October 7, 2013
Financial Terms and Roles
• Finance – Is a broad term that describes two related activities: the study of how money is managed and the actual process of acquiring needed funds. Because individuals, businesses and government entities all need funding to operate, the field is often separated into three sub-categories: personal finance, corporate finance and public finance. All three categories are concerned with activities such as pursuing sound investments, obtaining low-cost credit, allocating funds for liabilities, and banking. Yet each has its own specific considerations. For example, individuals need to provision for retirement expenses, which means investing enough money during their working years and ensuring that their asset allocation fits their long-term plans. A large company, on the other hand, may have to decide whether to raise additional funds through a bond issue or stock offering. Investment banks may advise the firm on such considerations and help them market the securities.
• Efficient market- Is one where the market price is an unbiased estimate of the true value of the investment. It is the speed at which investors act and the way that prices respond to the information. In an efficient market, equity research and valuation would be a costly task that provided no benefits. The odds of finding an undervalued stock should be random (50/50). At best, the benefits from information collection and equity research would cover the costs of doing the research. In an efficient market, a strategy of randomly diversifying across stocks or indexing to the market, carrying little or no information cost and minimal execution costs, would be superior to any other strategy that created larger information and execution costs. There would be no value added by portfolio managers and investment strategists. In an efficient market, a strategy of minimizing trading, i.e., creating a portfolio and not trading unless cash was needed would be superior to a strategy that required frequent trading.
• Primary market – Is a market that issues new securities on an exchange. Companies, governments and other groups obtain financing through debt or equity based securities. Primary markets are facilitated by underwriting groups, which consist of investment banks that will set a beginning price range for a given security and then oversee its sale directly to investors. The 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. A primary market is a market in which new, as opposed to previously issued, securities are bought and sold for the first time. In this market, firms issue new securities to raise money that they can then use to help finance their businesses.
• Secondary market – Is a market where investors purchase securities or assets from other investors, rather than from issuing companies themselves. The national exchanges - such as the New York Stock Exchange and the NASDAQ are secondary markets. Secondary markets exist for other securities as well, such as when funds, investment banks, or entities such as Fannie Mae purchase mortgages from issuing lenders. In any secondary market trade, the cash proceeds go to an investor rather than to the underlying company/entity directly. Secondary market is where all subsequent trading of previously issued securities takes place. In this market the issuing firm does not receive any new financing, as the securities it has sold are simply being transferred from one investor to another.
• Risk – Is defined as the chance that an investment's actual return will be different than expected. This includes the possibility of losing some or all of the…