The INVESTOPEDIA Guide to Wall Speak

The terms you need to know to talk like Cramer, think like Soros, and buy like Buffet

The McGraw-Hill Companies, Inc.

Copyright © 2009 Investopedia
All right reserved.
ISBN: 978-0-07-162498-5

Chapter One

A

ABSOLUTE RETURN

What Does Absolute Return Mean?

The return that an asset achieves over a certain period of time; it considers appreciation or depreciation (expressed as a percentage) of the asset, which is usually a stock or a mutual fund. Absolute return differs from relative return because it looks only at an asset’s return; it does not compare returns to any other measure or benchmark.

Investopedia explains Absolute Return

Generally, mutual funds seek returns that are better than those of their peers, their fund category, and/or the market as a whole. This type of fund management is referred to as a relative return approach to fund investing. Absolute return funds seek positive returns by employing investment strategies that often are not permitted in traditional mutual funds, such as short selling, futures, options, derivatives, arbitrage, leverage, and unconventional assets. Alfred Winslow Jones is credited with forming the first absolute return fund in New York in 1949. Today, the absolute return approach to fund investing has become one of the fastest growing investment products in the world; it’s called a hedge fund.

Related Terms:

• Mutual Fund

• Return on Assets

• Return on Investment

• Total Return

• Yield

ACCOUNTS PAYABLE (AP)

What Does Accounts Payable (AP) Mean?

An accounting entry that represents an entity’s obligation to pay off a short- term debt to its creditors; it is found on the balance sheet under current liabilities. Accounts payable often are referred to as “payables.” AP also may refer to a business department or division that is responsible for making payments owed by the company to suppliers and other creditors.

Investopedia explains Accounts Payable (AP)

Accounts payable debts must be paid off within a specific period to avoid default. For example, at the corporate level, AP refers to short-term debt payments to suppliers and banks. However, APs are not limited to corporations. People also have APs owed to creditors. For example, the phone company, the gas company, and the cable company are types of creditors. Each creditor provides a service and then bills the customer after the fact. The payable is essentially a short-term IOU obligation of the customer. If people or companies do not pay their bills, they are considered to be in default.

Related Terms:

• Accounts Receivable

• Balance Sheet

• Current Liabilities

• Liability

• Receivables Turnover Ratio

ACCOUNTS PAYABLE TURNOVER RATIO

What Does Accounts Payable Turnover Ratio Mean?

A short-term liquidity measure used to quantify the rate at which a company pays off its accounts payable to suppliers. The accounts payable turnover ratio is calculated by taking the total purchases made from suppliers and dividing it by the average accounts payable amount during the same period.

Investopedia explains Accounts Payable Turnover Ratio

The measure reveals how many times per period a company pays its average payable amount. For example, if the company makes $100 million in purchases from suppliers in a year and at any specific point holds an average accounts payable of $20 million, the accounts payable turnover ratio for the period is 5 ($100 million/$20 million). A falling turnover ratio is a sign that the company is taking longer to pay off its suppliers, which could be a bad sign. A rising turnover ratio means that the company is paying off suppliers at a faster rate, which is good.

Related Terms:

• Accounts Payable—AP

• Accounts Receivable—AR

• Current Ratio

• Liquidity

• Receivables Turnover Ratio

ACCOUNTS RECEIVABLE (AR)

What Does Accounts Receivable (AR) Mean?

Money owed by customers (individuals or corporations) to vendors in exchange for goods or services rendered. Receivables usually come in the form of operating lines of credit and are usually due within a relatively short period, ranging from a few days to a year. On a balance sheet, AR often is recorded as an asset because it represents cash legally owed by a customer.

Investopedia explains Accounts Receivable (AR)

When a company has receivables, that means that it has made a sale but has not collected the money from the purchaser yet. Most companies operate this way. This allows frequent customers to avoid the hassle of making cash payments for each transaction. In other words, the company receives an IOU for goods or services rendered. People have ARs as well in the form of a monthly or biweekly paycheck. It’s the company’s IOU for services (work) rendered. ARs are the opposite of APs (accounts payables).

Related Terms:

• Accounts Payable—AP

• Accrual Accounting

• Asset

• Balance Sheet

• Receivables Turnover Ratio

ACCRUAL ACCOUNTING

What Does Accrual Accounting Mean?

An accounting method that measures the performance and status of a company regardless of when cash transactions occur; financial transactions and events are recognized by matching revenues to expenses (the matching principle) at the time when the transaction occurs rather than when payment actually is made (or received). This allows current cash inflows and outflows to be combined with expected future cash inflows and outflows to provide a more accurate picture of a company’s current financial condition. Accrual accounting is the standard accounting practice for most big companies; however, its relative complexity makes it more expensive to implement for small companies. This is the opposite of cash accounting, which recognizes transactions only when there is an exchange of cash.

Investopedia explains Accrual Accounting

The need for this method arose because of the complexity of business transactions and the need for more accurate financial information. Selling on credit and projects that provide future revenue streams affect a company’s financial condition when they occur. Therefore, it makes sense to reflect those events during the same reporting period in which the transactions occur. For example, when a company sells a television to a customer on credit, the cash and accrual methods view this transaction differently. The cash method does not recognize the sale until actual cash is received, which could be a month or longer. Accrual accounting, in contrast, recognizes that the company will receive the cash at some point in the future. Therefore, even though the cash has not been collected yet, the sale is booked to “accounts receivable” and thus sales revenue.

Related Terms:

• Accounts Receivable

• Accrued Expense

• Accrued Interest

• Cost of Goods Sold—COGS

• Income Statement

ACCRUED EXPENSE

What Does Accrued Expense Mean?

An accounting expense (current liability) recognized on the company’s books before it actually is paid for. Such expenses are typically periodic and are recorded on a company’s balance sheet because of the high probability that they ultimately will be collected.

Investopedia explains Accrued Expense

Accrued expenses are the opposite of prepaid expenses. Typical company accrued expenses include wages, interest, and taxes. Even though they will be paid on a future date, they are recorded on the balance sheet until the moment they are paid. An example would be interest that accrues on a simple bank loan.

Related Terms:

• Accrual Accounting

• Accrued Interest

• Balance Sheet

• Gross Income

• Liability

ACCRUED INTEREST

What Does Accrued Interest Mean?

(1) A term used to describe an accrual accounting method when interest from a payable or a receivable has been recognized but not yet paid or received. Accrued interest occurs as a result of the difference in the timing of cash flows and the measurement of those cash flows. (2) The interest that has accumulated on a bond since the last interest payment up to but not including the settlement date.

Investopedia explains Accrued Interest

(1) An accrued interest receivable occurs when interest on an outstanding receivable has been earned by the company but has not been received yet. A loan to a customer for goods sold would result in interest being charged on the loan. If the loan is extended on October 1 and the lending company’s year ends on December 31, there will be two months of accrued interest receivable recorded as interest revenue in the company’s financial statements for the year.

(2) Accrued interest is added to the contract price of a bond transaction, reflecting interest earned since the last coupon payment. Because the bond has not matured or the next payment is not yet due, the owner of the bond has not received the money officially. Therefore, when the bond is sold, the accrued interest is added to the sale price.

Related Terms:

• Accrual Accounting

• Accrued Expense

• Coupon

• Interest Rate

• Settlement Date

ACID-TEST RATIO

What Does Acid-Test Ratio Mean?

A stringent test to determine whether a firm has enough short-term assets to cover its immediate liabilities without selling inventory; the acid-test ratio is far more strenuous than the working capital ratio because the working capital ratio allows for the inclusion of inventory assets. The acid-test ratio is calculated as follows:

= (Cash + Accounts Receivable + Short-term Investments)/Current Liabilities

Investopedia explains Acid-Test Ratio

Companies with ratios <1 cannot pay their current liabilities and therefore should be viewed with extreme caution. If the acid-test ratio is much lower than the working capital ratio, this means current assets are highly dependent on inventory. Retail stores are examples of this type of business. The term is said to have come from the method gold miners used to verify that a gold nugget was real. Unlike other metals, gold does not corrode in acid; if a nugget did not dissolve when submerged in acid, it was the real thing and was said to have passed the acid test. Today, if a company’s financial statements pass the figurative acid test, this indicates the company’s financial integrity.

Related Terms:

• Current Assets

• Current Liabilities

• Current Ratio

• Liability

• Working Capital

ALPHA

What Does Alpha Mean?

(1) A measure of performance on a riskadjusted basis. Alpha takes the volatility (price risk) of a mutual fund and compares its riskadjusted performance with a benchmark index. The excess return of the fund relative to the return of the benchmark index is a fund’s alpha. (2) The abnormal rate of return on a security or portfolio in excess of what would be predicted by an equilibrium model such as the capital asset pricing model (CAPM).

Investopedia explains Alpha

(1) Alpha is one of five technical risk measures that are used in modern portfolio theory (MPT); the others are beta, standard deviation, R-squared, and the Sharpe ratio. These indicators help investors determine the risk-reward profile of a mutual fund. Simply stated, alpha often is considered to represent the value that a portfolio manager adds to or subtracts from a fund’s return. A positive alpha of 1.0 means the fund has outperformed its benchmark index by 1%. Conversely, a similar negative alpha would indicate an underperformance of 1%. (2) If a CAPM analysis estimates that a portfolio should earn 10% on the basis of the risk of that portfolio yet the portfolio actually earns 15%, the portfolio’s alpha would be 5%. The 5% is the excess return above the predicted CAPM return.

Related Terms:

• Beta

• Capital Asset Pricing Model—CAPM

• R-Squared

• Sharpe Ratio

• Standard Deviation

AMERICAN DEPOSITARY RECEIPT (ADR)

What Does American Depositary Receipt (ADR) Mean?

A negotiable certificate issued by a U.S. bank representing a specified number of shares in a foreign stock that is traded on a U.S. exchange. ADRs are denominated in U.S. dollars, with the underlying security held by a U.S. financial institution overseas. ADRs help reduce administrative and duty costs that otherwise would be levied on each transaction.

Investopedia explains American Depositary Receipt (ADR)

ADRs are an excellent way to buy shares in a foreign company and realize any dividends and capital gains in U.S. dollars. However, ADRs do not eliminate the currency and economic risks for the underlying shares in another country. For example, dividend payments in a foreign currency would be converted to U.S. dollars, net of any conversion expenses and foreign taxes. ADRs are listed on the NYSE, AMEX, or Nasdaq.

Related Terms:

• Derivative

• Global Depositary Receipt—GDR

• MSCI—Emerging Markets Index

• Security

• Spiders—SPDRs

AMERICAN STOCK EXCHANGE (AMEX)

What Does American Stock Exchange (AMEX) Mean?

The third-largest stock exchange by trading volume in the United States. The AMEX is located in New York City and handles about 10% of all securities traded in the United States.

Investopedia explains American Stock Exchange (AMEX)

The AMEX has merged with the Nasdaq. It was known as the “curb exchange” until 1921. It used to be a strong competitor of the New York Stock Exchange, but that role has been filled by the Nasdaq. Today, almost all trading on the AMEX is in small-cap stocks, exchange-traded funds, and derivatives.

Related Terms:

• Dow Jones Industrial Average

• Index

• Nasdaq

• New York Stock Exchange—NYSE

• Stock Market

AMORTIZATION

What Does Amortization Mean?

(1) The paying off of debt in regular installments over a period of time. (2)The deduction of capital expenses over a specific period (usually over the asset’s life). More specifically, a method measuring the consumption of the value of intangible assets, such as a patent or a copyright.

Investopedia explains Amortization

If XYZ Biotech spent $30 million on a piece of medical equipment with a patent lasting 15 years, the company would record $2 million each year in amortization expense. Although amortization and depreciation often are used interchangeably, technically this is incorrect because amortization refers to intangible assets, whereas depreciation refers to tangible assets.

Related Terms:

• Asset

• Depreciation

• Earnings before Interest, Taxes, Depreciation, and Amortization—EBITDA

• Intangible Asset

• Tangible Asset

ANNUAL PERCENTAGE YIELD (APY)

What Does Annual Percentage Yield (APY) Mean?

The effective annual rate of return after considering the effect of compounding interest; APY assumes that funds will remain in the investment vehicle for a full 365 days and is calculated as follows:

= (1 + periodic rate)^#Periods – 1

Investopedia explains Annual Percentage Yield (APY)

APY is similar to the annual percentage rate insofar as it standardizes varying interest rate agreements into an annualized percentage number. For example, suppose you are considering whether to invest in a one-year zero-coupon bond that pays 6% at maturity or a high-yield money market account that pays 0.5% per month with monthly compounding. At first glance, the yields appear identical—12 months multiplied by 0.5% equals 6%—but when the effects of compounding are included, it can be seen that the second investment actually yields more: 6.17% (1.005^(12 ? 1) = 0.0617).

Related Terms:

• Certificate of Deposit—CD

• Compound Annual Growth Rate—CAGR

• Compounding

• Money Market Account

• Yield

ANNUITY

What Does Annuity Mean?

A financial product designed to pay out a stream of payments to the holder at a later point in time. Annuities are used primarily as a means of securing a steady cash flow for an individual during his or her retirement years.

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