Term of the day

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DEFINITION of 'Cockroach Theory'
A market theory that suggests that when a company reveals bad news to the public, there may be many more related negative events that have yet to be revealed. The term comes from the common belief that seeing one cockroach is usually evidence that there are many more that remain hidden.

INVESTOPEDIA EXPLAINS 'Cockroach Theory'
For example, in February 2007, subprime lender New Century Financial Corporation faced liquidity concerns as losses arising from bad loans to defaulting subprime borrowers started to emerge. This company was the first of many other subprime lenders that faced financial problems, contributing to the subprime mortgage meltdown.

In other words, the fact that one subprime lender (one cockroach) faced financial problems indicated that many other similar businesses were likely to face the same issues.

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DEFINITION of 'Herd Instinct'
A mentality characterized by a lack of individual decision-making or thoughtfulness, causing people to think and act in the same way as the majority of those around them. In finance, a herd instinct would relate to instances in which individuals gravitate to the same or similar investments, based almost solely on the fact that many others are investing in those stocks. The fear of regret of missing out on a good investment is often a driving force behind herd instinct.

INVESTOPEDIA EXPLAINS 'Herd Instinct'
Also known as herding, such investor behavior can often cause large, unsubstantiated rallies or sell-offs, based on seemingly little fundamental evidence to justify either. Herd instinct is the primary cause of bubbles in finance. For example, many look at the dotcom bubble of the late 1990s and early 2000s as a prime example of the ramifications of herd instinct in the development and subsequent pop of that industry's bubble.

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Chief Operating Officer - COO
The senior manager who is responsible for managing the company's day-to-day operations and reporting them to the chief executive officer (CEO).

Investopedia Explains:
A company needs a chief operating officer (COO) because the CEO is usually too busy to monitor production quotas and other factors on a daily basis.

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DEFINITION of 'Zombies'
Companies that continue to operate even though they are insolvent or near bankruptcy. Zombies often become casualties to the high costs associated with certain operations, such as research and development. Most analysts expect zombie companies to be unable to meet their financial obligations.

Also known as the "living dead" or "zombie stocks".

INVESTOPEDIA EXPLAINS 'Zombies'
Because a zombie's life expectancy tends to be highly unpredictable, zombie stocks are extremely risky and are not suitable for all investors. For example, a small biotech firm may stretch its funds extremely thin by concentrating its efforts in research and development in the hope of creating a blockbuster drug. If the drug fails, the company can go bankrupt within days of the announcement. On the other hand, if the drug is successful, the company could profit and reduce its liabilities. In most cases, however, zombie stocks are unable to overcome the financial burdens of their high burn rates and most eventually go bankrupt.

Given the lack of attention paid to this group, there can often be interesting opportunities for investors who have a high risk tolerance and are seeking speculative opportunities.

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DEFINITION of 'Stalking-Horse Bid'
An initial bid on a bankrupt company's assets from an interested buyer chosen by the bankrupt company. From a pool of bidders, the bankrupt company chooses the stalking horse to make the first bid.

INVESTOPEDIA EXPLAINS 'Stalking-Horse Bid'
This method allows the distressed company to avoid low bids on its assets. Once the stalking horse has made its bid, other potential buyers may submit competing bids for the bankrupt company's assets. In essence, the stalking horse sets the bar so that other bidders can't low-ball the purchase price.

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DEFINITION of 'Triple Witching'
An event that occurs when the contracts for stock index futures, stock index options and stock options all expire on the same day. Triple witching days happen four times a year on the third Friday of March, June, September and December.

This phenomenon is sometimes referred to as "freaky Friday".

INVESTOPEDIA EXPLAINS 'Triple Witching'
The final trading hour for that Friday is the hour known as triple witching. The markets are quite volatile in this final hour, as traders quickly offset their option/futures orders before the closing bell. If you are a long-term investor, triple witching will have a minimal impact on you.

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DEFINITION of 'Short-Term Investments'
An account in the current assets section of a company's balance sheet. This account contains any investments that a company has made that will expire within one year. For the most part, these accounts contain stocks and bonds that can be liquidated fairly quickly.

INVESTOPEDIA EXPLAINS 'Short-Term Investments'
Most companies in a strong cash position have a short-term investments account on the balance sheet. This means that a company can afford to invest excess cash in stocks and bonds to earn higher interest than what would be earned from a normal savings account.

Microsoft, which is always in a strong cash position, had short-term investments totaling approximately $32 billion at the end of 2005.

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DEFINITION of 'High-Yield Bond'
A high paying bond with a lower credit rating than investment-grade corporate bonds, Treasury bonds and municipal bonds. Because of the higher risk of default, these bonds pay a higher yield than investment grade bonds.

Based on the two main credit rating agencies, high-yield bonds carry a rating below 'BBB' from S&P, and below 'Baa' from Moody's. Bonds with ratings at or above these levels are considered investment grade. Credit ratings can be as low as 'D' (currently in default), and most bonds with 'C' ratings or lower carry a high risk of default; to compensate for this risk, yields will typically be very high.

Also known as "junk bonds".

INVESTOPEDIA EXPLAINS 'High-Yield Bond'
All "junk" connotations aside, high-yield bonds are widely held by investors worldwide, although most participate through the use of mutual funds or exchange-traded funds. The yield spread between investment grade and high-yield will fluctuate over time, depending on the state of the economy, as well as company and sector-specific events.

Generally, investors in high-yield bonds can expect at least 150 to 300 basis points greater yield compared to investment-grade bonds at any given time. Mutual funds provide a good way to gain exposure without the undue risk of investing in just one issuer's junk bonds.

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DEFINITION of 'Glide Path'
Refers to a formula that defines the asset allocation mix of a target date fund, based on the number of years to the target date. The glide path creates an asset allocation that becomes more conservative (i.e., includes more fixed-income assets and fewer equities) the closer a fund gets to the target date.

INVESTOPEDIA EXPLAINS 'Glide Path'
Target date funds have become very popular among those who are saving for retirement. They are based on the simple premise that the younger the investor, the longer the time horizon he or she has and the greater the risk he or she can take to potentially increase returns. A young investor's portfolio, for example, should contain mostly equities. In contrast, an older investor would hold a more conservative portfolio, with fewer equities and more fixed-income investments.

Each family of target date funds will have a different glide path, which determines how the asset mix changes as the target date approaches. Some have a very steep trajectory, becoming dramatically more conservative just a few years before the target date. Others will take a more gradual approach.

The asset mix at the target date can be quite different as well. Some target date funds assume that the investor will want a high degree of safety and liquidity, because he or she might use the funds to purchase an annuity. Other target date funds assume that the investor will hold onto the funds, and will therefore include more equities in the asset mix, reflecting a longer time horizon.

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DEFINITION of 'Exchange-Traded Mutual Funds (ETMF)'
An ETMF, or exchange-traded mutual fund, is an exchange-traded security that is a hybrid between an exchange-traded fund (ETF) and an actively managed open-ended mutual fund. It allows a standard net asset value (NAV)-based mutual fund to trade in real-time on a stock exchange, similar to the trading of a stock or ETF.

ETMF intraday trading prices will be directly linked to the fund’s next end-of-day NAV. All bids, offers, and trade prices will be quoted in terms of premium or discount to the end-of-day NAV (like NAV+$0.02, or NAV-$0.05). For each trade, the premium or discount to NAV is locked-in at trade execution time, and the final transaction price is determined once NAV is calculated at the end of the day.

INVESTOPEDIA EXPLAINS 'Exchange-Traded Mutual Funds (ETMF)'
Essentially, an ETMF is a mutual fund available in the guise of an ETF.

ETMFs offer the benefits of both mutual funds and ETFs. They combine the advantages of investment strategies of an actively managed mutual fund and the performance and tax efficiencies of an ETF.

ETMFs differ from a traditional ETF, as they are not required to disclose their portfolio holdings on a daily basis, enabling them to protect confidential portfolio trading details. ETMFs differ from a traditional mutual fund as they trade in real time using NAV-based trading.

ETMFs will utilize “in-kind” transfers of portfolio securities in redeeming and issuing fund units, thereby saving on transaction costs.

ETMFs will give intraday and short-term traders arbitrage and speculation opportunities on mutual funds, and capital gains and dividend income to long-term investors.

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DEFINITION of 'Ordinary Shares'
Any shares that are not preferred shares and do not have any predetermined dividend amounts. An ordinary share represents equity ownership in a company and entitles the owner to a vote in matters put before shareholders in proportion to their percentage ownership in the company.

Ordinary shareholders are entitled to receive dividends if any are available after dividends on preferred shares are paid. They are also entitled to their share of the residual economic value of the company should the business unwind; however, they are last in line after bondholders and preferred shareholders for receiving business proceeds. As such, ordinary shareholders are considered unsecured creditors.

Also known as "common stock".

INVESTOPEDIA EXPLAINS 'Ordinary Shares'
Ordinary shares include those traded privately as well as shares that trade on the various public stock exchanges. Ordinary shares have a stated "par value", but this value is more of a technicality, and will rarely be more than a few pennies per share. The true value of an ordinary share is based on the price obtained through market forces, the value of the underlying business and investor sentiment toward the company.

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DEFINITION of 'Modified Internal Rate Of Return - MIRR'
While the internal rate of return (IRR) assumes the cash flows from a project are reinvested at the IRR, the modified IRR assumes that positive cash flows are reinvested at the firm's cost of capital, and the initial outlays are financed at the firm's financing cost. Therefore, MIRR more accurately reflects the cost and profitability of a project.

The formula for MIRR is:



INVESTOPEDIA EXPLAINS 'MODIFIED INTERNAL RATE OF RETURN - MIRR'
For example, say a two-year project with an initial outlay of $195 and a cost of capital of 12%, will return $121 in the first year and $131 in the second year. To find the IRR of the project so that the net present value (NPV) = 0:

NPV = 0 = -195 + 121/(1+ IRR) + 131/(1 + IRR)2 NPV = 0 when IRR = 18.66%

To calculate the MIRR of the project, we have to assume that the positive cash flows will be reinvested at the 12% cost of capital. So the future value of the positive cash flows is computed as:



$121(1.12) + $131 = $266.52 = Future Value of positive cash flows at t = 2



Now you divide the future value of the cash flows by the present value of the initial outlay, which was $195, and find the geometric return for 2 periods.



=sqrt($266.52/195) -1 = 16.91% MIRR



You can see here that the 16.91% MIRR is materially lower than the IRR of 18.66%. In this case, the IRR gives a too optimistic picture of the potential of the project, while the MIRR gives a more realistic evaluation of the project.

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DEFINITION of 'Delta-Gamma Hedging'
An options hedging strategy that combines a delta hedge and a gamma hedge. A delta-gamma hedge is designed to reduce or eliminate the risk created by changes in the underlying asset’s price, as well as variances in how much the price changes.

INVESTOPEDIA EXPLAINS 'Delta-Gamma Hedging'
In options, delta refers to a change in the price of an underlying asset, while gamma refers to the rate of change of delta. They are used to gauge movement in an option’s price relative to how into or out of the money the option is. Investors use a gamma hedge to protect themselves from the remaining exposure created through the use of a delta hedge, which is generated because delta hedges are more effective when the underlying asset has a single price.

A delta-gamma hedge requires the purchase of shares and a call option, while selling a call option at another strike price. The goal of the hedge is to eliminate both gamma and delta for the shares. The delta option component involves selling options to produce a negative delta.

Using a gamma hedge in conjunction with a delta hedge requires an investor to create new hedges when the underlying asset’s delta changes. The number of shares that are bought or sold under a delta-gamma hedge depends on whether the underlying asset price is increasing or decreasing, and by how much.

Because the investor is more actively purchasing the underlying shares, a portfolio using a gamma hedge will be slightly more volatile because of a higher exposure to equities.

Large hedges that involve buying or selling significant quantities of shares and options may have the effect of changing the price of the underlying on the market, requiring the investor to constantly and dynamically create hedges for a portfolio to take into account greater fluctuations in prices.

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International Monetary Fund - IMF
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DEFINITION OF 'INTERNATIONAL MONETARY FUND - IMF'
An international organization created for the purpose of:

1. Promoting global monetary and exchange stability.

2. Facilitating the expansion and balanced growth of international trade.

3. Assisting in the establishment of a multilateral system of payments for current transactions.

INVESTOPEDIA EXPLAINS 'INTERNATIONAL MONETARY FUND - IMF'
The IMF plays three major roles in the global monetary system. The Fund surveys and monitors economic and financial developments, lends funds to countries with balance-of-payment difficulties, and provides technical assistance and training for countries requesting it.

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Risk-Return Tradeoff
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DEFINITION OF 'RISK-RETURN TRADEOFF'
The principle that potential return rises with an increase in risk. Low levels of uncertainty (low-risk) are associated with low potential returns, whereas high levels of uncertainty (high-risk) are associated with high potential returns. According to the risk-return tradeoff, invested money can render higher profits only if it is subject to the possibility of being lost.

INVESTOPEDIA EXPLAINS 'RISK-RETURN TRADEOFF'
Because of the risk-return tradeoff, you must be aware of your personal risk tolerance when choosing investments for your portfolio. Taking on some risk is the price of achieving returns; therefore, if you want to make money, you can't cut out all risk. The goal instead is to find an appropriate balance - one that generates some profit, but still allows you to sleep at night.

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DEFINITION of 'Quantitative Easing'
An unconventional monetary policy in which a central bank purchases government securities or other securities from the market in order to lower interest rates and increase the money supply. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity. Quantitative easing is considered when short-term interest rates are at or approaching zero, and does not involve the printing of new banknotes.

INVESTOPEDIA EXPLAINS 'Quantitative Easing'
Typically, central banks target the supply of money by buying or selling government bonds. When the bank seeks to promote economic growth, it buys government bonds, which lowers short-term interest rates and increases the money supply. This strategy loses effectiveness when interest rates approach zero, forcing banks to try other strategies in order to stimulate the economy. QE targets commercial bank and private sector assets instead, and attempts to spur economic growth by encouraging banks to lend money. However, if the money supply increases too quickly, quantitative easing can lead to higher rates of inflation. This is due to the fact that there is still a fixed amount of goods for sale when more money is now available in the economy. Additionally, banks may decide to keep funds generated by quantitative easing in reserve rather than lending those funds to individuals and businesses.

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DEFINITION of 'European Central Bank - ECB'
The central bank responsible for the monetary system of the European Union (EU) and the euro currency. The bank was formed in Germany in June 1998 and works with the other national banks of each of the EU members to formulate monetary policy that helps maintain price stability in the European Union.

INVESTOPEDIA EXPLAINS 'European Central Bank - ECB'
The European Central Bank has been responsible for the monetary policy of the European Union since January 1, 1999, when the euro currency was adopted by the EU members. The responsibilities of the ECB are to formulate monetary policy, conduct foreign exchange, hold currency reserves and authorize the issuance of bank notes, among many other things.

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DEFINITION of 'Bund'
A bond issued by Germany's federal government, or the German word for "bond." Bunds are the German equivalent of U.S. Treasury bonds. The German government uses bunds to finance its spending. Long-term bonds are the most widely issued, with billions of euros' worth outstanding, and these come in 10- and 30-year durations.


INVESTOPEDIA EXPLAINS 'Bund'
Similar to U.S. Treasuries, bunds are auctioned off in the primary market and traded in the secondary market. They can be stripped, meaning their coupon payments can be separated from their principal repayments and traded individually. Bunds pay interest and principal three times a year.

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DEFINITION of 'Grexit'
Grexit, an abbreviation for "Greek exit," refers to Greece's potential withdrawal from the eurozone, after which it would most likely revert to using the drachma, its currency until 2001.

INVESTOPEDIA EXPLAINS 'Grexit'
Following the global financial crisis of 2008-2009 Greece suffered a series of recessions, and the country's debt-to-GDP ratio rose to nearly 150% in 2010. Greek government bonds were downgraded to junk status, and the risk of a government default became untenable for other members of the currency union. Eurozone countries, European Central Bank and the IMF offered a Euro 110 billion bailout in May 2010, which was later expanded to Euro 240 billion. In exchange, Greek officials promised to pursue aggressive austerity measures and structural reforms. The trio has earned the disparaging nickname the "troika" for what many Greeks perceive as callous treatment of ordinary citizens through its insistence on austerity.

In November 2011, violent protests over austerity led Prime Minister George Papandreou to resign. An early election was held in 2012, but no government was formed for months as protests continued. Around this time, analysts coined the phrase Grexit to capture investors' worries that Greece would default on its debt and withdraw from the eurozone.

In January 2015, the left-wing Syriza party won snap elections on an anti-austerity, anti-troika platform that has renewed worries of a Grexit. Prime Minsiter Alexis Tsipras and Fincance Minister Yanis Varoufakis have not presented a reform package that Greece's lenders find satisfactory; the latter have suspended bailout payments, which may render Greece unable to make its next loan repayment to the IMF. According to German Chancellor Angela Merkel, with whom Greek officials have clashed repeatedly, changes have been made to the currency union since 2012, so that the prospect of a Greek exit does not endanger the single currency as a whole.

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DEFINITION of 'Treasury Yield'
The return on investment, expressed as a percentage, on the U.S. government’s debt obligations (bonds, notes and bills). Looked at another way, the Treasury yield is the interest rate the U.S. government pays to borrow money for different lengths of time. Treasury yields don’t just influence how much the government pays to borrow and how much investors earn by investing in this debt, however; they also influence the interest rates individuals and businesses pay to borrow money to buy real estate, vehicles and equipment. Treasury yields also tell us how investors feel about the economy. The higher the yields on 10-, 20- and 30-year Treasuries, the better the economic outlook.

INVESTOPEDIA EXPLAINS 'Treasury Yield'
Treasuries are considered to be a low-risk investment because they are backed by the full faith and credit of the U.S. government, which includes the government's authority to raise taxes to cover its obligations. Because of their low risk, Treasuries have a low return compared to many other investments. Especially low Treasury yields like the ones seen from 2009 through 2013 can drive investors into riskier investments, such as stocks, where they can earn a higher return.

The different types of U.S. Treasuries include Treasury notes, Treasury bills and Treasury bonds, which come in different maturities up to 30 years. There are one-month, three-month, six-month, one-year, two-year, three-year, five-year, seven-year, 10-year, 20-year and 30-year securities. Each has a different yield, and the U.S. Treasury publishes the yields for all of these securities daily on its website. Under normal circumstances, longer-term Treasury securities have a higher yield than shorter-term Treasury securities. For example, the yield on a one-month security might be 0.06%, while the yield on a three-year security is 0.79% and the yield on a 30-year security is 3.70%.

Treasury yields can go up if the Federal Reserve increases its target for the federal funds rate (in other words, if it tightens monetary policy), or even if investors merely expect the fed funds rate to go up. When demand for Treasury bonds decreases, Treasury yields increase; when demand increases; Treasury yields decrease.