liquid cash is in short supply. These distributions are generally acknowledged in the form of fractions paid per existing share. An example would be a company issuing a stock dividend of 0.05 shares for each single share held. Active Management Investors who believe in active management do not follow the efficient market hypothesis. They believe it is possible to profit from the stock market through any number of strategies that aim to identify mispriced securities. Active management is a function of security selection and market timing factors. The portfolio manager of a diversified active fund, for instance, first selects securities within the investable universe of stocks. The manager then buys and sells the securities on a continual basis. The funds objective is to generate higher returns than the benchmark index. Such excess return is called alpha returns and is the reason why active funds charge higher management fees compared with passive funds. Passive Management Passive management typically refers to index funds. The portfolio manager of such a fund simply takes exposure to pre-defined universe of securities constituting the index. Besides, the manager does not engage in market timing. Passive management refers to those people who believe in the efficient market hypothesis. It states that at all times markets incorporate and reflect all information, rendering individual stock picking futile. As a result, the best investing strategy is to invest in index funds, which, historically, have outperformed the majority of actively managed funds. Mosaic Theory A method of analysis used by security analysts to gather information about a corporation. Mosaic theory involves collecting public, non-public and non-material information about a company in order to determine the underlying value of the company's securities and to enable the analyst to make recommendations to clients based on that information. Closet Indexing

A portfolio strategy used by some portfolio managers to achieve returns similar to those of their benchmark index, without exactly replicating the index. A portfolio manager practicing closet indexing might stick to an index in terms of weighting, industry sector or geography. A manager's performance is usually compared to that of his or her benchmark index, so there is an incentive for managers to gain returns that are at least similar to the index. Closet indexing is often viewed negatively by investors because they could simply choose an index fund and pay lower fees. Not surprisingly, "closet" indexing is so named because these practices are often not publicly announced, but a close examination of a fund's prospectus can sometimes uncover which funds are practicing closet indexing. Watch for funds with high MERs and holdings that look quite similar to the fund's benchmark index. 4 Box Matrix The 4-box active-passive choice essentially separates the security selection and the market timing factors. Active-Active- This Refers to active management (market timing) of active exposure (security selection). Applying active-active decision for the satellite portfolio is suitable for aggressive investors, as market timing is more risky than security selection. Passive-active This decision refers to passive management of active exposure. That is, the investor actively selects securities and holds the portfolio till the investment horizon. Active-Passive - This decision refers to active management of passive exposure, where the investor actively engages in market-timing her index exposure. Passive- Passive This decision refers to passive management of passive exposure. Alpha A measure of performance on a risk-adjusted basis. Alpha takes the volatility (price risk) of a mutual fund and compares its risk-adjusted performance to a benchmark index. The excess return of the fund relative to the return of the benchmark index is a fund's alpha. The abnormal rate of return on a security or portfolio in excess of what would be predicted by an equilibrium model like the capital asset pricing model (CAPM). Alpha, in other words, is a zero-sum game. This means the excess returns of all active managers add to zero, as some will outperform, some will underperform and most will perform just as well as the benchmark index. Beta It is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. In finance, the beta () of a stock or portfolio is a number describing the relation of its returns with that of the financial market as a whole. An asset with a beta of 0 means that its price is not at all correlated with the market. A positive beta means that the asset generally follows the market. A negative beta shows that the asset inversely follows the market; the asset generally decreases in value if the market goes up and vice versa.

Core Satellite approach A portfolio generates beta returns because of its exposure to the market. In the portfolio theory, this comes off the Capital Asset Pricing Model (CAPM), which states that investors can only expect to earn market return if they assume market risk. The portfolios alpha returns refers to the excess return over the benchmark index that a portfolio manager generates because of her skill. The managers skill comes from security selection and, sometimes, from market timing. All active managers charge higher fees than index funds do, with a promise to deliver alpha returns. Suppose an active fund charges fees of 2.5 per cent. Further suppose 90 per cent variation in fund returns can be explained by the change in the benchmark index. The investor is then essentially paying alpha fees to the fund that largely (90 per cent) generates beta returns. What if the investor can buy index fund for the 90 per cent beta exposure and an active fund for the 10 per cent alpha exposure? That way, she can save on paying active fees on the entire portfolio. This is rationale behind the alpha-beta separation. The core-satellite framework is built on this alpha-beta separation. The core portfolio is exposed primarily to the benchmark risk and therefore earns the benchmark return (beta exposure). The alpha portfolio is set-up to outperform the benchmark. Investors can construct the core portfolio through low-cost beta exposure, typically in index funds and benchmark fixed-income securities. This is believed to be an optimal strategy for all classes of individual investors- mass affluent, HNWIs and Ultra-HNWIs. Typically, index funds benchmarked to a broad index such as the S&P CNX500 is preferable. The satellite portfolio contains exposure to styles such active mid-cap funds, sector funds and direct exposure to stocks. Investors should also consider exposure to alternative asset class such as commodity through commodity futures. HNWIs and Ultra-HNWIs should consider alternative strategies on existing asset classes such as private equity and hedge funds, as they are also good alpha generators. The core-satellite portfolio framework is behaviourally optimal. A typical investor would like to invest for the long-term but want to profit from short-term asset price movements. The core portfolio takes care of the long-term investment objective while the satellite portfolio satisfies the urge to have continual cash flow into the trading account. Market Timing The act of attempting to predict the future direction of the market, typically through the use of technical indicators or economic data. Diversification A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique contends that a portfolio of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio. Diversification strives to smooth out unsystematic risk events in a portfolio so that the positive performance of some investments will neutralize the negative performance of others. Therefore, the benefits of diversification will hold only if the securities in the portfolio are not perfectly correlated. Pecking Order Hypothesis

It states that companies prioritize their sources of financing (from internal financing to equity) according to the Principle of least effort, or of least resistance, preferring to raise equity as a financing means of last resort. Hence, internal funds are used first, and when that is depleted, debt is issued, and when it is not sensible to issue any more debt, equity is issued. This theory maintains that businesses adhere to a hierarchy of financing sources and prefer internal financing when available, and debt is preferred over equity if external financing is required. Risks Risk Free Asset An asset which has a certain future return. Treasuries (especially T-bills) are considered to be riskfree because they are backed by the U.S. government. They do not have a reinvestment or a credit risk. Market Risk/ Interest Rate Risk As interest rates rise (fall), the price of a fixed income security will fall (rise). For an investor who plans to hold a fixed income security to maturity, the change in its price before maturity is not of concern; however, for an investor who may have to sell the fixed income security before the maturity date, an increase in interest rates will mean the realization of a capital loss. This risk is referred to as market risk, or interest-rate risk, which is by far the biggest risk faced by an investor in the fixed income market. Duration To control interest-rate risk, it is necessary to quantify it. The most commonly used measure of interest-rate risk is duration. Duration is the approximate percentage change in the price of a bond or bond portfolio due to a 100 basis point change in yields. Modified Duration Modified duration follows the concept that interest rates and bond prices move in opposite directions. This formula is used to determine the effect that a 100-basis-point (1%) change in interest rates will have on the price of a bond. Reinvestment Risk The cash flows received from a security are usually (or are assumed to be) reinvested. The additional income from such reinvestment, sometimes called interest-on-interest, depends on the prevailing interest rate levels at the time of reinvestment, as well as on the reinvestment strategy. The variability in the returns from reinvestment from a given strategy due to changes in market rates is called reinvestment risk. Inflation Risk, or purchasing power risk This arises because of the variation in the value of cash flows from a security due to inflation, as measured in terms of purchasing power. For example, if an investor purchases a five-year bond in which he or she can realize a coupon rate of 7%, but the rate of inflation is 8%, then the purchasing power of the cash flow has declined. For all but inflation-adjusted securities, and adjustable- or floating-rate bonds, an investor is exposed to inflation risk because the interest rate the issuer promises to make is fixed for the life of the security. To the extent that interest rates reflect the expected inflation rate, floating-rate bonds have a lower level of inflation risk. Credit Risk

1. The risk that the issuer will default on its obligation (default risk). 2. The risk that the bonds value will decline and/or the bonds price performance will be worse than that of other bonds against which the investor is compared because either (a) the market requires a higher spread due to a perceived increase in the risk that the issuer will default or (b) companies that assign ratings to bonds will lower a bonds rating. LIQUIDITY RISK Liquidity risk is the risk that the investor will have to sell a bond below its true value where the true value is indicated by a recent transaction. The primary measure of liquidity is the size of the spread between the bid price and the ask price quoted by a dealer. The wider the bid-ask spread, the greater is the liquidity risk. Markowitz According to the theory, it's possible to construct an "efficient frontier" of optimal portfolios offering the maximum possible expected return for a given level of risk. This theory was pioneered by Harry Markowitz in his paper "Portfolio Selection," published in 1952 by the Journal of Finance. There are four basic steps involved in portfolio construction: -Security valuation -Asset allocation -Portfolio optimization -Performance measurement Post-Modern Portfolio Theory (PMPT) A portfolio optimization methodology that uses the downside risk of returns instead of the mean variance of investment returns used by modern portfolio theory. The difference lies in each theory's definition of risk, and how that risk influences expected returns. Post-Modern Portfolio Theory (PMPT) uses the standard deviation of negative returns as the measure of risk, while modern portfolio uses the standard deviation of all returns as a measure of risk. Risk using Standard Deviation is calculated by 1 day risk or 1 day volatility * square root of Time If Minimal Accepted Risk is > than calculated risk then Risk is prevalent. Term to Maturity A key feature of any bond is its term-to-maturity, the number of years during which the borrower has promised to meet the conditions of the debt (which are contained in the bonds indenture). A bonds term-to-maturity is the date on which the debt will cease and the borrower will redeem the issue by paying the face value, or principal. Bonds A debt investment in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate. Bonds are used by companies, municipalities, states and U.S. and foreign governments to finance a variety of projects and

activities. Bonds are commonly referred to as fixed-income securities and are one of the three main asset classes, along with stocks and cash equivalents. Zero Coupon Bond A debt security that doesn't pay interest (a coupon) but is traded at a deep discount, rendering profit at maturity when the bond is redeemed for its full face value. Floating Interest Rate Vs Fixed Interest Rate An interest rate that is allowed to move up and down with the rest of the market or along with an index. This contrasts with a fixed interest rate, in which the interest rate of a debt obligation stays constant for the duration of the agreement. A floating interest rate can also be referred to as a variable interest rate because it can vary over the duration of the debt obligation. Yield Curve In many situations, a bond of a given maturity is used as an alternative to another bond of a different maturity. An adjustment is made to account for the differential interest-rate risks in the two bonds. However, this adjustment makes an assumption about how the interest rates (i.e., yields) at different maturities will move. To the extent that the yield movements deviate from this assumption, there is yield-curve, or maturity, risk. Pull to Par Pull to Par is the effect in which the price of a bond converges to par value as time passes. At maturity the price of a debt instrument in good standing should equal its par (or face value). Another name for this effect is reduction of maturity. It results from the difference between market interest rate and the nominal yield on the bond. The Pull to Par effect is one of two factors that influence the market value of the bond and its volatility (the second one is the level of market interest rates). Yield to Maturity (YTM) The rate of return anticipated on a bond if it is held until the maturity date. YTM is considered a long-term bond yield expressed as an annual rate. The calculation of YTM takes into account the current market price, par value, coupon interest rate and time to maturity. It is also assumed that all coupons are reinvested at the same rate. Sometimes this is simply referred to as "yield" for short. Price Yield Relationship For any given bond, a graph of the relationship between price and yield is convex. This means that the graph forms a curve rather than a straight-line (linear). The degree to which the graph is curved shows how much a bond's yield changes in response to a change in price. Inverse Price Yield Relationship Involved concept http://www.investopedia.com/ask/answers/04/031904.asp Bond Strategies Bond Ladder

A strategy for managing fixed-income investments by which the investor builds a ladder by dividing his or her investment dollars evenly among bonds or CDs that mature at regular intervals such as every six months, once a year or every two years. Bond Barbell A bond investment strategy that concentrates holdings in both very short-term and extremely longterm maturities. This is also known as the "dumbbell" or "barbelling." Bond Bullet A no callable regular coupon paying debt instrument with a single repayment of principal on the maturity date. Algorithmic Trading A trading system that utilizes very advanced mathematical models for making transaction decisions in the financial markets. The strict rules built into the model attempt to determine the optimal time for an order to be placed that will cause the least amount of impact on a stock's price. Large blocks of shares are usually purchased by dividing the large share block into smaller lots and allowing the complex algorithms to decide when the smaller blocks are to be purchased. Bid Ask Price The amount by which the ask price exceeds the bid. This is essentially the difference in price between the highest price that a buyer is willing to pay for an asset and the lowest price for which a seller is willing to sell it. For example, if the bid price is $20 and the ask price is $21 then the "bid-ask spread" is $1. Liability Driven Investment (LDI) A form of investing in which the main goal is to gain sufficient assets to meet all liabilities, both current and future. This form of investing is most prominent with defined-benefit pension plans, whose liabilities can often reach into the billions of dollars for the largest of plans. Drawdown The peak-to-trough decline during a specific record period of an investment, fund or commodity. A drawdown is usually quoted as the percentage between the peak and the trough. Mutual Funds An investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. Mutual funds are operated by money managers, who invest the fund's capital and attempt to produce capital gains and income for the fund's investors. A mutual fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus. Net Asset Value

A mutual fund's price per share or exchange-traded fund's (ETF) per-share value. In both cases, the per-share dollar amount of the fund is calculated by dividing the total value of all the securities in its portfolio, less any liabilities, by the number of fund shares outstanding. Open end Fund A type of mutual fund that does not have restrictions on the amount of shares the fund will issue. If demand is high enough, the fund will continue to issue shares no matter how many investors there are. Open-end funds also buy back shares when investors wish to sell. Close Ended Fund A mutual fund that has been closed - either temporarily or permanently - to new investors because the investment advisor has determined that the fund's asset base is getting too large to effectively execute its investing style. Exchange Transfer Funds (ETF) A security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange. ETFs experience price changes throughout the day as they are bought and sold. An ETF holds assets such as stocks or bonds and trades at approximately the same price as the net asset value of its underlying assets over the course of the trading day. Most ETFs track an index, such as the S&P 500 or MSCI EAFE. ETFs may be attractive as investments because of their low costs, tax efficiency, and stock-like features. Only so-called authorized participants (typically, large institutional investors) actually buy or sell shares of an ETF directly from/to the fund manager, and then only in creation units, large blocks of tens of thousands of ETF shares, which are usually exchanged in-kind with baskets of the underlying securities. Authorized participants may wish to invest in the ETF shares long-term, but usually act as market makers on the open market, using their ability to exchange creation units with their underlying securities to provide liquidity of the ETF shares and help ensure that their intraday market price approximates to the net asset value of the underlying assets. Cash Drag Defined for index funds as the cost of holding cash to deal with potential daily net redemptions. New Fund Offering A security offering in which investors may purchase units of a closed-end mutual fund. A new fund offer occurs when a mutual fund is launched, allowing the firm to raise capital for purchasing securities. Asset Location Asset location is a tax minimization strategy that takes advantage of the fact that different types of investments get different tax treatments. Using this strategy, an investor determines which securities should be held in tax-deferred accounts and which securities should be held in taxable accounts in order to maximize after-tax returns.

Hedge Making an investment to reduce the risk of adverse price movements in an asset. Normally, a hedge consists of taking an offsetting position in a related security, such as a futures contract. Hedge funds Invest in traditional asset classes Absolute-returns strategies? Extensive use of derivatives to structure payoffs Not open to all investors Derivatives A security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterized by high leverage. Strike Price The price at which a specific derivative contract can be exercised. Strike prices are mostly used to describe stock and index options, in which strike prices are fixed in the contract. For call options, the strike price is where the security can be bought (up to the expiration date), while for put options the strike price is the price at which shares can be sold. The difference between the underlying security's current market price and the option's strike price represents the amount of profit per share gained upon the exercise or the sale of the option. This is true for options that are in the money; the maximum amount that can be lost is the premium paid. Short Sell The selling of a security that the seller does not own, or any sale that is completed by the delivery of a security borrowed by the seller. Short sellers assume that they will be able to buy the stock at a lower amount than the price at which they sold short. Forward Contract A cash market transaction in which delivery of the commodity is deferred until after the contract has been made. Although the delivery is made in the future, the price is determined on the initial trade date. Futures/ Future Contract A contractual agreement, generally made on the trading floor of a futures exchange, to buy or sell a particular commodity or financial instrument at a pre-determined price in the future. Futures contracts detail the quality and quantity of the underlying asset; they are standardized to facilitate trading on a futures exchange. Some futures contracts may call for physical delivery of the asset, while others are settled in cash. Options

A financial derivative that represents a contract sold by one party (option writer) to another party (option holder). The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price (the strike price) during a certain period of time or on a specific date (exercise date). Call options give the option to buy at certain price, so the buyer would want the stock to go up. Put options give the option to sell at a certain price, so the buyer would want the stock to go down. The primary difference between options and futures is that options give the holder the right to buy or sell the underlying asset at expiration, while the holder of a futures contract is obligated to fulfil the terms of his/her contract. Call An option contract giving the owner the right (but not the obligation) to buy a specified amount of an underlying security at a specified price within a specified time. PUT An option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying asset at a set price within a specified time. The buyer of a put option estimates that the underlying asset will drop below the exercise price before the expiration date. Example When an individual purchases a put, they expect the underlying asset will decline in price. They would then profit by either selling the put options at a profit, or by exercising the option. If an individual writes a put contract, they are estimating the stock will not decline below the exercise price, and will not fall significantly below the exercise price. Consider if an investor purchased one put option contract for 100 shares of ABC Co. for $1, or $100 ($1*100). The exercise price of the shares is $10 and the current ABC share price is $12. This contract has given the investor the right, but not the obligation, to sell shares of ABC at $10. If ABC shares drop to $8, the investor's put option is in-the-money and he can close his option position by selling his contract on the open market. On the other hand, he can purchase 100 shares of ABC at the existing market price of $8, and then exercise his contract to sell the shares for $10. Excluding commissions, his total profit for this position would be $100 [100*($10 - $8 - $1)]. If the investor already owned 100 shares of ABC, this is called a "married put" position and serves as a hedge against a decline in share price. Novation The exchange of new debts or obligations for older existing ones. Sharpe Ratio The Sharpe ratio is a single number which represents both the risk, and return inherent in a fund. As is widely accepted, high returns are generally associated with a high degree of volatility. The Sharpe

ratio represents the trade off between risk and returns. At the same time, it also factors in the desire to generate returns, which are higher than risk-free returns. Mathematically, the Sharpe ratio is the returns generated over the risk-free rate, per unit of risk. Risk in this case is taken to be the fund's standard deviation. A higher Sharpe ratio is therefore better as it represents a higher return generated per unit of risk. However, while looking at Sharpe ratio, please keep in mind that it being only a ratio, is a pure number. In isolation it has no meaning. It can only be used as a comparative tool. Thus the Sharpe ratio should be used to compare the performance of a number of funds. Alternatively, one can compare the Sharpe ratio of a fund with that of its benchmark index. If the only information available is that the Sharpe ratio of a fund is 1.2, no meaningful inference can be drawn as nothing is known about the peer group performance. Secondly, it may be misleading at times. For example, a low standard deviation can unduly influence results. A fund with low returns but with a relatively mild standard deviation can end up with a high Sharpe ratio. Such a fund will have a very tranquil portfolio and not generate high returns. Information Ratio A ratio of portfolio returns above the returns of a benchmark (usually an index) to the volatility of those returns. The information ratio (IR) measures a portfolio manager's ability to generate excess returns relative to a benchmark, but also attempts to identify the consistency of the investor. This ratio will identify if a manager has beaten the benchmark by a lot in a few months or a little every month. The higher the IR the more consistent a manager is and consistency is an ideal trait.

A high IR can be achieved by having a high return in the portfolio, a low return of the index and a low tracking error. For example: Manager A might have returns of 13% and a tracking error of 8% Manager B has returns of 8% and tracking error of 4.5% The index has returns of -1.5% Manager A's IR = [13-(-1.5)]/8 = 1.81 Manager B's IR = [8-(-1.5)]/4.5 = 2.11 Manager B had lower returns but a better IR. A high ratio means a manager can achieve higher returns more efficiently than one with a low ratio by taking on additional risk. Additional risk could be achieved through leveraging. Enhanced Indexing An investment philosophy that attempts to amplify the returns of an underlying portfolio or index fund while also minimizing the effects of tracking error. This type of investing is considered a hybrid between active and passive management and is used to describe any strategy that is used in conjunction with index funds for the purpose of outperforming a specific benchmark.

For example, an investor can short sell poor performing stocks from an index and then use the funds to purchase shares of companies they expect will have high returns. Investors can substantially outperform a benchmark over long time horizons by consistently eliminating their exposure to poor performing stocks and by using the proceeds to invest in other securities.